The Hindu Business Line : Aarvee Denims: Buy

AN INVESTMENT can be considered in the Aarvee Denims stock from a medium-term perspective. At the current market price, the stock trades at about nine times its expected FY-06 earnings per share, on an expanded equity base.

The largest manufacturer of denim fabric in India after Arvind Mills, the company delivered an impressive performance in FY-05 and in the just-concluded quarter. It appears set for another year of good performance. The recently-commissioned fresh capacities would ensure that the company is well-placed to cater to the strong demand for denim, which has made a comeback.

Stable cotton prices and lower power costs could also make for steady operating margins in a price-driven operating environment. The performance could, however, be affected if there is a reversal in the demand for denim on account of fashion trends. This would be the key risk to our recommendation.

Aarvee Denims operates predominantly in the domestic market. Thanks to a strong demand on the domestic front, the company managed a revenue growth in excess of 30 per cent over the past two years. Several companies are setting up capacities for manufacturing jeans, as there is now an increasing demand for finished products from developed countries. This would ensure robust demand for the denim fabric. Aarvee Denims also derives about 20 per cent of its revenues directly from the export market.

But its domestic focus helps it earn better realisations compared to denim exporters. The operating margin, which for FY-05 was at about 22 per cent, is likely to improve. In the April-June quarter, margins improved from 17.5 per cent to 23.5 per cent. Aarvee Denims has arranged for captive power by way of two windmills and a coal-based power plant. The company expects savings in power costs of 20 per cent. Power costs now account for about 10 per cent of sales. Prices of cotton — the key raw material — are likely to remain stable over the next year.

Aarvee's expansion plans include enhancing its capacity of denim by more than 30 per cent; this is expected to go onstream by the next fiscal. Other denim manufacturers are also expanding capacity, which could lead to pricing pressure over the long term. Most players are, however, at towards the export market.

Given the commodity aspect to its current business operations, however, the company's plans to diversify into value-added segments such as garments and home textiles bode well for its long-term profitability. The expansion plans would be funded through a combination of private placement of shares and internal accruals. The new segments are, however, unlikely to be significant contributors to revenues and profits over the next two/three years. Any contribution from these ventures has not been factored into our recommendation.

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