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VSF segment disappoints; Chemical performs better

Lower margin in the VSF segment led to lower-than-estimated profit

* Grasim’ 3QFY22 performance was below our estimate, led by a significant decline in profitability of the VSF segment. EBITDA stood at INR9.2b, 5% below our estimate, while profit at INR4.9b was 15% below our estimate led by higher depreciation and tax rate. The VSF segment posted a disappointing performance, with an OPM decline of 10.5pp YoY (6.8pp below our estimate). OPM for the Chemical segment was 2.6pp above our estimate.

* We have reduced our FY22E/FY23E/FY24E EBITDA by 5%/1%/2% considering higher cost pressures. We have cut our profit estimate by 9%/4%/4% in FY22E/FY23E/FY24E.

* We maintain Buy rating on the stock considering the benefit of capacity expansion in both business segments (VSF and Chemicals) as well as its plan to enter into the Paint business. Our SoTP based TP (Exhibit10) stands at INR2,110/share (v/s INR2,050 earlier) as we roll forward valuations to FY24E.

OPM in VSF falls 10.5pp YoY, but rises 8.8pp in the Chemical space

* Standalone revenue/EBITDA/PAT stood at INR57.8b/INR9.2b/INR4.9b (+56%/+43%/+48% YoY and +7%/-5%/-15% v/s our estimate). OPM in the VSF segment stood at 12% (est. 18.8%).

* Revenue in the VSF segment rose 55% YoY to INR33.3b, led by volume/realization growth of 22%/39%. EBITDA fell 17% YoY and 31% QoQ to INR4b, while OPM contracted by 10.5pp YoY and 7.3pp QoQ to 12%.

* EBITDA/kg in the VSF segment stood at INR24 v/s INR32/INR35 in 3QFY21/2QFY22. The management said the cost increase in this segment stood at INR4b QoQ (including the impact of higher volumes).

* Sales volumes in Caustic Soda rose 8% YoY. Realization (calculated on Caustic Soda volumes) grew 69% YoY and 31% QoQ. Revenue in this segment rose 83% YoY, while EBITDA grew 3x to INR5.3b. OPM in the segment improved by 8.8pp YoY and 8.3pp QoQ to 22.6%.

* Revenue rose 81% YoY to INR197.9b in 9MFY22, while EBITDA increased by 3.3x YoY to INR24.6b. OPM stood at 17% v/s 9.4% in 9MFY21. Adjusted profit rose 4.6x YoY to INR18.8b.

Highlights from the management commentary

* Demand for Textile products remained strong in India in 3QFY22. The Textile value chain is operating at peak capacity utilization. VSF’s share of domestic sales rose to 91% v/s 84% in 2QFY22. The share of VAPs (value added products) stood at 29% v/s 22%/27% in 3QFY21/2QFY22.

* The VSF segment faced unprecedented cost pressures due to an increase in prices of chlorine, crude, and logistical challenges. Cost in this segment rose INR4b QoQ (including the impact of higher volumes). Of that, INR1.2b was the impact of higher energy costs.

* There was an upward trend in Caustic Soda prices and capacity utilization rose 7pp QoQ to 93%. Chlorine demand is growing at a higher rate v/s that for Caustic Soda. Grasim aims to increase chlorine integration to 45% (v/s 29% at present) over the next three-to-four years.

* The company has received environmental clearance (EC) for the Paints business at two sites: Ludhiana and Panipat. It expects to receive EC for its plant in South India soon. The company has spent INR5.1b on the Paints business till date.

Valuation and view

* Grasim is expected to benefit from capacity expansions in VSF and the Chemicals segment. We expect 11%/8% sales volume CAGR in VSF/Caustic Soda over FY22-24E.

* Grasim’s large capex plan in Paints indicates its commitment towards becoming a serious player in this segment. Its strong Balance Sheet will take care of capex requirements in this segment. We expect the company to leverage the strong distribution network of Birla White (of UltraTech).

* We value the standalone business at 6x FY24E EV/EBITDA and other listed subsidiaries at a 40% holding company discount to arrive at our TP of INR2,110. Our TP for Grasim includes a 5% premium to its underlying SoTP in order to capture the potential upside from its Paints foray. We maintain our Buy rating.

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