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Strong demand outlook, margin should improve in 2HFY22

Beat in VSF business cushions margin miss in the Chemicals business

* Grasim' 2QFY22 operating profit was 7% below our estimate due to lower profits in the Chemical segment (OPM down 4.9pp QoQ v/s our estimate of a 1.3pp improvement). In the VSF Segment, Volume/EBITDA was 10%/16% above our estimate. The management said the impact of price hikes will be felt in 2HFY22 and margin should improve in the Chemical segment.

* We have reduced our FY23E standalone EBITDA by 7% to factor in higher costs for the Chemical business. We value the standalone business at 6x Sep’23E EV/EBITDA and other listed subsidiaries at a 40% holding company discount to arrive at our TP of INR2,035 per share. We have also assigned a 5% premium to our SoTP-based TP for its entry into the Paints business. We maintain our Neutral rating as the stock has run up 13% in the last one month.

Higher cost in the Chemical business led to a 7% miss on EBITDA

* Revenue/EBITDA/adjusted PAT stood at INR49.3b/INR8b/INR9.5b as against INR29.6b/INR3.3b/INR3.3b (on a like-to-like basis, excluding the Fertilizer business) in 2QFY21 and was +8%/-7%/-2% v/s our estimate. The miss on EBITDA was due to lower margin in the Chemical segment (OPM down 4.9pp QoQ v/s our estimate of a 1.3pp improvement).

* Revenue for the VSF segment improved 79% YoY to INR30.1b, led by volume growth of 22% YoY. EBITDA stood at INR5.8b v/s INR1.9b in 2QFY21, with margin at 19.3% (+7.8pp YoY).

* In VSF, realization rose 47% YoY, leading to 2.5x increase in EBITDA/kg at INR35 (down 14% QoQ).

* Revenue/EBITDA for the Chemicals business rose 44%/24% YoY to INR16.3b/INR2.3b as benefits of realization growth was offset by cost inflations (OPEX/kg up 38% YoY and 13% QoQ).

* Revenue/EBITDA/adjusted PAT stood at INR87b/INR15.4b/INR13.9b in 1HFY22 v/s INR43b/INR1.1b/INR744m in 1HFY21

Highlights from the management commentary

* The manufacturing plants for Paints will be set up in Ludhiana (Punjab), Panipat (Haryana), Mahad (Maharashtra), Cheyyar (Tamil Nadu), and Chamarajanagar (Karnataka). In 1HFY22, INR2.7b has been spent on land acquisition across plant locations. Environmental clearances for different locations is expected to be received in 3-6 months, after which construction work will start.

* Vilayat VSF brownfield expansion of 300TPD (out of 2x300TPD) has been completed in Nov’21. Fixed cost for expanded capacity is expected to rise by 8-10% as against a 40% increase in capacity, while variable cost is expected to be lower by 10% (as these plants are of bigger size – 300TPD v/s its earlier plant size of 110-120TPD).

* Capex guidance: The management has maintained its FY22 capex guidance of INR26b (INR9.1b in 1H), but expects a part of it to be deferred to FY23.

* The enterprise value (EV) of the Fertilizer business will be adjusted against the receipt of outstanding government subsidies. Grasim has received INR10b out of outstanding subsidies of ~INR14.5b, and hence its EV will be INR16b v/s INR26b earlier. The divestment is expected to get completed in Dec’21.

Valuation and view

* Grasim’s large capex plans for the Paints business indicates its commitment towards becoming a serious player in this segment. The company’s strong Balance Sheet will take care of its capex requirements for this segment.

* We believe the company will be able to leverage the strong distribution network of Birla White (of UltraTech). Its strong brand strength should help it make inroads into the Paints business.

* We value the standalone business at 6x Sep’23E EV/EBITDA and other listed subsidiaries at a 40% holding company discount to arrive at our TP of INR2,035 per share. Our target price for Grasim includes a 5% premium to the underlying SoTP in order to capture the potential upside from its Paints foray. We maintain our Neutral rating as the stock has run up 13% in the last one month.

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