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Strong margin performance continues…

About the stock: Vardhman Textiles (VTL) (earlier known as Mahavir Spinning) is part of the Vardhman Group, a large textile conglomerate with a presence across the textile value chain.

* Vardhman is among few textile companies that have been able to maintain a debt equity ratio below one despite continuous capacity addition

* Healthy cash flows have enabled VTL to reduce debt by ~| 152 crore in FY21 (D/E: 0.3x in FY21). We expect a further debt reduction of ~| 450 crore over the next two years to result in a D/E of ~0.2x in FY23E.

Q1FY22 Results: Vardhman Textiles reported a strong EBITDA margin performance in Q1FY22 amid strong demand in the yarn segment.

* Revenues de-grew marginally by 1% QoQ (up 136% YoY) to | 1927 crore

* Gross margin expanded even on a QoQ basis and by 170 bps YoY to 54.8% on lower power cost (down 107 bps QoQ to 8.5%) and decline in other expense by 163 bps QoQ to 12.8% that enabled EBITDA margin expansion of 460 bps QoQ to 24.8%

* Consequently, PAT grew 27% QoQ to | 317 crore.

What should investors do?

Despite being in the cyclical textile business, VTL’s stock price has appreciated at 12% CAGR in the last five years.

* We continue to remain structurally positive and maintain BUY rating

Target Price and Valuation: We value VTL at | 2240 i.e. 10x FY23E earnings.

Key triggers for future price performance:

* Global retailers are looking at de-risking their supply chains and VTL is expected to be a beneficiary in the yarn and fabric segment

* Strong demand coupled with supply constraint owing to closure of ~5-6% of capacities due to impact of pandemic is expected to result in stronger spreads in the yarn business

* The improved financial performance is expected to result in augmentation of RoCE profile (570 bps improvement in FY21-23E to 13.4%)

* We model revenue and earnings CAGR of 18% and 76%, respectively, in FY21-23E with higher RoCE of ~16%

Alternate Stock Idea: Apart from VTL, in our textile coverage we also like KPR Mill.

* KPR Mills is among select vertically integrated textile players in India that has displayed consistent operating margins with strong return ratios

* BUY with a target price of | 2310

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