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Eastern Silk: So far so good - Views on News from Equitymaster

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Eastern Silk: So far so good
Sep 5, 2006

Performance summary
Eastern Silk Industries, the second largest exporter of silk garments and fabrics from the country, was amongst the few textile companies to post enthusing results for 1QFY07. New capacities, higher utilisation and a change in product mix have helped the company improve its operating as well as net profit margins by 400 basis points each. More importantly, lower tax incidence and insulation from foreign exchange risks have augured well for the company’s bottomline.

(Rs m) 1QFY06 1QFY07 Change
Net sales 867 1,130 30.4%
Expenditure 744 926 24.5%
Operating profit (EBIDTA) 123 204 66.1%
EBIDTA margin (%) 14.1% 18.0%  
Other income 15 22 46.7%
Interest 31 37 19.4%
Depreciation 17 31 82.4%
Profit before tax 90 158 76.0%
Tax 6 14 133.3%
Profit after tax/(loss) 84 144 71.9%
Net profit margin (%) 9.6% 12.7%  
No. of shares (m) 7.2 15.5  
Diluted earnings per share (Rs) 46.7 37.0  
Price to earnings ratio (x)   5.8  

Company background
Eastern Silk Industries, established in 1946, is one of the leading exporters of silk fabrics from India. It is present across the entire value chain from yarn to basic and design fabrics to embroidered fabrics to made-ups. It caters to the specialised requirements of fashion labels (for garments and accessories) and furnishing companies. The company garners 70% of its revenues from exports, of which consumption in the US and Europe account for about two-third of its export despatches. The company has realigned its portfolio mix in favour of larger volume furnishing fabrics (75% of revenues in FY06) as compared to small volume fashion apparel fabrics. It has also embarked on various initiatives such as capacity expansion, forward integration, inorganic growth and greater market reach so as to align its margins with that of the market leader (Himatsingka Seide).

What has influenced performance in 1QFY07?
Volume-value chain play: Eastern Silk’s efforts of capitalising on higher volume for the furnishing fabrics and on value added products for the apparel as well as home fabric segments has started paying off well. The company has realigned its portfolio mix in favour of high volume furnishing fabrics as against low volume fashion apparel fabrics. Sales contribution from furnishing fabrics increased from 40% in FY04 to 80% in FY06. Also, within furnishings, the existing 85:15 split between fabrics and made-ups (value add products) would become 70:30 following the successful commissioning of the Bangalore capacity (of 1,500 pieces a day) in 4QFY07.

The company has embarked on various initiatives such as capacity expansion, forward integration and market diversification to chart its growth trajectory. It is expanding its fabric capacity including double width jacquard and velvet fabrics by 0.5 mmpa (million metres per annum). The new madeups facility will use almost the entire expanded fabric capacity, thus leading to better utilisation, instead of relying on external buyers. Also, this will increase sales realisation from in-house production and reduce dependence on outsourced low-margin fabric production. Besides, the profitability will also improve due to a shorter operating cycle. Further, the company is progressing well on its goal to increase its realisation from US$ 5 per metre for handloom fabrics to US$ 12 per meter for embroidered fabrics and to US$ 21 per meter for made-ups. We believe that this volume-value chain play will help the company position itself very favourably amongst the most efficient textile companies in the country.

Over the quarters… Eastern Silk is well on the track of aligning its margins with that of its peer Himatsingka Seide, which enjoys one of the best operating margins in the textile sector. The operating margins of the company improved by as much as 390 basis points over that of 1QFY06. This was primarily because besides the higher realisations, Eastern silk was able to bring down its operating costs to 82% of sales in 1QFY07 from 86% in 1QFY06. Eastern Silk achieved this by reducing reliance on outsourced jobs and building in-house production capacities. The mix of the company's in-house to outsourced production, which was largely skewed towards the latter earlier, has considerably reduced due to the capacities acquired during the merger (with Sstella Silk and Eastern Jingying) and the commissioning of fabric capacity at Anekal (Unit II) in 1QFY07.

Vs other textile players: What clearly distinguishes Eastern Silk against other players in the textile sector is the hedge that it enjoys against foreign exchange volatility. Firstly, its outsourced yarn requirement is entirely imported and secondly, nearly 70% of the company's turnover is derived from exports. Given that the export revenues cover the import liability and work as a natural hedge, the company’s forex risks are limited to that extent. As a result, while forex losses have bled the profit margins of most textile companies (including the larger ones) in this quarter, Eastern Silk remained largely insulated on this front.

Sustainability issues: Eastern Silk garners 70% of its revenues from exports, of which consumption in the US and Europe account for about two-third of its export despatches. With the signs of slowdown in the US and European economies, the risk of lower demand from these markets going forward looms large. An oversupply to these markets may also impact the company’s realisations.

What to expect?
At the current price of Rs 220, the stock is trading at an attractive valuation of 6.1 times our estimated FY08 price to earnings multiple. Higher capacity in fabrics and made-ups, better realisations and enhanced product mix position Eastern Silk very favourably to compete against its peers. While market leaders like Himatsingka Seide are witnessing margin suppression and lower incremental growth due to concentrated customer base and limited product portfolio (only machine made fabrics), Eastern Silk is well poised to enjoy better margins and higher growth due to its diversified portfolio and wide customer base. Nonetheless, as mentioned earlier, an economic slowdown in the major markets and the resultant pressure on realisations cannot be ignored.

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