The Hindu Business Line : Aditya Birla Nuvo: The new cash cow on the block

FROM carbon black to fashion and retailing, Aditya Birla Nuvo will be the most diversified listed company. This new entity will subsume the businesses of the diversified Indian Rayon, the fertiliser major Indo Gulf, and the emerging financial services play Birla Global Finance.

We have buy recommendations outstanding on the three stocks and are sanguine about the prospects for the merged entity.

With this merger, the Aditya Birla group has embarked on yet another round of restructuring. Grasim remains untouched. But news flows on restructuring in Grasim — consolidation of cement businesses is just a question of when — bears monitoring for implications on Aditya Birla Nuvo. Grasim has a presence in textiles and retail distribution that would fit in nicely with the focus businesses of the new company.

A pure play in cement — its presence is now spread across Grasim, UltraTech Cement, Shri Digvijay Cement and Narmada Cement — that could attract greater investor interest is likely to be the trigger. If the group decides to pursue this course, Aditya Birla Nuvo may well add a few more strings to its bow. Grasim also has a presence in sponge iron, viscose staple fibre and chemicals businesses that will dovetail well with the cash generators of Aditya Birla Nuvo; they share attributes such as robust cash flows that are far in excess of what is required to bankroll growth, and limited opportunities. The new company is also likely to emerge as the channel for big-ticket investments; this role was over the years played by Grasim, Indian Rayon and Hindalco.

We believe that such a restructuring is a distinct possibility, but are not factoring in value on this score into our recommendation now, as the timing of such a move is uncertain.

At a price-earnings multiple of about 15 times its likely FY 07 earnings on a consolidated basis, the Aditya Birla Nuvo stock will be attractive. As about 80 per cent of its revenues is likely to flow from high growth businesses such as insurance, asset management, financial services, branded garments, telecom and retailing, there will be scope for valuations to grow. The discount that investors attach to a diversified company — Aditya Birla Nuvo will have interests in ten businesses — is likely to shrink compared to that of Indian Rayon, as the new entity has a superior portfolio of businesses.

The proposed merger is significantly EPS-accretive for Indian Rayon. Based on FY 05 numbers, the merger will scale up revenues, earnings and equity by 25 per cent, 150 per cent and 40 per cent respectively.

This will improve profitability and propel per share earnings by about 80 per cent. Against this backdrop, we do not perceive the swap ratio to be unfavourable for shareholders of Indian Rayon.

It may appear so on the basis of the market price of the three stocks, but a sizeable premium component in the swap ratio in favour of shareholders of Birla Global and Indo Gulf is justified as they are effectively in a takeover situation; that they also scale up profits and per-share earnings is a factor that supports the terms of the merger.

The merger will also substantially enhance Indian Rayon's ability to absorb losses in its insurance business. At one stroke, this exercise has boosted the consolidated earnings card that appeared rather anaemic. The insurance business is likely to move into the profit zone over the next couple of years and the payoffs will be attractive.

Indian Rayon is still in investment mode in this business; the merged entity will be even better placed to bankroll the growth in insurance. The value embedded in the insurance business is priced in to an extent. But there is space for appreciation in the value attached to Birla Sun Life Insurance.

The latter's business has shown robust growth; a high degree of stickiness in renewal premiums over the past couple of quarters and a product portfolio that curtails risks to the insurer strengthen the prospects for an upside. We expect Birla Sun Life to fortify its position as one of the top five players in the private sector over the long term.

In asset management, Birla Sun Life Mutual appears to be getting its act together after a wobbly period post the 2000 meltdown in equities. With the recently completed acquisition of Alliance Capital, it has assets worth about Rs 13,000 crore under management.

Its asset management company is one of the more profitable operations in the mutual fund industry. In distribution of financial products and insurance advisory services, Birla Sun Life has a profitable business with significant room for expansion.

An improvement in profitability in the textiles, IT-enabled services and readymade garments; a rapid expansion in its retailing network; the buoyancy in chemicals and carbon black businesses; and a larger share of the earnings of Idea Cellular are the near-term triggers for earnings growth.

As Indian Rayon has operated in several businesses over the years, the merger is unlikely to pose integration problems. A strengthening of its already lean and mean balance-sheet is an added positive.

Look at this stock with a two/three-year perspective, as such an investment horizon is necessary to capitalise on growth prospects in insurance, asset management, financial services, telecom and retailing.

If pension funds are opened to the private sector, Aditya Birla Nuvo will be well placed to capitalise on this opportunity too.

Indian Rayon, Indo Gulf and Birla Global trade at Rs 590, Rs 192 and Rs 182 respectively. Shareholders of Indo Gulf and Birla Global will get one share of Indian Rayon for every three shares held. Aditya Birla Nuvo will have an equity base of Rs 83.5 crore. A detailed profile of the new entity and terms of the merger is available on the group Web site — www.adityabirla.com.

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