Grasim Industries-Growing fibre of success:: Macquarie

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Grasim Industries
Growing fibre of success
Event
 In line results: Grasim reported 2Q FY 3/11 earnings, which were in line with
our estimates. More importantly, an announcement of a large expansion in
VSF (viscose staple fibre) which will increase capacity by 50% to 490kt puts
the company on a growth path. We are adjusting our estimates to factor in the
restructuring and announced expansions and increasing our target price to
Rs2,488 from Rs2,400. We maintain our Outperform recommendation.
Impact
 Weak 2Q consolidated results: Net sales of Rs44bn were down 5% due to a
drop in cement realisation by 18%. EBITDA of Rs7.2bn is down 51% as
higher energy costs hurt the cement business. Net profit of Rs3.2bn is down
59% as both interest and depreciation costs increased post expansion.
 VSF business – water shortage hit supplies: The VSF business performed
quite well despite production loss as realisation improved by 11% YoY. Prices
are up again by 2% in Oct as the short supply in cotton pushed prices up. We
expect earnings to be strong in 3Q as volume recovers.
 Cement – under pressure: The cement business earnings hit a new nadir,
with realisation drop coinciding with increased energy costs. There has been
a recovery in cement prices but we believe it is unlikely that it will be
sustained as oversupply concerns may not resolved for another 12-18months.
 VSF expansions – reduce uncertainty: The expansion of the VSF business
by 156ktpa, to be completed by FY13 at an estimated capex of US$650m,
reduces concerns on growth options as well as the utilisation of the large
amount of cash on Grasim’s standalone balance sheet.
 Expansion of cement business – is it too early? Grasim has announced a
brownfield expansion of 9.2mtpa at a cost of US$1.25bn. While Grasim does
need 5mtpa expansion every year to maintain its market share, given the
oversupply situation, an aggressive measure could lead to increased
competition. Also, the profitability guided for the recently acquired ETA Star
cement at Rs400/t of EBITDA indicates potential EPS dilution.
Earnings and target price revision
 We are adjusting FY11 and FY12 estimates for Grasim by -5% and 11%,
respectively.
Price catalyst
 12-month price target: Rs2,488.00 based on a DCF methodology.
 Catalyst: Rally in VSF prices, recovery in cement prices & clarity on
expansion.
Action and recommendation
 Maintain Outperform: Grasim appears to be the only hedged play among the
large cement companies and it is also trading at a sharp discount of 30–40%
to them. It is our preferred name in the sector.