The performance of Grasim Industries has been adversely hit by the slowdown in the global economy during FY2009.
The reported net profit on a stand-alone basis declined by 19.5% year-on-year (y-o-y) to Rs1,648 crore. The poor performance is on account of demand contraction in viscose staple fiber (VSF) and sponge iron divisions.
However, the revival in the cement demand in the second half of the year benefited the cement division, which posted a 17% growth in its revenues.
Surge in power & fuel cost and freight charges coupled with drop in realisation of VSF products led the overall operating margin of the company to contract by 672 basis points y-o-y.
During the year the company raised long-term debt of Rs722 crore on a stand-alone basis (including foreign currency loan and non-convertible debentures) to fund capacity expansion.
The company has also repaid a part of its debt (as per the repayment schedule) that resulted in net increase in debt to Rs326 crore. Despite the increase in interest cost, the interest cover remains at a comfortable level of 11.6x.
The interest cost grew by 33% to Rs142 crore on account of commissioning of projects and increased borrowing.
As a part of strategic growth initiatives, the company has embarked upon a series of expansionary plans. In cement business, major projects undertaken by the company to expand its grinding capacity are near completion.
To highlight the development during the year, the 3.3 million tonne (MMT) clinkerisation plant at Shambhupura and Kotputli each have been commissioned.
Additionally, one of the mills in Shambhupura having cement capacity of 1.6MMT has become operational and 1.3MMT split grinding unit at Dadri has also commenced operations. The total grinding capacity at the end of FY2009 stood at 19.65MMT as against 16.75MMT as on FY2008.
In line with its strategy of focusing on the core business, the company has divested its sponge iron business by way of slump sale at a consideration of Rs1,030 crore to Welspun group.
The transaction was completed on May 22, 2009 and the proceeds will be utilised to fund the on-going capital expenditure (capex) plan.
Due to decline in earnings, the return ratio has also contracted during the financial. The Return on net worth (RoNW) declined to 17.4% (as against 24.8% in FY2008) and the return on capital employed (RoCE) dipped to 12.8% (as against 18.6% in FY2008).
We believe Grasim Industries is well placed to capture the strong volume growth (in cement) due to its relatively early capacity expansion.
Furthermore, pick up in demand for VSF products coupled with improved realisation (for VSF) and hive-off of less profitable sponge division augur well for the company.
However, the upcoming cement capacity of 48MMT by the end of FY2010 is likely to pressurise the cement realisation in H2FY2010.
At Rs2,611 the stock trades at a price/earnings (PE) of 16.9x FY2011 earnings estimate, an enterprise value (EV)/earnings before interest, tax, depreciation and amortisation (EBITDA) of 9.4x (on a stand-alone basis) and an EV/tonne of US$106 on FY2011 capacity (including proportionate capacity of Ultratech Cement held by Grasim Industries).
As the stock could underperform in the near-term due to seasonal weakness (monsoon) we maintain our HOLD recommendation on the stock with a revised price target of Rs2,682 based on the sum of the parts (SOTP) methodology.