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Margin under pressure; near-term outlook cautious

Challenges continue for VSF; OPM in the Chemical segment fell 7pp QoQ

* GRASIM faced margin pressures in key business segments (VSF and Chemical). EBITDA grew 19% YoY to INR9.6b (est. INR11.4b). OPM fell 2pp YoY to 14% (est. 15.7%). Adjusted profit grew 9% YoY to INR10.3b (est. INR11.5b).

* The management said that demand for VSF remains under pressure globally, which, in turn, has led to rising imports from China and Indonesia. As the Sep’22 exit price for VSF was 4% lower than its 2QFY23 average, margin in 3QFY23 could fall further.

* We downgrade our FY23/FY24 EBITDA estimate by 8%/7% and EPS estimate by 10%/9% on lower margin in the VSF/Chemical segment. We maintain our Buy rating, considering our positive view on UTCEM and higher HoldCo discount of 38% (v/s 34% in Sep’22). We have valued GRASIM, assigning a 35% HoldCo discount to its holding in subsidiaries and 7x Sep’24 EV/EBITDA for the standalone business.

Margin pressure in both VSF and Chemical segment

* Standalone revenue/EBITDA/adjusted PAT stood at INR67.5b/INR9.6b/ INR10.3b (up 37%/19%/9% YoY and 8%/16%/10% below our estimate).

* Volume in the VSF segment (including VFY) grew 10% YoY (14% lower than our estimate) and realization rose 19% YoY. EBITDA fell 44% YoY and 35% QoQ, with a 11pp YoY and 3pp QoQ drop in OPM to 8.3%. EBITDA/kg in the VSF segment (including VFY) stood at INR18 v/s INR35/INR24 in 2QFY22/1QFY23.

* Volume in the Chemical segment rose 17% YoY (4% higher than our estimate). Realization rose 43% YoY. EBITDA grew 2.6x YoY, but fell 24% QoQ, with an 8pp YoY growth in OPM (down 7pp QoQ) to 22.5%.

* In 1HFY23, standalone revenue/EBITDA grew 61%/48% YoY. OPM fell 1.5pp YoY to 16.3%. Adjusted PAT grew 32% YoY. CFO stood at INR19.5b in 1HFY23 v/s INR11.7b in 1HFY22.

* Capex stood at INR16.5b v/s INR12b in 1HFY22. Gross debt stood at INR46.1b v/s INR41.2b in Mar’22. Net cash stood at INR5.1b v/s INR8.5b in Mar’22.

Highlights from the management commentary

* The sentiment for VSF has not been good globally, with demand lower due to subdued market conditions. Profitability in the VSF space is expected to remain under pressure in the near-term. The cotton market is depressed. Capacity utilization for VSF has been rationalized at 70%.

* VSF prices are expected to remain volatile in the near-term. Exit VSF price in Sep’22 was 4% lower than its 2QFY23 average.

* Commissioning of first Paints plant is expected in 4QFY24 (capacity of 0.2- 0.22m kl/annum). Other plants (total capacity for Paints will be 1.3b kl/year) will come on stream in phases in FY25. The pilot plant is expected to be commissioned by the end of Nov’22 (for testing of product quality).Brand launch will occur only after the commissioning of the first factory

Valuation and view

* GRASIM, via its holdings in UTCEM, is a quasi-play on the Cement space. In our SoTP valuation, UTCEM contributes 65% to GRASIM’s TP. We are positive on the Cement business, with UTCEM being our top pick in the largecap space.

* The management plans to invest INR100b in the Paints business, which indicates its intent of entering this space on a large scale. We view its entry into this business as a positive step as this marks its diversification into the high-growth, high-RoCE segment from a cyclical and non-core (divestment of its Fertilizer business has been completed) business segments.

* We value the standalone business at 7x Sep’24 EV/EBITDA and other listed subsidiaries at a 35% holding company discount to arrive at our TP of INR2,000 (from INR1,880 earlier). We maintain our Buy rating on the stock.

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