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Indian Rayon: Margins under pressure

Jul 28, 2004

Introduction to results
AV Birla Group Company, Indian Rayon, declared lacklustre results for 1QFY05. While the topline of the company grew by 23% YoY, the bottomline of the company declined marginally (down 3%). Operating margins also witnessed a slide of 280 basis points. However, an extraordinary income component rescued the bottomline hit, thus restricting the net profit margin fall to 140 basis points.

(Rs m) 1QFY04 1QFY05 Change
Net sales 3,390 4,153 22.5%
Other income 28 15 -46.4%
Expenditure 2,861 3,620 26.5%
Operating profit (EBDITA) 529 533 0.7%
Operating profit margin (%) 15.6% 12.8%  
Interest 43 40 -7.1%
Depreciation 209 197 -5.8%
Profit before tax 305 311 1.9%
Extraordinary items 40  
Tax 89 142 59.2%
Profit after tax/(loss) 216 209 -3.2%
Net profit margin (%) 6.4% 5.0%  
No. of shares (m) 59.9 59.9  
Diluted earnings per share (Rs)* 14.4 13.9  
P/E ratio (x)   17.2  
(* annualised)      

Company background
Indian Rayon is a diversified company under the A. V. Birla group. The company has presence in various sectors like viscose filament yarn (VFY), carbon black, garments, textiles, insurance and information technology. The company's presence in software (PSI Datasystems) and insurance (Birla Sun Life Insurance) are through its subsidiary holdings. It has hived off its insulator division into a separate joint venture with NGL of Japan.

What impacted performance in 1QFY05?
The garment business of the company grew by 20% during the quarter on the back of higher volumes (up 18%). The realisations for this segment also improved marginally (up 1%). Apart from launching some new collections in its power brands like Van Heusen and Louis Philipe, it has also launched Peter England suits in southern part of India.

Carbon black business witnessed a significant 48% YoY growth in the topline. While the volumes sale of the division grew by 64%, the realisations have come down because of elimination of import duty differential that earlier protected domestic producer from cheap imports. The divisionís 40,000 tonne carbon black brown field expansion has been commissioned in February 2004. So on a YoY basis, the revenues of this segment will remain on higher side for FY05.

Revenue mix
(Rs m) 1QFY04 1QFY05 Change
Garments 892 1,071 20.1%
PBDIT margins 7.8% 7.2%  
Carbon Black 747 1,107 48.2%
PBDIT margins 27.7% 17.9%  
VFY 686 753 9.8%
PBDIT margins 25.7% 26.0%  
Textiles 867 1,017 17.3%
PBDIT margins 5.2% 5.3%  
Insulators 135 180 33.3%
PBDIT margins 31.9% 22.2%  
Others 63 25 -60.3%
Total 3,390 4,153 22.5%

The VFY revenues grew by 7% during the quarter due to higher growth in the chemicals business. On the other hand, for VFY, the volumes grew by 7% YoY, but the realisations were lower (down 5%) due to cheap imports from China. The textiles business of the company witnessed a healthy 17% YoY growth on the back of higher growth in the flax yarn and fabrics.

Operating margins: Operating margins of the company declined by 280 basis points mainly due to poor performance of its carbon black business. As can be seen in the table above, the PBDIT margins of the carbon black business (down 930 basis points) is primarily due to pressure on realisations. Margins from the garment business have suffered a marginal 50 basis points as the company has increased its spending on advertisements (12% of sales in 1QFY05 compared to the average 7%-8% in the previous quarters), in order to increase its visibility well before the festival season starts. VFY and textile businesses have witnessed a marginal improvement in the PBDIT margins.

Net profit margins: The bottomline of the company declined by 3% due to lower other income and higher tax provisions during the quarter. The interest outgo of the company reduced on the back of the repayment of debentures worth Rs 1 bn and instead raising funds at cheaper rates. An extra ordinary income of Rs 40 m received due to the hive off of its global export division capped the bottomline fall of the company. However, excluding the extra ordinary income, bottomline of the company is down 22%.

What to expect?
At the current price level of Rs 240, the stock trades at P/E multiple of 17.2x annualised 1QFY05 earnings. The near term outlook for the company is challenging, as realisations for its carbon black and VFY segments are expected to remain under pressure. While we believe that the company is well positioned to capitalize on the growth opportunity on the core business front, the diversified nature is a key cause of concern. The company has had a track record of utilising its strong cash flows to fund diversification in the past. In this context, the risk profile of the stock is on the higher side from a retail investorís perspective.

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