The Hindu Business Line : Grasim Industries: Buy

Major capacity additions
Concrete cost cutting initiatives
Focus on core business
Cost-control initiatives and capacity-additions brighten the prospects for long-term growth.

Mr Kumar Mangalam Birla, Chairman.

Rajalakshmi Sivam

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The stock of cement-maker Grasim Industries looks an attractive buy for investors with a long-term view. At the current market price of Rs 1710, the stock trades at 8 times its standalone earnings and six times its consolidated earnings for FY-08. These valuations factor in modest growth expectations. In cement, the company’s cost-control initiatives and capacity additions (to take total volume to 25 million tonnes by mid-FY-09) suggest reasonable prospects over a three-year period, though cement prices may weaken. In the viscose staple fibre (VSF) segment, though margins have been under pressure, growth prospects over the medium term appear better on the back of substitution demand due to rising cotton prices and a global supply shortage.

Cement

The company’s cement production and sales increased by 7 per cent in FY-08. The realisation per tonne too witnessed a growth of 11 per cent to Rs 3,192 per tonne compared to the previous year. While the RMC (ready mix concrete) segment of the company witnessed capacity expansion, rise in fuel prices of over 31 per cent hit the division’s operating margins.

Cost control

Pressures relating to fuel and input costs have been the key concern for cement producers. Grasim has initiated several cost-cutting measures to lower the spending on variable costs. The company has proposed to support its volume-additions with captive power plants to meet the needs of the plants completely. In the March quarter, the company erected a 23 MW thermal power plant at Madhya Pradesh. A further 144 MW capacity thermal power plant is expected to be commissioned in FY-09.

Grasim’s strategic location of its new plants may reduce the lead distance (distance between the plant and the market) in the northern markets. The company has also made investments in logistics and bulk terminals to reduce transportation costs. De-bottlenecking exercises on existing plants saw the company’s capacity increase by 2.4 million tonnes during FY-08 to 16.75 million tonnes. These initiatives may have helped hold the OPM at 32 per cent in FY-08.

Capacity Additions

During the March quarter, Grasim added a clinker plant at its Rajasthan unit to be operational by mid-FY09 and a grinding unit at Haryana. It is also adding two green-field units, one each at Rajasthan (3.2 million TPA) and Uttar Pradesh (1.3 million TPA), expected to come on stream by the third quarter of FY-09. This is expected to take total capacity to the targeted 25 million tonnes by end-FY-09. The northern and western parts of the country may witness higher cement prices due to tighter supply conditions as a result of the lifting of the export ban.

Funding of the above capacities may not pose a big strain on the balance-sheet as Grasim’s debt-equity of 0.5:1 allows room for further leverage. With strong cash flow from operating activities, the company hopes to fund the capex plans from internal accruals.

VSF

Grasim dominates the domestic VSF market and proposes to increase VSF capacity to 365,000 tpa by FY-10. VSF is an artificial fibre used in textile making and is preferred over fibres such as cotton for its lower cost.

Globally, Grasim’s VSF (Birla Viscose) has a market share of 11 per cent. VSF realisation rose 21 per cent year-on-year in March 08. Profit margins in this segment saw a dip in the March quarter, due to lower sales volume and higher input price. The business was challenged by cost pressures on the back of rising prices of rayon grade wood pulp and sulphur.

The years 2006 and 2007 saw the VSF demand growing by over 10 per cent backed by strong global demand. But it started moderating since the beginning of this year due to a downturn in the textile industry on account of economic woes in US.

However, the sharp rise in cotton prices in recent times on the back of a global shortfall in supplies may encourage substitution and improve the demand outlook for VSF over the medium term.

The company may also gain relief from cost pressures on backward integration moves.

The company has taken initiatives to control cost by captive power generation and backward integration into pulp production; rayon grade pulp production in Canada is expected to be completed by Q2FY09.

Sale of Sponge iron business

In June 2008, Grasim announced its proposal to exit the sponge iron business by selling it to Welspun. The sale consideration of Rs 1,030 crore would help Grasim part-fund its expansion plans.

Though this could curtail earnings in the current fiscal, the divestiture could lend support to the company’s profitability over the medium term as the sponge iron division has historically delivered lower profit margins when compared to its other businesses.

Consolidated financials

The company’s financials have been improving steadily. The turnover has risen over 83 per cent in three years from FY-05. The PAT (before extraordinary gains) has increased from Rs 880 crore in FY-05 to Rs 2,650 crore in FY-08.

The company’s operating margin expanded 700 basis points from 24.5 per cent in FY05 to 31.8 per cent in FY-08.

The near-term risks to the recommendation would be higher than expected weakness in cement prices, moderating demand for VSF and pressure from rising input prices in both businesses.

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