Buy Grasim Industries: Net revenues grew 18% YoY to Rs12.1b: Motilal Oswal

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 Grasim Industries (GRASIM IN; Mkt Cap USD4.7b, CMP Rs2,369, Buy)

 VSF business volumes grew 4% YoY (~25% QoQ) to 84,621 tons (vs est 85,500 tons). Realizations improved Rs6.6/kg QoQ to Rs123/kg (vs est Rs122/kg).

  Net revenues grew 18% YoY to Rs12.1b. EBITDA margins at 29.9% were lower 790bp YoY (+160bp QoQ) impacted by higher than estimated cost push.

 VSF margins are expected to improve driven by price increase of ~Rs7/Kg from 1-Jan, benefit of which would be partly diluted by higher pulp prices.

 3QFY11 VSF utilization at ~100% leaves limited headroom to grow volumes till new capacities commence operations in FY13.

The outlook for VSF business has improved considerably. This coupled with improving short-term outlook for cement business augurs well for Grasim. We are upgrading consolidated EPS for FY12 by 2.2%.  The 

stock is quoting at very attractive valuations of 8.9x FY12E consolidated EPS and 7x FY13E consolidated EPS, and 1.3x FY12 P/BV and 1.1x FY13 P/BV. Maintain Buy with target price of Rs2,852. 

Standalone performance disappoints; cost push restricts margin expansion
Net revenue grew 18% YoY (~30% QoQ drop) to Rs12.13b. EBITDA margin contracted
790bp YoY (but expanded ~160bp QoQ) to 29.9%, impacted by cost push. EBITDA declined
7% YoY (increased ~38% QoQ) to Rs64b (v/s our estimate of Rs3.96b). However, lower
tax provisioning drove 8% YoY (flat QoQ) growth in PAT to Rs2.83b.
Consolidated revenue grew 12.4% YoY (~21% QoQ) to Rs53.8b. EBITDA margin declined
810bp YoY (improved ~460bp QoQ) to 20.8%. PAT declined 13.5% YoY (grew ~55%
QoQ) to Rs5b. Consolidated EPS was Rs55 for the quarter and Rs152.7 for 9MFY11

VSF business: higher realization diluted by higher cost push
VSF business volumes grew 4% YoY (~25% QoQ) to 84,621 tons, aided by normalcy in
operations (~25 days shutdown in 2QFY11). Realizations were marginally better than
estimated at Rs123/kg (+12% YoY, +6% QoQ; our estimate: Rs122/kg). However, higher
cost push in the form of pulp price (up 35% YoY) and sulphur (up 117% YoY) impacted
standalone PBIDT margin by 750bp YoY to 34.4% (~250bp QoQ improvement; our
estimate: 36.6%). Consolidated PBIDT margin declined 710bp YoY to 32.6% (~140bp
QoQ improvement).
Global cotton shortage and resultant strong cotton prices (up 135% since January 2010)
augur well for VSF demand and pricing. Grasim has increased VSF prices by Rs7/kg
from 1 January 2011. However, higher pulp and sulphur prices would dilute the benefits of
higher VSF prices. We are factoring in Rs5.5/kg QoQ increase in realization in 4QFY11,
translating into EBITDA margin expansion of 40bp QoQ. For FY12, we are modelling in
Rs6.5/kg decline in VSF realization over 4QFY11 (flat on FY11 average).

Positive outlook for both VSF and cement business; reflecting in enhanced
capex
For VSF business, the management expects demand growth to remain strong, driven by
cotton shortage in the short term and structural factors in the long term. It has revised
upwards its capacity addition in VSF from 80,000 tons (greenfield) to 156,500 tons
(greenfield + brownfield). This is supplemented by caustic capacity addition of 182,500
units. It would be investing Rs29b to augment its capacity by 47% to 490,475 tons by
FY13. However, in the short term, it has limited headroom to grow volumes as it currently
operates at ~100% utilization.
For cement, it expects demand to grow at over 10% for the next five years, with margins
returning to normalcy in FY13. It believes trough in the cycle to be behind, as normal
construction activity resumes post monsoon. It is investing Rs105.6b in its cement business
for augmenting capacity (~9.2m tons @ Rs56b), logistics infrastructure and modernization/
upgradation.
Valuation and view
The outlook for the VSF business has improved considerably. This coupled with improving
short-term outlook for cement business augurs well for Grasim. The demerger of the
cement business has triggered de-rating of the stock; it currently trades at implied holding
company discount of ~50% to UltraTech.
We upgrade our consolidated EPS estimates by 2% to Rs266.8 for FY12 and by 3.5% to
Rs340.7 for FY13 to factor in the upgrade in VSF business. The stock quotes at attractive
valuations of 8.9x FY12E and 7x FY13E consolidated EPS, and 1.3x FY12E and 1.1x
FY13E BV. Implied valuation of cement business: EV of 4.3x FY12E EBITDA and US$65/
ton. Maintain Buy with a target price of Rs2,852 (SOTP-based, valuing economic interest
in cement business at US$96/ton post 20% holding company discount, and VSF at 4x EV/
EBITDA).

Company description
Grasim is a diversified company with cement and VSF being
core business, accounting for 65% and 35% of revenues
(post-restructuring). Its other business includes chemicals
and textiles. The acquisition of UltraTech Cement, the
cement division of L&T, by Grasim catapulted it to number
one position in the Indian cement industry with total capacity
under control of 51mt.
Key investment argument
 Being largest player with total capacity of 51MT
(existing capacity) under control and highest organic
growth visibility, Grasim would be biggest beneficiary
of any further increase in cement price.
 Global leader in VSF business, with backward
integration in pulp, experiencing robust demand in both
global and domestic markets.
Key investment risks
 Cement sector is likely to add huge capacities in coming
year which can result in significant volatility in cement
prices.
 Increasing VSF prices poses substitution risk, whereas
cost inflation pose risk to margins.
Recent development
 Started consolidating Star Cement, a UAE based
cement company, acquisition of which was completed
in September 2010.
Valuation and view
 The stock is quoting at very attractive valuations of
8.9x FY12E consolidated EPS and 7x FY13E
consolidated EPS, and 1.3x FY12 P/BV and 1.1x FY13
P/BV. Implied valuation of cement business is 4.3x FY12
EV/EBITDA and US$65/ton.
 Maintain Buy with target price of Rs2,852 (SOTP
based).
Sector view
 Although sector would continue to be plagued by overcapacity
at least till Dec-11 and expect volatility in
cement prices and cement companies’ performance
over next 6-9 months.
 However, we believe we have already witnessed
bottom-of-the-cycle utilization & profitability, and it
should gradually improve hereon given sustainable
demand drivers.
 Next 6-9 months to witnessed increased level of volatility
in cement prices