The Hindu Business Line : Alok Industries: Hold

SHAREHOLDERS can retain their holdings of the Alok Industries stock. A buoyant export market, new capacities that would go on stream over the next couple of months and a greater contribution from high-margin products suggests that Alok will continue to perform well over the next couple of quarters.

These were also some of the factors that underpinned our "Buy" recommendation on the stock when it was trading at Rs 64 (March 13, 2005). On a conservative estimate, the stock now trades at about 15 times its expected FY06 earnings per share (EPS), on a fully expanded equity base.

This is not too demanding a valuation for a company whose profits have grown at a CAGR (compound annual growth rate) of 25 per cent over the past five years. But the constant expansion in equity has meant that the EPS growth has not kept pace with that of profits and has even been negative in some years; in FY05, while profits increased by nearly 30 per cent, the EPS declined by about 8 per cent.

The expansion in equity base has, since our last recommendation, been more than anticipated; the company raised convertible debt worth $70 million (about Rs 300 crore) from overseas markets recently.

With another round of capacity expansion, to cost Rs 120 crore in the offing, a further expansion of the equity base cannot be ruled out. Fresh exposures can, therefore, be avoided for now. Building presence across segments. Our long-term outlook remains positive. Alok's aggressive expansion plans are likely to pay off, as they are building a presence in segments such as home textiles and knitted garments, which have seen an impressive growth in 2005, after quotas were lifted.

Expanding rapidly in anticipation of quotas being lifted, Alok has graduated to a large company by industry standards, with revenues in excess of Rs 1,200 crore. It is also making the transition from a pure-play fabric manufacturer to an integrated player with a presence in all segments. Its entry into home textiles, for instance, has been successful. The segment has been a major driver of exports, which now account for about 25 per cent of sales. It is also putting up fresh spinning capacities for complete integration and recently announced that it would set up a partially-oriented yarn facility. Alok is likely to emerge as a one-stop shop for importers, which could make it a preferred vendor.

It would, however, have to build expertise in these new segments. For instance, its expansion into terry towels wouldcomplement well its home textiles portfolio.

Alok would, however, be pitted against large exporters such as Welspun India, which have already established their competence in this segment.

Earnings outlook: Robust growth in revenues is likely to drive profits over the near term. Alok's Rs 1,000-crore expansion project, which it set in motion last year, is nearing completion. The new capacities across various segments are likely to become operational over the next couple of quarters. The addition to capacities, post-expansion, will also be substantial. For instance, its annual capacity in garments wouldrise to eight-million pieces from one million. Given the strong demand, the fresh capacities are likely to be well utilised and give revenues a lift.

In addition, Alok recently took a 5 per cent stake in The Shirt Company, a garment manufacturer that is expected to tap the primary market with a public offer soon. The move was made with the intention of tying up long-term fabric supply. Operating margins, too, — now at a healthy 20 per cent — are likely to be maintained despite input cost pressures, as profitable segments such as garments and home textiles make greater contribution to profits.

Concern remains only on the equity expansion front. The equity could expand to Rs 200 crore from about Rs 155 crore now, on conversion of the overseas bonds into equity. Even a substantial growth in profits may have, at best, a neutral or slightly negative effect on the EPS. Pending any further expansion in the equity base, the growth in profits should begin to reflect more positively on the EPS from FY07. Shareholders should watch out for any move on the company's part to raise further equity or convertible debt and take that opportunity to pare exposure.

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