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Arvind Mills: Raw material pressure

Jul 27, 2004

Introduction to results
Textiles major, Arvind Mills, has posted lackluster results for 1QFY05. Despite the topline registering a growth of 6% YoY, the bottomline has witnessed a decline of 35% during the quarter. Both, operating as well as net profit margins of the company, are lower as compared to the same period last year (down 380 and 290 basis points respectively).

(Rs m) 1QFY04 1QFY05 Change
Net sales 3,733 3,959 6.0%
Other income 23 1 -94.4%
Expenditure 2,750 3,068 11.6%
Operating profit (EBDITA) 983 891 -9.4%
Operating profit margin (%) 26.3% 22.5%  
Interest 354 336 -5.1%
Depreciation 371 367 -1.2%
Profit before tax 281 189 -32.7%
Tax - 7  
Profit after tax/(loss) 281 182 -35.3%
Net profit margin (%) 7.5% 4.6%  
No. of shares (m) 195.4 195.4  
Diluted earnings per share (Rs)* 5.7 3.7  
P/E ratio (x)   20.4  
(* annualised)      

Business profile of the company
Arvind Mills is the world's third largest and India's largest denim producer with 90 mm (million meters) of denim rolling out every year. The company is also into knit and shirting. The company has recently started manufacturing bottom-weight fabric also. Apart from textiles, Arvind Mills has a presence in ready-to-wear, agrochemicals and telecom sectors. The denim division contributes to more than 60% of the company's revenues and 50% of the denim produced is exported. In high value cotton shirting (HVCS), it has a production capacity of around 30-mm and the segment contributes to around 20% to the company's topline. Currently, Arvind Mill's capacity utilisation levels are close to 85%-90%. The margins from this segment are volatile depending on cotton prices. Garmenting is another key focus area of the company.

What has dented performance in 1QFY05?
The topline of the company grew by 6% YoY on the back of higher sales of its shirting and knitting business. The denim segment witnessed a revival in international demand and as a result, the volume sales of denim surged by 25% QoQ and 4% on YoY basis. (Earlier Arvind had shifted some of its denim production capacities to shirting because of a weak denim demand) However, the realisations remained on the lower side as compared to same quarter last year.

Shirting business on the other side witnessed a growth in volumes (up 1%) as well as realisations (up 15%). Currently, the HVCS capacities are operating at optimal level. The company is also carrying out de-bottlenecking on certain key production functions in order to achieve the rated capacity of 34 mm, which will enable the company to meet the enhanced internal requirements for the additional 2.4 m pieces ready-to-wear shirt production capacity.

It must be noted that the company has taken initiatives to enter ready-to-wear segment with the setting up of the garment manufacturing capacity of 2.4 million pieces per annum at Banglore. Knitting business of the company has witnessed a significant YoY growth of 59%. Arvind Mills has entered into a tie-up with major international brands like Nike and Banana Republic for supplying knitting fabrics. The knits business has a robust order book position as on June 2004. The company also added some new customers in order to diversify its markets.

Operating margins The operating margins of the company declined by around 380 basis points as compared to the same quarter last year. Since cotton is the most important raw material for denims and shirting, higher cotton prices adversely affected the company's operating margins. Increased naphtha prices (because of higher global crude prices) for its captive power plant also dented company's operating performance (fuel as percentage of sales stood at 13% this quarter as compared to 11% last year). Lastly, lower denim realisations also had its share in adversely affecting the operating margins of the company.

Net profit margins The bottomline of the company declined by 35% YoY because of the trickle effect of lower operating margins and lower other income. The company has not provided any specific reason for the lower other income during the quarter.

What to expect?
At the current price level of Rs 76, the stock trades at a P/E multiple 20.4x annualised 1QFY05 earnings. With international markets opening up post 2005, the growth opportunity for a fully backward integrated company like Arvind Mills is promising because of its cost competitiveness. Though the company has reduced some of its debts by converting them into equity, it has led to earnings dilution. Undoubtedly, the company has benefited from the restructuring exercise in the last two years. However, the relatively higher debt component in the balance sheet and the inherent volatility in the textile business increase the risk profile of the stock.

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