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Indian Rayon: Realization key concern

Nov 2, 2004

Performance summary
AV Birla Group Company, Indian Rayon, declared lackluster results for 2QFY05. While the topline of the company grew by only 9% YoY, the bottomline of the company declined by 56% on account of contraction of operating margins as well as extraordinary expenses. The operating margin declined by 370 basis points, while net profit margin declined by 8 percentage points.

(Rs m) 2QFY04 2QFY05 Change 2HFY04 2HFY05 Change
Net sales 4264.6 4650.8 9.1% 7654.7 8803.7 15.0%
Total Expenditure 3541.0 4031.4 14% 6456.9 7651.5 18.5%
Operating profit (EBITDA) 723.6 619.4 -14% 1197.8 1152.2 -3.8%
EBITDA Margin (%) 17.0% 13.3%   15.6% 13.1%  
Other income 80 52.1 -35% 138.4 77.5 -44.0%
Interest 67.3 54.1 -20% 140.9 104.8 -25.6%
Depreciation 224.7 198.2 -12% 409.9 394.8 -3.7%
Profit before tax 511.6 419.2 -18% 785.4 730.1 -7.0%
Extraordinary items 199.5 (71.50) -136% 199.5 (31.40) -115.7%
Tax 144 101 -30% 234 243 4.2%
Profit after tax 567 247 -56% 751 455 -39.4%
Net profit margin (%) 13.3% 5.3%   9.8% 5.2%  
No. of Shares (m) 60 60   60 60  
Diluted Earnings per share* 37.9 16.5   25.1 15.2  
P/E Ratio         16.4  

Company background
Indian Rayon is a diversified company belonging to the A. V. Birla group. The company has presence in various sectors like viscose filament yarn (VFY), carbon black, garments, textiles, insurance and information technology. The company's presence in software (PSI Datasystems) and insurance (Birla Sun Life Insurance) businesses are through its subsidiary holdings. It has hived off its insulator division into a separate joint venture with NGL of Japan.

What impacted performance in 2QFY05?
One of the company's largest business segment's, i.e. the garment business saw a 12.4% growth in its topline during the quarter on the back of higher realizations. While volume stood at over 4%, realizations grew by nearly 8%. The basic reason for growth in realizations is contribution form high value products. Apart from launching some new collections in its power brands like Van Heusen and Louis Philipe, it has also launched Peter England suits in South India.

As far as the Carbon black business is concerned, it witnessed a significant 28.7% YoY growth in the topline. While the volume sale of the division grew by 37%, realisations have declined by 5.5% because of elimination of import duty differential (5%), which protecting domestic producers from cheap imports. The divisionís 12,500 tonne carbon black brown field expansion has been commissioned in February 2004. So, on a YoY basis, revenue growth will remain on the higher side for FY05.

The VFY revenues witnessed a decline of 7% during the quarter due to decline in realisations to the tune of about 14%. The fall in realisation is due to oversupply in the country and cheap imports from China. Also, huge inventory build up in the last few quarters had added to the woes on the realization front. However, the company has indicated that going forward, with inventory clearance happening in coming quarters we see stability on the realizations front.

The performance of textile business was satisfactory with growth of 13.5%. The major growth driver in this segment was Flax yarn and Linen fabrics business, which saw growth of 66% and 12% respectively in volume.

Segmental Performance
  Sales Change EBIT Margins
2QFY04 2QFY05 2QFY04 2QFY05
Garments 1,127 1,267 12.4% 0.1% 4.8%
(as % of total sales) 26.4% 27.2%      
Viscose Filament Yarn (VFY) 962 892 -7.3% 26.4% 17.2%
(as % of total sales) 22.6% 19.2%      
Carbon Black 881 1,134 28.7% 19.3% 11.3%
(as % of total sales) 20.7% 24.4%      
Textiles 1,000 1,135 13.5% 1.1% 4.8%
(as % of total sales) 23.4% 24.4%      
Insulator 166 197 18.7% 27.7% 20.6%
(as % of total sales) 3.9% 4.2%      
Others 130 26 -79.9% 6.6% 32.7%
(as % of total sales) 3.0% 0.6%      
Total 4,266 4,651 9.0% 11.5% 9.6%

Carbon black impact margins:  Operating margins of the company declined by 370 basis points mainly due to poor performance of its carbon black business and VFY businesses, as both were marred by falling realizations. As can be seen in the table above, the EBIT margins of the carbon black business (down 800 basis points) is primarily due to pressure on realisations. The same is visible in the case of VFY business. Margin of the garment business has witnessed some strength (up 470 basis points). The increase in per unit realisation and lower advertisement costs has helped the cause.

Lower other income impacts net margin:  The bottomline declined by 56% due to lower other income and higher tax provisions during the quarter. Also, there was an extraordinary expense (Rs 71.5 m) on account of VRS given to 408 employees. However, if one excludes the impact of extraordinary items the fall in PBT will be more acceptable 18%. The interest outgo of the company reduced on the back of the repayment of debentures worth Rs 1 bn and instead raising funds at cheaper rates in the last quarter.

What to expect?
At the current price level of Rs 249, the stock trades at P/E multiple of 16.4x annualised 1HFY05 earnings. The short-term outlook for the company is challenging, as realisations for its carbon black and VFY segments are expected to remain under pressure. While we believe that the company is well positioned to capitalize on the growth opportunity on the core business front, the diversified nature is a key cause of concern. The company has had a track record of utilising its strong cash flows to fund diversification in the past. In this context, the risk profile of the stock is on the higher side from a retail investorís perspective.

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