The Hindu Business Line : Grasim: Buy

INVESTORS can cement their stake in the Grasim stock, especially by taking advantage of any declines. Fundamentally, the company is on a solid footing. Generating loads of profits — sustainable earnings are up 40 per cent — and cash in 2002-03, particularly in the last two quarters, it is well placed to build on through expansions and acquisitions.

And thot too without expanding the equity base — a constant positive for the Grasim stock for more than ten years now.

A favourable base of growth

The strong showing enables Grasim to continue its internal accruals and debt route to growth.

If the trends of the past three years are anything to go by, the company has been able to tap debt funds at fine rates. Interest costs have been lower by 12 per cent due to declining interest rates, Grasim's credit quality and its consequent ability to tap debt funds at attractive rates.

This strength of the balance-sheet is important, as it would have to fork out about Rs 945 crore for open offer for an additional 20 per cent stake in Larsen & Toubro, where Grasim already holds about 15 per cent.

Strength in cement

An important facet of Grasim's operations from a long-term perspective has been its aggressive approach in the cement business. In a good year in terms of volume growth, Grasim has outpaced the industry by a good six percentage points. This aggressive volume push has ensured that it stays in the race with the Gujarat Ambuja-ACC combine for marketshare across the country.

Even substantially low price levels have not deterred Grasim from pushing its product. The resultant 16 per cent volume growth has helped improve cement revenues by 5 per cent. Such an approach, even if it means lower operating profits, would be a plus from the long-term view.

Going forward, any price improvement will go improve the bottomline. Three factors point towards a gradual improvement of the producers' pricing power over the next couple of years:

The limited capacity additions in the pipeline;

The rising levels of consolidation that will bring about better discipline in capacity creation in the next three to five years, and

The good growth demand growth rates in four of the last five years that has narrowed the demand-supply gap. Grasim has reckoned that in the North and East, a better demand-supply balance may be evident in the next 24 months. But in the West, it sees a better outlook only by 2006.

In the short term, the worst may be over on the pricing front unless the monsoon fails yet again. Once L&T comes into its fold in the legal sense, Grasim will control close to 30 million tonnes of capacity. With the Gujarat Ambuja-ACC combine, Grasim will be one of two major beneficiaries of the phased improvement expected in the demand-supply equation and the price levels.

The plus and the minus

If Grasim has been able to take the weak cement prices in its stride, it was largely due to the strong support from the viscose stable fibre unit — for long the cash cow for the company. Now, it is a virtual monopoly in this business, though this has not helped much with sluggish domestic demand and lower price realisation.

The driver of the strong performance was a 52 per cent growth in exports. Now at 31 per cent, exports may well account for an increasing share of revenues from this line of business. Grasim's low cost structure makes it competitive in export markets even at the lower end of the price range.

The volume growth here and to a lesser extent in cement as well as a tight check on costs were responsible for the operating profit margins expanding by about five percentage points in the last four years.

The scope for revenue and profit expansion in the VSF business may be limited at least for the next fiscal or two. Grasim has operated its capacities to the full and as a consequence volumes may not show any notable jump.

If prices remain as they do in the domestic market, Grasim will need the support of better international prices to maintain profit levels in the VSF business. In 2002-03, VSF contributed 65 per cent of operating profits.

Grasim's sponge iron and chemicals businesses incrementally contributed about Rs 95 crore to operating profits, riding on firm prices.

The upside here may be limited. What may, however, neutralise any possible downside in these two businesses is the trend of declining losses in Grasim's textile business.

The shutting down of one of its older capacities — even if meant a cash outgo to induce a new owner — has had a favourable impact.

Restructuring still in the air

Grasim and the Aditya Birla group companies have put intra-group restructuring on hold. Now the process of weeding out unviable businesses is underway.

The exit from the textiles unit, the troublesome fibre unit at Mavoor in Kerala, and offloading strategic equity holding in MRPL (Mangalore Refinery) were all crucial moves by Grasim. These are in the nature of cutting losses and also freeing up cash flow obligations.

However, the presence of overlapping businesses between Indian Rayon and Grasim makes the case for a structuring fairly strong. If Grasim gets to the 35 per cent equity mark in L&T, it would be in the driving seat after the two-year quiet period, post open offer. Then the cement business would be the prime candidate for a rejig.

Grasim closed last fiscal with revenues of Rs 4,626 crore, sustainable profits after tax of Rs 542 crore and cash profits of about Rs 800 crore. The stock trades at a price earnings multiple of six times its per share earnings of Rs 59.

There is room for valuation gains. But a buy-and-hold approach will not pay. Gains of 15-20 per cent from entry levels should be used to evaluate the possibility of profit booking.

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