Bombay Rayon Fashions: Book profits

Investors can book profits in the Bombay Rayon stock, owing to higher valuations on a run up in the stock's price.

Bombay Rayon manufactures fabric and garments for the domestic and export markets. Falling margins on higher costs of raw materials, depreciation and interest, and renewed worries in its key export economies could mute performance in the coming quarters.

At Rs 274, the stock trades at 16 times the trailing 12-month earnings, at a stiff premium to peers such as Alok Industries. Valuations are close to a peak of 19 times for a three-year period. Investors who took exposure in the stock on our buy recommendation in January '10 would have made an absolute return of 45 per cent.

Rising costs

Input costs such as cotton and polyester had been on an upsurge from the second half of 2010. The company was unable to completely pass on the price rises in both garments and fabric with the result that operating margins slipped to 20 per cent in FY-11 against the 22 per cent in FY-10. As a proportion of sales, input costs spiralled to 55 per cent in FY-11 from 51 per cent the year before.

While prices of cotton and polyester have tamed in the past few months, they still rule at high levels. Cotton output and related export allowances are debated, which could have a bearing on prices going forward. The company has faced difficulties previously in sourcing yarn and grey fabric. Input costs in the June '11 quarter has remained at 54 per cent of sales.

Revenues in the quarter ended June '11 grew a fairly healthy 20 per cent. Net profits, however, managed just a 9 per cent growth. In the March ‘11 quarter too, profits grew 4 per cent against a 44 per cent expansion in revenues. Interest outgo shot up 56 per cent in FY-11, accounting for a hefty 6 per cent of revenues. This figure has inched up to 7.3 per cent in the June '11 quarter.

Total debt expanded 26 per cent in FY-11, though equity expansion by way of warrant and GDR conversion kept debt-equity in check at 1.2 times (end-March '11) Still, bankrolling fresh capacity expansion, or widening its overseas retail network, could call for further increases in debt.

Capacity expansions in garmenting and yarns undertaken led to depreciation more than doubling in FY-11, eating away a good 6 per cent of sales. The high costs have persisted in the June '11 quarter as well, with depreciation increasing 35 per cent compared to the year-ago period.

The combined onslaught of interest and depreciation led to net margins slipping to 7 per cent in FY-11 from 9 per cent the year before. The June '11 quarter net margins stood at 9 per cent, down from the 10 per cent in the same quarter in 2010.

Demand squeeze

Garments are entirely exported, with the US, the UK and Europe the key markets for Bombay Rayon. Exports make up almost half the revenues, at 46 per cent in FY-11. While this share has declined over the years (62 per cent in FY-09), the company is still vulnerable to consumer purchasing patterns, overseas. The optimism over consumer buying in the US and Europe has long since faded, with growth in these regions still sluggish. Bombay Rayon also does not have a leaning towards premium garments, the segment where demand still holds.

Fabric is slated for captive consumption and sale in domestic markets. While a focus on domestic markets helped offset export pressures in the past, the India consumption story too is beginning to wear thin. Excise duty resulting in higher prices, inflation and high interest rates have already exerted pressure on domestic apparel spends; these factors are unlikely to let up in the near future. Retailers have already resorted to early and prolonged discounts.

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