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Arvind Mills – Visit note
Sep 19, 2005

We met with the management of Arvind Mills in Ahmedabad last week to understand the denim cycle, how the company hopes to de-risk revenues going forward and the growth drivers, post the quota-free regime. We also visited the denim manufacturing plant in Ahmedabad (90 million metres - mm) of capacity or 75% of overall capacity of the company). Here are the key takeaways. What is the company’s business?
Arvind Mills is India’s largest denim manufacturer and exporter, with a total capacity of 120 mm, after taking into account the recent 10 mm expansion at Santej. The company also ranks among the top three denim producers worldwide. It manufactures and sells textiles and ready to wear garments as well. The total fabric production capacity at 34 mm is big, even by world standards. While the company has been hitherto been focusing on fabric and denim production, it has aggressively entered the garmenting and knits businesses.

In a very important step, through a GDR issue, the company has acquired ICICI Venture’s stake in Arvind Brands recently. After this, the company hopes to grow its readymade branded garments business significantly in the next three years, given that the company is now fully under its control.

Denim – Industry structure…
The total domestic denim capacity stands at 350 mm in FY05, which five years before, was around 200 mm. Of this expansion in capacity, the top two players viz. Arvind Mills and Raymond accounted for 30 mm each or 40% incremental capacity share. The industry is cyclical in nature, i.e. global fashion trends influence denim prices. As against the current price of Rs 102 per meter for Arvind Mills, prices in the mid-1990s touched around Rs 96 per meter. Looking below the top two players, Aarvee Denim and KG Denim have capacities of 45 mm and 20 mm respectively. These two players, till now, have been largely domestic players, while Aarvee is looking at growing exports.

The top four players therefore, command 64% of the industry capacity with smaller players having capacity of 10 mm and 20 mm. Almost 50% of the industry production is exported, with the contribution higher at 60% for Arvind. If one looks at the global scenario, the US consumed 45% of total production typically and has a big say on denim prices. Retail demand therefore, in the US is an important lead indicator to that extent.

Since the expansion in denim facilities is generally considered economical at 10 mm, the cost of setting up such a facility is Rs 700 m, which excludes spinning and land. Of this, 50% of the cost can be typically attributed to weaving machinery (Rs 1.8 m per loom). But if it is a green-field expansion, the cost increases to Rs 1.5 bn.

Arvind and Denim…
Against the current capacity of 110 mm, which will shortly touch 120 mm, denim is one of the largest denim manufacturers in the world. Out of 110 mm, around 37 to 40 mm are direct value-add denim i.e. rope dyed denim. Value-add denim commands around Rs 6 to Rs 7 per meter premium to normal the denim fabric. The company also does value-addition in the rest of the capacity by altering the dyeing and weaving process. According to the company, the key differentiating factor in denim manufacturing is weaving and dyeing, where Arvind has developed few patented technologies.

Arvind Vs Raymond…
When asked the difference between Raymond and Arvind Mills, the company opined that the entire manufacturing facility of Raymond is in the higher value-add segment. Therefore, realisations per meter are higher than Arvind. But in terms of net margins, Arvind ranks higher owing to one key reason. Arvind has developed a technology (patented one) by which it is able to manufacture the same quality output as Raymond by using inferior quality of cotton. This results in lower raw material costs to sales and therefore, relatively better margins.

Three key strategic decisions taken in the last three years…

  1. Shifting of plant from Mauritius to India: The key purpose of this facility was to benefit from the AGOA (African Growth and Opportunity Act). The fabrics and garments manufactured in these regions were eligible for duty free and quota free access to the key markets of North America and Europe. But given the postponement of the implementation of this act, the company decided to bring back the machinery into India and close the Mauritius operations.

  2. Foray into garmenting: The company has set up a garmenting facility in Bangalore (4 m pieces of denims, 4.5 m pieces of shirts, around 4 m knits and 1.5 m of trousers on a single-shift basis).

  3. Purchase of brands: i.e. bought out ICICI Venture’s stake in Arvind Brands (a subsidiary) through the proceeds from the GDR issue. This would enable the company to have full control over the branded garments business, which it hopes to grow faster going forward.

Other highlights…

  1. The company has one of the largest fabric manufacturing capacities in the world at 34 mm of shirtings and around 3,600 tonnes of knits at the Santej facility. The company aims to increase knitting capacity over the long-term and expects faster growth in the next three years.

  2. As far as the branded garments business is concerned, the total estimated domestic market size is Rs 220 bn, of which the company’s turnover stands at Rs 4 bn (Arvind Brands). Of this, Rs 1.6 bn to Rs 2.0 bn is accounted by ‘Lee’ and ‘Arrow’. The company has licensed these brands into India (the last renewal of license was two years earlier).

  3. The company expects softer cotton prices next year, given the yield. This is expected to result in raw material cost savings. It also expects cost rationalisation in selling & distribution, salaries and chemicals over the next three years.

  4. Capital expenditure is estimated at Rs 3.5 bn over the next three years of which Rs 1.5 bn is towards maintanence capex. The company does not foresee any need to borrow money to fund this capex.

What to expect?
The stock is currently trading at Rs 140, implying a price to earnings multiple of over 20 times FY05 earnings. We will update the research report with our new buy/sell limits this week.

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