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Improving core business, Paints should shine

Capacity expansion in VSF/Caustic soda and foray into Paints should underpin growth

* Grasim Industries (Grasim) should benefit from the changes in cotton industry dynamics. VSF demand growth should outpace cotton until FY25E. Further, the US ban on cotton imports from Xinjaing region may trigger a shift to substitute products.

* Focus on backward integration in the Chemical segment should improve chlorine usage as Grasim plans to increase chlorine consumption in value added products (VAPs) to 40% by FY25E from 28% in FY21. Chemical segment’s OPM should improve to 19% in FY23E from 13% in FY21.

* Further, likely capacity expansions of 37%/33% in the VSF/Caustic soda segments, respectively, should improve volume/profits during FY22-24E. We estimate a 16%/15% volume CAGR for the VSF/Chemical business, respectively, over FY21-24.

* Grasim’s plan to augment the capex of its Paints business indicates its intent of entering the paints segment on a large scale. Brand recall of Grasim as well as its strong balance sheet, and distribution network of UTECM’s white paints segment should help the company succeed in this segment.

* We upgrade our rating on Grasim to BUY from Neutral. We assign a: a) 6x Dec-23 EV/EBITDA to the standalone segment, b) 40% HoldCo discount for its holding in subsidiary companies, and c) 5% premium to our SoTP-based TP for the paints business, to arrive at our revised target price of INR2,050. Grasim is a quasi-play on the cement segment with UTCEM being our top pick in the large-cap space.

* Key risks to our call: a) delay in entry into the paints business, b) inability to gain volumes in the paints segment and c) margin pressure on the VSF/caustic business.

Changes in the cotton industry dynamics; higher growth potential for VSF

The US ban on cotton imports from Xinjiang, China (one of the major cotton producers accounting for 21% of global production in CY20) due to forced labor issues may lead to a shift to other regions or cotton substitutes to meet apparel manufacturers’ needs. This may aid global VSF producers. VSF seems to be more sustainable than cotton in long run due to: a) lower water/pesticides requirement and b) no competition from food crops for arable lands. The consumption of wood-based fibers is estimated to record a 3-5% CAGR over FY19-25 (higher growth for Lyocell, Modal and Viscose) compared with -1 to 1% growth for cotton.

Caustic soda margins likely to improve; focus on Chlorine VAPs to help

Caustic soda prices in the industry have increased recently and margins seem to be improving from the lows of FY20/21. Grasim has gained a competitive edge by developing higher VAPs from chlorine, which results in better ECU realizations. The company targets to increase chlorine consumption in VAPs to 40% by FY25E from 28% in FY21. This will augment the production of Caustic Soda. Further, Grasim’s tie up with Lubrizol will help the former raise its chlorine sales.

Capacity expansions in VSF and Chemical segments to boost growth

Grasim is in the process of increasing its VSF segment capacity by 37% to 810ktpa, which is expected to be completed by 3QFY22. The company is likely to raise its caustic soda production by 33% to 1,530ktpa by FY23E (237ktpa in FY22E and 136ktpa in FY23E) and its epoxy capacity by 125ktpa as on FY24E. We estimate a 16%/15% volume CAGR for the VSF/Chemical business, respectively, over FY21-24. Grasim plans to improve its mix of VAPs in the chemical segment to 40% by FY25E from 28% in FY21 and to 35-40% by FY25E in VSF segment from 27% in 2QFY22.

Entry into paints to help diversify from cyclical to a high-RoCE business

Grasim’s plan to invest INR50b of capex for the Paints business indicates its intent of entering the paints segment on a large scale. We view Grasim’s entry into this business as a positive step as this marks its diversification into a high-growth, highRoCE segment from the cyclical and non-core (divestment of its fertilizer business has been completed) business segments. Though, historically some of the companies have found it difficult to achieve a meaningful scale in this business, we believe Grasim has fair scope of succeeding. This is because: a) the distribution network of Birla White/Putty (of 54,000 dealers) has 70% overlap between Paints and Birla White dealers and b) the Birla group enjoys a strong brand recall. Further, Grasim’s strong balance sheet will support this segment to grow initially and the company may pose a serious threat to incumbents over the long run. The management is targeting a 20% IRR from this business and is aiming to make Grasim the No. 2 player in the paints industry.

Quasi-play on the cement business; UTCEM is our top pick in the sector

Grasim, through its holding in UTCEM, is also a quasi-play on the cement segment. In our SoTP valuation for Grasim, UltraTech contributes 65% of the total value for Grasim. We are positive on the cement business and UTCEM is our top pick in largecap space driven by its: a) growth plans, b) cost-saving initiatives, c) leadership position and d) improving balance sheet strength. The HoldCo discount for Grasim’s holding in subsidiary companies has reduced to 40-45% from 60%+ two years back (when there were concerns of fund infusion in VIL), which we expect to sustain going forward.

Valuation and view: Upgrade to BUY from Neutral

Grasim’s significant capex plans for its Paints business indicates its intent to enter the segment on a large scale. The company’s strong balance sheet is likely to be sufficient for its capex requirements in this segment. Grasim’s net debt is anticipated to decline notably to INR11.7b in Mar’22 from INR29.4b in FY20. We expect the company to turn net cash positive in FY23 (excluding capex for the paints business). We value the standalone business at 6x Dec-23E EV/EBITDA and other listed subsidiaries at 40% HoldCo discount to arrive at our revised target price of INR2,050. Our target price for Grasim includes a 5% premium to the underlying SoTP valuation in order to capture the potential upside from its paints business. We upgrade our rating on Grasim to BUY from Neutral.

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