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Arvind: Input costs cannibalize profits - Views on News from Equitymaster
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Arvind: Input costs cannibalize profits
Feb 8, 2010

Performance summary
  • Topline remains flat YoY in 9mFY10, falls by 9% YoY in 3QFY10. Results not comparable due to the demerger of branded apparel and retailing businesses.
  • EBIDTA margins improve from 10% in 9mFY09 to 13% in 9mFY10 due to higher volumes and lower power costs. Denim and shirting realisations continue to remain under pressure.
  • Lower interest costs bring in positive bottomline for the third quarter and nine month periods.
  • Fall in other income in 9mFY10 is primarily due to the receipt from sale of land in 2QFY09.
  • Arvind has hived off the branded apparel and retail (Megamart) businesses to 100% subsidiaries Arvind Lifestyle Brands and Arvind Retail respectively w.e.f. Aril 2009.


Standalone financials
(Rs m) 3QFY09 3QFY10 Change 9mFY09 9mFY10 Change
Net sales 5,995 5,439 -9.3% 17,142 17,222 0.5%
Expenditure 5,178 4,880 -5.8% 15,398 14,981 -2.7%
Operating profit (EBDITA) 817 559 -31.6% 1,744 2,241 28.5%
EBDITA margin (%) 13.6% 10.3%   10.2% 13.0%  
Other income (18) 236   653 300 -54.1%
Interest 772 381 -50.6% 1,767 1,309 -25.9%
Depreciation 307 292 -4.9% 890 866 -2.7%
Profit before tax (280) 122   (260) 366  
Extraordinary items - -   - -  
Tax 52 -   14 -  
Profit after tax/(loss) (332) 122   (274) 366  
Net profit margin (%) -5.5% 2.2%   -1.6% 2.1%  
No. of shares (m)       218.9 226.4  
Diluted earnings per share (Rs)**         0.6  
Price to earnings ratio (x)         60.0  
(*On a trailing 12-month basis)

What has driven performance in 9mFY10?
  • Despite the signs of recovery in the export markets and better consumption demand in the domestic markets, Arvind failed to retain improved realisations for its denim and shirting businesses in 9mFY10. Infact the cost of raw materials as a percentage of sales went up significantly as the company resorted to buying semi-finished products to meet the surge in orders.

    Denim fabric, which continues to be the mainstay in Arvindís business, showed encouraging signs of improvement in volume off-take. However, the realisations dipped by 9% YoY. The shirting division which is a supplier to the companyís garmenting arm, also did not disappoint on the volumes front (up 47% YoY). However, its realisations got impacted due to the slowdown in the garmenting business itself. As per the company, the average realisations are lower as volume growth has come in largely from domestic market where the product mix sold has lower price points.

    Fabrics
      9mFY09 9mFY10 Change
    Denim      
    Volume (mm) 15.5 21.1 36.1%
    Avg Price (Rs/mt) 122 111 -9.0%
    Shirting      
    Volume (mm) 7.1 10.4 46.5%
    Avg Price (Rs/mt) 141 125 -11.3%

  • Arvindís garmenting business seems to be doing well in the shirts category while the knits and jeans categories suffered with lower realizations. We have been conservative in our future growth estimations in this segment considering the pressure on input costs.

  • In 1HFY10, Arvind had signed a nine-year gas supply agreement with GAIL, thus putting to rest the concern over supply of gas to its captive power plants. Going forward, lower power costs are expected to aid the margins of the company. Cost of power at the companyís Naroda plant was Rs 4 per unit and at Santej Rs 5 per unit in 9mFY10 as against previous year averages of Rs 7 and Rs 7.5 respectively. The cost of cotton however continues to remain high due to lower production of the same in China. Arvind expects the cost of cotton to be higher in 2HFY10 than in 1HFY10.

  • While the lower interest and depreciation costs along with negligible tax incidence buoyed the companyís bottomline performance during the third quarter and nine month periods, the same may be unsustainable going forward as interest costs start rising.

What to expect?
At the current price of Rs 36, the stock is trading at a multiple of 7 times our estimated FY12 EV/EBIDTA. While the management has projected 20% growth in revenues and 2% growth in margins in FY11, the continued volatility in realisations reduces the visibility in the medium term. However, the policy of servicing the key markets with value added products and focused marketing of brands seems to be yielding positive results. Despite the relative attractiveness of the stock to its peers in terms of price to book value, we maintain a cautious stance on the earnings potential of the company

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