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Shanthi Venkataraman

Expanding retail space to combat intensifying competition.

INVESTORS can consider booking profits in Raymond, which has been viewed as one of the bigger beneficiaries of the textile quotas phase-out. Large scale of operations, aggressive expansion plans, substantial cash reserves to fund growth plans, and a strong brand presence in the domestic market have helped the stock command premium valuations. We have had `buy' recommendations outstanding on the stock at Rs 92 (May 11, 2003) and Rs 286 (November 14, 2004). However, a stream of disappointing results over the past few quarters tempers our bullishness in this stock.

Admittedly, the company is likely to witness stronger revenue growth, as demand remains robust on the export front. The prospect of quotas being imposed on Chinese exports by the US and the EU now appears a strong possibility, which could step up the demand for Indian textiles and clothing. At 21 times the FY-05 earnings per share, however, the current price of the stock appears to have factored in any benefits that would accrue to the company over the medium term. The pressure on margins is unlikely to ease over the next few quarters. Lower contribution from `other income', higher depreciation costs on the back of massive expansion and possible one-time costs on account of the company's `right-sizing' measures are also likely to strain earnings growth.

Disappointing results

Raymond's performance over the past year has not matched expectations. Although there was a strong growth in exports, the overall revenue growth in FY-05 was not too impressive. Sales grew 12 per cent, mainly aided by the cut in excise duty. A steep drop in `other income' and the rising raw material and labour costs led to a 36 per cent drop in recurring profits. Operating margins fell by 110 basis points to 11 per cent.

With robust demand from the export market, particularly for worsted fabric and denim, the revenue growth is likely to be stronger. There is, however, little scope for improvement in margins. The denim division is likely to benefit to a greater extent from low cotton prices in the coming quarters, as the company has liquidated its inventory of high-cost cotton. The margins for the worsted textiles division, which still contributes the bulk of its revenues, are, however, likely to remain flat, at best. Recent reports of the drought in Australia intensifying, suggest a possible uptrend in wool prices over the next year. Prices of its other raw materials, such as polyester and steel, are also unlikely to soften in the near term.

The steel files division has not been performing well over the past couple of quarters, with rising steel prices hurting margins. The company recently entered into a joint venture with MOB Outillage of France, a hand-tools manufacturer, which it believes would further consolidate its position as a world leader in this segment.

Raymond has also shut down its plant at Thane, which is expected to generate cost savings. But with little flexibility to pass on rising raw material prices to the end-user, this segment is likely to remain an underperformer in the medium term.

Higher depreciation to drag profits

Raymond is on an aggressive expansion drive. Having just commissioned its new denim facility, Raymond is adding another 10-million metres to its annual existing denim capacity of 30 million metres. A new worsted fabric capacity at a different location and a shirting fabric capacity are also underway. Its jeans facility is expected to be operational shortly.

On the domestic front as well, Raymond Apparel, a wholly-owned subsidiary, is ramping up retail space to give its brands — Park Avenue, Parx and Manzoni — greater visibility, with competition from domestic and international brands intensifying. With a sizeable war chest at its disposal, Raymond is well-placed to see through these expansion plans, without expanding its equity base or increasing its debt.

While the additional capacities would stimulate revenue growth, increasing depreciation is likely to cap earnings growth. As Raymond deploys more funds towards expansion, `other income' is unlikely to remain a significant contributor to profits.

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