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Raymond: Tough times

Oct 25, 2004

Performance summary
Raymond India, one of the country's leading textile players, has reported subdued numbers for the second quarter ended September 30, 2004. While net sales are higher, owing to higher raw material costs (especially for its files division), operating margins have declined sharply. Lower other income has not helped matters either. We will have to revise our earnings estimates for FY05 downwards post the 1HFY05 results.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 2,980 3,390 13.7% 4,713 5,266 11.7%
Expenditure 2,410 2,985 23.9% 3,906 4,852 24.2%
Operating profit (EBDITA) 571 405 -29.1% 806 413 -48.8%
EBDITA margin (%) 19.1% 11.9%   17.1% 7.8%  
Other income 131 150 14.3% 281 348 23.7%
Interest (34) 50 - (61) 72 -
Depreciation 156 140 -10.1% 304 273 -10.2%
Profit before tax 580 364 -37.2% 844 415 -50.8%
Extraordinary income/(expense) - 6 - - 6 -
Tax 185 50 -73.1% 240 70 -70.9%
Profit after tax/(loss) 395 320 -18.9% 604 352 -41.8%
Net profit margin (%) 13.2% 9.5%   12.8% 6.7%  
No. of shares (m) 61.3 61.3   61.3 61.3  
Diluted earnings per share (Rs)* 25.8 20.9   19.7 11.5  
Price to earnings ratio (x)         20.6  
(* annualised)            

What is the company's business?
Raymond is India's largest and world's third largest integrated manufacturer of wool and wool blended fabrics with production capacity of 24 mm (million meters). It is the domestic market leader in files and tools with around 80% market share. The company is the second largest denim producer in the country with a capacity of 20 million meters (mm). It has a widespread distribution network across the country, which it can leverage to sell some of its well-recognised brands.

What has driven performance in 2QFY05?
Denim shows the way:  The denim division has reported a 39% growth in sales in 2QFY05. Basically, this growth is accruing from capacity expansion, which the company has been undertaking over the last two years (from 10 mm in FY03 to 20 mm FY04, which is to be expanded further by 5 mm in FY05). Though denim prices have not strengthened significantly in the recent past, Raymond has benefited from a better export mix. The textile division has also posted higher growth in 2QFY05 at 7%. A combination of retail outlet expansion and higher growth from branded garments has been the main growth driver. The textile business is seasonal in nature (second half typically witnesses higher growth in sales) and therefore, we expect growth to accelerate in the second half.

Segmental snapshot...
(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Textiles 2,259 2,407 6.6% 3,334 3,485 4.5%
PBIT margins 22.2% 18.7%   19.6% 15.8%  
Denim 435 605 38.9% 838 1,079 28.8%
PBIT margins 6.5% 8.7%   10.4% 7.8%  
Files & Tools 295 382 29.5% 558 713 27.7%
PBIT margins 7.2% -1.1%   9.4% 1.6%  

Higher steel prices impact margins:  In 1QFY05, all the three majors divisions of Raymond posted a sharp drop in PBIT margins. While the pressure on the denim and textile margins could be attributed to the strengthening of cotton prices, robust steel prices impacted margins of the files division (graph below). While margins have improved for textiles and denim divisions in 2QFY05, the files division has posted a loss at the PBIT level. With steel prices showing no signs of weakening, the pressure on margins is likely to continue. Since the files division is mature in nature, the company does not have the bargaining power with the customers to pass on the rise in input costs.

Lower other income impacts net profit margins:  While other income has increased, net interest charge has risen sharply (this includes the interest component as well). While we had factored in a 28% fall in other income in our estimates for FY05, on the margin side, the company has underperformed. We have to revise our margin estimates downwards for FY05 post the 1HFY05 results.

What to expect?
The stock currently trades at Rs 237 implying a price to earnings multiple of 20.6 times 1HFY05 annualised earnings. While the topline growth is likely to be higher in 2HFY05, the pressure at the margin level is unlikely to reduce, considering the firmness in steel prices. The additional expenses incurred towards expanding the denim capacity will also have a impact on margins. Raymond is well placed to capitalise on the long-term growth opportunities emanating from the post 2005 quota regime. Besides, the company's strong presence in the fast-growing branded garments side is also a positive. Nevertheless, the out-performance of the stock in the recent past and the aforesaid near-term risks could weigh on the stock price for sometime.

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