The Hindu Business Line : Mahavir Spinning: Buy

INVESTORS can consider fresh exposures in the stock of Mahavir Spinning. The merger of the yarn and fabric businesses of Vardhman Spinning has shored up the numbers for Mahavir, which is now the largest textile player in the country, with revenues of about Rs1,850 crore and net profits of Rs120 crore.

It now has substantial spinning capacities and remains the market leader in cotton yarn. Bringing the units of the group companies under one roof has also led to operational synergies.

Lower cotton prices and a sharp drop in the interest cost have driven up profits, even as topline growth has flattened out.

Through the merger, Mahavir has entered the fabric business. An increasing contribution from this segment would improve margins and valuations. The stock, too, has been an out-performer over the past year. Trading at an ex-bonus price of Rs 290, it is valued at about 15 times its trailing four quarter earnings per share.

The good performance of Indian textiles and clothing in the export market in the early quota-free months of 2005 is likely to ensure that the stocks of frontline companies such as Mahavir sustain current valuations.

The long-term prospects remain bright; the company is focusing on higher value-added fabrics and is planning a massive expansion over the next three years.

The company is set to enjoy the benefit of low cotton prices over the next few quarters. This could, however, in the near term, be partly offset by flat revenues and the possibility of higher interest and depreciation costs on the back of Mahavir's expansion plans. The current valuations are, however, not too forbidding, as there is scope for appreciation from these levels.

Tepid revenue growth

Intense competition in the export market and low cotton prices has put tremendous pressure on yarn realisations. This appears to have affected Mahavir's revenue growth, which has been tepid. Yarn remains the biggest contributor to revenues.

The export market for cotton yarn itself is stagnating, as the demand for finished products is stronger. While demand from the domestic market is strong, the current oversupply does not favour good realisations.

The operational efficiencies from the merger appear to have kicked in. Mahavir has been able to keep a tight control on operating costs, helped by lower cotton prices.

Operating margins in the April- June quarter improved by more than 200 basis points to 18.5 per cent, mostly due to an impressive performance by the threads business. This improvement in margins, along with a dramatic drop of 35 per cent in interest cost boosted Mahavir's profits by 60 per cent in the April-June 2005 quarter.

The profitability is unlikely to improve significantly from these levels over the medium term. With steel prices reaching a plateau, the steel division, which has at times compensated for the poorer performance of the others, may not turn in a substantially better performance. The threads and fabric businesses are likely to have a favourable impact on profits.

The fortunes of the business, given its commodity nature, rest on the price movements of cotton.

Latest reports suggest that the demand-supply situation is likely to correct at the global level by 2006; cotton prices are, therefore, unlikely to head further south and would probably consolidate at these levels.

The company would benefit from low cotton prices over the next few quarters, at least. But an uptrend in cotton prices, if not passed on to the consumer, could hurt margins.

Expansion plans

Given the stronger demand for finished clothing on the export front, the yarn business is unlikely to be the future driver of growth. In this context, Mahavir's focus on value-added segments such as fabric augurs well for profitability and also de-links the company from a strictly commodity business.

Mahavir plans to spend Rs 1,000 crore in building a textile plant in Madhya Pradesh and modernising some of its existing facilities. This project is likely to take the next three-to-five years to complete. An expansion in debt or equity or both, cannot be ruled out.

From a long-term perspective, however, the expansion would strengthen Mahavir's leadership position in the textile segment, as the contribution of the fabric business is also likely to be more significant.

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