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Indian Rayon: Impressive, yet…

Jul 25, 2002

Indian Rayon, the diversified major under the Aditya Birla Group, has posted a sharp rise in net profit for the first quarter ended June 2002. The core businesses of the company viz. viscose filament yarn (VFY) and carbon black reported improved performance. Garment demand remained subdued on account of weaker economy.

(Rs m) 1QFY02 1QFY03 Change
Net sales 3,421 3,653 6.8%
Other Income 22 11 -50.9%
Expenditure 2,983 3,087 3.5%
Operating Profit (EBDIT) 439 566 29.1%
Operating Profit Margin (%) 12.8% 15.5%  
Interest 112 130 15.2%
Depreciation 183 185 1.3%
Profit before Tax 165 262 58.8%
Extraordinary items (2) -  
Tax 64 111 74.1%
Profit after Tax/(Loss) 99 151 52.2%
Net profit margin (%) 2.9% 4.1%  
No. of Shares (m) 59.9 59.9  
Diluted Earnings per share* 6.6 10.1  

On the divisional front, the performance of the VFY division is impressive at 18% growth during the quarter. However, exports of VFY fell by 17% on account of sluggish demand in the international markets. VFY realisations have gone up by 12% YoY and 7% QoQ. At the same time, the performance of the VFY division has to be viewed in context with the strike in its manufacturing facility last year. One of the key growth drivers for the company in the last two years has been garments. Though garment sales was lower by 8% in 1QFY03, the company's continued emphasis on exports (notably Middle East) has yielded positive results. It had already set up more than two 'Planet Fashion' stores in the international markets for its core brands like Allen Solly, Louis Phillipe and Peter England. Garment exports grew at 25%, contributing 15% to total garment sales of Indian Rayon (11% of garment sales in 1QFY02).

With demand for passenger cars, commercial vehicles and two-wheeler remaining robust in the current fiscal, Indian Rayon has reaped the benefit by recording a 29% rise in carbon black sales (carbon black is the key raw material for manufacturing tyres). Since Indian Rayon is one of the most cost competitive producers of carbon black, exports have also performed well. Indian Rayon had initiated various measures to boost exports like branding of some of its commodity products like VFY and expansion of its garment business post the acquisition of international rights. For 1QFY03, exports contributed to 27% of sales as compared to 25% in the corresponding quarter previous year.

Segmental break-up…
(Rs m) 1QFY02 % sales 1QFY03 % sales Change (%)*
VFY 691 20.2% 813 22.3% 17.7%
Garments 852 24.9% 784 21.5% -8.0%
Carbon black 613 17.9% 765 20.9% 24.8%
Insulators 340 9.9% 440 12.0% 29.4%
Textiles 861 25.2% 802 22.0% -6.9%
Others 64 1.9% 49 1.3% -23.4%
Total 3,421 100.0% 3,653 100.0% 6.8%
*Change over 1QFY02

The spurt in operating profit was led by a 270 basis points rise in operating margins, which was led by higher capacity utilisation, comparatively favorable raw material prices and savings in employee costs on account of VRS last year. One of the key concerns is rising interest costs. Indian Rayon has been on a diversification spree in the last two years. In FY02, it acquired PSI Datasystems and entered into a joint venture with Sun Life of Canada to set up insurance services (Birla Sun Life Insurance). After initial capital contribution for the insurance subsidiary, Indian Rayon went on to infuse further capital towards the end of FY02. A combination of all these factors have resulted in higher interest cost for the company. But since Indian Rayon generates adequate free cash flow, we expect interest costs to decrease for FY03. Despite a sharp rise in tax provision on account of new norms, net profit has increased by 52%.

Meanwhile Indian Rayon has proposed to demerge its insulator division to a separate 50:50 joint venture between Indian Rayon and NGK Industries. This is a big positive for the company considering the fact that this division has been affected on account of various factors like slower power reforms and volatility in select raw material prices. This will result in a sharp rise in operating profits in the future.

The stock currently trades at Rs 99 implying a P/E multiple of 9.8x annualised 1QFY03 earnings. The restructuring initiatives and increasing emphasis on exports are a big positive for Indian Rayon. We expect the company to post a drop in sales in FY03 now that the insulator division would be hived off. But profitability will increase notably. Despite all these initiatives, the stock has been languishing at the current level for more than two years. While the standalone numbers are in favour of the company, on a consolidated basis, net profit in FY02 stood at a meager Rs 100 m. Insurance is relatively a new business and will take atleast six years to break even. PSI Datasystem continues to remain in the red (1QFY03 net loss at Rs 39 m).

Apart from loss making subsidiaries, Indian Rayon has been increasingly diversifying (Read Indian Rayon: New IDEAs). Instead of retiring its debts and rewarding investors (the buyback programme was postponed in FY02), the company's diversification strategy has raised serious concerns amongst investors. The fear is that the company would continue to fund Aditya Birla Group initiatives in the future (for instance, it invested Rs 880 m in IDEA Cellular). As a result, valuations may suffer going forward.

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