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Arvind Mills: Conference call extracts - Views on News from Equitymaster

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Arvind Mills: Conference call extracts

Apr 18, 2006

We had earlier updated you on our visit to Arvind Garment’s Bangalore facility and our view on the company’s de-risking strategy. We recently also had a conference call with the management of Arvind Mills to get their view on the denim cycle, cotton prices and expectations from the new businesses. Following are the key excerpts of the same. Denim Vs Shirting
In the denim business, Arvind Mills is yet to recover from the volume pressures witnessed in 3QFY06. The company attributes this to huge inventory built up by the large brands in the US and Europe. Also, emergence of Pakistan as a strong regional competitor is acting as impediment to volume recovery. The requisitions from Bangladesh, which were earlier serviced mainly by the larger players in India, is being replaced by local capacities that are coming up. The European market volumes have also to some extent been impacted by large capacity build up in Turkey. Pakistan and Turkey have also become preferred sourcing bases over India due to the logistical advantage due to geographical proximity to Europe.

Realisations in the domestic denim market (Rs 97 per metre in 3QFY06 against Rs 105 in 3QFY05) continue to be under pressure due to substantial increase in the supply from new capacities being added. Most of the new capacities coming up are focused on the domestic market (because of their inability to venture in the export market) and the aggressive position taken by the new entrants has severely dented the price levels. Arvind Mills also acknowledged that the prices in the domestic market are unlikely to recover in the near term and the company sees these correcting by further 2% in FY07.

Nevertheless, the shirting business has proven to be a hedge against volatility in the denim business due to relative stability in realisations and growth in volumes over the past couple of quarters. This can also be attributed to the higher consumption by the garment and branding units. Arvind Mills had earlier attributed this business to be able to break into some of the absolutely top end brands, which were hitherto exclusive domain of Italian or Japanese mills.

Outlook on cotton prices
Arvind Mills expects the weakening trend in cotton prices to continue wherein a correction of approximately 2% from the current levels (Rs 40 per kg in 3QFY06) is envisaged in FY07. Also, the company had a substantial cotton inventory at the beginning of the current season and the cover is likely to last till July 2006. The average cost of cotton consumed during FY06 was lower by Rs 12 per kg as compared to the average price level in FY05 (20% YoY lower). It may further be recalled that Arvind Mills has a patented technology to produce premium products using low quality cotton, which gives it a cost advantage over peers like Raymond.

Hedging strategies in place
Since more than 50% of Arvind Mills’ revenues are from exports, the company is well exposed to forex risks. As a policy for hedging its revenues against foreign exchange fluctuations, based on annual projections, the company sells the net dollar (after providing for outflow) forward for the entire financial year. The process had been followed for FY06 too and the earnings in dollar were frozen at rate of Rs 44 per dollar. The company does not hedge the dollar position on long-term debt.

Performance of subsidiaries
Arvind Products, a 54% subsidiary of Arvind Mills (largely into manufacturing of gabardine fabric), declared a loss for the nine months ending December 2005. The loss, nevertheless, was lower than that of the corresponding period in FY05. Also, Arvind Mills discontinued the operations of Arvind Spinning and Arvind Mauritius in FY06, both of which were no longer feasible businesses, thus reducing the pressure on profit margins.

Our view
At the current price of Rs 104, Arvind Mills’ stock is trading at a price to earnings multiple of 7.6 times our estimated FY08 earnings. While the strategy of product diversification has already stabilised the revenue stream of the company and hedged it against wild fluctuations witnessed in the past, moving up the value chain (garmenting and branding) is also expected to generate better operating margins going forward. More importantly, the strategy of ‘verticalisation’ will enable the company become an integrated player and help it leverage this strength to bargain for global orders.

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