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Grasim: An overview… - Views on News from Equitymaster

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Grasim: An overview…
Sep 27, 2006

Grasim, the diversified major has industry leading positions in almost all the business segments where it has a presence. The Company is the 3rd largest cement producer (standalone) with a total capacity of 13 million tonnes (MT). In 2003, Grasim acquired a 51% percent stake in L&T's cement division called CemCo and later re-christened it to Ultratech Cement. Post Ultratech acquisition, it became the 7th largest producer of cement in the world. Besides cement, it also has a monopolistic status in the VSF segment with a 24% market share. It is also the largest producer of sponge iron in India and has India’s 2nd largest caustic soda unit. Past performance:
Between FY04 and FY06, while the revenues of the company have registered a CAGR of 12%, operating as well as net profit margins have come under pressure and have dropped by 330 basis points and 200 basis points respectively and have stood at 22% and 14% of net sales respectively.

In terms of contribution to the topline, cement and VSF have remained top contributors over the last three years, accounting for on an average, 73% of the total revenues of the company on a standalone basis. However, while the contribution of VSF to the total topline has reduced from 30% to 26% between FY04 and FY06, it has increased from 44% to 51% for the cement division. Among other segments, while the contribution from chemicals has remained fairly unchanged (3%), share of textiles in the overall revenue pie has fallen marginally (4% to 3%) while that of sponge iron has declined from 12% to 9%.

As far as contribution to the company PBIT is concerned, record high cement prices have enabled the division to almost double its contribution from 27% to 53% to the overall PBIT of the company between FY04 and FY06. Performance of the VSF division has however been disappointing as its contribution to the company PBIT has shrunk from 48% in FY04 to 36% in FY06. Contribution from the sponge iron division also dropped sharply and accounted for just 3% of the total PBIT of the company during FY06 as opposed to a significant 20% in FY04. Among other divisions, while the textile segment continues to bleed, contribution from chemicals division improved from 5% to 9%.

On a consolidated level, thanks to the turnaround achieved by UtraTech, the topline has registered a CAGR of 34% between FY04 and FY06 while operating and net profit margins have declined by 370 basis points and 300 basis points respectively and stood at 20% and 10% respectively during FY06.

How each business performed in FY06
Cement Business: Higher capacity utilisation, increased sales volume, and better realisations have led to improvement in operating margins. Capacity utilisation was 105% in FY06 as against 95% in FY05. Also, as mentioned earlier, cement prices have been ruling at record highs owing to favorable demand supply situation thus enabling the division to post robust margins. Profitability of the company would have been even better but rising coal and furnace oil costs have put some downward pressure on margins.

VSF Business: It should be noted that demand for VSF moves in opposite direction to the demand for cotton as they are viewed to be a substitute for each other. Thus, global VSF prices were under pressure in FY06 due to bumper cotton crop. Further, the reduction in import duty (from 20% to 15%) and certain incentives also had a negative impact on realisations. Although sales volume increased by 12% owing to deemed and direct exports, VSF realisations were lower by 7% compared to previous year reflecting the lower prices of cotton and VSF globally. This coupled with the increase in the price of caustic soda, a key input, impacted the margins.

Chemical Business: The chemical business performance improved during FY06 Compared to the previous year (FY05). Sales growth was 2% during FY06 while the revenue growth was 10% for the same period as realisation of caustic soda increased in line with the international price trend.

Sponge Iron Business: The Sponge Iron business was affected mainly due to sharp rise in input costs such as iron ore, pellets and natural gas and lower sponge iron prices. Prices of iron ore and natural gas were raised by 10% and 25% respectively. Production fell by 35% during FY06 as compared to previous financial year, due to poor availability of natural gas. Due to correction in steel cycle and weak scrap prices, realisations were lower by 4% in FY06 compared to FY05.

What Next
To enhance its competitive edge, company plans to set up additional RMC units and captive power plants (to reduce the rising cost pressure) entailing an investment outlay of Rs 11 bn. It has also earmarked Rs 26 bn investment to set up 3 split grinding units; capacity expansion of UP cement plant by 1.5 MTPA (million tonnes per annum), setting up 4 MTPA greenfield cement plant and another 4 MTPA brownfield expansion (both in Rajasthan). As far as capex in other segments is concerned, to cater to growing demand of VSF in India and South Asian countries, the company is increasing its capacity by 50,000 tonnes at an investment of approximately Rs 4 bn.

At the current price of Rs 2517, the stock is trading at a P/E multiple of 20x its trailing twelve month earnings. Robust capex plans and softening of cement prices are likely to put pressure on the company’s cash flows in the medium term. Moreover, with most of its products being commodities, we believe the current valuations are at the higher end of the spectrum and as such see very little upside from the current levels.

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