Grasim Industries is the flagship company of Aditya Birla Group with cement (75% of FY16e EBITDA), VSF (12%), and chemicals (11%) being its core businesses. The company is the second-largest VSF producer globally, has a majority stake (60.25%) in Ultratech (UTCEM IN, `3,273.70, Reduce), which is the leading cement producer domestically, and is the largest caustic soda producer in the country.
While an upturn in cement demand is widely anticipated, we believe a robust recovery in Grasim’s VSF business has yet to be priced in and could therefore be a key catalyst for the stock. We expect an improvement in realisations for VSF on the back of higher demand and a better product mix to lead to margin expansion and an eventual narrowing of the holding company discount. A deteriorating VSF business has, in the past, weighed on Grasim’s shares, which have traded at a substantial discount to the market value of its stake in Ultratech. However, strong VSF earnings over the past three quarters have resulted in the discount narrowing. We expect to see this momentum continue, with the holding company discount narrowing from c30% currently to 20% in FY17e. Over the long run, limitations to growth in cotton, due to competition from other cash crops, a growing population, higher incomes in emerging economies, and increasing consumer awareness of the benefits of VSF over other fibres, support higher demand for VSF, in our view.
