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Welspun India: Battling forex volatility - Views on News from Equitymaster

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Welspun India: Battling forex volatility
Oct 22, 2007

Performance summary
  • Topline grows by meager 6.4% YoY in 2QFY08, largely impacted by appreciation in the value of rupee against the US dollar.

  • EBIDTA and net profit margins fall from 17.6% and 5.5% in 1HFY07 to 15.0% and 4.7% respectively in 1HFY08, largely due to the higher interest and depreciation costs on account of the company’s expansion phase.

  • Other income boosted by mark to market forex gains.

  • Higher volume, lower DEPB rates and benefits from Christy yet to filter in.

Standalone financial snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 2,761 2,938 6.4% 4,748 5,585 17.6%
Expenditure 2,338 2,470 5.6% 3,911 4,750 21.5%
Operating profit (EBIDTA) 423 468 10.6% 837 835 -0.2%
EBDITA margin (%) 15.3% 15.9%   17.6% 15.0%  
Other income 124 148 19.4% 81 272 235.8%
Interest 118 157 33.1% 226 312 38.1%
Depreciation 157 207 31.8% 301 402 33.6%
Profit before tax 272 252 -7.4% 391 393 0.5%
Tax 89 84 -5.6% 132 132 0.0%
Effective tax rate (%) 33% 33%   34% 34%  
Profit after tax/(loss) 183 168 -8.2% 259 261 0.8%
Net profit margin (%) 6.6% 5.7%   5.5% 4.7%  
No. of shares (m) 73.1 73.1   73.1 73.1  
Diluted earnings per share (Rs)*         7.2  
Price to earnings ratio (x)         8.9  
*(on a trailing 12-month basis)

What is the company’s business?
Welspun India is Asia's largest and world’s fourth largest manufacturer of terry towels (accounted for 79% of FY06 revenues). A wide product range, fully integrated capacities and the ability to offer value added products make the company a preferred supplier to major retailers in the EU and the US. Welspun also has marketing licences for the 'Nautica' and 'Tommy Hilfiger' brands and owns the 'Spaces' brand in India. The company's foray into bed linen is a step towards positioning itself as a single-point vendor in home textiles. It is a flagship company of the Welspun Group, with promoters holding a 34% stake. In 1QFY07, Welspun India bought 85% stake in CHT Holdings Limited, the holding company of UK's leading towel brand Christy**.

** Founded in 1851, Christy is the world's oldest towel manufacturer and is the UK's leading towel brand with an annual turnover of £ 35 m (Rs 3 bn). It is UK’s leading producer of branded terry towels and bed linen products. The company supplies to a wide range of retailers in the UK and overseas and is the sole supplier to Wimbledon Tennis Championships. The company employs 464 people.

What has driven performance in 2QFY08?
Towels – All but margins: Improved capacity utilisation in the towel segment (93% in 2QFY08), has led to Welspun capitalise on higher volumes despite the pressure on realisations. For the towel division, the company has been consuming 75% of its in-house yarn supplies, which it believes, in conjunction with the strong order book position, will enable sustained sales growth going forward. The completion of the phase II of its expansion (currently 35,000 tonnes capacity) will offer strong volumes to the towel division thus making up for the realisation concerns. The toweling division sustained EBIDTA margin of 21% during 2QFY08 (22% in 1QFY08). The lower margins over that of last year has been largely attributed to the 10% appreciation in the rupee against the US dollar, of which 7% has been made up for by higher volumes. The same is expected to enhance going forward as the benefit of ‘Christy’ acquisition (including the shift of the latter’s manufacturing capacity to Anjar, Gujarat) starts filtering in. Some of these will include access to a premium brand and incorporation of product development skills besides access to the leading retail stores in the UK and European markets. This will be coupled with the opportunity to rationalise Christy’s sourcing requirements and extend the brand to the domestic customers through Welspun’s retail stores.

Segmental performance
  Towel Bed sheet
  2QFY07 2QFY08 Change 2QFY07 2QFY08 Change
Capacity utilisation 90.0% 93.0%   60.0% 70.0%  
Volume (tonnes, mm) 6,320 7,237 14.5% 5.7 6.5 15.0%
Realisation 245 238 -2.9% 158 142 -10.1%
EBIDTA margin 21.0% 18.5%   13.0% 14.5%  

Bed linen – Realisations falter: Welspun’s bed linen segment, which accounted for approximately 12% of turnover in FY07, grew by 15% YoY in volume terms during 2QFY08. Realisations in this segment dropped by 10% YoY despite the high value business acquired from clients. The commissioning of Phase–II of the Anjar capacity will add to the bed linen capacity of the company, nearly doubling it to 45 MMPA (m metres per annum). The decorative bedding segment is also expected to be revenue accretive, as this will fetch the company realisations that will be much higher than that in the bed linen segment currently. The EBIDTA margin in the sheeting segment that has improved by 1.5% in the last 12 months is expected to improve further as the segment achieves optimum utilisation levels.

Additionally, in order to avail North American Free Trade Agreement (NAFTA) benefits and to save on freight costs, Welspun has decided to put up a decorative bedding facility in Mexico to produce 1.04 m bed-sets per annum, which is likely to be commissioned by 3QFY08.

The net debt on the company’s books at the end of 1HFY08 was to the tune of Rs 13 bn (under Technology Upgradation Fund – Rs 6.2 bn at 5% rate) and the debt to equity ratio was about 2.3 times.

Phase II expansion
Segment Capacity Likely completion Total capacity
Towels 16,500 tons 1QFY08 41,000 tons
Bed linen 10 m metres 4QFY08 45 m metres
Decorative bedding 0.72 m sets 2QFY08 0.72 m sets
Spinning 46,800 spindles 2QFY08 1,04,296 spindles

Other income – Forex benefit: Welspun is affected by cross currency fluctuations, as nearly 92% of the company's production is exported (last year Welspun’s average realisation was at Rs 45 per US dollar, in 1QFY08 it was at Rs 43.2 and in 2QFY08 at Rs 41.4). It also does not have any natural hedge, as the company has no import liabilities. The company has now reduced its forward cover to quarterly duration (3 months’ sales) and has booked mark-to-market forex profits in 1HFY08 to the tune of Rs 100 m that has been included under other income. Going forward, we envisage the fluctuations in currency rates to impact the company’s other income.

‘Powering’ growth: Welspun India earlier generated power in its captive power plant with the help of furnace oil, the price of which was directly linked to that of crude oil. Thus, to rationalise its power costs, the company set up a gas-based power plant in Vapi (catering to 40% of its power requirements), for which, it has entered into a gas supply agreement with Gujarat Gas. The Vapi operations have moved on gas as a fuel in 2QFY08 and the benefit of this will come in 2HFY08. The gas-based power plant will reduce the power cost to 2.5 to Rs 3 per unit, against Rs 4.5 per unit currently. For the remaining 60% power requirement, all the companies of Welspun Group will form an SPV, which will promote a lignite based power plant in Anjar. The other important thing that the company has achieved is the reduction in the working capital cycle from 147 days in 1QFY08 to about 127 days in 2QFY08 and Welspun hopes to maintain this going forward.

Combating competition: Primarily, there are 5 countries that are meaningful on the towel side. India, Pakistan and China which are about 60% of global exports of which India contributes 25% of global exports on towels followed by China (22%), Pakistan (17%) and Brazil and Turkey (together 9-10%). On the sheeting side, India, Pakistan and China contribute about 82% of global trades of which China’s share is close to 30%, Pakistan 27% and India is about 25%. Further, due to the political uncertainty in Pakistan and the lower end of the segment being catered to by that country, the competition for the premium segment is between China and India.

What to expect?
At the current price of Rs 65, the stock is trading at a multiple of 7 times our estimated FY10 earnings. The company has hived off its retail business (through Spaces and Home Mart outlets), through which it is targeting a turnover of Rs 400 m (over 70,000 sq feet retail space in 80 stores by FY08). The revenue in the retail segment is on an average Rs 12 to 15 per square feet per day. Also, 35% of its business is expected to be sourced though the branded home textile segment. Keeping in mind the company's strong presence in the home textile industry, global markets and capacities (through Christy) and future growth prospects, Welspun remains our preferred play amongst the mid-tier textile companies.

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