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VSF’s capacity utilization at 91% in 1QFY24

* Grasim reported an EBITDA of INR6.7b (vs. est. INR5.2b) and OPM of 10.8% (vs. est. 8.2%) in 1QFY24. The beat was driven by VSF segment that posted an EBITDA/kg of INR19.9 (vs. est. INR13.8/kg) and Chemical segment that clocked an OPM of 16.7% (vs. est. 13.5%). Profit was at INR3.6b (vs. est. INR1.6b).

* Management believes that margins in both the key business segments, VSF and Chemical, have almost bottomed out. Lower input costs aided profitability improvement for the VSF segment and higher sales of VAPs. Further, increased chlorine integration supported sequential margin improvement in the Chemical segment. Commissioning of Lubrizol plant as well as increase in VAP capacities will help improve chlorine integration to 72% from 61% in Jun’23 (60% in FY23).

* We largely maintain our EBITDA estimates for FY24/FY25. Margin in the VSF segment witnessed a strong recovery and we expect EBITDA/kg to be at INR13/INR18 in FY24/25. Reiterate BUY with a TP of INR2,100 (Exhibit 9).

Moderating input costs drive margin improvement

* Standalone revenue/EBITDA/adj. PAT stood at INR62.4b/INR6.7b/INR3.6b (down 14%/49%/57% YoY and down 2%/up 28%/124% vs. our estimates).

* VSF segment’s (including VFY) volume declined 5% YoY (in line) and realization dropped 12% YoY. Though EBITDA was down 22% YoY, it surged 2.7x QoQ led by reduction in RM costs. VSF’s blended EBITDA/kg was at INR19.9 (down 18% YoY; 2.8x QoQ) vs. estimated INR13.8/kg. OPM of VSF stood at 10.9% vs. 11.6%/3.8% in 1Q/4QFY23.

* Chemical segment’s volume increased 5% YoY, while realization was down ~25% YoY. EBITDA declined 56% YoY due to lower ECU realization. OPM in Chemical stood at 16.7% vs. 29.5%/15.3% in 1Q/4QFY23. Higher share of VAPs and lower RM costs led to sequential improvement in prices.

Highlights from the management commentary

* RM costs such as Pulp, Caustic and coal prices have declined vs. last year and 4QFY23. Realization is also declining; however, margins appear to be largely bottoming out. Going forward, Grasim is trying to retain/improve its volumes.

* There should not be much pressure on caustic prices; though most likely 2Q’s realization will be lower than 1Q. However, margins seem to be sustaining at current levels with change in product-mix.

* Three plants of Paints with a combined capacity of 0.63m liters will be commissioned by FY24-end and Grasim’s long-term goal is to become the second-largest player in this business, which is growing at double-digits.

* The company has invested INR36.4b in the Paints business until Jun’23 and will further invest INR32.4b in 9MFY24. Most of the paints business capex (INR100b planned) will be completed by FY25.

View and valuation

* International VSF prices remained weak; however, operating rates have improved significantly. The average inventory levels in China have reduced continuously for the last three months, averaging 16 days in 1QFY24 – lower than three-year average of 21 days. Grasim’s margin during the quarter improved led by softening input costs and better efficiencies.

* Caustic soda demand is likely to be subdued in 2HCY23 and realization in 2Q is also estimated to be lower than 1Q. Despite that management expects margins to sustain at current level supported by cost efficiencies and change in the product-mix (increasing sale of value-added products).

* We have assumed VSF’s profitability to be at INR13/INR19 per kg in FY24/25. FY23 average profit was at ~INR9/kg (at a decadal low with almost nil profit in 2H) as against an average of INR22/kg over FY13-22.

* We maintain our BUY rating on the stock with a TP of INR2,100 as we value: 1) its holding in subsidiary companies by assigning a higher HoldCo discount of 40%; 2) standalone business at 7x EV/EBITDA, and 3) investments into the Paints business at 1x of investments.

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