Buy Grasim at Rs 3886.10 and add on dips to Rs 3482 - Rs 3611 for Target Rs 4126 in 3 months ::HDFC Sec, report

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 Globally, there has been no respite from the oversupply situation. Pricing pressure has intensified with falling prices of competing fibres. Cotton prices have declined due to record inventory globally and change in Chinese cotton policy. Also there has been a sharp decline in PSF prices led by steep fall in crude prices.  VSF sales volumes were flat y-o-y during Q3FY15 due to destocking by value chain due to price weakness. The average realisations were down ~4% y-o-y with decline in international VSF prices. Lower pulp prices helped in reduction of variable cost y-o-y, despite sharp increase in Sulphur. It has helped in partially negating the impact of falling realisation.  The new capacity at Vilayat, with higher share of premium specialty fibre is set to drive volumes gradually. Concerted market and product development activities could lead to market expansion in domestic segment. GIL is undertaking co-branding with leading apparel retail chains. Its focus is on improving quality and increase in share of specialty products. The present pressure on realisation is expected to continue in near term. Weakness in Cotton and PSF prices could further impact the VSF growth rate. Amidst difficult conditions, new capacity additions have slowed down, which could gradually improve industry utilisation. Consolidation of capacities has started in China with acquisition by stronger players. Few non-viable capacities are on the verge of closure.  The financial performance of the Pulp JVs improved y-o-y despite lower realisation led by higher DG pulp volumes and cost optimisation leading to lower fixed cost. There was further reduction of captive prices in Q3FY15, benefit of which could accrue to the Fibre business in Q4FY15. Sequentially, PBIDT was lower due to planned maintenance shutdown. In Domsjo, forex rate fluctuations impacted profitability (borrowings kept unhedged due to long term natural hedge).  At its greenfield project, Line 1 and 2 entailing a total capacity of 77K TPA have been commissioned in July,14 while Line 3 with capacity of 21900 MT pa has commissioned during January 2015. Trial runs are on for the fourth line.

 Cement prices improved 6% y-o-y, declined from Q2 due to weak demand and festivals. Revenue increased by 15% backed by higher volumes. Variable Cost increased by 3% y-o-y due to higher input material prices and royalty on limestone. Continuous softening in energy prices and optimisation of fuel mix has helped in containing cost increase. Increase in railway freight by 6.5% in last railway budget led to increase in logistic cost. The cost control measures aided in PBIDT growth of 14%.  The acquired Gujarat Units are at PBIDT break even level. The additional depreciation and Interest cost has impacted profitability. Efforts are on to ramp up operations and achieve targeted efficiency, to be profitable at the Net level.  The merger of Gujarat Cement Units of Jaypee Cement Corporation Limited (JCCL) with UltraTech Cement Limited (UTCL), a subsidiary of the Company, has become effective from 12th June, 2014 and accordingly the financial results of the acquired units have been included with the UTCL’s financial results with effect from 12th June, 2014. As a result, figures for the quarter and nine months ended 31st December, 2014 are strictly not comparable with previous periods.  UTCL has entered into an agreement with Jaiprakash Associates Limited (JAL) for acquiring JAL’s Cement business in Madhya Pradesh, consisting of Cement capacity of 4.9 Mn TPA, Clinker capacity of 5.2 Mn TPA and Thermal Power Plant of 180 MW. The transaction is subject to the approval of shareholders and creditors, sanction of the Scheme of Arrangement by the High Courts, approval of the Competition Commission of India and all other statutory approvals.  Cement demand growth could accelerate going forward, likely to be over 8% in long term. Demand revival from infrastructure projects supported by regulatory reforms. Housing demand to improve with higher Government focus and softening in interest rates. Prices could continue to remain under pressure linked to the current surplus supply regime. Capacity utilisation could improve gradually with expected improvement in growth and slowdown in capacity creation. Capacity additions are constrained by current profitability and long gestation period. Softening of energy prices in global markets could augur well for the cement sector.  Cement capacity stands at 63.2 Mn TPA. The brownfield expansions under implementation are progressing well. Upon completion, this will take the total capacity to 74.7 MTPA. A 25 MW thermal power plant was commissioned at Tadipatri, Andhra Pradesh, taking total captive power capacity to 733 MW

Conclusion & Recommendation Revenues for Q3FY15 were lower than street expectations due to weakness witnessed in VSF division. Operating margins declined y-o-y due to higher costs in VSF and cement division. Net profit performance for the quarter was impacted by fall in margins along with higher interest, depreciation and tax and came below estimates. In the VSF sector, margins are likely to remain under pressure in the near term due to the overcapacity in China. Sharply declining cotton and polyester prices is a major challenge and may impact the growth of VSF consumption. However the slowdown in new capacity additions in China should lead to an improvement in industry utilization which augurs well for the Company. The focus on cost optimisation will continue relentlessly. Vilayat expansions could drive volumes gradually with higher share of premium specialty fibre. We expect a significant volume ramp up in the next few quarters on account of stabilization of expansion. In Cement, demand is likely to grow by ~ 8% in the current fiscal and should accelerate going forward. The key drivers will be renewed government focus on housing and infrastructure spending. The company’s highly backward integrated operations make it one of the lowest cost producers in the world. With additional capacity coming on stream in both the businesses, the Company will further consolidate its leadership position and is well-poised to benefit from the expected upturn in the economy. Further most of UTCL’s expansion plans worth over Rs.180bn are largely internally funded, maintaining a healthy balance sheet. The near-term demand outlook of the cement sector remains positive though the VSF business is expected to face a margin pressure owing to the overcapacity in the Chinese market. The stock can remain under pressure in the short term due to muted outlook in VSF and margin pressure in its chemical division. While cement business could do well over the next few quarters (partly driven by Budgetary announcements push), VSF and chemicals business could start performing from Q2FY16. In our Q3FY15 result update dated October 31, 2014, we had stated that the investors could enter the stock on dips in the Rs.3,085-3,232 band over the next quarter for target price of Rs.3,599. Post the report, the stock made a low of Rs.3,309 on December 18, 2014 and a high of Rs.3,968.8 on January 30, 2015. We have revised our FY15 and FY16 estimates downwards to account of weak Q3FY15 results. At the CMP of Rs.3,886.10, the stock is trading at 15.0x FY16RE EPS of Rs.207.7 and 15.7x FY16RE EPS of Rs.257.9.

LINK
http://www.hdfcsec.com/Share-Market-Research/Research-Details/StockReports/3011171