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Grasim: Cement to the rescue - Views on News from Equitymaster
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Grasim: Cement to the rescue
Oct 26, 2005

Performance Summary
Grasim, the diversified major of the Aditya Birla Group, has declared poor results for the quarter ended September 2005. While the topline of the company witnessed a mere 5% YoY rise during the quarter, operating margins came under considerable pressure and declined by 460 basis points. The effect of this has trickled down to the bottomline, which was lower by 7% YoY despite lower financial charges.

Consolidated financial performance snapshot…
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net Sales 22,217 23,277 4.8% 45,015 47,958 6.5%
Expenditure 17,218 19,114 11.0% 34,685 38,145 10.0%
Operating Profit (EBDITA) 4,999 4,163 -16.7% 10,330 9,812 -5.0%
EBITDA margin (%) 22.5% 17.9%   22.9% 20.5%  
Other income 382 447 17.1% 895 1,202 34.3%
Interest 704 540 -23.4% 1,392 1,106 -20.6%
Depreciation 1,484 1,374 -7.4% 2,832 2,728 -3.7%
Profit before tax 3,193 2,696 -15.5% 7,001 7,181 2.6%
Tax 1,121 687 -38.7% 3,049 1,884 -38.2%
Profit/(Loss) before minority interest 2,072 2,009 -3.0% 3,952 5,296 34.0%
Minority interest (80) 5   (288) 331  
Profit/(Loss) after tax and minority interest 2,152 2,004 -6.9% 4,240 4,965 17.1%
Net profit margin (%) 9.7% 8.6%   9.4% 10.4%  
No. of Shares (m) 91.7 91.7   91.7 91.7  
Diluted earnings per share*   87.4     108.3  
Price to earnings ratio (x)   13.2     10.6  
(* annualised)            

What is the company’s business?
Grasim is one of India's premier diversified companies with presence in five business segments. However, the company derives most of its revenues from two businesses viz. VSF (31% of FY05 turnover) and cement (44% of FY05 turnover). While the company is amongst the top two producers in the world in VSF with more than 12% market share, it is also the eighth largest producer of cement in the world with a total capacity of 31 MT (nearly 20% of the country's capacity). It achieved the latter distinction only recently, when it acquired L&T's cement capacity (thereafter listed as separate company called Ultratech Cement) for a net investment of Rs 22 bn. The company's other businesses include sponge iron, textiles and chemicals. On a consolidated basis, cement contributes to over 60% of the company’s revenues.

What has driven performance in 2QFY06?
Cement saves the day: The consolidated topline growth of the company during the quarter was rather subdued at 5% YoY, which could be attributed to the decline in revenues witnessed in its VSF and sponge iron businesses. While revenues from the former were lower by 3% YoY during the quarter, the sponge iron division ended the quarter with revenues lower by 25% YoY. It must be noted that since these two segments contribute to about 1/3rd of the company’s revenues, the poor performance by them put pressure on the company’s topline.

Segmental revenue snapshot…
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
VSF 5,282 5,137 -2.7% 10,355 9,473 -8.5%
Cement 12,971 14,453 11.4% 26,964 30,922 14.7%
Sponge Iron 2,275 1,704 -25.1% 4,775 3,908 -18.1%
Chemicals 814 1,041 27.9% 1,538 2,036 32.3%
Textiles 777 737 -5.2% 1,301 1,264 -2.8%
Others 439 548 25.0% 777 1,093 40.7%
Total 22,557 23,620 4.7% 45,709 48,696 6.5%

The poor performance by the VSF business was on account of VSF realisations weakening by 9% YoY during the quarter owing to lower cotton prices. However, the 4% increased volume sales, which could partially be accredited to the EU and US embargo on Chinese exports that lent a helping hand.

As far as the dismal performance of the sponge iron division is concerned, the company faced significant pressure on the volumes front. A sharp 38% YoY fall in production owing to disruption in supplies of natural gas led to lower volume sales by the company. Thus, despite the 2% higher realisations, the 28% YoY fall in sponge iron volume sales led to this division’s revenue contribution being lower by 25%. It must be noted that the average availability of natural gas during 2QFY06 was affected owing to the fire at ONGC’s Mumbai High terminal, which in turn affected the gas supply from GAIL.

Despite the above, the consolidated topline of the company was higher during the quarter, thanks to the 11% YoY growth in revenue of the company’s cement division, which contributes to almost 60% of the company’s total operating revenues. However, it must be noted that it was primarily the good performance by Grasim’s (the standalone entity) cement division that helped improve the overall picture. This is because, Ultratech, the 51% subsidiary of Grasim, was adversely affected due to the floods at the company’s plant in Gujarat and planned shutdown for maintenance of each of its production lines. As far as Grasim’s standalone cement performance is concerned, 7% higher volume sales and 3% better realisations helped the revenues to grow 11% YoY.

VSF and sponge iron drag margins: The poor performance of these divisions did not stay restricted to the topline level alone. Their gloomy performance had a critical role to play in nullifying the benefits derived from the cement division. Just to put things in perspective, while PBIT margins of the VSF division collapsed from 31% in 2QFY05 to 21% in 2QFY06, the PBIT margins of the sponge iron division nose-dived into the negative (-5%) from 29% in the corresponding quarter of the previous fiscal. Contrary to this, while the margins of the cement division improved by 270 basis points, the chemicals division also lent a helping hand with margins improving here by about 910 basis points.

Segmental PBIT margins…
  2QFY05 2QFY06 1HFY05 1HFY06
VSF 31.1% 20.8% 28.8% 19.3%
Cement 9.2% 11.9% 11.7% 14.4%
Sponge Iron 28.6% -4.8% 35.2% 13.4%
Chemicals 20.7% 29.8% 15.8% 31.5%
Textiles 2.3% 2.6% 0.5% 1.1%
Others 12.0% 16.1% 13.0% 16.0%
Total 16.5% 13.2% 17.9% 15.7%

Further, on assessing the reasons for the same, while the VSF division was adversely affected by higher input prices viz. caustic soda and sulphur, the operating margins of the sponge iron division were affected to higher input costs of iron ore (up 60% YoY), natural gas (up 110% YoY) and higher usage of alternative feedstock owing to shortage of natural gas. The improved performance thrown in by the cement and chemicals divisions could be attributed to better realisations during the quarter.

Lower financial expenses aid bottomline: While the operating profits of the company during the quarter were lower by 17% YoY, the bottomline was down only 7% YoY. This was owing to a 17% growth in other income, a sharp 23% fall in interest expenses, lower depreciation charges (down 7% YoY) and significantly lower tax burden at 25% of PBT compared to 35% in the corresponding quarter of the previous fiscal.

What to expect?
At Rs 1,153, the stock is trading at a price to earnings multiple of 8x our estimated FY08 earnings. The 1HFY06 performance of the company has been in line with our estimates and we will not be making any significant changes to our full year numbers. Thus, we maintain our HOLD view on the stock.

Going forward, we expect the favorable pricing environment for cement to continue on the back of a better demand-supply scenario, considering the lack of any significant cement capacities coming into existence. However, while we believe that Grasim remains a play largely keeping in view the prospects of the Indian cement industry going forward, it must be noted that the company has a significant presence in the viscose staple fibre (VSF) and sponge iron segments also. While we do not pin much hope on the sponge iron segment over the next couple of years and though we believe that the near-term prospects for the VSF segment could remain challenging, we believe that the company would be able to capitalise on the increasing opportunities available in the textiles industry from hereon.

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