Arvind- Inventory Write-down Lowers Margin : Nirmal Bang

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Inventory Write-down Lowers Margin
Following inventory write-down and lower sales prices, Arvind reported a 395bps
decline in operating margin at 9.6% as against our estimate of 14.6%. Operating
profit declined 24.6% YoY to Rs1,232mn, 30.5% lower than our estimate.
Adjusting for inventory write-down, the deviation in operating margin was limited
to ~9-11%. Arvind has cleared high-cost inventory and the benefit of low-cost
inventory would be reflected in FY13, thereby leading to bounce-back in
operating margin to 14.2% in FY13E from 9.6% in 4QFY12. We maintain our
FY13/14 estimates for Arvind and also Buy rating on it with a target price of
Rs117, valuing it at 9.2x/6.5x/1.3x PE, EV/EBITDA, P/B, respectively, for FY13E.
Operating margin under pressure: Following the fall in cotton prices, Arvind carried
out inventory write-down, which reduced the textile division’s operating margin to
13.4% in 4QFY12 from 15.8% in 4QFY11. Brands & Retail (B&R) division’s, sales
prices were cut in 4QFY12, but Arvind was carrying high-cost inventory and hence its
margin declined to 1.2% in 4QFY12 from 5.6% in 4QFY11. Following inventory writedown,
consolidated operating margin declined by 395bps to 9.6% against our estimate
of 14.6%. We believe that with lower inventory costs and lower cotton prices, the textile
division’s margins would be restored in 1QFY13 while that of B&R division would get
restored by 2QFY13. Hence, consolidated operating margin would improve to 14.2% in
FY13E from 9.6% in 4QFY12.
Strong B&R revenue, lower interest costs to drive profitability: Arvind was able to
increase the revenue of B&R business by 44% in FY12. With lower garment prices and
aggressive retail expansion, we expect B&R revenue to show 25.3% CAGR at
Rs19.1bn over FY12-14E. Following lower cotton prices and reduced advertisement
expenses, operating margin of B&R division should improve by 440bps to 9.5% over
the same period, which would increase consolidated operating profit by 17% CAGR at
Rs8.5bn. Following debt reduction and improved credit rating, Arvind has already
witnessed 16.9% QoQ reduction in interest costs. We expect interest costs to reduce
by 38.6% over FY12-14E, leading to net profit CAGR of 33.9% over the same period.
Valuation: We believe the street has over-reacted to Arvind’s results, with the stock
correcting 13.5% on 9 May 2012. It is trading attractively at 6.1x/4.5x FY13/14E P/E
and 5.1/4.1x EV/EBITDA, below the mean of 8.1x/6.5x, respectively. Revenue CAGR
of 8.5% aided by 200bps higher operating margin, working capital efficiency and debt
reduction by 19.3% should lead to profit CAGR of 33.9%, generate free cash flow of
Rs3.3bn, improve RoCE by 94bps over FY12-14E and calls for PE multiple expansion.