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Indian Rayon: Diversification blues - Views on News from Equitymaster

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Indian Rayon: Diversification blues

May 12, 2003

Led by impressive performance of its Viscose Filament Yarn (VFY), textiles and carbon black divisions, Indian Rayon (IRYN) has posted impressive FY03 results. While revenues have increased marginally by 2%, net profit has more than doubled during the year. The rise in sales and net profit has come at a time when the company has divested its insulator business into a separate joint venture and has taken a big hit towards the loss on sale of stake in Mangalore Refinery (MRPL).

(Rs m) 4QFY02 4QFY03 Change FY02 FY03 Change
Net sales 3,259 3,356 3.0% 14,106 14,438 2.4%
Other Income 110 111 0.7% 259 327 26.3%
Expenditure 2,852 2,813 -1.4% 12,278 12,144 -1.1%
Operating Profit (EBDIT) 407 543 33.5% 1,829 2,294 25.5%
Operating Profit Margin (%) 12.5% 16.2%   13.0% 15.9%  
Interest 147 77 -47.9% 625 437 -30.1%
Depreciation 183 176 -3.8% 735 717 -2.4%
Profit before Tax 186 401 115.2% 727 1,467 101.7%
Extraordinary items 87 (187) - 13 (187) -
Tax 125 36 -70.9% 306 227 -25.7%
Profit after Tax/(Loss) 148 178 20.1% 435 1,053 142.4%
Net profit margin (%) 4.5% 5.3%   3.1% 7.3%  
No. of Shares (m) 59.9 59.9   59.9 59.9  
Diluted Earnings per share (Rs) 9.9 11.9   7.3 17.6  
Stanalone P/E Ratio (x)         4.5  
Consolidated P/E (x)         12.5  

It is important to look at the performanc of the company on a division-wise basis when it comes to IRYN considering the diversified interests of the company. As mentioned earlier, it was a impressive year for the VFY division. After suffering from a strike in one of its plants in the second half of FY02, both capacity utilisation and volumes have improved significantly for FY03. The VFY division has seen a 46% rise in revenues led by a 20% rise volumes and a similar rise in realisation. IRYN has been focusing on the value-added segment of VFY as a result of which the contribution from the same has increased to 62% of total volume sales in the same period. The company has attributed this performance to the change in fashion trends and new applications of VFY.

Prospects of tyre manufacturers are closely linked to the performance of the CV segment (carbon black is one of the key raw materials for tyre manufacturers). With total commercial vehicle sales increasing by 30% in FY03, the carbon black division of IRYN has taken advantage of the upturn. While volumes grew by 20%, realisation was lower compared to FY02. Despite the volatility in crude prices (the key raw material for carbon black manufacturers is feed stock, which is influenced by crude price movement), IRYN has managed to improve PBIT margins in FY03. This is another commendable aspect of IRYN's FY03 results.

Segment wise contributionů
(Rs m) 3QFY02 3QFY03 Change FY02 FY03 Change
Garments 619 678 9.5% 3,561 3,275 -8.0%
PBIT margin (%) -14.4% -12.9%   -2.1% -4.4%  
Rayon 381 791 107.6% 2,310 3,380 46.4%
PBIT margin (%) 13.4% 30.3%   12.8% 28.7%  
Carbon black 769 895 16.3% 2,798 3,278 17.2%
PBIT margin (%) 15.9% 19.2%   16.1% 17.9%  
Insulators 647 23 -96.5% 1,963 632 -67.8%
PBIT margin (%) 21.1% 88.5%   19.7% 23.2%  
Textiles 743 886 19.2% 3,070 3,484 13.5%
PBIT margin (%) 3.3% 5.5%   3.6% 2.8%  
Others 106 83 -21.5% 416 392 -5.8%
PBIT margin (%) 4.6% 9.0%   0.8% 5.0%  
Total 3,266 3,356 2.8% 14,117 14,441 2.3%
PBIT margin (%) 7.7% 11.9%   8.3% 11.6%  

But it was yet another bad year for the garment division (23% of FY03 revenues). Overall unit sales fell by almost 13%, there has also been considerable pressure on prices at the lower end segment (Peter England, for instance). key reasons for the poor performance could be attributed to the general weakness in the economy and competitive pressure. Our interaction with Raymond also suggested that there has been a proliferation of regional brands at the lower end of the garment market. This, in turn, has resulted in inventory pile up at the dealer level and huge discounting. Though the company has reduced adspend from 14% of sales in FY02 to 11% in FY03, at the pre-tax level, losses have increased.

Operating profit, on the back of benefits from higher capacity utilisation of select divisions, has increased by 25% in FY03. The decline in interest cost should be viewed in the context of a lower interest rate regime, better cash flow and repayment of past debts (IRYN has repaid debentures to the tune of Rs 860 m in FY03). As a result, profit before adjusting for tax and extraordinary items has almost doubled in FY03. Extraordinary items here pertain to the loss on sale of stake in MRPL to ONGC to the tune of Rs 571 m and gain on insulator demerger for Rs 384 m. IRYN demerged its insulator business into a separate joint venture with NYK, Japan in mid FY03.

The stock currently trades at Rs 80 implying a P/E multiple of 4.5x FY03 earnings. Given the company's cost and market leadership in businesses like VFY, carbon black and textiles, we expect cash flows to remain strong for the long-term. The garment divisions offers significant long-term growth prospects led by various factors like shift towards branded segment and general rise in income level in the economy. Despite these positives, the stock has been languishing at the current levels since November 2000 (albeit brief rise in between).

The reasons for the same is not surprising for an investor. The company's venture into areas like insurance and software have raised apprehension about the focus of the management. Though valuations are attractive on a standalone basis, the stock trades at a P/E multiple of 12.5x consolidated FY03 numbers. Since insurance is a long gestation project combined with the poor tech spend that is daunting the technology sector, consolidated profitability may remain suppressed. This is an area of concern and would continue to weigh on the stock price going forward.


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