The Hindu Business Line : Grasim: Buy

AN INVESTMENT may be considered in Grasim Industries as there appears to be scope for sizeable capital appreciation linked to an improvement in its fundamentals as well as those of subsidiaries in the cement sector over the next couple of years.

If there is a move to split the stock (sister concern Hindalco has just completed such an exercise), it could lead to greater affordability, higher volumes and provide an impetus to the stock in the near term. Buy the stock with a one-to-two-year perspective.

We have a bullish view on Grasim for several years now and had switched to a `hold' in December last year when it traded at about Rs 1,250 due to concerns of a slippage in earnings from its sponge iron and viscose staple fibre businesses.

The stock has remained in a narrow band for several months now.

The phase of declining earnings in these two businesses appears to have ended and the company is well placed to show robust earnings growth with the cement and chemicals businesses acting as catalysts.

In this backdrop, we upgrade the stock to a `buy'. The stock trades at a price-earnings multiple of less than ten times its earnings for FY 06 and is more attractively valued, if one takes a longer view.

Big ticket investment in cements over the past three years set to pay rich dividends.

As its investments plans are completed over the next 18 months, the company would have a larger capacity in cement and viscose staple fibre, captive power facilities and a more contemporary chemicals unit.

This should have a positive effect on revenue growth and profitability.

We have not factored in any gains that will result from a consolidation of related businesses spread across several companies in the group's fold, as the timing of this exercise is an uncertain factor.

The group's cement businesses are scattered across UltraTech Cement, Narmada Cement and Shri Digvijay Cement and sooner than later, we expect these to brought under one fold.

Indian Rayon and Grasim, too, share similar businesses. We have been indicating the prospect for such a restructuring for a couple of years now.

As the group has completed its major investment plan in the cement business, the company now appears well placed to embark on such an exercise.

The Grasim stock may also weather any broad market weaknesses with moderate price declines. This is one of the superior large-cap exposures in the industrials space, as it has a presence in businesses where the positive outlook for demand and especially prices could lead to healthy earnings growth over the next couple of years.

This aspect is important, as rising prices of petroleum products could exert pressure on profitability in several sectors.

Grasim's chemical business is likely to provide a substantial boost to earnings with buoyant trends in the commodity price cycle for caustic soda and chorine products likely to persist.

This is likely to more than neutralise the lower level of earnings from its sponge iron business this fiscal.

The viscose staple fibre business may show lacklustre trends, though the worst appears to be over on the pricing front.

But this aspect appears to have been priced in at current levels.

The long-term outlook for the VSF business is bright with the textiles industry set to benefit from an improving business environment.

Its acquisition of a large pulp manufacturing facility in Canada is likely to yield benefits from FY07 and will also strengthen Grasim's competitive advantage in this business.

In cement, the healthy trend in demand in the northern and southern markets and the improving demand-supply balance in the north that would lead to price stability at higher levels is bound to augur well for growth.

Institutional investors are likely to fancy the cement sector stocks and Grasim would figure prominently in their preferences, as the largest player in the sector.

Perhaps the most attractive aspect is its cash flows and balance sheet strength. The costs of the big-ticket acquisition of UltraTech Cement have been effortlessly absorbed and the company has even managed to lower its debt burden and interest cost.

Having refrained from raising funds through the equity route for more than a decade now, Grasim has immense financial flexibility.

With these strengths, it is comfortably placed to acquire more properties in cement to augment its numero uno position in the industry. Any moves in this space would be a positive for the stock.

The pressures that could be imposed by the rising price of crude on energy and transportation costs represent the principal risk to our recommendation.

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