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Grasim: Banking on cement

Dec 11, 2003

Grasim, the largest producer of cement in the country, has seen its stock appreciate considerably in the past few months on the back of good growth seen in its VSF and Sponge Iron divisions. The cement division is also likely to turn in a better performance this year as the cement prices, a bane of the industry for quite some time now, have also been on the rise. In this article, let us briefly go through the company's strengths and weaknesses. Strengths

Perfect timing of Cemco acquisition: The acquisition of Cemco would not have come at a more opportune time for Grasim, as the cement industry is poised for a higher growth trajectory. Riding on the back of strong growth in the housing industry (housing loan disbursals are growing at more than 30% annually) and Government initiatives in the infrastructure sector (projects such as Golden quadrilateral, NHDP), the industry is expected to grow at around 8%-9% in the coming years.

Moreover, the high demand supply gap, which was resulting into lower realisations, is also showing signs of improvement as the pace of capacity addition has slowed down considerably. The consolidation, whereby the top 6-7 players now account for close to 60% of the country's capacity is also likely to result in price stability. Therefore, on account of all these factors, we believe that Grasim, with its sheer size and pricing muscle post the Cemco acquisition, is likely to post growth rates significantly higher than the overall industry growth rates.

Regional market share…
Region Rank % market share
North 2 16%
East 2 20%
South 1 19%
West 1 38%
Central 4 13%
All India   22%
* Source:Company data

Growing operational efficiencies: Grasim has undertaken a slew of restructuring initiatives in the last few years that have gone a long way in improving its efficiencies both operational as well as financial. Apart from a large-scale employee rationalization program the company has also chosen to shut down unviable units like its fiber and pulp plants in Mavoor, as well as its fabric unit in Gwalior. This has led to a noticeable improvement in operating margins of the company (15.6% in FY00 to 21.0% in FY03). Once realisations from the cement division improve, the operating margins are expected to receive a further boost.

Weaknesses

Growth concerns: While Grasim has done well to improve the sales volumes of its core business of VSF, (the division contributed 35% and 52% to Grasim topline and bottomline respectively in FY03) we believe that this division may grow at a slower rate in the future. This is indicated by the fall in volumes of VSF in the last few quarters. Another indication of the peaking business cycle is the fall in operating margins on a QoQ basis in 3QFY03 (39%) and 4QFY03 (35%). Also sustaining such high volumes may be a difficult proposition considering that the global economic scenario is still uncertain. One of the reasons for the increased usage of VSF internationally is owing to the fact that its substitute PSF had become more expensive due to higher crude prices. Therefore, when the prices fall on account of cyclicality of crude prices, the VSF demand may not be sustainable.

Divisional concerns: The Company's textiles business is still a drag on the topline as well as the bottomline of the company. Going forward unless there is a turnaround in the fortunes of the division, it is likely to continue to reduce Grasim's profitability. Grasim reported a negative operating margin of 4% in FY03 for its textiles division as well as an 18% drop in revenues.

The stock of the company is currently trading at Rs 920, implying a P/E of 13x of its annualised 1HFY04 earnings. Valuation of the company seems to be on the attractive side. However, it must be remembered that the company is in a transition phase, as the cement division and not the VSF division will propel the growth of the company in the future. For more information on the same, kindly click here to avail of a detailed report on Grasim.

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