Coming out of the woods: Grasim's core biz sees significant recovery in Q2

Improving prospects of core businesses to drive earnings, and better outlook for subsidiaries to reduce holding company discount

Grasim Industries’ saw strong rebound in the September quarter (Q2) after significant weakness in the lockdown-impacted Q1. Capacity utilisation revived thanks to rising demand, which in turn helped realisations, too. 

With the core Viscose Staple Fibre (VSF) and chemicals businesses recovering to pre-Covid levels, analysts feel, the bottom of the business cycle is behind. The company’s consolidated performance is also expected to improve with better outlook for investment companies and subsidiaries.  For instance, the cement business, represented by UltraTech, is seeing significant earnings upgrades and rebound in stock price. Similarly, concerns over the telecom business (Vodafone Idea) are reducing. Hence, one can expect the holding company discount to reduce.

Holding company discount reflects the discount investors assign to the fair value of businesses/investments held indirectly by a company while calculating its sum-of-the-parts valuation. At 53 per cent, Grasim’s holding company discount is already above its 10-year average of 47 per cent, according to Motilal Oswal Financial Services (MOFL). 

The brokerage doesn’t expect the discount to widen. In fact, many brokerages, including Antique Stock Broking, have increased their target fair value of Grasim because of the recent run up in stock prices of investment companies. The VSF and chemicals businesses also saw significant recovery in Q2. Capacity utilisation in the VSF business improved to 88 per cent from 26 per cent in Q1, and for the caustic soda segment it improved to 80 per cent from 49 per cent in Q1. VSF’s sales volumes rebo­u­n­ded over threefold sequentially, while caustic soda volumes grew 70 per cent. 

Revenue and profit are still down year-on-year (YoY), but with improving realisations, revenues surged 77 per cent sequentially to Rs 3,438 crore. Better realisations, reduction in input costs, and costs savings helped Ebitda (earnings before interest, taxes, depreciation, and amortisation) grow to Rs 680 crore, compared to a loss of Rs 46 crore in Q1. Grasim has also announced the sale its non-core fertiliser business to Indorama India for Rs 2,650 crore ($350 million) in a cash deal. Analysts say the divestment is a welcome step towards exiting non-core businesses. The proceeds would be used to deleverage Grasim’s balance sheet and expand its core businesses. 

The company’s net debt stood at Rs 2,329 crore (net debt-to-Ebitda of 1.46x), and it has capital expenditure of Rs 1,573 crore lined up for second half of FY21. The company plans to increase VSF capacities by 38 per cent and chemicals by 27 per cent by FY22.

It expects capacity expansion to accrue benefits in the coming years, and the prospects of core businesses have already improved with declining Chinese supplies, and rising demand and realisations. In China, inventory at VSF plants declined significantly from 45 days in April to 16 days in September. 

China’s yarn inventory with spinners also declined from 39 days (April) to 12 days (September) on the back of solid demand. China VSF prices, too, are up from 8,500 RMB in September to 10,700 RMB in November, which bodes well for realisations. For Grasim, export demand for VSF has already remained buoyant on the back of consumption in the US and European markets.

At the consolidated level, the prospects of the cement business remain strong with UltraTech having expanded capacities and witnessing strong volume growth. The favourable turn of cycle with higher-than-expected cement demand and regular gains in realisation improves its prospects. The financial services business (where Grasim holds stake) is also improving. 

The major concern was the telecom (Vodafone Idea) business, which is now seeing sentiments improve, thanks to tariff hikes and fundraising. Analysts say, the risk of investment in group companies like Vodafone Idea remain a key overhang and reason behind the high holding company discount.

Given this backdrop, analysts have upped their forward estimates and target prices. Kotak Institutional Equities (KIE) has increased its standalone Ebitda by 9 per cent, 9 per cent and 6 per cent for FY21, FY22 and FY23, respectively, while maintaining ‘buy’ on the stock.

Overall, analysts peg total value per share of Grasim (without discount) at Rs 1,650-1,900. If the discount reduces, there could be good gains for investors.