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New garmenting, ethanol capacity drives sales…

About the stock: KPR Mill is among select vertically integrated textile players in India (from yarn to garments) that has displayed consistent revenue growth and positive operating margin trajectory with strong return ratios.

* It is one of India’s largest knitted garment manufacturer with total capacity of 157 million pieces (post expansion)

* Consistently, over the years, it has maintained ~18-20% margins with average RoCE of ~20% and D/E ratio of 0.4x

Q1FY23 Results: Despite unfavourable cotton yarn spreads, KPR reported steady profitability growth on a sequential basis (on account of low cost cotton inventory). Healthy yarn realisations and strong order book for the garmenting division continued to drive topline growth.

* Revenue for the quarter grew 9% QoQ (75% YoY) to | 1584.8 crore. Revenue from textile division grew 6% QoQ to | 1276 crore while revenue from sugar division increased 28% QoQ to | 223 crore

*  Gross margins remained flattish QoQ at 41% as the company continued to carry low cost cotton inventory (~| 225/kg). Cotton prices during the quarter had risen sharply by 25% QoQ to | 275/kg

* Employee expenses grew 20% QoQ to | 133.6 crore, mainly on account of newly commissioned garmenting and ethanol plant. EBITDA margins remained flattish sequentially to 23.2% with absolute EBITDA increasing 10% QoQ to | 368.1 crore (up 64% YoY)ring the quarter had risen sharply by 25% QoQ to | 275/kg

What should investors do? Since our initiation report, the stock price has appreciated ~4.8x (from | 120 in September 2020 to | 570 in August 2022). ? We like KPR as a structural long term story to play the apparel export space. However, expected demand slowdown in key export markets (Europe and US: ~80% of revenues) could weigh on the performance in H2FY23. Order book traction for H2FY23 will be critical. Maintain HOLD rating on the stock

Target Price and Valuation: We value KPR at | 650 i.e. 25x FY24E EPS

Key triggers for future price performance:

* Two major capex projects worth | 750 crore towards garmenting (| 250 crore) and ethanol facility (| 500 crore) expected to be ramped up in FY23E

* Capital deployment towards value accretive projects (targeted RoCE: garmenting:30%, ethanol: 22%) augurs well for KPR

* Recent FTA with Australia to benefit KPR as the region contributes 11% to sales

Alternate Stock Idea: Apart from KPR, we also like Gokaldas Exports

* (GEL) is one of India’s leading apparel exporter with an annual capacity of 36+ million pieces which focuses on manufacturing complex garmenting

Key takeaways of recent quarter & conference call highlights

Q1FY23 Results:

* Despite significant increase in raw material prices (cotton), KPR reported a steady operational performance. Revenue for the quarter grew 30% YoY (15% QoQ) to | 1449.9 crore. On the segmental front, garmenting division recorded healthy volumes to the tune of 36.7 million pieces (up 31% YoY). Post the commissioning of new 42 million garment production capacity in Tamil Nadu, the current capacity is at 157 million garments per annum. At the current quarterly run rate, the plant is already operating at ~90% capacity utilisation. On the utilisation of expanded capacity, the management indicated that it would first increase volumes supplied to existing customers and later on supply to its newer customers. Of the total incremental capacity, 60-70% is going to be utilised for the existing customer while balance will be for new customers. Owing to significantly higher cotton yarn prices, average realisation per piece for garments increased 40% YoY (24% QoQ) to | 189/piece. We expect realisations to gradually decline as cotton prices are expected to soften from November onwards. Owing to slowdown and various challenges in key export markets (such as Europe & North America: ~80% of revenues) we expect volumes to taper down in H2FY23 (though management has not indicated major slowdown in orders yet). We expect capacity utilisation to slow down to <80% in H2FY23

* For yarn & fabric division, volumes declined materially by 15% QoQ (down 3% YoY) to 13606 tonnes in Q1FY23 owing to slowdown in yarn demand amid significantly higher prices and also on account of higher captive consumption for the new garmenting capacity. Average realisation for the division was at | 397/kg (up 10% QoQ). Subsequently, revenue declined 6% QoQ to | 541 crore. We expect yarn realisations to come down, going forward, and owing to weaker demand, it is currently hovering in the range of | 335-340/kg. We expect yarn prices to further decelerate from Q3FY23 onwards as cotton futures are currently trading at | 190-195/kg (from current | 240/kg). Overall revenue for yarn and fabric division volumes is expected to decline 15% YoY to 59300 tomes in FY23E owing to increase captive consumption for the garmenting capacity

* On the sugar and ethanol capacity front, the company has a current sugar capacity of 90000 tonnes per annum while the ethanol capacity is 4 crore litre. Post expansion, sugar capacity is expected to increase to 165000 tonnes per annum and ethanol capacity is expected to increase to 10 crore litre. Revenue from sugar division grew 2.5x YoY (27 QoQ) to | 284 crore in Q1FY23. The new sugar and ethanol plant is commissioned in Q4FY22 and the company is targeting revenue mix of 50:50 from ethanol and sugar division. With the new expanded capacity, the management is targeting overall sugar revenues to cross | 1200-1300 crore in the next two to three years with EBITDA margins of ~20%

* KPR Mills, over the last two years, has demonstrated robust financial performance with sales and EBITDA CAGR increasing 20% and 40%, respectively, in FY20-22, with RoCE of 25%+. We build in revenue CAGR of 11% mainly driven by healthy performance in garmenting and sugar division. The company had recorded its highest ever EBITDA margin in FY22 owing (25.3%) on account of significantly higher cotton yarn spreads. We expect margins to moderate in FY23, FY24E and subsequently model 6% EBITDA CAGR in FY22-24E. Given strong beat in Q1FY23 results, we revise our earnings estimates upwards for FY23, FY24E. We maintain HOLD rating on the stock with a revised target price of | 650 (previous TP: | 635)

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