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Arvind Ltd: Costs override realisations - Views on News from Equitymaster
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Arvind Ltd: Costs override realisations
Aug 4, 2008

Performance summary
  • Topline grows by a tepid 6% YoY on the back of appreciable performance of the garmenting and retail business. Fabric business (54% of sales) continues to remain under stress.

  • EBIDTA margins contract from 14.9% in 1QFY08 to 10.1% in 1QFY09 due to cost pressure; higher cotton and power costs to exert pressure on profitability in the coming quarters.

  • Net margins (excluding the extraordinary items) marginally slipped from 1.1% in 1QFY08 to 1.0% in 1QFY09.

  • In the instruments qualifying for hedge accounting, the company incurred net unrealised loss of Rs 831 m accounted for as a hedging reserve, to be ultimately recognised in the profit and loss account when the underlying transaction arises.

  • Property measuring 88,100 square meters near Ahmedabad sold for a profit of Rs 52 m.


Standalone financials
(Rs m) 1QFY08 1QFY09 Change
Net sales 5,147 5,454 6.0%
Expenditure 4,382 4,906 11.9%
Operating profit (EBDITA) 765 548 -28.3%
EBDITA margin (%) 14.9% 10.1%  
Other income 8 124 1489.7%
Interest 355 322 -9.3%
Depreciation 354 294 -16.9%
Profit before tax 64 56 -11.6%
Extraordinary items - 16  
Tax 5 3 -45.8%
Profit after tax/(loss) 59 38 -35.9%
Net profit margin (%) 1.1% 0.7%  
No. of shares (m) 209.4 218.9  
Diluted earnings per share (Rs)**   0.9  
Price to earnings ratio (x)   40.2  
(*On a trailing 12-month basis)

What has driven performance in 1QFY09?
  • Denim fabric, which continues to be the mainstay in Arvindˇ¦s business, showed very little signs of improvement in volume take offs although the company managed to retain the momentum made in the denim realisations (improved from Rs 103 per metre in 1QFY08 to Rs 109 per metre in 1QFY09). On the volumes front, off-takes were lower by 7.5% YoY for the quarter. The shirting division, that is a supplier to the companyˇ¦s garmenting arm, also did not disappoint in realisations although volumes got impacted due to the slowdown in the garmenting business itself.

  • Arvind has not yet taken any call on relocating its 20 mm per annum denim unit at Khatrej (that has been shut down). The company intends to focus only on the premium and mid premium product segments and for regular market is exploring possibilities of moving manufacturing capacities to logical locations.

    Fabrics
      1QFY08 1QFY09 Change
    Denim      
    Volume (mm) 18.6 17.2 -7.5%
    Avg Price (Rs/mt) 103 109 5.8%
    Shirting      
    Volume (mm) 5.9 5.9 0.3%
    Avg Price (Rs/mt) 126 134 6.3%
    mm-million metres; mt-metre

  • Arvindˇ¦s garmenting business seems to be doing well in the shirts and knits categories while the jeans category had a record performance in volume terms. The profitability of the business was, however, impacted by higher airfreight and shortage of staff. „X While volumes in the branded garment space are not very enthusing, the company has not compromised on the realisations on the same, seeking its positioning in the premium category. Arvind is targeting a capacity of 12 m pieces in the garment business by FY09 and would follow that up with an addition of 50% of the capacity over the next 3 fiscals. We have been conservative in our future growth estimations in this segment considering the pressure on input costs.

    Garments
      1QFY08 1QFY09 Change
    Shirts      
    Volume (m Pcs) 0.8 1.0 26.3%
    Avg Price (Rs/pc) 362 387 6.9%
    Knits      
    Volume (m Pcs) 1.4 1.5 7.1%
    Avg Price (Rs/pc) 175 187 6.9%
    Jeans      
    Volume (m Pcs) 0.9 1.3 44.4%
    Avg Price (Rs/pc) 407 378 -7.1%
    Branded garments      
    Sales (Rs m) 707.9 959.3 35.5%
    m Pcs-million pieces; pc-piece

  • Steep power and cotton costs have taken a heavy toll on margins and the company seems to be unable to find a solution to the problem. Cost of power cost at Naroda plant is Rs 5.27 Kwh and at Santej is Rs 7.85 per Kwh as against previous year average of 4.10 and 4.80 respectively, thus showing a 50% hike in power costs.

  • The management has said cotton prices have gone up substantially in last one year (up 35%) against the fundamentals on back of global commodity boom. The prices of cotton are artificially high in spite of increased production and falling demand. Arvind has been managing production so far with inventory bought almost 2 years back. The cost of Indian cotton has for the first time in last two years crossed the international price of Rs 29,000 per candy (1 candy is equal to 356.6 kgs).

What to expect?
At the current price of Rs 35, the stock is trading at a multiple of 10.3 times and 0.8 times our estimated FY10 earnings and book value respectively. Given the fact that the company maintains a cautious outlook on its near term revenue and earnings, and the continued volatility in rupee-dollar rate, there is little visibility in the medium term. However, the policy of servicing the key markets with value added products and focused marketing of brands seems to be yielding positive results. The company is targeting to improve its net margins by 1% till the end of FY09. Despite the relative attractiveness of the stock to its peers in terms of price to book value, we maintain a cautious stance on the earnings potential of the company.

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