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GRASIM 2QFY11: Below est as higher cost push in VSF impacts margins; 6% EPS downgrade; Maintain Buy
Grasim’s (GRASIM IN, Mkt Cap US$4.7b, CMP Rs2,282, Buy) 2QFY11 standalone results are below estimates, impacted by severe cost push in VSF business, with EBITDA margin of 28.3% (vs est 32.8%) and PAT of Rs2.8b (vs est Rs3.13b). Results are not comparable YoY due to divestment of cement business. Key highlights:
- VSF volumes declined 9% YoY to 67,488 tons (vs est 79,000 units) severely impacted by 25 days shutdown. Realizations were in-line at Rs116.5/kg (+10.7% YoY, -1% QoQ).
- On like-to-like basis, net revenues were flat YoY and QoQ at Rs9.3b. EBITDA margin at 28.3% was lower 530bp YoY (~360bp QoQ) impacted by ~52% YoY increase in pulp prices.
- Expect VSF margins to improve in 2HFY11 due to price increase of Rs3/Kg from 1 Oct and stable pulp prices (at higher level).
- Capacity expansion in VSF has been revised upwards from 80,000 tons to 156,500 tons with total capex of Rs29.1b, a 47% increase in capacity by FY13.
- We have downgraded consolidated EPS for FY11 by 6.2% to Rs234.3 and FY12 by 6.1% to Rs258.3, to factor in downgrade in UltraTech’s EPS
Standalone performance disappoints; higher other income, lower tax restricts PAT de-growth
- On like-to-like basis, net revenues were flat YoY and QoQ at Rs9.3b. EBITDA margin at 28.3% was lower 530bp YoY (~360bp QoQ) impacted by ~52% YoY increase in pulp prices.
- EBITDA declined 11% to Rs2.64b. However, higher than estimated other income and lower tax restricted PAT decline to 5% (~25% QoQ growth).
- Consolidated revenues de-grew 5% to Rs44.4b, whereas EBITDA margin declined 15.4pp YoY (~960bp QoQ) to 16.2%, with PAT de-growth of 58% YoY (~44% QoQ) to Rs3.23b.
- Consolidated EPS for the quarter was Rs35 and for 1HFY11 stood at Rs98.
VSF business – higher pulp price impacts 2Q performance; to benefit from higher cotton prices
- VSF business volumes declined 9% YoY to 67,488 tons (v/s est 79,000 units) severely impacted by 25 days shutdown.
- Realizations were in line at Rs116.5/Kg (+10.7% YoY, -1% QoQ).
- Higher cost push in form of pulp price (up 52% YoY) impacted standalone PBDIT margins by 980bp YoY (~360bp QoQ) to 31.9% (v/s est 35.1%).
- However, on consolidated basis, PBDIT margins declined just 660bp YoY (~110bp QoQ) to 31.2%, as increase in pulp cost was negated due to backward integration for pulp in subsidiaries.
- Global cotton shortage and resultant strong cotton prices (up 73% since Jan-10) augurs well for VSF demand and pricing.
- Grasim has increased VSF prices by Rs3/Kg from 1 Oct. This coupled with stable pulp prices (at higher levels) are expected to improve VSF margins in 2HFY11 (est 130bp improvement in 2HFY11 over 2QFY11).
Positive outlook for both VSF and Cement businesses, reflecting in enhanced capex
- For VSF business, the management expects demand growth to remain strong driven by cotton shortage in the short term and structural factors in the long term.
- It has revised upwards its VSF capacity addition from 80,000 tons (greenfield) to 156,500 tons (greenfield + brownfield). This is supplemented by caustic capacity addition of 182,500 tons. It would be investing Rs29b to augment its capacity by 47% to 490,475 tons by FY13.
- For Cement, it expects demand to grow over 10% for next 5 years, with margins to return to normalcy in FY13. It believes the cyclical trough to be behind us as normal construction activity resumes post monsoon.
- It is investing Rs105b in its cement business towards capacity addition (~9.2mt, Rs56b), logistics infrastructure and modernization/upgradation.
Valuation and view
- The outlook for VSF business is improving. This coupled with gradual recovery in cement business augurs well for Grasim.
- The de-merger of the cement business has triggered de-rating of the stock and currently trades at implied holding company discount of ~50% to UltraTech.
- We are downgrading our consolidated EPS for FY11 by 6.2% to Rs234.3 and FY12 by 6.1% to Rs258.3, to factor in downgrade in UltraTech’s EPS.
- The stock is quoting at very attractive valuations of 8.8x FY12E consolidated EPS, 4.4x EV/EBITDA and 1.3x P/BV. Implied valuation of cement business is 4x EV/EBITDA and US$60/ton.
- Maintain Buy with target price of Rs2,817 (SOTP based, valuing economic interest in cement business at US$96/ton post 20% hold-co discount and VSF at 4x EV/EBITDA).
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