Results below expectation; VSF, cement margins under pressure

We maintain ?Buy? on Grasim Industries with a target price of R3,747. However, we downgrade our consolidated EPS (earnings per share) estimates for FY14 and FY15 by 14.3% and 6.6% to R290 and R401 to factor in weak realisation trend in both VSF (viscose staple fibre) and cement business. The stock trades at 7.4x (times) FY15e consolidated EPS of R401, 1x FY15e BV (book value), and implied valuations of $92 per tonne. The board has maintained dividend at R22.5 per share.

Valuation and view: We are downgrading FY14 and FY15 EPS consolidated estimates. VSF business is expected to have bottomed-out on pricing and profitability; however recovery would be a function of demand recovery and/or competing fibre pricing (which are at unsustainable levels). Cement business outlook is improving with expected improvement in demand and pricing.

Further, its aggressive capex plan of investing R86 bn over FY14-16 endorses our long-term positive outlook for both the businesses.

Results below expectations: Grasim?s net sales declined 1% year-on-year but sequentially grew 13% to R13.8 bn (vs estimates R12.4 bn), Ebitda flat y-o-y and q-o-q at R2.14 bn and PAT down 13% y-o-y (7.5% q-o-q) at R2.1 bn. Ebitda margin declined by 210 bps q-o-q (flat y-o-y) to 15.6%.

Grasim accounted for R2.04 bn of profit on sale of its 15% stake in Alexandria Carbon Black Co and 2.75% stake in Thai Carbon Black to another AV Birla Group company. As a result, reported PAT was higher at R3.72 bn. Consolidated net sales grew by 5% to R75.5 bn, with Ebitda margin decline of 170 bps y-o-y to 19.3%, Ebitda de-growth of 3.4% y-o-y to R13.7 billion and PAT growth of 1% y-o-y at R8.2 bn. Consolidated performance was impacted by R240m PBIDT (profit before interest, depreciation & taxes) loss in Terrace Bay.

VSF business pressure on pricing continues: VSF realisations declined 2% y-o-y and q-o-q to R119 per kg (as against estimates R120.5 per kg). Weak realisations coupled with higher caustic prices impact PBITDA margins into 17.8% (-50 bps q-o-q versus -110 bps y-o-y). On a consolidated basis, PBIDT was at R2.04 bn (vs R2.51 bn in Q4FY12). Grasim?s proportionate losses at recently acquired pulp JV, AV Terrace Bay (Canada) for Q4FY13 and full-year FY13 were R273m and R602m, respectively.

Limited downside to pricing: The management has indicated that amidst challenging near-term, it does not see any further downside to VSF pricing, as at current global VSF prices Chinese players would be making losses.

In cement, the demand is expected to grow by an average 8% in the long term with housing, infrastructure and allied spending being the key value drivers. Industry capacity utilisation is likely to improve to 80% in FY16 as the pace of capacity addition will slow down. Cost pressures are easing off with the decline in global commodity prices, particularly energy.

Grasim is setting-up 9.2 mt capacity at Chattisgarh and Karnataka, along with with split grinding units and packaging terminals.

This capacity would be entirely operational by H1FY14. It has already commenced Clinkerisation unit of 3.3 mt at Chhattisgarh, grinding units of 1.55 mt and 0.6 mt in Maharashtra and Gujarat, taking total cement capacity to 50.9 mt.

The board has approved fresh brownfield capacity addition of 2.9 mt at Rajasthan, taking total capacity in India to 61.45 million tonnes.