Grasim Industries - Target price revision - Standalone OPM disappoints led by higher costs - Centrum

Rating: Hold; Target Price: Rs2,785; CMP: Rs2,511; Upside: 10.9%

Standalone OPM disappoints led by higher costs

We maintain Hold rating on Grasim Industries with a revised price target of Rs2,785 (Rs2,875 earlier) considering a) challenging scenario for the VSF business which is likely to persist in the near-term, b) lack of near-term triggers for the cement business and c) downward revision of 7.3%/6.6% in EPS estimates for FY14E/FY15E. We believe that the challenges in the VSF business will persist due to higher cotton inventory globally and favourable cotton procurement policy in China, which has put pressure on VSF realization. In the quarter, the profit of the company was below estimates due to disappointment in the standalone business, where margins contracted sharply.

- Disappointment in standalone business leads to lower profits: Led by higher operating costs, EBITDA from the standalone segment declined 9.7% YoY to Rs1.9bn (estimate: Rs2.7bn), despite 19.8% YoY growth in revenues to Rs14.6bn (estimate: Rs14.3bn). Led by lower than estimated EBITDA in the standalone segment, consolidated EBITDA at Rs9.8bn was below our estimate of Rs10.9bn. Consolidated EBITDA declined 21.7% YoY and OPM declined 4.8pp YoY. Profit declined 39.6% YoY during the quarter.

- VSF segment's margins contract due to higher raw material costs: OPM of the VSF segment contracted 4.7pp YoY due to higher pulp prices and rupee depreciation. Though there has been ~14% drop in VSF prices globally, rupee depreciation has kept prices favourable in the domestic market. Sales volume of VSF was up 23.5% YoY in the quarter. EBITDA/kg of VSF declined to Rs17.4 against Rs23.9/kg in Q3FY13 and Rs25.8/kg in Q2FY14.

- Earnings estimates revised downwards: We have revised EBITDA estimates downwards by 2.3%/1.5% for FY14E/FY15E considering higher raw material costs (pulp price) in the standalone segment. Our standalone EBITDA estimates are getting revised downwards by 5.2%/4.5% for FY14E/FY15E. Change in EBITDA estimates leads to 7.3%/6.6% downward revision in EPS estimates for FY14E/FY15E.

- Valuation and key risks: The stock trades at 9.5x FY15E EPS, 4.4x EV/EBITDA and 1.1x P/BV. We have valued the standalone entity at 5x Dec-FY15E EV/EBITDA and assign 40% discount for its holding in UltraTech and other companies. We maintain Hold rating on the stock with a potential upside of 10.9%. Upside risk to our thesis could be a) firm VSF prices going ahead and b) better-than-estimated cement price. Key downside risks could be a) fall in cotton price globally which could impact VSF price, b) lower-than-expected sales volume of its cement subsidiary.

Source : Equity Bulls

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