Vardhman’s Q1FY18 results were expectedly impacted by GST-led destocking, adverse exchange rate and high cotton prices.
Vardhman’s Q1FY18 results were expectedly impacted by GST-led destocking, adverse exchange rate and high cotton prices. Net income was saved by a change in depreciation policy. The management, in the conference call, ruled out recovery until the end of Q3FY18 given continuation of macro headwinds besides declining yarn exports to China given increase in domestic supply there. We cut our EBITDA estimates and retain ‘add’ with a reduced TP of Rs 1,225; Rs 1,350 previously. Vardhman’s Q1FY18 performance was impacted by 115 bps q-o-q decline in gross margins to 45.6% led by lower yarn-cotton spreads amid sharp increase in domestic cotton prices due to lower availability and 4-10% q-o-q decline in yarn and fabric sales due to GST-related destocking. EBITDA declined sharply by 29% y-o-y to Rs 2.21 billion with margins of 14.1%, significantly weaker compared to robust 20.2% achieved during FY2017. Reported net income declined 16.5% y-o-y to Rs 1.49 billion, albeit higher than our estimate, saved by Rs 241 million of benefit from change in depreciation policy, with the useful life of assets increased to 10 years from 7.5 years currently, higher other income, including Rs 364 million of receipts from tendering 8.9 million shares for buyback of Vardhman Acrylics and lower tax rate at 17.7%.
Production for yarn and processed fabric grew to 50.7k tonne, +2% y-o-y and 30 million metres, +4% y-o-y, respectively. Sales were presumably impacted by GST-led destocking as yarn and fabric sales declined sequentially to 51.1k tonne, -4% q-o-q and 29.5 million metres, -10% q-o-q, respectively. EBITDA margin at 14.1% was down 300 bps q-o-q and well below the company’s target range of 18-22%.
The company expects gradual moderation in cotton prices, further benefiting from higher acreage under cultivation and favorable monsoons, which will likely result in surplus cotton yields for the coming season. In the conference call, the management guided to a challenging year ahead led by compression in yarn spreads due to higher domestic price of cotton as compared to global benchmarks, reduction in yarn imports from India by China and Bangladesh and appreciation of rupee against other currencies; Q1FY18 also had disruptions in the value chain due to implementation of GST, although the company expects to benefit from it in the long run.
The company withdrew its guidance of 18-22% EBITDA margin due to uncertain macro environment. We cut our EPS estimates to Rs 95 (-6%) in FY2018 and Rs 122 (-1%) in FY2019, factoring in expected weakness during FY2018, revised exchange rate assumptions, lower depreciation rate in accordance with the new policy and other minor changes. We retain ‘add’ with a lower target price of Rs 1,225, based on 10X FY2019E EPS versus 11X earlier; reduced target multiple accounts for elevated EPS due to alignment of depreciation policy.