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Grasim: 'Steel' in numbers

Jul 28, 2004

Introduction to results
Grasim Industries announced its 1QFY05 results today. Backed by almost doubling of sales of sponge iron and robust growth in cement division sales, topline increased by 29% YoY. For the second quarter in succession, the sponge iron division saw PBIT margins in excess of 40%, which was the primary reason for margin improvement.

(Rs m) 1QFY04 1QFY05 Change
Net sales 11,747 15,171 29.1%
Other income 211 163 -22.8%
Expenditure 9,065 10,870 19.9%
Operating profit (EBDITA) 2,682 4,301 60.4%
Operating profit margin (%) 22.8% 28.4%  
Interest 391 329 -15.8%
Depreciation 670 698 4.2%
Profit before tax 1,832 3,437 87.6%
Extraordinary items (27) - -
Tax 500 1,245 149.0%
Profit after tax/(loss) 1,305 2,192 68.0%
Net profit margin (%) 11.1% 14.4%  
No. of shares (m) 91.7 91.7  
Diluted earnings per share (Rs)* 56.9 95.6  
P/E ratio (x)   10.1  
(* annualised)      

Background
Grasim is one of the Aditya Birla Group company and has leadership position in four of its five businesses. The company has presence in viscose staple fiber or VSF (33% of sales in FY04), cement (45%), sponge iron (12%), chemicals (6%) and textiles (4%). While the company is a world leader in VSF with a 24% market share, it is also the seventh largest producer of cement in the world with a total capacity of 31 MT (nearly 22% of the country's capacity). It achieved the latter distinction only recently, when it acquired L&T's cement capacity for a net investment of Rs 22 bn.

Segmental snapshot...
(Rs m) 1QFY04 (% sales) 1QFY05 (% sales) Change
VSF 3,825 32.2% 4,954 31.9% 29.5%
Cement 5,721 48.2% 6,823 43.9% 19.3%
Sponge iron 1,258 10.6% 2,500 16.1% 98.6%
Chemicals 539 4.5% 725 4.7% 34.5%
Textiles 521 4.4% 524 3.4% 0.7%

What has driven performance in 1QFY05?
Sponge iron propels growth: One of the key factors behind Grasim's impressive 1QFY05 numbers is the robust growth in sponge iron sales. The firmness in the steel cycle globally has helped Grasim to double revenues from sponge iron, which was once a drag on its overall profitability (prices higher by 61% YoY). As is evident from the segmental margin trend graph below, this division had 40% plus EBIT margins for the second quarter in succession. Though this division accounted for only 16% of sales, the contribution to the overall EBIT stood at 30%. While this is a positive for now, once the steel cycle softens, this kind of margins may evaporate.

Growth push from VSF and cement also helped matter: Despite the 40 day lock-out of the fibre division, VSF sales have increased by 30% and are accompanied by a 19% growth in cement sales. Though volume growth has been slower than expected, the pricing environment for cement has been favorable (up 13% YoY for Grasim), thus benefiting the market leader in the industry. The industry has seen recovery in volumes starting late 3QFY04. On the EBIT margin side, while cement division saw a significant YoY improvement, they were stable on a QoQ basis. Due to the lockout in the fibre division, the VSF division saw a 400 basis points YoY decline in EBIT margins.

Net margin higher despite lower other income: Profit before tax increased by 88% despite a 23% decline in other income on account of lower interest cost. While the long-term outlook for cement and VSF divisions' margins is positive, we are cautious about continued improvement in sponge iron margin beyond FY05. Since this division has accounted for a large share of profits in the last one and half years for Grasim, overall margins may remain at the current level.

What to expect?
The stock currently trades at Rs 970 implying a P/E multiple of 10.1x annualised 1QFY05 earnings. We expect a favorable pricing environment for the cement division combined with a better demand growth prospects in FY05 as compared to FY04 when the industry sales grew only by 5%. Synergies from the L&T acquisition are likely to result in cost savings to the tune of Rs 1 bn as well, which means that the margin outlook is positive. While the near-term firmness in steel prices is visible, the benefit could evaporate in the future. This might keep overall EBIT margins under check. From a long-term perspective, the acquisition of L&T's cement division, though costlier, has placed Grasim in a very competitive position.

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