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Eastern Silk: Lost some shine! - Views on News from Equitymaster
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Eastern Silk: Lost some shine!
Jun 5, 2008

Performance summary
  • Topline grows by a muted 5.5% YoY due to slowdown in demand from US and European markets
  • EBIDTA margins remain stable at 19.6% in FY08 on the back of better product mix and higher realisations.
  • Net margins (excluding the extraordinary items) drop from 12.8% in FY07 to 12.1% in FY08.
  • Has provided for mark-to-market (MTM) loss of Rs 51 m on forex derivatives entered into this year. The mark to market loss in derivative contracts at the end of FY08 was Rs 230 m.

Standalone financials
(Rs m) 4QFY07 4QFY08 Change FY07 FY08 Change
Net sales 965 313 -67.5% 4,512 4,762 5.5%
Expenditure 777 321 -58.7% 3,656 3,831 4.8%
Operating profit (EBDITA) 188 (8) -104.0% 856 931 8.8%
EBDITA margin (%) 19.5% -2.4%   19.0% 19.6%  
Other income 76 10 -87.5% 147 98 -33.3%
Interest 59 59 0.0% 202 229 13.4%
Depreciation 36 48 33.3% 104 157 51.0%
Profit before tax 169 (105) -162.3% 697 643 -7.7%
Extraordinary items** - 51   - 51  
Tax 14 - -100.0% 120 66 -45.0%
Profit after tax/(loss) 155 (156) -200.9% 577 526 -8.8%
Net profit margin (%) 16.0% -49.8%   12.8% 11.0%  
No. of shares (m)       15.8 15.8  
Diluted earnings per share (Rs)*         33.3  
Price to earnings ratio (x)         3.0  
(*On a trailing 12-month basis)
** Write off of MTM loss on derivative contracts

What has driven performance in FY08?
Retention of volume over value: Despite the strategic initiatives such as capacity expansion, forward integration and greater market reach, the economic slowdown in the US and European regions (accounting for about two-thirds of its export dispatches) have taken a toll on Eastern Silk’s sales growth over the past fiscal. The company has also compromised on the realisations of some of its high value products for retaining its market share. The sales contribution from the high-value made-ups increased from 9% in FY06 to 11% in FY08. The company has scaled up the value chain over the years and is currently operating in various segments such as handloom fabrics (realisation of US$ 5 per metre), powerloom fabrics (US$ 8 per metre), embroidered fabrics (US$ 12 per metre) and made-ups (US$ 21 per metre). The goal is to increase average realisation from the current US$ 16 per metre to US$ 20 per metre by FY10. This volume-value chain play will significantly increase the profitability of the company. The total order book size of the company at the end of FY08 was Rs 800 m (20% of FY08 sales).

Although Eastern Silk is primarily concentrating on enhancing its realisations, being the second largest player in the Indian silk export market, the company is well poised to multiply its margins if the projected silk export targets are achieved. To put things in perspective, Indian silk exports are expected to grow from US$ 750 m in FY07 to US$ 1.5 bn by FY11 (compounded annual growth of 17%). Players like Eastern Silk have the capability to deliver customised as well as variable volumes, thus leveraging on the volume growth. However, with the slowdown in the US and European economies, the risk of lower demand from these markets going forward looms large. An oversupply to these markets from the other low cost silk producing nations like China may also impact the company’s realisations.

Stagnant operating costs: Manufacturing capacities for silk products are being shifted from Europe to destinations such as China and India. China is the largest producer (72% of world silk production) of silk fabrics in the world, primarily focused on mass production. India is the second largest producer (17%), providing scope for an accelerated growth for the industry. India is the only country producing all varieties of silk. It stands to gain due to lower cost of production, skilled manpower, absorption of world-class technology and increasing acceptance of its value added products.

Although the fact that China remains Eastern Silk’s largest raw material source (nearly 80%), the fact that the company has entered into an associated joint venture in China wherein the latter is obligated to supply about 120 MT per annum to the company, is a comforting factor. As there is very little pressure on Eastern Silk’s input costs, the company’s operating costs in FY08 have shown negligible change over that of FY07.

Derivative contracts backfire: Eastern Silk has a natural hedge for its export revenues (nearly 70% of the company's turnover is derived from exports), as the outsourced yarn requirement is entirely imported. However, the company entered into some derivative contracts in FY08 that led to losses with the sharp appreciation of the rupee against the US dollar. The company has provided for mark-to-market (MTM) loss of Rs 51 m on forex derivatives in FY08. The mark to market loss in derivative contracts at the end of FY08 was Rs 230 m (due for expiry beyond FY09).

What to expect?
At the current price of Rs 100, the stock is trading at an attractive valuation of 3.0 times its trailing 12-month earnings. Higher capacity in made-ups, better realisations and enhanced product mix position Eastern Silk very favourably to compete against its peers like Himatsingka Seide that are witnessing margin suppression and lower incremental growth. However, slower exports takeoffs and lower realisation in the markets of US and Europe spell some concerns for the medium term. Also, writing off the MTM losses entirely may erode the margins of the company. We have recently spoken to the management of the company and shall soon update our revised view and target price of the stock.

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