We initiate coverage on Welspun with Outperform and target price of `115. The global home textile market size is $45 bn, with expected 8.3% CAGR over 2015-20. Of this, the US cotton textile market is $7.5 bn and India has a strategic advantage in this market due to the supply of cotton and free market access. In cotton bed sheets and towels, India has 50% and 40% market share, respectively, in the US. Welspun is a leading player in cotton towels and cotton bed sheets, with a continuously growing market share.
Three legs for the next phase of growth: Welspun’s business posted 17% organic CAGR over FY12-16, and in FY16, it drew out a “Welspun 2.0” strategy, targeting $2 bn revenue by 2020 ($1 bn in FY17). New products/channels, new geographies (Europe, Japan, India, Australia) and innovative/branded products are the key components of this strategy.
Well set for a recovery in FY19: The provenance issues of Egyptian cotton sheets in August 2016 led to the loss of a major client and a 13% fall in the revenue base. However, management handled the situation well, in our view. While revenue growth may drop to 5-8% in FY17-18 due to this, we expect a recovery in FY19, with 15% revenue growth. The new flooring capacity will also be operational in FY20, and can add 8-9% to FY20 revenue growth. While the margins may settle at 22-23% over the next 2-3 years, we expect over 20% earnings growth in FY19.
Initiate with Outperform: We initiate coverage on Welspun India with an Outperform rating and target price of `115, offering 37% potential upside from the current price. The fundamentals of the business are attractive, Welspun is a leading and well-managed player, the balance sheet is in a comfortable position and cash flows are attractive. While the Egyptian cotton provenance issue was an unfortunate one and likely reflects poor processes, we believe management handled the situation well and has come out of it with strong processes. We value the stock at `115 using a DCF model, with a cost of equity of 12.8%, target D/E of 0.25x, and terminal growth of 5%. On FY19 estimates, Welspun’s P/E and EV/Ebitda multiples are also in line or lower than its peer group. We estimate a 6% FCF yield in FY19. Any trade barriers, high customer concentration and volatility in cotton prices/currency are key risks.