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Arvind Mills: Denim disappoints

Mar 12, 2004

Indian textile major, Arvind Mills, declared lacklustre results for the December quarter 2003. The topline of the company dipped by around 8% during the quarter. Relatively high cotton prices affected operating margins significantly (down 530 basis points), as a result of which the bottomline of the company decline by 48% YoY.

(Rs m)3QFY033QFY04Change9mFY039mFY04Change
Net sales3,793 3,483 -8.2%10,883 10,860 -0.2%
Other income15 49 232.0%43 103 140.0%
Expenditure2,716 2,678 -1.4%7,749 8,215 6.0%
Operating profit (EBDITA)1,077 804 -25.3%3,134 2,645 -15.6%
Operating profit margin (%)28.4%23.1%  28.8%24.4% 
Interest 358 282 -21.3%1,156 909 -21.4%
Depreciation 368 379 3.2%1,107 1,122 1.3%
Profit before tax 367 192 -47.6%913 716 -21.6%
Tax- -   - -  
Profit after tax/(loss) 367 192 -47.6%913 716 -21.6%
Net profit margin (%)9.7%5.5%  8.4%6.6% 
No. of shares (m)171.1 195.3   171.1 195.3  
Diluted earnings per share (Rs)*8.6 3.9   7.1 4.9  
P/E ratio (x)        9.2  
(* annualised)           

Denim is the major contributor to the company's topline. Due to lower denim demand in the global markets, denim realisations were weak. This affected the topline growth of Arvind Mills. As shown in the graph below, denim realisations were close to the peak during the first quarter of the current fiscal. However, due to lower demand, prices have been steadily declining. Going forward, it is unlikely to see any improvement as well, as the offtake from global markets is expected to be at a lower side.

Considering the weak demand for denims, the company has decided to shift some of the denim production capacity to other products like shirting on temporary basis. Currently, India has a quota of 17 mm for US markets and 27,000 metric tonnes for European markets. However, post 2005, exports of denim can see a favorable momentum because of removal of quota restrictions.

The shirting business of the company witnessed a marginal growth due to higher quantity sold. The business contributed to around 22% to the company's topline. While shirting demand is not dependent on fashion cycles like denim, volume growth has been stable due to high competition in the domestic market. Realisations have also remained stable as compared to denims. With the increased shirting capacity, the segment is likely to benefit post 2005, as the largest consumers of the high value cotton shirting are European and US markets.

The company has taken initiatives to enter ready-to-wear segment with the setting up of the garment manufacturing capacity of 2.4 million pieces per annum at Banglore. Knitting business of the company has witnessed a significant YoY growth of 49%. The company has entered into a tie-up with major international brands like Nike and Banana Republic for supplying knitting fabrics.

At the current price level of Rs 45, the stock trades at P/E ratio of 6.9x expected FY04 earnings. With the foreign markets opening up post 2005, the growth opportunity for a fully backward integrated company like Arvind is promising because of its cost competitiveness. But the company's decision of shifting its denim capacity to other businesses raises concern as it contributes to 60% topline. Though the company has reduced some of its debts by converting them into equity, it has led to earnings dilution. No doubt the company has benefited from the restructuring exercise in the last two years, However, the relatively higher debt component in the balance sheet (debt to equity ratio stood at 1.7x in FY03) and the inherent volatility in the textile business increases the risk profile of the stock substantially.

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