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Arvind Mills: No respite!
Jan 27, 2007

Performance summary
Arvind Mills declared another disappointing set of numbers for the third quarter and nine months ended December 2006. Despite better off-take in garment volumes, lower volume and realisations in denim and shirting businesses have led to a decline in revenues for 3QFY07. Higher staff and power costs ensured that the company was not spared on the cost front either. All these factors put together have continued to drain the bottomline.

Standalone financials
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 3,900 3,600 -7.7% 12,340 11,080 -10.2%
Expenditure 2,890 2,920 1.0% 9,160 8,700 -5.0%
Operating profit (EBDITA) 1,010 680 -32.7% 3,180 2,380 -25.2%
EBDITA margin (%) 25.9% 18.9%   25.8% 21.5%  
Other income 20 10 -50.0% 140 60 -57.1%
Interest 300 380 26.7% 970 1,110 14.4%
Depreciation 390 330 -15.4% 1,170 1,080 -7.7%
Foreign exchange (gain) / loss 10 (60)   (50) 80  
Profit before tax 330 40 -87.9% 1,230 170 -86.2%
Tax 20 -   100 -  
Profit after tax/(loss) 310 40 -87.1% 1,130 170 -85.0%
Net profit margin (%) 7.9% 1.1%   9.2% 1.5%  
No. of shares (m) 209.4 209.4   209.4 209.4  
Diluted earnings per share (Rs)* 5.9 0.8   10.8 1.5  
Price to earnings ratio (x)         39.7  
(* trailing 12 months)            

On the path to vertical integration…
Arvind Mills is India’s largest denim manufacturer and exporter, with a total capacity of 120 mm, after taking into account the recent 10 mm expansion at Santej. The company also ranks among the top three denim producers worldwide. It manufactures and sells textiles and ready to wear garments as well. The total fabric production capacity at 34 mm is big, even by world standards. While the company has been hitherto been focusing on fabric and denim production, it has aggressively entered the garmenting and knits businesses. In a very important step, through a GDR issue, the company has acquired ICICI Venture’s stake in Arvind Brands. After this, the company hopes to grow its readymade branded garments business significantly in the next three years, given that the company is now fully under its control.

What has influenced performance in 3QFY07?
Denim & shirting – Domestic blues: The contribution of the denim business to the company’s topline continued to decline in the quarter under review, from 58% in 3QFY06 to 43% in 3QFY07. The over supply situation in the domestic market continued to persist in this quarter, leading to a drop in overall realisations and significant erosion in prices. As a result, the company continues to suffer setbacks on both volume and realisation fronts and expects this scenario to remain subdued in the near term (for 6 to 8 months at least). In 3QFY07 however, the company witnessed some recovery in export volumes and prices, which unfortunately, were more than offset by the continuing slide in the domestic market. In the said quarter, however, the denim realisations of Rs 93 per metre were a slight improvement for the company from the all-time low of Rs 90 per metre in 2QFY07. The company also estimates that its market share in the domestic market will continue to contract from the levels achieved in the past and a credible alternative for selling the surplus volumes needs to be established.

As far as the shirting segment is concerned, while volumes and realisations have witnessed a decline, the company maintains that the outlook for the shirting business is stable and realisations are not likely to witness any significant downturn in the near term.

Segmental breakup…
  3QFY06 3QFY07 Change
Denim      
Sales (Rs m) 2,216.0 1,943.6 -12.3%
% total turnover 58.0% 43.4%  
Volume (mm) 22.9 20.9 -8.8%
Avg Price (Rs/mt) 97.0 93.2 -3.9%
Shirting      
Sales (Rs m) 810.6 617.8 -23.8%
% total turnover 21.2% 13.8%  
Volume (mm) 6.5 5.1 -20.9%
Avg Price (Rs/mt) 125.4 120.8 -3.7%
Garments      
Sales (Rs m) 489.4 605.5 23.7%
% total turnover 12.8% 13.5%  
Volume (m Pcs) 1.4 1.9 31.2%
Knit Fabric      
Sales (Rs m) 60.9 83.0 36.3%
% total turnover 1.6% 1.9%  
Branded garments      
Sales (Rs m) - 711.4  
% total turnover 0.0% 15.9%  
Volume (m Pcs) - 1.9  
Others      
Sales (Rs m) 245.8 517.4 110.5%
% total turnover 6.4% 11.6%  

The contribution of the garment segment to the topline increased to 14% this quarter (13% in 3QFY06), which was attributed primarily to the addition of the jeans facility in the current year coupled with a 5% YoY and 20% YoY growth respectively in shirts exports and knits.

Costs – Not in control: Although Arvind Mills continues to leverage on the cotton inventory held by it in the wake of rising costs of cotton, costs have risen from Rs 38 per kg in 3QFY06 to Rs 41 per kg in 3QFY07. The current cotton inventory will suffice the company’s requirement till August 2007. The company has not undertaken any major buying of cotton during the current season and is currently in the process of reducing its inventory.

To reduce its power costs, the company had shifted to natural gas as feed for its captive power plant in January 2006. It had entered into a long-term gas supply agreement, with a penalty clause for 80% of the contracted volume. However, owing to severe shortage of supply of gas, Gujarat Gas is offering only 80% of the requirement. In absence of an alternative, the company is consuming the relatively expensive grid power, leading to higher power costs. To stem the attrition at the middle and junior levels, the company has undertaken a salary revision exercise leading to higher staff costs during the quarter.

Cost breakup…
(%) of sales 3QFY06 3QFY07 % change
Raw material cost 1,520 1,080 -28.9%
% sales 39.0% 30.0%  
Power & fuel 320 480 50.0%
% sales 8.2% 13.3%  
Staff cost 310 470 51.6%
% sales 7.9% 13.1%  
Stores 380 470 23.7%
% sales 9.7% 13.1%  
Others 360 420 16.7%
% sales 9.2% 11.7%  

Merger of Arvind Brands Limited: The company has completed the merger of Arvind Brands and its subsidiaries with itself and the merger is effective from April 1, 2006. The business of Arvind Brands comprises of the branded business of Excalibur, Newport, Flying Machine, Ruf N Tuf and Arrow. This business will continue to operate from Bangalore.

Over the past few quarters: During the past couple of quarters, Arvind Mills undertook several initiatives to de-risk its business, control costs and improve margins. This included initiating a garmenting facility in Bangalore, re-acquisition of Arvind Brands from ICICI Venture, cost control measures as mentioned earlier as well as capacity expansion in Santej, Gujarat. However, this has not lent any stability to its operating margins, which continue to shrink.

What to expect?
At the current price of Rs 59, the stock is trading at 39.7 times its trailing 12-month earnings. The company does not expect the revenue and earnings to look up significantly in the next 12 to 15 months, until the downstream investments starts contributing significantly to its earnings. While the continuity of downside in denim cycle and losses on the forex side are unpredictable, we believe that the de-risking strategies will prove to be benign to the company in the longer run. The benefits of capacity expansion will also filter in, in longer term.

In April 2006, we had recommended a ‘BUY’ on the stock with a FY08 target price of Rs 143. The same was inferred based on our estimations of the consolidated EPS numbers, factoring in the numbers projected by the company for Arvind Brands and considering stability in garment realisations and lower power costs. As we have highlighted in our results analysis, the company has failed to deliver on each of these parameters for the past several quarters thus grossly under-performing our estimations. The huge forex losses booked by the company (which we were unable to take call on) have further acted as dampeners to our EPS estimations. Given the fact that the company itself acknowledges to continue to remain in the ‘restructuring phase’ over the next 12- 15 months, and the continued volatility in rupee-dollar rates, there is little visibility in the medium term. We would therefore advise investors who do not wish to hold on to the stock for the longer term to pare their losses.

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