Grasim — Buy, PT Rs2,930; Cotton prices have increased sharply :: UBS

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Grasim — Buy, PT Rs2,930

Cotton prices have increased sharply

Average cotton prices have risen ~45% QoQ in Q4FY11 (~132% YoY). In

FY11, cotton prices have increased ~58% YoY. With such strength in cotton

prices, we expect Grasim’s VSF realizations to also rise in the upcoming

quarters (VSF realizations for Grasim have a high correlation with cotton

prices).

Low cost due to integrated operations

Grasim claims to be among the lowest-cost producers globally, due to its

integrated operations: 1) captive raw materials—pulp (75%)—one plant in India

and two JVs in Canada; 2) caustic soda—100% captive (capacity of

258,000tpa); 3) captive power and steam (capacity of 334MW); and 4) selfmanaged

water supply resources.

Although increasing pulp prices (pulp prices have risen ~7% QoQ in Q4FY11,

~19% YoY; FY11 pulp prices are up ~13% YoY) negatively impact margins,

margins are likely to improve in our view as: 1) the VSF price increase has been

greater than the increase in pulp prices; and 2) only 25% of pulp needs to be

sourced outside the company.

Grasim’s VSF EBITDA margins have averaged 27% in the past decade

(including the downturn of FY09)—the performance of this business has been

quite steady. We forecast an average EBITDA margin of 29% over the next few

years (30% in 9mFY11).

Valuation

Table 4: Price target deviation: SOTP

Rs m

Our value for Ultratech 169,209

Less: Holding company discount 33,842

Value of cement less holdco discount 135,368

VSF EBITDA -1 year forward 17,488

VSF EV/EBITDA (x) 5.5

VSF EV 96,185

Others - EBITDA - 1 year forward 3,994

(Others) EV/EBITDA (x) 5.0

(Others) - EV 19,969

Net debt (Sep-11) (17,084)

Target Market cap 268,605

Target share price 2,930

Source: UBS estimates

Though we have only marginally revised our PT for Ultratech to Rs1,020 from

Rs1,030 (based on lower earnings forecasts due to lower volumes, though

largely offset as we roll-forward our target multiple to Mar-13), we revise

upwards our PT for Grasim to Rs2,930 from Rs2,770 on the back of higher VSF

margins (and roll-forward of our target multiple to Mar-13).