Grasim: Buy

Investors with a long-term perspective can buy the stock of Grasim Industries at the current price of Rs 2,508. Revival in export demand for viscose staple fibre, drop in wood-pulp prices — the key input for the fibre — and signs of recovery in cement demand are arguments in favour of the stock. The stock trades at a price-earnings multiple of 9.8 times its consolidated earnings of FY12.

Grasim Industries has lower earnings risk compared to standalone cement manufacturers. The company derives 38 per cent of its income from viscose staple fibre with a 21 per cent share in the global market and 97 per cent share in the domestic market.

The company enjoys superior profit margins in the fibre business, thanks to its leadership position in the market and backward integrated operations. Further, as the company is increasing its manufacturing capacity by around 50 per cent (by end-FY13), it can be expected to have a better-than-industry growth.

Cement contributes 55 per cent of Grasim's consolidated earnings. This comes from the company's 60.3 per cent stake in UltraTech Cement — the single largest cement producer in the country with an all-India presence. With the November month data for the industry showing a 16.6 per cent jump in cement despatches, there are hopes that demand will revive. UltraTech's exposure to the southern cement market will also give the company the advantage of better realisations.

In the September quarter, the company reported 28 per cent jump in revenues and 29 per cent increase in net profits on a year-on-year . VSF volumes jumped 17 per cent in the quarter and cement despatches were higher by 9 per cent; realisation was higher in both the segments.

VSF strength

Grasim Industries' viscose staple fibre manufacturing capacity is around 334,000 tonnes per annum currently. Though the demand for this fibre was flat for most part of 2010-11, there has been a revival recently, thanks to higher demand from the US and European markets. Grasim is poised to exploit the revival in demand as it is adding new capacities. By end-FY13, new capacities in viscose staple fibre will be up and running — this includes the capacity at Gujarat, of 1,20,000 tonnes and expansion at Karnataka, of 36,500 tonnes. Realisation here may move up if demand sustains; in the September quarter, the average realisation was Rs 130/kg (up seven per cent year-on-year).

Revival in cement demand

For close to a year, sales and profits were driven by increase in realisation for most cement manufacturers. Now, however, things are looking up — in November, the industry posted close to 17 per cent increase in the volumes despatched. Cement dealers are pointing to a pick-up in rural demand and higher order flow from government infrastructure projects. With a good distribution network across the northern and southern markets, UltraTech Cement is poised to benefit from the improved demand scenario. The company has a total capacity of 48.8 million tonnes and is working at a capacity utilisation of around 78 per cent. While sales volumes improve, we expect cement prices to hold up for more time. In October, cement price was ruling at Rs 256/bag (Rs 227 last year) in Delhi and at Rs 300/bag (Rs 270 last year) in Chennai. In November, prices increased by around Rs 5-15/bag across the country.

Margin pressure

One key risk to earnings for Grasim could be the pressure on margins from increased input costs. Operating profit margins in both cement and VSF businesses have come down sequentially. In the fibre business, though the company has backward integrated operations and sources substantial amount of wood-pulp from joint venture companies, it has been susceptible to higher cost of externally sourced wood-pulp, sulphur and coal.

Increase in coal costs has eaten into margins of the cement segment too. Operating profit margins in UltraTech Cement were 17.5 per cent in the September quarter against 28 per cent in the June quarter. Prices of wood pulp and coal are correcting now, but the rupee's depreciation would offset much of the benefits from the fallen price. Wood pulp prices have dropped 15 per cent from July to $845 now; thermal coal prices are also down 12 per cent from highs.

In cement, players have been quite successful in holding prices up for close to a year despite lacklustre offtake; going ahead, as despatches improve, prices should remain buoyant and help offset some cost pressure..

In the fibre business, the global price correction in cotton that started in March this year triggered a correction in viscose staple fibre and the fibre's premium against cotton fell sharply. VSF (at Rs 130-135/kg) commands only a 15 per cent premium to cotton (at Rs 118/kg) from a premium of 30-40 per cent earlier. With production targets for cotton cut for the year 2012-13 by the International Cotton Advisory Committee, cotton prices may not correct much from here; this may help viscose staple fibre prices inch up.

Risks

If demand for viscose staple fibre drops following weakness in economic conditions in Europe, the company may be negatively impacted.

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