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Arvind Mills: Coarse finish!

Apr 29, 2006

Performance summary
Arvind Mills has declared results for the fourth quarter and year ended March 2006. The same have been way below our expectations. While the topline appears to have been battered by lower denim realisations, forex losses continue to drain the company’s bottomline. It must also be noted that while the annual profits of FY05 have been maintained in this fiscal, the numbers for 4QFY06 have been impacted due to unforeseen forex losses borne in the last quarter. The management’s outlook with regard to higher growth in its garment and branding businesses also seems to have not filtered in.

Standalone financials…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 4,386 3,578 -18.4% 16,549 15,920 -3.8%
Expenditure 3,294 2,663 -19.2% 12,731 11,844 -7.0%
Operating profit (EBDITA) 1,092 915 -16.2% 3,818 4,076 6.8%
EBDITA margin (%) 24.9% 25.6%   23.1% 25.6%  
Other income 21 60 185.7% 50 225 350.0%
Interest 308 330 7.1% 1,160 1,299 12.0%
Depreciation 382 394 3.1% 1,491 1,551 4.0%
Foreign exchange (gain) / loss (46) 51   (76) 87  
Profit before tax 469 200 -57.4% 1,293 1,364 5.5%
Tax (60) (15) -75.0% 20 93 365.0%
Profit after tax/(loss) 529 215 -59.4% 1,273 1,271 -0.2%
Net profit margin (%) 12.1% 6.0%   7.7% 8.0%  
No. of shares (m)       195.4 209.4  
Diluted earnings per share (Rs)*         6.1  
Price to earnings ratio (x)         15.2  
(* trailing 12 months)            

On the path to vertical integration…
Arvind Mills is India’s largest denim manufacturer and exporter, with a total capacity of 120 mm, after taking into account the recent 10 mm expansion at Santej. The company also ranks among the top three denim producers worldwide. It manufactures and sells textiles and ready to wear garments as well. The total fabric production capacity at 34 mm is big, even by world standards. While the company has been hitherto been focusing on fabric and denim production, it has aggressively entered the garmenting and knits businesses. In a very important step, through a GDR issue, the company has acquired ICICI Venture’s stake in Arvind Brands. After this, the company hopes to grow its readymade branded garments business significantly in the next three years, given that the company is now fully under its control.

What has influenced performance in 4QFY06?
Realisations gone awry: The denim business, which accounts for more than 60% of Arvind Mills’ topline, seems to have not recovered from the volume pressures witnessed in 3QFY06. The company had earlier attributed 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. While denim pressures were anticipated, what comes as a surprise is the inability of the company’s shirting and garment businesses to prove to be a hedge against volatility in the denim business due to relative stability in realisations and growth in volumes. Sales from the garment facility in Bangalore and turnaround of Arvind Brands appear to have done little to insulate the company’s topline.

Costs in control: On the cost control front, nevertheless, the company had made an appreciable attempt to safeguard its operating margins. Arvind 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. Also the power cost has been pared due to the use of naphtha instead of gas. This has atleast kept the EBIDTA margins steady for the company despite the drop in denim realisations.

Cost breakup…
(%) of sales 4QFY05 4QFY06 % change FY05 FY06 % change
Raw material cost 1,505 981 -34.8% 6,071 5,145 -15.3%
% sales 34.3% 27.4%   36.7% 32.3%  
Power & fuel 338 369 9.2% 1,789 1,435 -19.8%
% sales 7.7% 10.3%   10.8% 9.0%  
Staff cost 336 342 1.8% 1,231 1,357 10.2%
% sales 7.7% 9.6%   7.4% 8.5%  
Stores 413 417 1.0% 1,454 1,710 17.6%
% sales 9.4% 11.7%   8.8% 10.7%  
Others 702 553 -21.2% 2,186 2,194 0.4%
% sales 16.0% 15.5%   13.2% 13.8%  

Over the past few quarters: During the past couple of quarters, Arvind Mills has undertaken several initiatives to de-risk its business, control costs and improve margins. This included initiating a garmenting facility in Bangalore, re-acquisition of Arvind Brands from ICICI Venture, cost control measures as mentioned earlier as well as capacity expansion in Santej, Gujarat.

Forex plunge: Besides the operating anomalies, loss on the forex side is another factor that has been cause of worry for the company for sometime now. In fact, in 4QFY06, the company’s other income has almost been wiped out by the forex losses. Although we had projected some of these in our estimates, the loss incurred on this count has been much higher.

What to expect?
At the current price of Rs 92, the stock is trading at a price to earnings multiple of 8.8 times our estimated FY08 earnings. While the continuity of downside in denim cycle and losses on the forex side are unpredictable, we believe that the de-risking strategies will prove to be benign to the company in the longer run. Also, Arvind Mills discontinued the operations of Arvind Spinning and Arvind Mauritius in FY06, both of which no longer feasible business. The benefits of capacity expansion will also filter in, in the forthcoming fiscals. We shall revisit our projections for the company after a conference call with the management.

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