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Welspun India: ‘Christy’ning the growth story - Views on News from Equitymaster

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Welspun India: ‘Christy’ning the growth story
Nov 15, 2006

Performance summary
Asia's largest manufacturer of terry towels, Welspun India, announced its results for 2QFY07. While the near doubling of operating costs has tempered the EBIDTA margin by 500 basis points, an extraordinary other income has buoyed the bottomline for the quarter. For the half-year period however, the lower other income has kept the profit growth marginal. The on-going capacity expansion, foray into new product lines and acquisition of stake in ‘Christy’ is yet to filter into its numbers.

Standalone financials…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 1,547 2,764 78.7% 2,942 4,753 61.6%
Expenditure 1,228 2,342 90.7% 2,396 3,918 63.5%
Operating profit (EBDITA) 319 422 32.3% 546 835 52.9%
EBDITA margin (%) 20.6% 15.3%   18.6% 17.6%  
Other income 59 128 116.9% 169 90 -46.7%
Interest 81 122 50.6% 155 234 51.0%
Depreciation 115 157 36.5% 217 301 38.7%
Profit before tax 182 271 48.9% 343 390 13.7%
Tax 56 89 59.9% 108 132 21.6%
Effective tax rate (%) 31% 33%   32% 34%  
Profit after tax/(loss) 126 182 44.1% 235 258 10.1%
Net profit margin (%) 8.2% 6.6%   8.0% 5.4%  
No. of shares (m) 73.1 73.6   73.1 73.6  
Diluted earnings per share (Rs)* 6.9 9.9   6.4 7.0  
Price to earnings ratio (x)         12.8  
*trailing 12 months

What is the company’s business?
Welspun India is Asia's largest and world’s fifth 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 influenced performance in 2QFY07?
Towels – Global footprint: The commissioning of Phase-I of the greenfield capacity at Anjar and a higher capacity utilisation in the towel segment (95% in 1HFY07 against 75% in 1HFY06), has led to Welspun capitalise on higher volumes despite the pressure on realisations (realisation per towel Rs 255 in 2QFY07). For the towel division, the company has been consuming 85% 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 toweling division earned EBIDTA margin of 23% during 1HFY07. The same is expected to enhance going forward as the benefit of ‘Christy’ acquisition 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 rationalize Christy’s sourcing requirements and extend the brand to the domestic customers through Welspun’s retail stores. By 4QFY07, Welspun’s and Christy’s distribution operations will get integrated. Christy has acquired 3 new customers in 2QFY07 and Welspun expects revenue in this business to grow at 10% YoY in FY07. In 2QFY07, Christy’s EBIDTA was ₤ 0.6 m while its bottomline was ₤ 0.1 m.

Bed linen – Value driver: The bed linen segment, which accounted for approximately 12% of turnover in FY06, has contributed to 22% of the turnover in 1HFY07 and is fast catching up with the towel segment. The realisations in this segment improved by 10% YoY (approximately Rs 320 per metre) due to the high value business acquired from clients. The commissioning of Phase–II of the Anjar capacity will also add to the bed linen capacity of the company, nearly doubling it to 77 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 is, however, low at 6% currently as the division is yet to achieve optimum utilisation levels. This has pressurised the overall operating margin of the company.

Other income - ‘VAT’ benefit: The other income of 2QFY07 is bloated primarily due to the impact of lower base in 2QFY07 when the company had incurred a loss due to fire that has been recovered in this quarter. Besides this, the company also received benefit in excise duty due to VAT to the tune of Rs 53 m. Without considering this, the growth in other income has been to the tune of 27% YoY.

Rationalising costs: The company currently generates power in its captive power plant with the help of furnace oil, the price of which is directly linked to that of crude oil. Thus, to rationalise its power costs, Welspun India has set up a gas-based power plant in Vapi (catering to 40% of its power requirement), for which, it has entered into a gas supply agreement with Gujarat Gas. The gas supply will start coming in from 4QFY07 and subsequently rationalise the company’s power cost. With the gas-based power plant, the power cost will reduce 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.

Forex – No more a drag: Welspun is affected by cross currency fluctuations, as nearly 90% of the company's production is exported. 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 month’s sales) and the forex profits in 2QFY07 have nullified the losses incurred in 1QFY07. Going forward, we envisage the impact of forex risk on the company’s bottomline to marginalise.

What to expect?
At the current price of Rs 90, the stock is trading at a price to earnings multiple of 10.2 times our estimated FY08 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 50+ stores by FY08). 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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