Vardhman Textiles Ltd, one of the country’s largest yarn manufacturers, gained from soaring yarn prices through fiscal 2011 (FY11). Even during the March quarter when surging inflation hit the profitability of most firms, Vardhman registered strong growth in profits. Increase in realizations in yarn and fabric surpassed the surge in raw material (cotton) costs. Volumes grew, too, on the back of high consumption and demand. Net revenue for the quarter jumped 20% year-on- year. Improved operating leverage offset the rise in employee costs and other expenses, which consequently fell as a percentage of sales.
This translated into a huge 730 basis points (bps) jump in operating profit margin from the year-ago period and 190 bps from the preceding quarter. In fact, the operating margin is the highest since March 2009, when the textile cycle turned positive after prolonged recession that had threatened closure of many smaller firms.
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Almost all the improvement in margins accrued from Vardhman’s yarn segment, which accounts for a major portion of the business. Profit before interest and tax of the segment doubled from the year-ago period.
As a result, net profit for the quarter surged by around 84% to Rs139.5 crore. For the full year, net profit more than doubled on a 32% rise in revenue. What has also gone down positively in the Street is Vardhman’s decision to hive off its steel business, which accounted for hardly one-tenth of its revenue.
Rising demand has also led to planned capital expenditure of around Rs1,000 crore in the next two years that can be met through internal accruals. Two-thirds of this amount will be spent on increasing spindlage, while the rest will be used to add looms and dyeing capacity.
The key question is whether the uptrend in textile prices will continue. Since April, both cotton and yarn prices have cooled off by about 30%. Vardhman, like most large mills, is holding high-cost inventory of cotton, which means that if yarn realizations fall in the next two quarters due to weaker demand, its operating margin would be adversely affected.
A report by ICICI Securities Ltd says: “We expect dual pressure on the operating margin in FY12 due to correction in cotton and yarn prices and the high procurement cost of cotton.”
Vardhman’s shares, which had outperformed the BSE-500 Index of the Bombay Stock Exchange until the December quarter, have slowly started slipping since April on a weaker outlook for the next two quarters. At the current price of Rs262 apiece, the stock trades at around seven times FY12 earnings. While the valuation looks reasonable, being a cyclical industry, any indication of a downturn could affect the stock sharply.
Graphic by Yogesh Kumar/Mint
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