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Stock Recommendation | ARVIND LTD – BUY – Target Price : 130
Publish date: DECEMBER 5, 2018
Arvind has demerged its branded apparel & retail business and engineering business into separate companies Arvind Fashions Ltd (AFL) and Anup Engineering Ltd (AEL), respectively. This would create three separately listed companies focusing on different businesses which will increase focus on individual businesses. The company management is positive on the long term fundamental of all the entities. As per company PPT, AFL and AEL are expected to be listed on exchanges tentatively in early February 2019.
■ Post demerger, Arvind will be present in two main businesses; textiles ~87% of FY18 revenue and advance materials ~7% of FY18 revenue, while balance ~6% of FY18 revenue was contributed by other smaller businesses. The textiles business involves manufacturing of wide variety of fabrics including, woven, knitted, denim, garments, etc. Under advance materials, it caters to high growth sectors such as infrastructure, healthcare, energy, aviation, industrial, etc.
■ Arvind has adopted verticalization strategy in textiles business in order to move up in the value chain by increasing focus on garmenting business. It intends to invest ~Rs 15 bn in order to expand capacity in textiles and advance material businesses in the next three years.
■ The company has reported strong performance in advance material in H1FY19 and is targeting a revenue growth rate of 24% yoy in FY19E with 9% operating margins.
■ Arvind has maintained revenue guidance of ~10% on broader basis with slower growth rate of 5-6% in textiles business and 24% growth rate in advance materials in FY19E. The company has guided for 100bps improvement in EBITDA margin in the year.
In the recent times, textiles sector witnessed challenges related to currency volatility, increased raw material cost due to elevated cotton prices and reduced government incentives. We have factored these challenges in our estimates and valuations. Based on this, we have assigned EV/EBITDA multiple of 6.5x (vs 8x earlier) which is marginally premium to industry average and arrive at a target price of Rs 130 for Arvind (Vs Rs 452 pre-demerger). At CMP, Arvind is trading at FY19E and FY20E EV/EBITDA (post demerger basis) of 6.6x and 5.7x respectively. We maintain buy rating on Arvind post demerger.
Arvind has demerged its branded apparel and engineering business into separate companies and these entities are expected to be listed on exchanges tentatively in early February 2019. The branded apparel business has been demerged into AFL and engineering business has been demerged into AEL. The demerger would create three separately listed companies focusing on different businesses which will lead to increase in focus of individual businesses. As per scheme of arrangement, shareholders of Arvind Limited will be entitled for 1 equity shares of Arvind Fashions Limited (Face value Rs 4) for every 5 shares held by them. Further, Arvind shareholder will also get 1 equity shares of Anup Engineering Limited for 27 shares held by them. The record date for demerger of branded apparel business (AFL) and engineering business (AEL) was 29th November 2018. Due to the demerger, Arvind is trading at new adjusted price (Adjusted for value of AFL and AEL) which is ~30% of the pre-demerger valuation.
Post demerger, Arvind will be present in two main businesses textiles and advance material. The textiles business involves manufacturing of wide variety of fabrics including, woven, knitted, denim etc. It is also manufacturing garment with large focus on exports. Under advance materials, it caters to high growth sectors such as infrastructure, healthcare, energy, aviation, industrial, etc. ~87% of Arvind’s FY18 revenue is contributed by textiles business, ~7% by advance materials and balance ~6% is contributed by others which includes supply of water and waste water treatment plants for Industrial Process, environmental solutions, etc.
The company has adopted verticalization strategy in order to move up in the value chain by increasing focus on garmenting business. Over the next five 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 H1FY19 which was earlier part of textiles and others segment. 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 maintained revenue guidance of ~10% on broader basis for Arvind Ltd (textiles, advance materials and others). In textiles business, it targets slower growth rate of 5-6% due to slowdown in denim sales and also reduced growth estimates of 20% in garmenting in FY19E as against earlier target of 35% yoy growth due to some delay in commissioning of new facilities. On the other hand, Advance materials segment is expected to grow at a strong pace of 24% on yoy. The company has maintained 100bps improvement in EBITDA margins led by sharp improvement in advance material segment margin (from -1% in FY18 to 9% in FY19E), while textiles margins is expected to be lower by 80bps.
AFL has a portfolio of 15 international licensed brands and 12 in-house brands targeting different segments. The business is managed by qualified and experienced professionals who have vast experience in consumer and fashion industry. The rise in scale of operation of these brands resulted in increased contribution to the bottomline. The company is targeting for EBITDA positive in FY19E for most of its brands except a few (like GAP), where the losses have reduced to a larger extent. In addition, its power brands like Arrow, US Polo and Flying Machine which commands higher margins would maintain its pace in terms of growth. The company targets to improve margins in power brand to ~15% by FY21/FY22 from present ~13% (in Q2FY19). The company is positive on improving margins in branded apparel business based on increased scale of emerging brands and retail business resulting in operating leverage and improved profitability in power brands.
The company has guided for ~20% growth in AFL (branded apparel business) driven by Power Brands to maintain momentum, improved sales in Unlimited and traction in Innerwear business on full year basis. The company expects 100 bps improvement in margins in the business despite increase in marketing investment by about 0.5%.
Anup Engineering (engineering business) has built up capability to manufacture critical process equipment and caters to marquee clientele. The segment has grown at a CAGR of 25% in FY13-18 with high margins of 30% and RoCE of ~40%. It has net cash balance sheet and has been generating healthy cash flows. The company is also looking at global opportunity in the business and has a vision to achieve Rs 10 bn revenue in the next 5-6 years. In FY19E revenue growth guidance for AEL is maintained at 10-12% with flattish margins.
In the recent times, textiles sector witnessed challenges related to currency volatility, increased raw material cost due to elevated cotton prices and reduced government incentives. Arvind is also facing elevated growth related challenges in denim business due to oversupply, aggression in pricing and higher credit terms offered by some of its peers in the domestic market. We have factored these challenges in our estimates and valuations. Presently, we are giving detailed consolidated financial estimates of Arvind (pre-demerger) and giving only key financial estimates of each of the demerged entities.
Based on our previous SoTP valuation, ~40% value (adjusted for debt) was attributed to listed entity Arvind Ltd (which was ~Rs 187 per share) and balance was for demerged businesses. Our valuation for Arvind’s textiles business was based on FY20E EV/EBITDA of 8x. Factoring in recent challenges related to the textiles business, we have assigned EV/EBITDA multiple of 6.5x which is premium to industry average (due to presence in high growth advance material business) and arrive at a target price of Rs 130 for Arvind (Vs Rs 452 pre-demerger).
We have valued AFL (branded apparel & retail business) at 17x FY20E EV/EBITDA (Vs 15x earlier), which is discount to industry average valuation of brand and retail players. We have valued AEL (engineering business) at 10x FY20E EV/EBITDA (Vs 12x earlier) factoring in near term risk related to growth. Post demerger, share capital of AFL will be 57.7 mn shares of face value Rs 4 and for AEL will be 10.21 mn of face value Rs 10. Based on this, the one year target price for AFL and AEL would be Rs 1154 and Rs 666 respectively post listing. At CMP, Arvind is trading at FY19E and FY20E EV/EBITDA (post demerger basis) of 6.6x and 5.7x respectively. We maintain buy rating on Arvind post demerger.
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