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Grasim: Cement to the rescue - Views on News from Equitymaster

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Grasim: Cement to the rescue

Apr 29, 2006

Performance summary
Grasim, the diversified major of the Aditya Birla Group, reported strong numbers for the quarter ended March 2006, wherein the bottomline grew by a strong 39% YoY on the back of a 17% growth in topline, aided primarily by its cement business. However, the company has ended FY06 on a relatively weaker note with a 10% YoY topline growth and an 18% YoY PAT growth. This underperformance on the full year basis is on the back of the poor performance of the company during 2QFY06 and 3QFY06, as its sponge iron business came under tremendous pressure.

Consolidated financial snapshot…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net Sales 24,748 29,014 17.2% 93,148 102,003 9.5%
Expenditure 19,263 22,431 16.4% 72,645 80,858 11.3%
Operating Profit (EBDITA) 5,484 6,583 20.0% 20,503 21,146 3.1%
EBITDA margin (%) 22.2% 22.7%   22.0% 20.7%  
Other income 888 668 -24.7% 2,221 2,166 -2.5%
Interest 725 487 -32.8% 2,846 2,123 -25.4%
Depreciation 1,368 1,448 5.8% 5,562 5,598 0.6%
Profit before tax 4,279 5,317 24.2% 14,316 15,591 8.9%
Extraordinary item (1,281) 41   (1,281) 41  
Tax 391 1,270 225.0% 4,421 4,114 -6.9%
Profit/(Loss) before minority interest 2,608 4,089 56.8% 8,614 11,518 33.7%
Minority interest 115 621 440.0% (190) 1,132  
Profit/(Loss) after tax and minority interest 2,493 3,468 39.1% 8,804 10,386 18.0%
Net profit margin (%) 10.1% 12.0%   9.5% 10.2%  
No. of Shares (m) 91.7 91.7   91.7 91.7  
Diluted earnings per share         113.3  
Price to earnings ratio (x)         21.4  

What is the company’s business?
Grasim, an Aditya Birla Group company, has presence in various businesses. It has presence in viscose staple fiber or VSF (19% of sales in FY06), cement (66%), sponge iron (6%), chemicals (4%) and textiles (2%). While the company is a world leader in VSF with a 24% market share, it is also the seventh largest producer of cement in the world with a total consolidated capacity of 31 MT (nearly 22% of the country's capacity). It achieved the latter distinction post its acquisition of L&T's cement capacity for a net investment of Rs 22 bn.

What has driven performance in 4QFY06?
It’s all about cement: As mentioned above, Grasim operates in 5 different business segments. However, when we look at the segmental performance of the company for the quarter, barring cement and VSF, none of the other divisions have contributed to the company’s topline growth. In fact, considering the small contribution of the VSF business to the overall sales of the company, it would not be incorrect to state that Grasim, at the current juncture, is all about cement. This division notched a growth of 35% YoY in sales as both sales volumes and realisations ruled strong. While volume sales were higher by about 15% YoY, realisations too were higher by a similar margin. For the full year, the cement division’s sales were higher by 21% YoY.

As far as Grasim’s other businesses during the quarter were concerned, while the VSF business registered a growth of 9% YoY, primarily led by higher volumes sales (realisations were marginally lower) on the back of a sharp rise in direct and deemed exports. The low base effect of 4QFY05 also helped prop up the current quarter numbers. For the full year, however, VSF sales were down 1% YoY, affected by the underperformance of the previous quarters. In the case of the chemicals division, sales were lower by 13% YoY, which were depressed by a 17% YoY fall in realisations, as additional global capacities pressurised prices. For the full year, revenues from this segment were higher by 10% YoY. Further, the textiles division continued to be a drag on the company’s topline affected by the intense competition from the unorganised sector and lower exports owing to poor realisations.

However, the biggest culprit that put immense pressure on the company’s performance was the sponge iron division. The revenues from this business segment more than halved as compared to 4QFY05, declining by over 60% YoY. With the continued poor performance of this division, the share of revenues of this segment to the total revenues has come down from 11% in FY05 to 6% in FY06. The performance of the sponge iron business was severely hampered during the quarter and the year due to the continued shortage in supply of natural gas and steep rise in input costs. This led to 50% lower production and consequently volume sales were also lower to this extent. To make matters worse, realisations were down 20% YoY.

Cost break-up (% of net sales)
  4QFY05 4QFY06 FY05 FY06
Inc/Dec in stock in trade -2.1% 0.8% -1.3% 0.0%
Raw material consumed 25.3% 20.1% 24.0% 21.7%
Purchase of finished goods 0.5% 1.2% 0.6% 1.1%
Staff costs 5.2% 5.1% 5.5% 5.3%
Power & Fuel 20.6% 19.7% 22.1% 20.9%
Freight & Forwarding 12.6% 16.4% 11.9% 15.2%
Other expenditure 15.8% 14.2% 15.3% 15.0%
Total expenses 77.8% 77.3% 78.0% 79.3%

Sponge iron and textiles drag margins: The operating profits of Grasim during 4QFY06 grew by 20% YoY aided by the improvement of 50 basis points in operating margins. This is encouraging considering that the company’s other divisions have largely been a drag on the company’s operational performance. As can be seen in the table below, while the VSF and cement businesses have delivered significantly improved performances, the other three divisions have been clear laggards for reasons mentioned above.

Segmental PBIT margins…
  4QFY05 4QFY06 FY05 FY06
VSF 23.1% 26.5% 27.6% 21.4%
Cement 12.1% 19.4% 10.2% 15.7%
Sponge Iron 34.3% -12.2% 34.8% 5.3%
Chemicals 32.9% 25.3% 24.7% 27.8%
Textiles 0.7% -4.6% -0.2% -1.2%
Others 18.2% 21.4% 16.3% 16.7%
Total 17.3% 19.1% 16.9% 16.2%

Cement saves the day: Thanks to the performance of the cement division, and to a certain extent of the VSF division, the company posted a 24% YoY growth in profit before tax. It must be noted that the advantage of lower interest outgo was negated by the fall in other income to a similar extent. However, at the PAT level, profits have surged by 39% YoY for the quarter, which is not the correct picture in the true sense as 4QFY05 had an extraordinary write-off pertaining to impairment of goodwill. Moreover, the tax outgo in 4QFY05 as percentage of PBT was a mere 9% as compared to 24% in 4QFY06. The provision for minority interest component has also leapfrogged (up 440% YoY) during 4QFY06. Nonetheless, considering the company’s PBT performance, the results have been good for the quarter.

Performance over the quarters…
  1QFY06 2QFY06 3QFY06 4QFY06
Net sales (YoY growth) 55.8% 4.8% 5.7% 17.2%
Operating profit margin 22.6% 17.9% 19.4% 22.7%
Net profits (YoY growth) 47.8% -6.9% -25.4% 39.1%

What to expect?
At Rs 2,430, the stock is trading at a price to earnings multiple of 16 times our consolidated FY08 estimates, making the valuations a trifle expensive. However, considering a favorable environment for the cement division on the back of better demand and pricing scenario in the medium-term and the announced capacity expansion plans of the company, we remain positive on the long-term prospects of the company.

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