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Arvind Mills: Well stretched!

Dec 6, 2004

Performance Summary
Textiles major, Arvind Mills, posted lackluster results for 2QFY05. Despite the topline registering a growth of 14.5% YoY, the bottomline witnessed a decline of 17% during the quarter. Both operating as well as net profit margins were lower as compared to the same period last year (down 220 and 180 basis points respectively).

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 3,706 4,244 14.5% 7,439 8,202 10.3%
Expenditure 2,787 3,328 19.4% 5,537 6,396 15.5%
Operating profit (EBDITA) 919 915 -0.4% 1,902 1,806 -5.0%
Operating profit margin (%) 23.8% 21.6%   25.6% 22.0%  
Other income 30 18 -40.3% 54 19 -63.9%
Interest 335 352 5.3% 689 689 -0.1%
Depreciation 372 372 0.2% 743 739 -0.5%
Profit before tax 243 209 -14.0% 524 398 -24.0%
Tax 0 8 - 0 2 -
Profit after tax/(loss) 243 201 -17.2% 524 397 -24.3%
Net profit margin (%) 6.6% 4.7%   7.0% 4.8%  
No. of shares (m) 195 195   195 195  
Diluted earnings per share (Rs)* 9.0 4.1   5.4 4.1  
P/E ratio (x)         29  
(* annualised)            

What is the company’s business?
Arvind Mills is the world's third largest and India's largest denim producer with 90 mm (million meters) of denim rolling out every year. The company is also into knit and shirting. Apart from textiles, Arvind Mills has presence in ready-to-wear, agrochemicals and telecom sectors. The denim division contributes to more than 60% of revenues and 50% of the denim produced is exported. In the high value cotton shirting (HVCS), it has a production capacity of around 30-mm and the segment contributes to around 20% to the company's topline. Currently, Arvind Mill’s capacity utilisation levels are close to 85% to 90%. Margins from this segment are volatile, depending on cotton prices. Garmenting is another key focus area of the company

What has dented performance in 1QFY05?
Denim leads the pack: The topline of the company grew by 14% YoY on the back of higher growth in demand for denims as well as from higher shirting and knitting sales. While the production of denims increased by 8% YoY, realisations also strengthened and are in the range of Rs 104 per meter compared to Rs 98 in the same quarter last year. The company’s denim facilities are running at full capacity and the demand for the denim is likely to grow in the medium-term. The impetus will also come from the removal of the quota restrictions starting January 2005.

Shirting business, on the other hand, saw a decline in volumes but in value terms, it saw a growth of about 25% in per unit realisations. Total revenues from the HVCS (high value cotton shirting) business witnessed a growth of about 9% compared to the same quarter last year. Currently, the HVCS capacities are operating at optimal level. The company is also carrying out de-bottlenecking on certain key production functions in order to achieve the rated capacity of 34 mm, which will enable the company to meet the enhanced internal requirements for the additional 2.4 m pieces ready-to-wear shirt production capacity.

The knitting business also witnessed a growth in volumes as well as in value terms. Per unit realisations of knitting business has grown by about 34% to Rs 255 per unit. The total revenue growth from this segment was about 85%. The company is setting up garment manufacturing facility in Bangalore with a capacity of 2.4 million pieces per annum. Besides its existing tie-ups with major international brands like Nike and Banana Republic for supplying knitting fabrics, the company also added new customers.

Higher costs-lower realizations: Operating margins declined by around 220 basis points as compared to the same quarter last year. Since cotton is the most important raw material for denims and shirting, higher cotton prices adversely affected the company’s margins. Also, increase in naphtha prices (because of higher global crude prices) for its captive power plant also dented company’s operating performance (fuel as percentage of sales stood at 10.5% this quarter as compared to 9.6% last year). However, margins has improved slightly compared to the June quarter this year due to improved realisations in both denim as well as shirting business.

Cost break up
(Rs m) 2QFY04 2QFY05 Change
Raw material 1,361 1,677 23.2%
(as % of sales) 36.7% 39.5%  
Power and fuel 369 452 22.5%
(as % of sales) 9.9% 10.6%  
Staff cost 269 300 11.7%
(as % of sales) 7.3% 7.1%  
Stores consumption 293 347 18.2%
(as % of sales) 7.9% 8.2%  
Other expenses 495 552 11.6%
(as % of sales) 13.4% 13.0%  
Total 2,787 3,328 19.4%

Net profit margins declines: The bottomline of the company declined by 17% YoY because of the trickle effect of lower operating margins and lower other income. Also, the interest outgo in the quarter increased due revaluation of foreign currency loans due to rising rupee.

What to expect?
At the current price level of Rs 116, the stock trades at a price to earnings multiple of 29 times annualised 1HFY05 earnings. While the opportunity for growth is visible with international markets opening up post 2005, for a fully backward integrated company like Arvind Mills, prospects are promising because of its ability to work in large volumes. However, we believe that the current valuations of the company are stretched. While company has undoubtedly benefited from the restructuring exercise in the last two years, the relatively higher debt component in the balance sheet and the inherent volatility in the textile business increase the risk profile of the stock.

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