In a relatively mixed year for the cement sector as a whole, Grasim, India' s third largest cement producer saw its topline grow by 5% while the net profits increased by a healthy 21% for FY03. For 4QFY03, the topline grew by 9% while the net profit was affected due to a huge write-off, mainly on account of the loss it incurred on the sale of shares in MRPL. Riding on the robustness in demand for cement and VSF, the company has managed to increase its operating margins by around 350 basis points, both for the last quarter and full year.
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Growth in topline for FY03 has been mainly brought about by the robust increase in the sales from its VSF business. This was mainly due to significant growth in sales volumes of VSF (Viscose Staple Fiber), primarily driven by exports. Exports have grown by 52% in FY03 and constitute nearly 32% of sales volume. The company's cement business on the other hand, saw significant growth in volumes but due to considerable fall in realisations (12%), the contribution of this business to overall topline growth has been limited. Due to the improvement in the fortunes of the steel industry, the sponge iron business of the company also saw significant improvement in FY03. While the chemicals business of the company performed well for FY03, the textiles business continues to remain a drag on the topline of the company.
Grasim reported an improvement in its operating margins primarily driven by topline growth and to a lesser extent due to reduction in freight costs. The company also reduced its trading exposure thus reducing its expenses further. Operating margins have improved by 350 basis points for FY03. Operating margins could have been better but for the drastic fall in cement realisations. More specifically the improvement in margins has been the result of a considerable improvement in the margins of the VSF business. Operating margins of the division have improved to 36% from 27% last year.
Apart from improvement in operating margins bottomline growth has been further driven by a 12% reduction in interest expenses. This seems to be due to substitution and repayment of old high cost debt. In 4QFY04 the company has incurred extraordinary expenses that have depressed net profits considerably. The extraordinary expenses pertain to the write-off of investments in MRPL (Rs 2,086 m) and VRS expenses (Rs 59 m). Due to a write back of tax provision to the tune of Rs 400 m, extraordinary expenses are lower at Rs 1,745 m. Despite the write-off, net profit for FY03 has grown by a healthy 21%. If one did not account for the extraordinary expenses, then the growth in net profit would have been to the tune of 40%.
At Rs 363 the stock is trading at a P/E multiple of 9x its FY03 earnings. The company has done well to grow its core businesses of cement and VSF, especially VSF. The company's strategy of exploring new markets as well as uses for VSF seems to be paying off. On the cement front, low realisations have been the only dampener. But having pointed out the positives about the company we must also point out that Grasim is primarily engaged in the commodities businesses which is susceptible to cyclicalities. Thus past performance may not be an indicator for the future.
While the prospects for the cement sector seem encouraging going forward, it is difficult to safely forecast the prospects of the VSF business. Currently the VSF business is riding the upturn in the cycle. Investors may want to look at the performance of the company's VSF business going forward to identify a trend. The stock has already risen by 10% in the last quarter and from here on valuations are likely to depend on the company's ability to maintain volumes in the VSF business. Or in other words, it remains to be seen whether the company's new strategy regarding VSF is sustainable in the long run.
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