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Raymond: Denim calling the shots! - Views on News from Equitymaster
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Raymond: Denim calling the shots!
Feb 3, 2006

Performance Summary
Raymond has announced impressive results for the third quarter and nine month period ended December 2005. Even as the denim segment retains prominence in the company’s performance, turnaround of the files and tools segment has also made its due contribution. Our analysis of the company’s results includes extracts of the results’ conference call.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 2,989 3,453 15.5% 8,251 9,405 14.0%
Expenditure 2,583 2,864 10.9% 7,418 7,947 7.1%
Operating profit (EBDITA) 406 589 45.1% 833 1,458 75.0%
EBDITA margin (%) 13.6% 17.1%   10.1% 15.5%  
Other income 158 141 -10.8% 506 535 5.7%
Interest 49 69 40.8% 121 178 47.1%
Depreciation 165 188 13.9% 438 534 21.9%
Profit before tax 350 473 35.1% 780 1,281 64.2%
Extraordinary income/(expense) (170) (25) -85.3% (243) (101) -58.4%
Tax 80 143 78.8% 150 318 112.0%
Profit after tax/(loss) 100 305 205.0% 387 862 122.7%
Net profit margin (%) 3.3% 8.8%   4.7% 9.2%  
No. of shares (m) 61.4 61.4   61.4 61.4  
Diluted earnings per share (Rs)*         18.7  
Price to earnings ratio (x)         22.0  
(* trailing 12 months)            

What is the company's business?
Raymond is India's largest and world's third largest integrated manufacturer of wool and wool blended fabrics with production capacity of 24 mm (million meters). It is the domestic market leader in files and tools with around 80% market share. The company is the second largest denim producer in the country with a capacity of 30 million meters (mm). It has a widespread distribution network across the country, which it can leverage to sell some of its well-recognised brands.

What has driven performance in 3QFY06?
Denim leads the growth: Despite lower margins (40 basis points contraction), denim remains the fastest growing segment in Raymond’s product portfolio. Given the capacity expansion in its denim facility from 20 mm to 30 mm (expected to go up to 40 mm by FY06), the 41% YoY growth in 3QFY06 is appreciable. While the company anticipates the pressure on denim prices to continue in the coming quarter, introduction of products in the premium segment is expected to aid margins. No additional capacity expansion is foreseen in this segment in the next 3 to 4 years.

The textile division of the company (70% of which is poly wool) registered revenue growth of 11% YoY on the back of 8% YoY growth in volumes and 7% YoY growth in realisations. The division continues to witness pricing pressure due to overcapacity in the domestic market and is therefore concentrating on the export markets to propel growth. It may be noted that additional fabric capacity of approximately 140 mm has intensified competition in the domestic market, as the new entrants are not targeting export markets. The company may expand textile capacity by 3 mm in the next 3 to 4 years. While the management believes that wool prices have bottomed out with a 7% YoY fall, polyester prices are expected to remain stable going forward. Raymond has a forward cover upto April 2006 in cotton prices, which are expected to harden going forward.

The VRS write offs that were booked in 3QFY05 (extraordinary expenses) had dented profits in the said quarter last fiscal. The reduction of the same in the current fiscal has inflated the company’s bottomline. The company has offered VRS to 230 employees in the Thane plant until 9mnFY06 and paid compensation of Rs 85 m. While no new employees are being recruited to fill up the positions, the VRS scheme remains a continuing one. The scheme has brought down the company’s employee cost by 8% to 9% YoY in 3QFY06.

Segmental snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Textiles
Revenue 2,027 2,241 10.6% 5,478 6,121 11.7%
% share 68.4% 65.1%   66.9% 65.2%  
PBIT margins 17.6% 17.2%   19.3% 18.6%  
Denim
Revenue 580 815 40.5% 1,655 2,123 28.3%
% share 19.6% 23.7%   20.2% 22.6%  
PBIT margins 13.6% 10.8%   9.8% 9.8%  
Files & Tools
Revenue 356 385 8.1% 1,056 1,139 7.9%
% share 12.0% 11.2%   12.9% 12.1%  
PBIT margins -5.7% 7.7%   0.1% 8.7%  

Apparel – The dark horse: The branded apparel segment of the company continues to remain its focus area, with Raymond Apparel and Color Plus (most profitable standalone brand in the country) witnessing revenue growth of 10% YoY and 6% YoY respectively in 3QFY06. Although the company believes that the current EBIDTA levels of these two subsidiaries (at 17% and 24% respectively) have peaked, it expects the apparel division to continue clocking 20% plus growth in the medium term. It has also cited that despite having tie ups with 17 to 18 malls, the slow opening of the malls has delayed the company’s growth in this division. Raymond had 301 ‘Raymond Stores’ at the end of 9mFY06, which is expected to go up to 400 in the next 3 years, while the Color Plus stores (44 in 9mnFY06) are expected to double in the same period. It may also be noted that the promoters of the ‘Color Plus stores’ have an ‘exit clause’ which is mandatory to be exercised by May 2006, depending on its performance.

Files and tools – Slow recovery: The financial restructuring of this division following the shut down of the files and tools plant in Thane has helped the division to slowly but steadily recover. While the company's initiative to increase production in the value-add segment was one reason for the improvement in performance, the other reason for the turnaround of this division was the softening of input cost (steel).

Auto components – Growth play: Raymond’s foray in the auto components segment is to capture the growth opportunities in the sector. Scissors Engineering Products, a 100% subsidiary of the company, has acquired 86% controlling stake in Ring Plus Aqua, which is engaged in the manufacturing of ring gears and integral shaft bearings used in automobiles. While the company is envisaging 50% capacity expansion in the ring gears segment, inorganic growth is also not ruled out.

What to expect?
Raymond has opened a design Studio in Italy in 3QFY06, which will be a joint venture between the company and its shirting partner Gruppo Zambaiti, Italy, to be managed by the latter. The design studio will provide Raymond with strategic design capabilities for all its textile and apparel businesses. Besides, the same is expected to provide the company access to international design talent and visibility to Raymond’s products globally. Although margin pressures for the apparel division and higher raw material costs for the textile division remain our prime concerns, we believe that the capacity expansions, extended retail network and auto component foray will accelerate the company’s growth in the long term.

At the current price of Rs 411, the stock is trading at a price to earnings multiple of 12.5 times our estimated FY08 consolidated earnings. We had earlier upgraded our price target for the HOLD recommendation from Rs 450 to Rs 490 post our meeting with the management. At the current juncture, we maintain our view on the stock.

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