J.P. Morgan - Grasim Industries Ltd

Grasim Industries Ltd (GRASIM IN) 4Q results: VSF margins remain weak, driving EBITDA miss; consolidated beat on lower tax rate		Overweight Price: Rs2,629.60 02 May 2014 Price Target: Rs3,200.00 PT End Date: 31 Dec 2014

Grasim reported higher-than-consensus consolidated results, with EBITDA of Rs15.3bn (+47% q/q, -3% y/y) vs. JPMe/consensus of Rs14.0bn. However, the PAT beat (Rs6.8bn vs. JPMe/consensus of Rs5.2bn/Rs5.6bn) was driven by lower tax rates both at standalone and Ultratech. Standalone results were lower than expectations, with EBITDA of Rs1.6bn (-32% y/y, -24% q/q) vs. JPMe/consensus of Rs2.1bn/Rs2.0bn. The VSF segment reported its lowest EBITDA margin ever, at 10%, which management attributed to the increase in imported pulp prices, compounded by rupee depreciation. Depreciation (+16% q/q) increased on a standalone basis, driven by the commissioning of VSF expansion at Vilayat, in our view. Standalone PAT of Rs1.3bn was in line with JPMe, with higher other income and a lower tax rate offsetting muted operational performance. Grasim announced a dividend of Rs21 per share vs. JPMe of Rs22.5 and Rs22.5 in FY13.

· VSF margins weaker than expected on higher costs: Grasim reported poor VSF EBITDA of Rs1.3bn (vs. JPMe Rs1.5bn) due to a higher-than-expected cost of production (+10% y/y, +4% q/q; higher imported pulp prices compounded by rupee depreciation). Margins came in at 10.0% vs. JPMe at 11.4%. Volumes were up 2% q/q (+4% y/y, lower than JPMe 105Kt), driven by domestic markets. ASPs remained flat, with management highlighting that a 15% decline in global VSF prices was offset by 14% rupee depreciation.

· Margins to remain under pressure due to pricing; additional capacity to enhance volumes: The company highlighted in its presentation that VSF margins would remain under pressure near-term due to overcapacity in China. Grasim highlighted that industry utilization should show gradual improvement with new capacity additions slowing. On the greenfield expansion at Vilayat, the company indicated that trial runs for the first line (43,800 TPA) started in April and that the second line would start trial runs shortly, with two more lines to be commissioned in 2QFY15. The last two lines will focus on specialty fibre, which the company expects to improve product mix and realizations. The company maintained its cautious outlook, with a focus on balance between volumes and pricing for expanded capacity. We would watch for management commentary on the ramp-up of expansions in Harihar and Vilayat.

· Cement outlook: Demand remained weak, with Grasim estimating FY14 industry growth at ~1%, with some recovery in 4Q (volume +2-3%). Management maintained that cement demand should recover to 8% as the economic environment improves. However, it expects the surplus supply situation to continue over the next three years, with capacity addition plans of 50MT (vs. the earlier indication of 60MT), taking total industry surplus capacity to ~100MT by FY17. The company highlighted in its presentation that “maintaining margins remain challenging,” with industry capacity utilization expected at ~75% till FY17.

· Capex highlights: Grasim’s capex in 4QFY14 was ~Rs8.5bn (Rs2.0bn standalone and Rs6.5bn cement). The company commissioned the 1.45MnT grinding capacity at Malked, Karnataka, during the quarter. Grasim started the trial runs for the Greenfield VSF project at Vilayat for Line 1 in April and expects to initiate trial runs for Line 2 shortly. Together, these two lines have a total capacity of 77ktpa out of a total 120ktpa to be commissioned. The company expects to commission the remaining two lines, focusing on specialty fibre, in 2QFY15. For FY14, Grasim incurred total capex of Rs32.5bn (Rs9.5bn standalone and Rs23.0 cement) vs. management’s earlier (3QFY14) estimate of Rs33.4bn (Rs1.0bn standalone and Rs23.2bn cement). For FY15, Grasim has guided to capex of Rs47.1bn (Rs0.8bn standalone and Rs39.3bn cement).

· Balance sheet highlights: Per the company presentation, Mar-14 standalone net cash stood at Rs0.6bn (down Rs1.3bn q/q). On a consolidated basis, net debt decreased to Rs 34.4bn vs. Rs37.5bn at Dec-13.

Key questions for the analyst call: The company has scheduled a call for 10AM on Monday (May 5); the key comments that we look for include:

VSF: How do current VSF realizations look? As the rupee has shown some appreciation during 4Q, should costs come down from here on? We would also like to hear management’s comments on the ramp up of VSF volumes from new capacity over the near term. When does management expect the cycle for VSF demand to turn?

Cement: What are management’s expectations for a recovery of cement demand following the elections? Which segments could drive this growth?

Figure 1: Grasim's VSF segment volumes and ASP

Year-end March

Source: Company reports and J.P. Morgan estimates.

Figure 2: VSF EBITDA (Rs in millions) and EBITDA margin

Year-end March

Source: Company reports and J.P. Morgan estimates.

Table 1: Grasim consolidated quarterly summary

Rs in millions, %, Year-end March

	4QFY13	3QFY14	4QFY14	%y/y	%q/q
Net Sales	76,724	71,205	84,187	10%	18%
EBITDA	15,784	10,375	15,270	-3%	47%
Interest	811	1,249	1,082	34%	-13%
Depreciation	3,286	3,667	3,892	18%	6%
Other Income	2,075	1,057	1,283	-38%	21%
Profit before tax	13,762	6,517	11,579	-16%	78%
Less Current Tax	4,698	1,836	1,684
Less Minority Share	2,932	1,362	3,103
Recurring Profit	6,132	3,319	6,793	11%	105%
EBITDA Margin (%)	20.6%	14.6%	18.1%
Tax rate (%)	34.1%	28.2%	14.5%

Source: Company reports, J P Morgan estimates.

Table 2: Grasim Standalone Quarterly Summary

Rs in millions, %, Year-end March

	4QFY13	3QFY14	4QFY14	%y/y	%q/q
Net Sales	13,962	14,701	15,489	11%	5%
EBITDA	2,338	2,088	1,587	-32%	-24%
Interest	145	134	109	-25%	-18%
Depreciation	451	547	635	41%	16%
Other Income	984	348	630	-36%	81%
Profit before tax	2,726	1,757	1,472	-46%	-16%
Less: Current Tax	1,046	496	169	-84%	-66%
Recurring Profit	1,679	1,261	1,303	-22%	3%
EBITDA Margin (%)	16.7	14.2	10.2
Tax rate (%)	38.4	28.2	11.5

Source: Company reports, J P Morgan estimates.

 

Investment Thesis

GRASIM’s VSF business remains a key catalyst with additional capacity coming on-stream. We see INR depreciation as a big positive for VSF, as both demand and ASP/T should benefit going into FY15 as textile demand picks up. The cement business in UTCEM (62%-owned by GRASIM), while seeing a seasonal rebound in H2, continues to face challenging industry dynamics. We maintain our OW rating on GRASIM with a Dec-14 PT of Rs3,200 (now rolled forward to FY16E EBITDA).

Valuation

Our Dec-14 PT of Rs3,200 is based on SOTP. We value the VSF business at a multiple of 6x (mid-cycle multiple) and the company’s 60% holding in UTCEM at a 30% discount to CMP.

GRASIM- SOTP breakdown

Rs bn, Rs

	Mcap Contribution (Rs bn)
VSF 6x of FY16E EBITDA	82.7
Chemical 0.2x of FY16E Sales	1.9
Grasim standalone EV	84.6
Net debt – Standalone	(25.4)
Grasim - Standalone M cap	110.0
60% holding in UTCEM at 30% discount to CMP	184.2
Total Grasim Implied M cap	294.2
Per share value (Rs/share)	3,200

Source: Company reports and J.P. Morgan estimates.

Risks to Rating and Price Target

Key risks include a sharp decline in VSF prices and a consequent decline in standalone profitability, delays in VSF expansion and large overseas acquisition risk.

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