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Raymond: Research meet extracts

Jul 3, 2007

Warren Buffet’s words in his 1978 letter to the shareholders of Berkshire Hathaway, "The textile industry illustrates in textbook style how producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage” - were confirmed in our meeting with the largest integrated textile company in the country, Raymond. Supply overhang led cyclical downtrend and input pressures coupled with expansion costs have taken a toll on the company’s meager return ratios (return on equity and return on assets). While Raymond represents the fate of companies across the sector, even factors like vertical integration and scalability has failed to offer it a hedge. Following are some of the key excerpts from the meet. Denim – The spoilsport: The cyclical downturn in the denim industry globally impacted the global and Indian markets alike in FY07. Mills in Europe operated at 60% capacity while several in the US declared closures. In Europe, while domestic denim production was down 13% YoY in 2006, imports were lower by 30% YoY. Overall the European denim market contracted by approximately 10% YoY in 2006. In the US, while the denim volumes were down 8.4% YoY, two companies announced closures. In the Indian market, the excess denim capacity was to the tune of 150 m metres in FY07. The consequent pricing pressure and lower offtakes coupled with the rupee appreciation is expected to force several small players in India to discontinue their operations. This is a sentiment being echoed in unison by the major denim players in the country.

The base premise on which we had given our previous recommendation on Raymond was on the fact that the company had successfully differentiated itself from the denim mass market and had commanded a considerable premium in realisations to its peers. The same were atleast 10% higher than the industry average, and thus gave enough headroom despite the pricing pressure. The denim division, which comprised 17% of revenue and 14% of the profits of the company in 1QFY07, was hived off into a separate joint venture (JV) with UCO of Belgium that is one of the largest European players in the premium denim segment. The JV (with total capacity of 80 mm) was expected to benefit from international standards in product design, development and manufacturing practices through the European and US facilities (of UCO). With this focus, Raymond was expected to rise above the competition seen in the almost commoditised denim segment. Raymond’s projections of the results of the JV operations, however, did not fructify in FY07 due to severe pricing and volume pressures especially in the US and European markets and quelled our estimates for its denim business.

Going forward, though not very positive on the denim business, the company will adopt a ‘wait-and-watch’ approach and try to capitalise on the premium realisation being earned by it in some of the global markets. Also, with a relatively stronger order book and stable pricing, the company hopes to turn around the business in the medium term. We have estimated the denim businesses of the company (the JV with UCO as well as Everblue Apparel) to break even by FY10E.

Sales volumes
Order backlog
(million metres)  
India fabric 2.5
Europe fabric 1.0
US fabric 3.0
Total 6.5
Source: Raymond presentation
Average realisations
(Euro per metre) 2007 Order book
India fabric 1.9 1.9
Europe fabric 4.2 4.2
US fabric 3.7 3.1
(Euro per piece) 2007 Order book
India garment 4.9 6.0
Source: Raymond presentation

JVs – Yet to cross the hurdle rate: The company’s shirting and woolen JVs with Zambaiti and Fedora respectively started operations in the latter half of FY07. Raymond expects the capacity utilisation in each of these ventures to touch 60% in FY08. We have, however, factored in relatively conservative assumptions due to the lower export offtakes. While Raymond expects the shirting JV to break even in the near term (we have estimated FY09E), the woolen garments JV with Fedora, being largely export oriented (70% is exported), is expected to languish in the red for sometime due to the strong rupee (we have estimated FY10E break even).

Worsted fabric: The capacity expansion in Vapi being completed in FY07 (bringing the worsted fabric capacity to 31 mm), Raymond also managed to operate the same at 100% levels. However, the input cost pressures, with wool (accounting for 50% of raw material costs) prices having risen by an average 30% YoY due to a severe drought in Australia, have been putting pressure on margins.

Retail: Raymond has opened 82 new outlets in FY07 bringing the total to 450 (1 m square feet of retail space). The company is targeting 1,000 outlets by FY10. While the retail venture has enabled the company position its brands at a premium and given it a first mover advantage, with the rise in rental rates, the pressure on operating margins is unavoidable.

Revised outlook
Raymond is envisaging a capex of Rs 1 bn in the next two years of which 50% will be spent on retail operations and the rest on the international JVs. Despite having 35% of its debt from the TUF (technology upgradation fund), the rising interest costs are expected to weigh on the company’s bottomline. Raymond is, however, trying to counter this by reducing its working capital requirements. In the textile segment, current assets to turnover ratio has been reduced by 15% in the last 2 years. In the apparel business, the same has been reduced by 5%. We expect the company to record unimpressive performances in FY08 and FY09, after which a possible turnaround in the loss making business will offer some upsides. Until then, due to the lower return on equity and return on invested capital (both less than 10%), we have revised our valuation band to 8 times to 12 times price to earnings multiple. Consequently, our FY09E target price for the stock stands reduced from Rs 570 to Rs 286.

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