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Grasim: ‘Cementing’ focus - Views on News from Equitymaster
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  • Mar 16, 2002

    Grasim: ‘Cementing’ focus

    Diversification is not a universally favoured strategy for companies to adopt. Indeed, a large number of diversified Indian conglomerates have all but disappeared from the corporate landscape. Some like Grasim, on the other hand, have benefited from their diversified business portfolio.

    Grasim is the largest producer of VSF in the country (39% of revenues) with a capacity of nearly 220,000 tonnes per annum. It is the only producer of VSF in the country (93% market share) (SIV Industries, a competitor, recently stopped operations). VSF is a blending material and it competes with cotton in this segment.

    Grasim is one of the cheapest producers of VSF globally. One of the reasons for this is that Grasim has vertically integrated operations. It produces the two basic raw materials caustic soda and rayon grade wood pulp. Integrating forward, the company also has a presence in textile manufacturing. Historically, Grasim has been earning operating margins in the range of 30% from this business.

    Grasim:Revenue Break-up
    VSF Cement Sponge iron
    FY99 42% 30% 8%
    FY00 39% 37% 10%
    FY01 39% 39% 8%

    The VSF business has been a cash cow for the company in recent years (capex requirements for VSF are limited to maintenance expenditure). Going forward, though VSF will continue to be a key business for Grasim, it is clear that it cannot become its growth engine for future.

    The smaller businesses of Grasim – sponge iron and textiles, also do not hold out much hope in terms of generating profitable growth. While the sponge iron business has been hit by the shortage and irregularity of gas supplies, the textiles business has been incurring losses at the operating level.

    That leaves the company’s cement business (39% of revenues), which incidentally requires a lot of capital – a one million tonne plant can cost nearly Rs 3.5 bn. But that is not much of a concern for Grasim, which earned cash profits (from operating activities) of Rs 7.6 bn in 2001.

    Grasim zeroed in on cement to provide it the much-needed impetus for future growth. The company is already the fourth largest producer of cement in the country with a capacity of 10.7 million tonnes (in FY98 its cement capacity was just over 5 m tonnes).

    Anticipating a strong growth in the demand in the long term Grasim has been expanding capacities on a regular basis, the recent addition being a 1 million tonne grinding unit in Punjab. Strong volume growth combined with better realisations and lower distribution and manufacturing costs have led to improvement in the operating margins. OPM stands at 17.0% in FY01 compared to 13.3% in FY00. In the current year also the company has been able to maintain these margins, with a third quarter FY02 operating margin of 17.2%. Aggressive focus on new and high realisation markets has helped the company to increase its aggregate market share from 9% to 10% in FY01.

    Grasim however has also been aggressive in generating growth inorganically. The company recently acquired a 10% stake in Larsen & Toubro Limited, which has a cement capacity of 16 million tonnes. L&T is India's second largest cement company. The company paid a whopping Rs 7.7 bn for the stake.

    The acquisition will help Grasim in gaining a presence in the western and southern markets, where traditionally L&T has been strong. As a result of these efforts and also industry wide consolidation, realisations of both companies will improve in the long run. This is already evident from the consistent improvement in operating margins over the last several quarters. Going forward Grasim and L&T can work on a cross branding strategy (much like ACC-Gujarat Ambuja) which can significantly reduce logistics costs. This will further improve operating efficiencies.

    The acquisition goes a long way in underscoring Grasim's commitment to generate growth by investing in the cement sector.

    Grasim has been able to turn in a better than industry performance over the last couple of years. This above average performance indicates a proactive management and a flexibility to change.

    With cement targeted as the main growth driver the prospects of the company will depend on a large extent on the demand growth in the cement industry. The short-term demand trends of the cement market paint a bleak picture but the medium to long-term scenario is encouraging with good growth in demand forecasted (at least 8%-9%). However, profitability is subject to a balance between demand and supply, which will only be realised if no new capacities are added to a market that is facing a glut in supply.



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