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Grasim: Living upto expectations

Jan 28, 2005

Performance Summary
Grasim, the diversified major of the Aditya Birla Group, has continued to post impressive quarterly numbers. The company announced its 3QFY05 numbers just a short while ago wherein it posted a healthy topline growth. This, coupled with the improvement in margins and aided by a strong growth in other income, has helped the company's bottomline to outpace its topline growth.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net Sales 13,320 15,597 17.1% 36,801 46,049 25.1%
Expenditure 10,131 11,670 15.2% 28,264 33,852 19.8%
Operating Profit (EBDITA) 3,189 3,927 23.1% 8,537 12,197 42.9%
EBITDA margin (%) 23.9% 25.2%   23.2% 26.5%  
Other income 207 379 83.0% 1,372 869 -36.6%
Interest 394 352 -10.7% 1,188 1,048 -11.8%
Depreciation 695 717 3.2% 2,049 2,121 3.5%
Profit before tax 2,307 3,236 40.2% 6,672 9,897 48.3%
Tax 670 1,065 59.0% 1,700 3,335 96.2%
Profit after Tax/(Loss) 1,637 2,171 32.6% 4,972 6,562 32.0%
Net profit margin (%) 12.3% 13.9%   13.5% 14.2%  
No. of Shares (m) 91.7 91.7   91.7 91.7  
Diluted earnings per share* 71.4 94.7   72.3 95.4  
Price to earnings ratio (x)   13.9     13.8  
(* annualised)            

What is the company's business?
Grasim, an Aditya Birla Group company, has presence in various sectors. It has leadership position in four of its five businesses. The company has presence in viscose staple fiber or VSF (33% of sales in FY04), cement (45%), sponge iron (12%), chemicals (6%) and textiles (4%). While the company is a world leader in VSF with a 24% market share, it is also the seventh largest producer of cement in the world with a total capacity of 31 MT (nearly 22% of the country's capacity). It achieved the latter distinction only recently, when it acquired L&T's cement capacity for a net investment of Rs 22 bn.

What has driven performance in 3QFY05?
Cement and sponge iron lead charge: The topline growth of the company during the quarter witnessed a YoY rise of 17%, which could primarily be attributed to the growth witnessed in its cement and sponge iron businesses. It must be noted that while these two segments contribute to about 2/3rd of the company's revenues, in the quarter under consideration, a strong performance in both these segments has aided the company report good numbers. The importance of the growth in these two segments can also be gauged from the fact that they have alone contributed to nearly 90% of the company's incremental topline during the quarter.

The robust performance of these divisions of the company can be attributed to both, strong volume sales as well as significant improvement in realisations. Just to put things in perspective, volume sales of cement was higher by 8% and realisations also improved by 7% culminating into an 18% YoY growth in revenues. However, the margin improvement was neutralized owing to the sharp increase in input costs. In the case of the sponge iron business, while the volume sales improved by 15% YoY during the quarter, a significant increase in realisations of 48% led to a 68% growth in revenues from this segment. The margin contribution was also positive (up by above 450 basis points).

Segmental revenue snapshot…
(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
VSF 4,825 4,896 1.5% 12,677 14,954 18.0%
Cement 5,861 6,885 17.5% 17,045 20,361 19.5%
Sponge Iron 1,569 2,627 67.5% 4,062 7,402 82.2%
Chemicals 839 949 13.2% 2,156 2,487 15.4%
Textiles 583 609 4.5% 1,772 1,910 7.8%

Other businesses also contribute: As far as the company's other businesses are concerned i.e. VSF, chemicals and textiles, which together contribute to the remaining 40% of the company's business (down from 46% in 3QFY04), their performance was also decent. In the VSF business, despite the sales volumes taking a hit (down 12% YoY) owing to increased availability of cotton during the quarter, 15% stronger realisations saved the day for this business segment (revenues up 2% YoY and PBIT margins improved by about 180 basis points). Grasim's chemicals and textiles businesses also logged in positive revenue growth (13% and 5% respectively) but the textile segment reported losses during the quarter thus proving a marginal drag on the company's profitability.

Cost break-up
(% of net sales) 3QFY04 3QFY05
Raw materials 27.5% 30.5%
Staff costs 0.8% 0.8%
Stores 6.6% 6.0%
Power & Fuel 17.1% 17.7%
Other expenditure 13.1% 12.8%

Mixed operating margins: The robust demand in the domestic market on the back of the ongoing strength in the steel sector and a sharp rise in global scarp prices have helped the company in garnering higher realisations for its sponge iron sales. This has been one of the key contributors in sustaining the company's overall operating margins since the last few quarters. It must be noted that while 2QFY05 had witnessed a fall in margins, the same have recovered during the current quarter. Further, though the realisations were higher for cement sales, higher raw material costs nullified the margin gains from this segment. It must be noted here that if we consider the costs break-up as % of sales, raw materials and power and fuel, which together form about 2/3rd of the company's total operating expenditure, have witnessed a YoY rise of 300 basis points and 60 basis points during the quarter, thus capping the operating margin improvement.

Other income aids bottomline growth: Apart from the topline growth and improvement in operational efficiencies, the 83% rise in other income has also aided Grasim's 33% growth in bottomline. Further, this growth should be viewed in the context of a sharp 59% rise in tax provisioning during the quarter. Also, while interest expenses fell by 11%, depreciation costs witnessed a rise of 3%.

What to expect?
At Rs 1,315, the stock is trading at a price to earnings multiple of 13.8 times its annualised 9mFY05 earnings. We expect a favorable pricing environment for the cement division combined with a better demand scenario in the remaining months of FY05 as well as into FY06, considering the lack of any significant cement capacities coming into existence. Further, as earlier stated by the company, synergies from the L&T acquisition are likely to result in cost savings to the tune of Rs 1 bn as well, which means that the margin outlook is positive. However, considering our cautious stand with respect to the sustenance of the steel cycle throughout FY06, we remain cautious about continued improvement in sponge iron margins (near-term firmness may continue) beyond FY05. Since this division has accounted for a large share of profits in the last few quarters for Grasim, overall margins may come under pressure to this extent.

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