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Stock Recommendation | ARVIND LTD – BUY – Target Price : 110
Publish date: FEBRUARY 12, 2019
Arvind reported subdued performance in Q3FY19 due to challenging competitive environment in denim business.
■ Consolidated Net Sales declined by 0.6% yoy to Rs 16.8 bn due to 7% yoy decline in textiles business segment, while advance material business segment grew by 32% yoy. Textiles segment faced challenges due to decline in exports as some of its large clients took inventory correction.
■ EBITDA margins for the quarter declined by 120 bps yoy to 8.9% driven by 365 bps yoy decline in textiles margin due to lower sales, higher pre-operative expenses in new garments manufacturing plants and write off related to Arvind Stores.
■ The company has cut FY19E revenue growth guidance from 10% to 5% yoy and targets for 30 bps yoy (Vs 100 bps earlier) improvement in EBITDA margins in the year.
■ We have downgraded our revenue and margins estimates factoring in challenging business environment in denim business.
■ The stock is presently trading at FY19E/20E PE of 6.0x/4.8x based on FY19E/FY20E EPS of Rs. 13.3/16.5 respectively. We maintain BUY recommendation on the stock with revised target price of Rs 110 (earlier target price of Rs 130), valuing the stock at FY20E EV/EBITDA of 6.5x.
Q3FY19 consolidated net sales declined by 0.6% to Rs 16.8 bn due to 7% yoy decline in textiles business segment while advance material business segment grew by 32% yoy. Textiles segment declined due to 21% yoy decline in denim volume while garments segment grew by 15% on yoy basis. Decline in denim business is due to decline in exports as some of its large clients took inventory correction. Even in domestic market the volume was flattish. Denim industry in India is facing challenges due to a) over supply, b) aggression in pricing and c) higher credit offered by some of its peers (who have surplus capacity). Under this scenario, the company took decision to hold prices and forego volume which impacted denim sales.
EBITDA margins for the quarter declined by 120 bps yoy to 8.9% driven by 365 bps yoy decline in textiles margin due to lower sales volume in Denim, higher pre-ops in new manufacturing plants and write off related to Arvind Stores. The denim business took a volume hit on exports side due to destocking by major clients. In textiles garments business, the company is undergoing through expansion phase and is increasing capacity from 30 mn pcs to 90 mn pcs per annum in the next three years. The preoperative expenses related to garment expansion also negatively impacted margins in the quarter. Further, the company is restructuring fabric retail business under brand Arvind Store. It is shifting the model from company owned store to franchisee owned. Hence, there are certain write offs associated to the same which also impacted margins in the quarter.
EBITDA margins in Advance materials segment continued to improve and was at 10.2% (Vs -3% yoy) in the quarter. The margin in the business improved on account of a) operating leverage as mature part of portfolio started to hit scale, b) improved realization from higher value added products and c) tie-up with a European firm for Cured-In-Place-Pipe technology yielding positive results. In the quarter, the company reported exceptional items of Rs 185 mn related to write-off of GST credits due to change in regulations. Further, there was retrenchment compensation of Rs 10 mn and devaluation in value of investment in subsidiary of Rs. 50 mn. Due to lower margin and exceptional items, PAT for the quarter declined by 42% yoy to Rs 406 mn.
The company has adopted verticalization strategy in order to move up in value chain by increasing focus on garmenting business. Over the longer period of next 5 years, Arvind aims to convert ~50% of its fabrics into garments from ~10% in FY18. In order to increase garmenting, the company is increasing its garment capacity by 3x to 90 mn pcs per annum in the next three years. The company is expanding garment manufacturing business by setting up units in states like Jharkhand, AP and Gujarat where government is giving labour subsidy (upto 50% labour cost for initial 5 years) to encourage employment. This will save cost for the company particularly in the initial phase of expansion. It has also setup garmenting unit in Ethiopia where the labour cost is 50% lower and enjoys zero duty for exports to the US and Europe and helps in competing against Bangladesh and Sri Lanka. The company intends to invest ~Rs 15 bn in order to expand capacity in textiles and advance material businesses in the next three years. This includes Rs 8 bn investment for expanding garment facilities (Rs 7 bn in India and Rs 1 bn in Ethiopia) ~Rs 2 bn in advance materials, ~Rs 1-1.5 in activewear, ~Rs 1 bn in specialized garment, etc.
The company has reported strong performance in advance material in 9MFY19. The segment is expected to grow at faster pace in the longer run and has potential to achieve Rs 15 bn revenue from Rs 4.8 bn in FY18. The company is catering to various segments under this division. This includes human protection products (such as firefighting jackets, bullet proof jackets, etc), composite products for industries (such as railway coaches, automobile industry), belting for industries, etc.
The company has cut revenue growth guidance for FY19E to 5% from earlier guidance of 10% with slower growth rate of 2% (Vs 5-6% earlier) in textiles segment due to lower denim sales and 3-6 months delay in new garment manufacturing projects. On the other hand, Advance materials segment is expected to grow at 24% on yoy. The company has cut margins improvement guidance to 30 bps Vs 100bps improvement estimated earlier. This is on account of 1% decline in margins of textiles business. However sharp improvement is expected in margins of advance material segment (from -1% in FY18 to 9% in FY19E). Further, spillover of water projects to Q1FY20 will also affect the revenue and margins for FY19.
■ As per company, likely listing of Arvind Fashions & Anup Engineering is expected later in February 2019.
■ The company has net debt of Rs 28.32 bn at the end of Q3FY19 and is expected to remain the same in FY19 end.
■ The company will be incurring Rs 4-4.5 bn in FY19E and it is expected to remain the same in FY20E as well.
We have updated our estimates based on actual segmental breakup for Arvind Ltd post demerger as given by the company which includes textiles, Advance materials and others. We are giving the summary of financial estimates for FY19E and FY20E and will give the detailed financials post FY19E results. We will come out with separate note on demerged businesses Arvind Fashions and Anup Engineering later post listing.
We have downgraded our revenue and margins estimates factoring in challenging business environment in denim business. We expect Arvind’s revenue and PAT to grow at a CAGR of 8.2% and 23.4%, respectively in FY18-20E. The stock is presently trading at FY19E/20E PE of 6.0x/4.8x based on FY19E/FY20E EPS of Rs. 13.3/16.5, respectively. We maintain BUY recommendation on the stock with revised target price of Rs 110 (earlier target price of Rs 130), valuing the stock at FY20E EV/EBITDA of 6.5x.
Arvind Ltd, founded in 1931 by Lalbhai family, is a leading textiles company with interest in Textiles, Advance materials, etc. The company manufactures and sells about 300 million meters (mn mtr) of fabrics and over 30 mn pieces of garments (FY18). In Advance materials business, the company is catering to various segments under this division. This includes human protection products such as firefighting jackets, bullet proof jackets, etc. The company has demerged branded apparels business under Arvind Fashions Ltd which own brands such as Flying Machine, Colt, Ruggers and Excalibur, etc. It also has a portfolio of licensed brands which includes US Polo Association, Arrow, Tommy Hilfiger (TH), Gap, Calvin Klein (CK), Hanes, Gant, Nautica, Izod, Ed Hardy, Elle, Cherokee, The Children’s Place, Aeropostale, etc. It has also demerged engineering business under Anup Engineering which designs and manufactures critical process equipment for petrochemical, fertilizer, power and other process industries.
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