Grasim Industries: Buy

A leadership position in both its core businesses — man-made textile fibres and cement — makes the stock of Grasim Industries a good bet for conservative investors.

The March quarter results of the company were above market's expectations, with improved performance in both viscose staple fibre (VSF) and cement business. Revenue growth for the period was 19 per cent and PAT growth was reported at 32 per cent. Of the company's consolidated revenues, 73 per cent is contributed by cement and 22 per cent from VSF.

In VSF, Grasim's Birla Cellulose is the dominant player enjoying superior margins of around 30 per cent at the operating level because of its pricing power and backward integration advantages. With the company set to increase VSF capacity by close to 50 per cent over the next two years, sales can be expected to grow at a pace higher than the industry. The company has earmarked a capex of Rs 7,078 crore for expansion in cement (aggregating 9.2 million tonnes per annum) and VSF business in FY12.

Grasim's investors also get to own an indirect 60.3 per cent stake in UltraTech Cement. After consolidation of the Aditya Birla group's cement businesses, UltraTech became the country's single largest cement producer with a capacity of close to 48.8 million tonnes. Scale and a diversified geographic presence allow UltraTech Cement to handle the ups and downs of the cement industry — swinging offtake and fluctuating prices — more easily than competitors. This company will be able to provide investors a more stable growth in the coming years compared to other cement players.

At the current market price of Rs 2,228, the stock is trading at 1.9 times its consolidated book value of Rs 1200 a share. Stocks of other large cement players trade at price-book of 3 times.

Cement offtake will revive

Cement despatches have grown at 4.5 per cent in 2010-11. Lacklustre demand growth can be cited as the reason. But, will the situation improve?

Despatches will have to eventually pick-up. The Government has allocated about Rs 2.14 lakh crore for rural and urban infrastructure development in 2011-12, 23 per cent higher than last year's allocation.

Further, the government has let infrastructure companies raise money through tax-free bonds to the tune of Rs 30,000 crore this year, which will fund infrastructure activity.

Grasim Industries reported a volume growth of 7 per cent for the January-March period (industry average of 5 per cent), with similar growth for the full year FY-11. On the pricing front, UltraTech is protected to the extent that its market is focussed in the South, where pricing discipline among manufacturers has held up prices. In the March quarter, prices in the region were around Rs 265-275/bag while the all-India average was Rs 270/bag.

The new capacities (close to 30 million tonne) likely to come in this year may moderate prices, but, this may not completely work to the disadvantage of players as offtake is likely to improve over the medium term.

Rising input prices may continue to be a source of worry for cement players. Sharp rally in coal price and petcoke, fly ash and diesel prices over the last year have cut margins sharply. For full year 2010-11, Grasim's cement segment revenue was up 3 per cent while operating profit dropped 38 per cent (margins down 10 percentage points).

A pick up in demand and higher realisations may help partly make up for this over the medium term. Grasim however is working on improving its operational efficiency by increasing investment in logistics infrastructure and putting up additional captive power plants (currently 80 per cent of power requirement is met internally).

VSF business is promising

Grasim Industries enjoys a share of around 21 per cent in the global market for VSF. The company has a capacity of 3,33,975 tonnes per annum of VSF.

After a 31 per cent volume growth in 2009-10 on sharp recovery in demand from emerging markets, the company's VSF business reported flat sales in 2010-11 mainly because of capacity constraints.

With demand gaining ground, Grasim is adding on its VSF capacity (by around 40 per cent) to retain its leadership position in the market. Expansion work is under progress in Vilayat, Gujarat (1,20,000 TPA) and Harihar, Karnataka (36,500 TPA) and is expected to be completed by FY13.

Demand outlook is positive for the year ahead with rise in consumer spending in India and exports looking up. Higher cotton prices have been aiding demand for man-made fibres world over. Grasim's VSF business reported a revenue growth of 17 per cent in 2010-11 helped however by higher realisations. Realisation was around Rs 125/kg on an average basis during the year, higher by 18 per cent, year-on-year.

Cotton prices, though, have come off from the peak now (to $3.26/kg) still continue at historic highs. In the domestic market, VSF continues to hold up at around Rs 158/kg. Some softening in price can be expected in the medium term with the Chinese monetary tightening measures working against investor sentiment.

Grasim has managed a high operating margin of around 33-34 per cent over the last two years in its VSF business. Going ahead, margins may moderate while still remaining quite healthy.

On the raw material front, though rising wood pulp prices are a worry for VSF manufacturers, Grasim is hedged to the extent that it has integrated operations backward and buys most of its pulp from subsidiary companies.

To provide for additional raw material requirements at the new plants where expansion work is happening at present, Grasim recently acquired a 33 per cent stake in Domsjo Fabrica, Sweden, a leading pulp manufacturer, where it will now get priority in long-term contracts for bulk purchases.

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