Goldman Sachs: Grasim Industries: Attractive valuations, up to Buy

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Grasim Industries (GRAS.BO): Attractive valuations, up to Buy

Investment Thesis

We upgrade Grasim to Buy from Neutral and revise our 12-m

SOTP-based TP to Rs2,984 (from Rs2,265) on higher replacement

cost for Ultratech, Grasim’s 60% cement subsidiary, and higher

multiple for VSF business.

VSF business is a cash cow: we expect robust margins of 28%-

30% in FY12E/FY13E

The VSF business of Grasim (which contributes 35% to consolidated

ytd FY11 EBITDA) is currently enjoying the tailwind of strong margins

on the back of a rebound in demand led by the global economic

recovery and shortage of its key substitute cotton. In 4QFY11, VSF

prices rose 16% on: 1) cost push of key inputs such as pulp and

sulphur, and 2) strengthening prices of competing fibres such as

cotton and PSF.

VSF is a cash cow (normalized 5-yr EBIT margins of 25% and ROCE of

50%) – average margins of 30% over the past 6 quarters. While we

note that VSF prices currently are near record high levels, and there

may be a potential correction from hereon, we do not expect margins

to correct significantly due to Grasim’s high upstream integration

(100% self sufficiency in caustic and 70% in captive pulp).

Cement business margins (Ultratech) have bottomed out: Given

an improving demand environment, we expect 11% volume growth in

the cement business for FY12E. Moreover, amid enhanced supplier

discipline and continued cost pressures, we expect cement prices to

remain firm (adjusted for seasonality) which will drive a gradual

recovery in margins, in our view.

We revise FY11E-FY13E EPS by 3%-8% to account for higher cement

and VSF prices.

Attractive valuations: At 5.1X FY12E EV/EBITDA, Grasim is currently

trading at a 10% discount to its mid-cycle of 5.5X and at a 36%

discount to Indian peers. This implies that either: (1) the VSF business

is trading at a 40% discount to its peers, despite superior margins and

returns, or (2) the implied holding company discount for the cement

business is a steep 40%, both of which we believe are unjustified.

Key risks: Weakening VSF prices and margins, muted volume growth

in cement, price correction in cement.