Edelweiss - Spentex Industries

Edelweiss Research report on Spentex Industries:

Spentex Industries’ (Spentex) Q4FY07 results were below our expectations. Net revenues grew 18% Q-o-Q to Rs 3.13 billion. Pressure on realisations and higher power expenses caused EBITDA margin to decline 160bps Q-o-Q to 11.3%. Higher depreciation costs, on account of revaluation of assets, caused PBT to decline 186% Q-o-Q, bringing about a loss of Rs 67 million. PAT decreased 124% Q-o-Q, causing a loss of Rs 31 million. There was a deferred tax write-back of Rs 50 million.

For the full year FY07, Spentex (consolidated) reported revenues of Rs 9.41 billion. Its EBITDA margin was at 11.9% (12.3% in 9MFY07) versus our estimate of 12.4% for FY07.

Spentex also announced the acquisition of Schoeller Textil (Schoeller) headquartered in Germany, with manufacturing plant in the Czech Republic. Schoeller is the European market leader in ‘corner markets’ in the yarn industry and manufactures special sewing thread yarns, carpet warp yarns, and core yarns for weaving mills. Schoeller was valued at Euro 25 million for the transaction (FY06 revenues of Euro 54.5 million, EBITDA of Euro 5.8 million).

We expect earnings downsides in FY08 from our earlier estimates, primarily on the back of Rupee appreciation and decline in yarn prices. However, scale-up of all the capacities acquired in FY07 and the company’s continued inorganic growth at inexpensive valuations imply strong growth in EBITDA and profitability, going forward. We have revised our FY08 earnings downward to factor in the appreciated rupee and lower yarn prices. We maintain ‘BUY’ on Spentex owing to its strong business model that enables it to earn superior RoCEs. At CMP, the stock is trading at a PE of 4.8x and EV/EBITDA of 4.6x on our FY08E consolidated earnings.

Result highlights and outlook

Topline growth muted, power, and depreciation costs create further bottomline pressures Net revenues grew 18% Q-o-Q to Rs 3.13 billion. Pressure on realisations and higher power expenses (power costs in Maharashtra units peaked at Rs 5.2/ unit in February as against Rs 4.25 now) caused EBITDA margin to decline 160bps Q-o-Q to 11.3%. Higher depreciation costs of Rs 247 million as against Rs 152 million in Q3 FY07 (due to revaluation of assets) caused PBT to decline 186% Q-o-Q bringing about a loss of INR 67 mn. PAT decreased 124% Q-o-Q, causing a loss of Rs 31 million. There was a deferred tax write-back of Rs 50 million.

Yarn prices to keep earnings subdued in FY08; acquisitions to compensate

An appreciated Rupee, coupled with pressure on yarn prices, is likely to keep topline and margins under pressure in FY08. However, Spentex will be able to derive full utilization of the capacities it acquired in FY07 in FY08. Also, the company continues to pursue its strategy of inorganic growth at inexpensive valuations, which implies strong growth in EBITDA and profitability.

Revised proforma numbers

We have revised our FY08 and FY09 estimates to factor in lower yarn realizations and a full year average Re/USD conversion rate of 43 as against 45 earlier. We have also factored in estimates for the Czech acquisition in the proforma consolidated estimates.

Schoeller Textile acquisition to be value accretive

Spentex also announced the acquisition of Schoeller Textil (Schoeller) headquartered in Germany, with manufacturing plant in the Czech Republic. Schoeller is the European market leader in ‘corner markets’ in the yarn industry and manufactures special sewing thread yarns, carpet warp yarns, and core yarns for weaving mills. Schoeller was valued at Euro 25 million for the transaction (FY06 revenues of Euro 54.5 million, EBITDA of Euro 5.8 million). The deal involves share purchase of 100% of Schoeller Litvinov k.s., the Czech Republic company along with 11 employees in Germany based front end operations from Leopold Schoeller.. This will be financed completely though the books of Spentex’s Netherlands based subsidiary (SNPV) which will raise a debt of Euro 17 million to infuse equity and debt into Schoeller and to cater to other costs.

Valuations- Inexpensive, upsides to come from future acquisitions

We believe, Spentex will continue to pursue inorganic growth opportunities, which will drive its asset base growth at low costs. We maintain ‘BUY’ on Spentex owing to its strong business model, which enables it to earn superior RoCEs on the spinning operations. At CMP, the stock is trading at a PE of 4.8x and EV/EBITDA of 4.6x on our FY08E consolidated earnings.