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Grasim Industries – VSF entering a sweet spot
Prices of the competing fibres for VSF - cotton and polyester - are rising. Cotton prices have
risen by 65% in 2010, and PSF by 35% in 3QFY11. Grasim is raising VSF capacity by 46%
to meet rising demand. We have raised our VSF EBITDA by 20% for FY12F and FY13F. We
upgrade to Buy, and raise our TP to Rs2,609.7.
VSF regaining its former glory on rising cotton prices
With cotton prices rising 65% in 2010 and the availability of cotton also being an issue,
demand for viscose staple fibre (VSF) has been growing globally, particularly in non-woven
applications. The Wall Street Journal has recently reported Tembec’s findings that global
production of pulp (which is also used in filters, screen films and nappies) had grown roughly
25% to 5.2m tonnes since 2008. Even in clothing applications, more global players are
switching to VSF given the rising cotton price. Grasim’s 1HFY11 sales volume fell 5% due to
water shortages and, hence, production cuts at its Nagda plant, but we expect 2HFY11 VSF
sales to grow strongly at 12.5% yoy.
VSF pricing and volumes likely to drive earnings
Grasim raised VSF prices by 10% effective 1 January 2011, and we expect EBITDA margin
to return to its 39-40% peak in 4QFY11 and FY12. We have raised our VSF EBITDA
estimates by 20% for both FY12 and FY13, and, as a result, the contribution of the business
to total EBITDA has risen to 36% in FY12 (vs 25% earlier). We have trimmed our cement
earnings forecasts given the recent weakness in volumes and pricing and, hence, also cut our
consolidated EPS revision by 2.5% for FY12.
Upgrading rating to Buy (from Hold), SOTP-based target price to Rs2,609.74
We believe Grasim offers upside potential despite our cautious cement outlook and near-term
earnings downgrades, as potentially stronger VSF earnings will reflect directly in standalone
earnings, raising the stock value. We value Grasim’s VSF EBITDA at 6.5x, ie, a 15% discount to
the multiple for Lenzing (NR; the world’s largest VSF producer) based on Bloomberg consensus
estimates. We value Grasim’s 61% stake in UltraTech Cement (UTCEM IN, Rs995.45, Sell) at a
25% holding-company discount to our UltraTech target price of Rs832.19. We value other group
investments (Hindalco and Aditya Birla Nuvo [ABNL]; both rated by RBS, and Idea Cellular, NR)
at 40% discounts.
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