• OCTOBER 24, 2002

Indian Rayon: Not a P/E story

Indian Rayon has posted an impressive performance for the second quarter ended September 2002. While revenues have increased by 12%, the core divisions of the company have witnessed sharp recovery in demand thus aiding both volume and value growth during the quarter. But the garment division has been affected by the slowdown in the economy.

(Rs m) 2QFY02 2QFY03 Change 1HFY02 1HFY03 Change
Sales 3,631 4,050 11.5% 7,053 7,703 9.2%
Other Income 20 75 266.2% 42 85 103.1%
Expenditure 3,082 3,378 9.6% 6,065 6,464 6.6%
Operating Profit (EBDIT) 549 672 22.4% 988 1,238 25.4%
Operating Profit Margin (%) 15.1% 16.6% 14.0% 16.1%
Interest (net) 133 98 -26.6% 246 227 -7.5%
Depreciation 184 188 2.3% 367 373 1.8%
Profit before Tax 252 461 82.7% 417 723 73.3%
Extraordinary item (2) - (4) -
Tax 99 84 -15.4% 163 195 19.8%
Profit after Tax/(Loss) 151 377 149.5% 250 528 111.0%
Net profit margin (%) 4.2% 9.3% 3.5% 6.9%
Number of shares 59.9 59.9 59.9 59.9
Diluted Earnings per share* 10.1 25.2 8.4 17.6
P/E (x) 5.1

Garments sales are lower by 4% and 6% for 2QFY03 and 1HFY03 on account of weak consumer sentiment. This was also aggravated by stiff competition and aggressive price reduction by smaller niche players in the branded garments segment. While we expect a revival in demand during the festive season, downward pressure on price would continue to have a bearing on value growth for the rest of the quarters in FY03. While sales volume has declined by 19%, operating profit margins are lower by 300 basis points in 2QFY03 for the garments division. The company, in its outlook for the immediate term, has said that demand growth prospects are challenging.

Revenue mix Strong growth...
(Rs m) 2QFY02 2QFY03 Change 1HFY02 1HFY03 Change
Garments 930 891 -4.2% 1,782 1,675 -6.0%
VFY 760 864 13.7% 1,451 1,678 15.6%
Carbon black 725 804 10.9% 1,338 1,568 17.2%
Insulator 382 502 31.4% 722 942 30.5%
Textiles 731 854 16.8% 1,592 1,656 4.0%
Others 104 135 29.8% 168 184 9.5%
Total 3,632 4,050 11.5% 7,053 7,703 9.2%

But the surprise during the second quarter was the sharp spurt in demand for Viscose Filament Yarn (VFY). Though unit sales in 2QFY03 fell by 4%, average realisation has increased by 14% due to higher contribution from first grade yarn products (62% of sales). Higher capacity utilisation and favorable prices have pushed operating margins of this division from 25% in 2QFY02 to 34% in 2QFY03. The improvement in prices is a positive surprise. However, we expect demand to remain subdued for the rest of the year and there could be pressure on margins in the coming quarters due to strengthening of select raw material prices and poor rainfall (water is one of the key material for processing VFY).

Since Indian Rayon is the market leader in the carbon black business (key raw material for manufacturing tyres), the revival in commercial vehicle sales and stable demand for passenger cars have benefited the company in a large way. While sale volumes increased by 20%, price realisations were lower as the company could not pass on the rise in input costs (crude prices) to its customers. But higher capacity utilisation compensated for weaker prices at the operating level thus increasing margins to 21% in 2QFY03. With CV sales looking up, growth prospects of the division are promising though there might some squeeze at the operating level on account of higher input costs.

Divisional operating margin trend...
(% of sales) 2QFY02 2QFY03 1HFY02 1HFY03
Garments 10.9% 7.8% 5.7% 7.0%
VFY 24.8% 34.3% 24.2% 33.3%
Carbon black 20.6% 21.1% 21.0% 19.9%
Insulator 24.4% 23.3% 22.2% 23.6%
Textiles 7.0% 6.3% 16.2% 12.9%

Indian Rayon in the last quarter has finalised a deal to hive off its insulator business in a 50:50 joint venture with NGK Industries of Japan. Pending regulatory clearance, the company has included insulator division performance in its 2QFY03 numbers. Since this division is highly dependent on the power sector for growth, spurt in activity in the transmission and distribution activity has benefited Indian Rayon in 2QFY03. While overall sales increased by 29%, domestic sales was higher by 24%. Textile business continues to face pressure on both prices and demand. Turnover decreased by 5% in 1HFY03 with downward pressure on margins. We expect this trend to continue in the coming years as well.

The rise in operating margins both in 2QFY03 and 1HFY03 is primarily on account of better capacity utilisation and rise in realisation for Indian Rayon's VFY division (expenses include royalty paid to its subsidiary). Interest costs have declined sharply in 1HFY03 as the company has reduced its overall debts by 3% till September 2002. Stable depreciation charges and lower tax outgo have enabled the company to more than double net profits in 2QFY03.

The stock currently trades at Rs 90 implying a P/E multiple of 5.1x annualised 1HFY03 earnings. However, earnings in 1HFY03 exclude loss on account of sale of Indian Rayon's stake in Mangalore Refinery (MRPL) to Oil and Natural Gas Corporation (ONGC) to the tune of Rs 569 m. If one were to adjust for the same, net profit in 1HFY03 is totally wiped off. While we expect the standalone numbers to improve significantly in the next two years, on a consolidated basis, net profits are significantly lower. This is due to acquisition of PSI Datasystems that posted record losses in the most recent quarter and venture into life insurance with Sun Life of Canada. Though the markets reacted positively to the 1HFY03 performance of the company, one will not be surprised if the stock languishes at the current levels in the near term even if P/E multiple looks attractive. A slew of diversifications in the recent past has affected sentiment towards the stock.

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