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Sunday, March 14, 2010

Grasim Industries Ltd

I expect the Cement Sector to add around 76mtpa of capacity over FY2010-12E. Such a large capacity addition is expected to eventually create over supply in the market, as demand is not expected to catch up with supply in the short term. Nonetheless, on a positive note, a stable government at the Centre is expected to boost infrastructure spending in the country and, along with the ongoing recovery being witnessed in Real Estate activities, concerns on the demand front appear to have reduced considerably. However, All-India capacity utilisation is expected to drop to 78% in FY2010 from around 85% in FY2009. In the case of Grasim, it is currently in the process of increasing its cement capacity by 4.5mtpa at Kotputli and by 4.4mtpa at Shambhupura, by 3QFY2010E, taking its total standalone capacity to 25.8mtpa in FY2010E. Along with the capacity expansions of 4.9mtpa at Ultratech, the total capacity of the merged entity will touch 48.9mtpa by end-FY2011E. Grasim is India’s sole player in the VSF business and exports a substantial portion of its output. The division, after going through a lean patch over the past one year, due to the overall economic slowdown, has begun to show signs of revival in the current quarter. The company recorded its highest-ever quarterly sales for this division during 2QFY2010, while also achieving the highest-ever operating profit, on account of a substantial reduction in the prices of raw materials such as pulp and caustic soda. The company plans to set up an 80,000MT Greenfield project, at a cost of Rs1,000cr, to meet the growing demand. Going ahead, the volume outlook for this division looks positive, both in the domestic and the international market, although there is little scope for any further price increases, due to a growing price differential between other textile fibers, such as polyester and cotton. We have derived the value of Grasim on an SOTP basis.

I have valued the company’s 65% stake in Samruddhi at an average of an EV/tonne of US $100/Tonne and an EV/EBITDA of 6x FY2011E, based on the de-merger plan. I have arrived at a value of Rs725/share for Grasim’s direct holding in Samruddhi. The value attributable to the 35% stake of Grasim’s shareholders in Samruddhi stands at Rs434/share. We have valued the VSF business at 5x EV/EBITDA, implying a P/BV of 1.75x on an FY2011E basis. I have assigned the valuation multiple based on the VSF business’s superior RoCE as compared to its global peers (which are trading at 3x P/BV, based on CY2010E book value). I have valued the company’s 54.8% stake in Ultratech by assigning a holding company discount of 20%. Hence, our SOTP Fair Value for Grasim works out to Rs2, 548. I upgrade the stock to buy.

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