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Grasim Industries |
VSF earnings to gain momentum-upgrade target |
ACCUMULATE
CMP: Rs2,365 Target Price: Rs2,730
n Standalone earnings to gain momentum - VSF volumes set to reach peak levels of H2FY10. Surge in Cotton prices fuel domestic VSF prices (up Rs8/kg since Sept-10 to ~Rs125/kg)
n Southern & Western region have seen cement price hike of ~Rs40/bag from Aug lows- Ultratech’s earnings (though at nascent stage of sustainable recovery), likely to see sharp improvement in H2FY11
n Upgrade FY12 earnings by 3.2% -driving a 5% upgrade in our TP to Rs2730. At 25% holdco disc standalone business trades at undemanding EV/EBITDA multiple of 2.5x for FY12E
VSF plants operating at full utilisation - volumes to reach peak of H2FY10
We met the management of Grasim Industries (Grasim) and we remain confident that
Grasim standalone earnings is on the verge of gaining momentum, fuelled by VSF
operations almost reaching full utilisation (post commencement of Nagda Plant-40% of
production) and benign VSF prices. We expect H2Y11 volumes to reach peak levels
witnessed in H2FY10, implying a strong sequential growth 20%+.
VSF Prices hiked by Rs8/kg- VSF EBIDTA margins could touch ~35%
Following the strong surge in Cotton prices (due to damage of cotton crop in Pakistan
causing acute shortage) domestic VSF prices have seen hike of Rs8/kg since Sept-10
(Currently at ~Rs125/kg vs H1FY11 avg of Rs117/kg). We expect VSF prices to remain
firm as shortage of competing fibers and their sharp prices drive increasing preference
for VSF. Driven by uptrend in VSF realization, pick up in volumes and stabilization of
key costs items, we expect Grasim VSF EBIDTA margins to improve 340 bps (over
31.9% in Q2FY11) to 35.3% by Q4FY11.
Cement prices in Ultratech’s key markets cross Q1FY11 levels
After a sharp fall in Q2FY11, cement prices in Southern & Western region, where
Ultratech dispatches ~ 50% of its production, have seen a hike of ~ Rs40/bag from Aug-
10 lows and are up 5% as compared to Q1FY11 average. Consequently, Ultratech’s
earnings (though at very nascent stage of sustainable recovery), are likely to witness
sharp improvement in H2FY11. Management expects cement surplus scenario to
continue till Q4FY12, however receding capacity addition and healthy demand growth of
9-10% would help ease the supply-demand mismatch by the start of FY13.
Upgrade earnings & target - Maintain ACCUMULATE
Driven by recent surge in VSF prices, we have upgraded Grasim’s consolidated
earnings by 3.2% for FY12E driving a 5.1% upgrade in our target price to Rs2730. Stock
implies holding company discount of ~45%. Assigning a 25% holdco discount to all
investments, Grasim's standalone business looks significantly undervalued with the
implied EV/EBIDTA multiples of 2.5x FY12E. We believe such pessimistic valuations
are unwarranted, given that peak VSF margins are ahead for us -ACCUMULATE.
We met the management of Grasim and we remain confident that Grasim’s standalone
earnings are on the verge of gaining momentum, fuelled by VSF operations almost reaching
full utilisation and benign VSF prices
VSF plants operating at full utilisation - volumes to reach peak of H2FY10
Grasim’s H1FY11 VSF volumes declined by 4.7% yoy led by extended shutdown at Nagda
plant (40% of production) due to acute water shortage. The plant started production on 25th
July and since then has resumed full production. With healthy demand for VSF, we expect
H2Y11 volumes to reach peak levels witnessed in H2FY10, implying a strong sequential
growth 20%+
VSF Prices hiked by Rs8/kg - driven by surge in prices of competing fibres
Grasim’s VSF realisation (H1FY11 average Rs117/kg) improved 15% yoy driven by healthy
VSF demand and sharp rise in prices of competing fibres like cotton. Cotton prices have
been on firm uptrend on account acute Cotton shortage globally and the situation has
deteriorated led by damage of crops in Pakistan. Following the strong surge in cotton
prices, domestic VSF prices have been hiked by Rs8/kg since Sept-10 and are now ruling
at ~Rs125/kg. We expect VSF prices to remain firm as shortage of competing fibers and
their sharp prices drive increasing preference for VSF.
Pulp prices seeing some stabilization after 2X jump
During H1FY11 Grasim VSF margin were under pressure on account of 2X jump in prices
of Rayon Grade Wood Pulp (RGWP). Pulp Prices have been on an uptrend with prices in
H1FY11 averaging USD 990 as compared to average of USD550 in H1FY10, i.e. almost a
2X jump. Our interactions with management indicated that though the direction of pulp
prices remains uncertain, post October pulp prices have started stabilising around levels of
USD1000.
VSF EBIDTA margins could touch ~35%
Driven by uptrend in VSF realisation, pick up in volumes and stabilization of key costs
items, we believe that Grasim’s peak VSF margins are ahead of us. We expect Grasim
VSF EBIDTA margins to improve 340 bps (over 31.9% in Q2FY11) to 35.3% by Q4FY11.
However even after this surge, we notice that the margins would still be lower by 660 bps
from peak levels of 41.9% witnessed in Q3FY10.
Grasim to add ~150K VSF capacity by H2FY13
Though VSF demand is growing at healthy rate, Grasim is likely to face capacity constraints
by FY12 as almost all of plants are operating close to full capacity, while VSF capacity
addition of 156000 tons is expected to get operational only by H2FY13. Greenfield project
of 120000 tons at Vilayat, Gujarat at a cost of Rs.16.9 bn is expected to be completed by
Q4FY13 whereas Brownfield expansion at Harihar with a capacity of 36500 tons and plant
upgradation at a cost of Rs.4.5 bn is expected to be commissioned by Q3FY13.
Cement Prices see sharp hikes–prices in Ultratech’s key markets cross
Q1FY11 levels
After a sharp fall in Q2FY11, cement prices have picked up over last 3 months led by some
pick up in cement demand and producer discipline. Oct-10 cement prices are up, close to
Rs14/bag from Aug-10 lows, but are still 3% below Q1FY11 average. However prices in
Southern & Western region, where Ultratech dispatches ~ 50% of its production have seen
a hike of almost Rs40 from Aug-10 (+20% from Aug-10) and are up 5% as compared to
Q1FY11 average. Consequently, after the disastrous performance in Q2FY11, Ultratech’s
earnings (though at very nascent stage of sustainable recovery), is likely to witness sharp
improvement in H2FY11.
Cement – demand growth remains the key
Cement prices fell substantially during H1FY11 impacted by subdued demand growth of 6%
and significant surplus capacity in the system. Though the prices have recovered post
September, led by supply discipline, the demand is yet to see significant pick up. Grasim
management remains confident that over long term as infrastructure development gathers
pace the cement demand is expected to see sustained growth of 9-10%. Management also
highlighted that, though the overcapacity scenario is expected to continue for next 6
quarter, its sees the pace of capacity addition receding thereby reducing the surplus
overhang in the system and easing the supply-demand mismatch
As mentioned earlier, management remains confident that over long term as infrastructure
development gathers pace the cement demand is expected to see sustained growth of 9-
10%. Management highlighted that even if Ultratech’s cement volumes grow at 9% (lower
end of industry growth), it will reach domestic volumes of ~48 mtpa and hence will be
running out of capacity (FY13 capacity utlisation of ~98%) to serve additional demand in
FY14.
Massive capex plan of Rs101 bn–focusing on all facets of cement operations
Ultratech has charted out aggressive capex plan of Rs101 bn which is a massive 57% of its
(Ultratech+Samruddhi) FY10 gross block. This capex is to be incurred over next the next 3
years and covers all the facets of Ultratech’s cement operations i.e. from manufacturing-tomarketing.
For example the capex plans entails ~55% of the planned amount to be spent
on capacity augmentation through brownfield expansions. However a massive 45% of the
planned capex is to be spent on augmenting grinding capacity, installation of waste heat
recovery systems and setting up of bulk/packaging terminals across locations. This capex
not only aims at providing Ultratech the required head room to grow faster than the industry,
but also enhancing Ultratech efficiency to further build upon its competitive advantage. We
highlight the key area of planned capex.
55% of planned capex for adding 9.2 mtpa of new capacity by Q4FY13
Ultratech plans to set up clinkerization plants at Chhattisgarh and Karnataka, with kiln
capacity of 10K tons/day at each location, entailing new cement capacity additions of 9.2
mtpa at a cost of Rs56 bn or ~USD135/t. The Chattisgarh plant will have 4 grinding units
with aggregate capacity of 4.8 mtpa and a CPP of 45 MW. Whereas Karnataka plant will
have 1 split grinding unit of 1.2 mtpa in addition to the mother grinding unit of 3.2 mtpa,
along with CPP of 45 MW. Major equipments for these plants have already been ordered
and the construction is expected to commence in Q4FY11 with expected commissioning by
Q4FY13. Consequent to these additions, Ultratech total cement capacity would stand at ~
61 mtpa.
Though the industry is still plagued by surplus cement capacity with FY11E/12E cement
surplus still at ~10% of demand, we see the pace of capacity addition receding by 50%
over next 6 quarter thereby reducing the surplus overhang in the system and easing the
supply-demand mismatch by the start of FY13. Consequently we believe that the
commissioning time of Q4FY13/Q1FY14 for Ultratech 9.2 mtpa of new capacity will be the
most opportune time as it is expected to provide Ultratech a head start over its competitors
at time of demand supply crunch by FY13.
45% of planned capex on target at enhancing value addition and improve
efficiencies
Ultratech’s 45% of the planned capex is to be spent on augmenting grinding capacity,
installation of waste heat recovery systems and setting up of bulk/packaging terminals
across locations. This capex focuses on capturing value addition opportunities (conversion
of surplus clinker to cement) as well as enhancing Ultratech efficiency to further build upon
its competitive advantage.
n 2mtpa grinding Capacity addition at Gujarat to increase value addition
Ultratech’s Gujarat plant currently has cement capacity of 5.8mtpa based on its kiln
capacity. However the company exports close to 2mtpa clinker to Middle East markets
as the plant does not have enough grinding capacity. On account of sharp slowdown in
Middle East markets Ultratech’s H1FY11 clinker realization have dropped 29% yoy to
Rs1485/t. As against this its cement realisation at Rs3215/t though has dropped 13%
yoy still are more 2X the clinker realisation. Even on a conservative estimate we see
incremental EBIDTA/t of Rs500 on conversion of clinker to cement. To capture this
significant opportunity of value addition Ultratech plans to enhance grinding capacity at
its Gujarat plant by by 2.3 million and the company will now be using the surplus 2
million tonne clinker (which it exports) to manufacture cement.
n Capex on material evacuation & logistics infra to drive freight cost efficiencies
At Rs715/t Ultratech has amongst the highest freight cost on account of its higher lead
distance and comparatively lower capacity of split grinding units. In order to improve its
freight efficiencies Ultratech plans to invest ~Rs12 bn material evacuation and logistic
infrastructure by setting up bulk terminals in major cities. This will help the company to
transport cement through bulk wagons, thereby reducing freight costs by 20% (for
respective plants) thereby improving efficiency and strengthening cost competitiveness.
Upgrade FY12E earnings by 3.2 – target to Rs2730
Driven by recent surge in VSF prices we have upgraded Grasim’s consolidated earnings
estimates by 3.2% for FY12E (EPS of Rs235). The upgrade in earnings has driven a 5%
upgrade in our target price to Rs2730 (Rs2600 earlier).
Grasim’s Standalone Business significantly undervalued – FY12E implied
EV/EBIDTA at 2.5X
At current levels the stock is implying holding company discount of ~45%. Assigning a 25%
holdco discount to all investments of Grasim, at current levels, Grasim's standalone
business looks significantly undervalued with the implied multiples of 2.5x FY12
EV/EBITDA. We believe such pessimistic valuations are unwarranted, given that peak VSF
margins are ahead for us. Maintain our ACCUMULATE rating on the stock with a revised
price target of Rs2730.
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