Grasim Industries

With Grasim Industries’ stock price correcting by 11 per cent over the past week, the market appears to have largely discounted the marginal value erosion that shareholders are likely to suffer due to the transfer of the company’s cement business to a subsidiary. Except for this ‘holding company’ discount, the move to de-merge the cement business does not have any major negative implications for Grasim investors.

Investors can hold the stock for the present, as listing of the cement business has the potential to discover a better price for it than it currently enjoys. Devoid of cement, Grasim will be a pure VSF (viscose staple fibre) and chemicals manufacturer and is likely to see lower valuation multiples. Post-demerger, Grasim is likely to be valued more for its group holdings — the stake in UltraTech Cement and Samruddhi Cement together with investments in group companies such as Hindalco Industries, Idea Cellular, L&T. The company’s cash-rich status and plans to expand its VSF capacity by 25 per cent and increase its global market share may also prove value-accretive for the core business.

What is the deal?

Under the demerger scheme announced last week, Grasim’s shareholders are promised one share in the new subsidiary (Samruddhi Cement Limited — SCL) for every share held by them in the parent entity. Grasim’s shareholders are to get a direct exposure to the cement business with a 35 per cent stake in SCL (the remaining 65 per cent to be held by Grasim).

But is this deal a value-eroding one for the shareholders of Grasim Industries? A rough calculation, based on the segment results reported by Grasim in 2008-09, suggests it is not. Consider this:

The non-cement businesses of Grasim (pulp, chemicals and textiles divisions) reported operating profits of about Rs 935 crore in 2008-09. This works out to net profits of about Rs 522 crore, after apportioning interest costs (based on liabilities), depreciation and taxes, translating into per share earnings of Rs 57 on Grasim’s equity base.

Assuming this business manages a PE multiple of about eight times, post demerger, Grasim’s residual businesses will give the holders of the stock a value of only Rs 455 per share. Investment in group entities including the interest in UltraTech Cement will bring Rs 858 per share at today’s market prices.

Based on the cement division’s operating profit of Rs 1,912 crore in 2008-09, net profits of about Rs 1,011 crore and per share earnings of about Rs 39 appear likely for the cement subsidiary — Samruddhi Cement. At a PE multiple of about 10 enjoyed by cement companies now, as Samruddhi lists it could trade at a price of about Rs 390. Assuming that Grasim’s 65 per cent stake in Samruddhi is valued at a 10 per cent discount due to the indirect holding, the value of this holding works out to Rs 645 per Grasim share.

This calculation suggests that the value of Grasim, post-demerger, may work out to about Rs 1,958 per share, with Rs 455 for the core business and the remaining for its investment book and holding in Samruddhi.

Investors will in addition be entitled to one Samruddhi share valued at Rs 390, taking the total value to Rs 2,348, not much below current market price.
VSF Business

Valuations apart, what are the prospects for Grasim, post-demerger? Grasim derived close to 75 per cent of its revenues from the cement business last year. With cement being hivedoff into a separate subsidiary now, Grasim’s core revenue generating business will be textiles.

The company’s fibre division manufactures an artificial fibre — viscose staple fibre (VSF). The company claims to meet almost 98 per cent of India’s VSF requirements. But as a significant portion of the segment’s revenues are from overseas, this division didn’t perform well in 2008-09. The company’s VSF sales volume was down 12 per cent in the last year.

Over the last five years, the VSF segment has posted less than one per cent annualised volume growth, with realisations lifting overall growth rates.

The challenges to the VSF business come from rising input prices, global economic slowdown and the related fall in textile exports to countries such as the US, Brazil and Turkey. With small and mid-sized players going though a squeeze, Grasim plans to take this as an opportunity to spread its wings in the global VSF market (it holds a current share of 10 per cent).

Plans have been outlined to set up an 80,000 tonnes per annum VSF plant in Vilayat, Gujarat, raising its capacity by 25 per cent at an investment of Rs 1000 crore in the next three years.

The carving out of the cement division will reduce Grasim’s debt burden (70 per cent of the company’s overall debt is for cement related investments) giving it leeway for fresh borrowings for the new investment activity.

However, demand and prices need to catch up to make Grasim’s VSF division a lucrative investment for investors.
Chemicals

Grasim has a capacity of 2.58 lakh tonnes per annum for caustic soda. This division mainly caters to the VSF business’ raw material requirements, but has diversified into products such as hydrogen gas, bleaching powder, hydrochloric acid, etc. This division’s volume sales rose 11 per cent and margins (operating) expanded 3 per cent points in 2008-09. CAGR growth in sales volumes of this division over the past five years were at 6 per cent. Though the company is taking initiatives to cut costs in this division there are no expansion plans.
group companies

Post the de-merger it is Grasim’s investment book that will hold greater value for investors than its core business, the major components being holdings in UltraTech Cement and Samruddhi Cement.

The other listed companies in which Grasim holds a stake are Hindalco Industries, Idea Cellular and Larsen & Toubro. In all these three companies, Grasim holds less than a 6 per cent stake each.

The step-up in revenues in the subsidiaries — UltraTech Cement & Samruddhi Cement — and the other group companies will be closely watched by the market as it values Grasim when Samruddhi lists soon, as proposed by the company.
Samruddhi Cement

Grasim’s entire cement business — grey cement (of 25.7 mtpa capacity), white cement (of 0.6 mtpa capacity), ready-mix concrete (36 plants of 6.8 million cubic metres capacity) together with the 268 MW capacity thermal power plants have been carved out into the subsidiary — Samruddhi Cement.

Grasim had spent Rs 1,467 crore in the last year for various capex activities in cement and from now it is expected that Samruddhi Cement will carry on with the capital outlay plans. Grasim had outlined Rs 2,105 crore over the next two years for completion of existing projects, adding captive thermal power plants and waste heat recovery systems.

When Samruddhi Cement merges with UltraTech Cement in its “next natural step” as the company calls, shareholders would gain from higher earnings that follow from higher volumes and higher market spread.

However, the price at which Samruddhi lists in the market and the swap ratio that UltraTech offers Grasim’s investors will be key factors that would determine investors’ loss/gain.

via BL