Robust margins offset weak volumes; multiple factors to drive strong growth in earnings; FY19e EPS reduced 6%; retain ‘Add’
Vardhman’s Q4FY18 results were largely in line with our estimates; an unexpected decline in volumes and revenues was adequately offset by sharp improvement in margins aided by favourable cotton prices. Moderation in domestic cotton prices amid easing domestic supply-demand balance, a weaker Rupee and on-track expansion projects will drive robust growth in earnings. We retain our Add rating on the stock with an unchanged TP of Rs 1,400 based on 10X FY2020e EPS.
In-line results as 6-7% y-o-y decline in volumes is offset by 350 bps q-o-q expansion in margins
Vardhman’s results were largely in line with our estimates despite lower-than-expected volumes and revenues, which were offset by sharply higher Ebitda margins. Revenues declined 8% q-o-q to Rs 15.1 bn, led by weaker off-take of yarn and fabric amid oversupply in the domestic market. Ebitda margins surprised on the upside, improving 350 bps q-o-q to 17.2%, a tad slower than 575 bps q-o-q expansion in gross margins to 49% and underpinned by favourable procurement pricing during early cotton harvesting season. Ebitda increased 15% q-o-q to `2.6 bn, partially helped by 2-4% q-o-q decline in power and fuel and employee expenses. Reported net income increased 21% q-o-q to Rs 1.64 bn, in line with our estimate.
Vardhman’s FY2018 performance remained weak, impacted by (i) a strengthening Rupee, (ii) GST-led disruptions in the supply chain and (iii) lower yarn spreads on high-price cotton inventory. Revenues grew 3% y-o-y to Rs 62.5 bn, while Ebitda declined sharply by 26% y-o-y to `9 bn. Gross margins reduced by 620 bps y-o-y to 45.5% and Ebitda margins declined by 575 bps y-o-y to 14.5%. Adjusted EPS declined by 12.4% y-o-y to `106.6, partially benefiting from a change in depreciation policy.
Yarn sales declined sharply: Yarn sales declined 9% sequentially to 50.1 k-tons and processed fabric sales declined 1% q-o-q to 31 mn metres. Yarn production reduced 1% q-o-q to 50.9 k-tons, while processed fabric production was down 1.6% q-o-q to 31 mn metres. Domestic yarn players are expected to gain from moderation in cotton prices from the peaks of FY2018. In recent months, the company has also seen an uptick in the exports to China. With the currency in favour and an easing supply-demand balance, Vardhman is expected to benefit from these macro tailwinds.
Cotton price unlikely to decline further: The management indicated that cotton prices may not soften further as the acreages in the Kharif season are expected to decline by 5-10% given lower yields, pest attacks and weak farmer profitability last year. This may keep Vardhman’s Ebitda margins at the lower end of the long-term guidance of 18-22%.
Fine-tune estimates; retain ADD with a target price of Rs 1,400 We reduce our FY2019E EPS estimate by 6% to Rs 130, factoring in slower growth in volumes/revenues; our FY2020E EPS remains largely unchanged at Rs 140. We retain our Add rating on the stock with an unchanged target price of `1,400, as we find the reward-risk favourable amid a cyclical recovery in yarn spreads amid a conducive macro environment.
Kotak Institutional Equities