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  • MARCH 31, 2004

Indian Rayon: Is it really undervalued?

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

Let's have a look at the business profile of the company. The graph below shows that the revenues of the company are evenly spread amongst its four core divisions viz. textiles, VFY, carbon black and garments. VFY is made from natural fibers and is much cheaper as compared to cotton yarn. Margins from this segment depend on wood pulp prices (the key raw material) and since it is a mature industry, there is not much pricing power. The segment contributed to around 23% to the company's FY03 revenues.

Indian Rayon's take over of Madura Garments provided a big presence in the apparel segment with renowned brands such as Van Heusen, Louis Phillipe, Allen Solly, Peter England, Byford and San Frisco (contributed 26% to the company's topline). Indian Rayon is also the second largest producer of carbon black that is largely used in manufacturing of automotive tyres. The segment contributed to 26% of revenues in FY03. In textiles, the company is into manufacturing of flax and worsted yarn. This yarn is used for weaving, knitting, hosiery, appeals and defense purposes. This segment contributed 25% to the company's revenues.

Considering the robust automobile sales, Indian Rayon is planning to increase the carbon black production by 33% and is likely to be operational by FY05. With international tyre companies like Bridgestone and Michelin setting up capacities in India, the move seems to be in the right direction. It is also planning to increase VFY production capacity by around 1,000 metric tonnes (7% of current capacity).

(Rs m)FY06E
Net Sales18,171
Operating profit3,142
Net Profit2,191
Operating margins (%)17.3%
Net profit margins (%)12.1%
EPS (Rs)36.6
P/E (x)5.1
RONW (%)14%

The table above shows our projected numbers for the company on a stand-alone basis. Looking at the P/E ratio in isolation, it seems the stock is cheap but there are other factors like unrelated diversification that has hampered valuations.

Indian Rayon, being cash rich company, has often been used a diversification vehicle for A.V Birla Group. After its acquisition of Madura Garments, the company ventured into insurance (Birla Sun Life Insurance) and software (PSI Datasystems). Indian Rayon also invested a substantial sum of Rs 880 m in IDEA Cellular (formerly BATATA), a joint venture. The management has failed to inspire confidence amongst investors due to its diversification strategies.

At the current price level of Rs 188, the stock trades at 5.1x expected FY06 earnings. But the dynamics change on consolidated basis. Just to give a perspective, while the standalone profitability of the company seems impressive at Rs 1 bn, on a consolidated basis, earnings stood at Rs 385 m in FY03 because of huge losses from its subsidiary companies. Ventures like insurance and telecom are long gestation projects and given the intense competition and unstable regulatory environment, the pay back period of such investment could be elongated. As a result, the risk profile of the company is on the higher end of the spectrum.

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