The Hindu Business Line : Arvind Mills: Hold

ARVIND Mills has delivered an impressive performance over the past four quarters, powered by lower cotton prices, an upswing in demand for denim and lower fuel cost. But the likely slowdown in demand for the fabric appears to have given the stock market the blues.

Over the past month, the stock has tanked by more than 25 per cent. Even as the company declared an 85 per cent growth in profits during the quarter ended September, the management confirmed fears that denim prices are likely to be `subdued' over the next few quarters. Shareholders can, however, hold the stock, especially if they have entered it at lower levels. At Rs 106, the stock trades at about 13 times its trailing four-quarter earnings per share. At this level, much of the likely downside over the near term appears to have been factored in. Given the robust performance of the first two quarters, Arvind Mills may still be able to pull off a double-digit growth rate in FY-06.

Shareholders should, however, watch out for performance over the next few quarters, as it would be a good indication of whether or not the company's attempts to diversify its focus on denim will pay off. While pricing pressure will remain over the next couple of quarters, low cotton prices promise to lighten the burden on margins in the near term; the company has covered its cotton requirements for FY-06. A firming up of cotton prices in 2006 could affect growth, unless Arvind is able to significantly ramp up the operations and earnings of its other businesses.

Financial performance

For the fourth quarter in a row, Arvind Mills has managed to post a profit growth in excess of 80 per cent. This quarter, however, growth was achieved almost completely from lower cotton prices and fuel costs, with revenues remaining flat.

The cost of cotton consumed declined 30 per cent from the corresponding previous quarter. Having switched from naphtha to natural gas, the company has also shaved off 18 per cent from its power costs. Operating margins have improved by 300 basis points to about 25 per cent.

Our optimism is, however, tempered by the rather dim outlook for the denim segment which now contributes 60 per cent of revenues. Inventory has piled up for international retailers, as demand for jeans has been lower than expected. As a result, the demand for denim in the export market is likely to slacken. Prices, too, are likely to come under pressure both in the international and domestic markets as fresh capacities become operational. Denim prices have declined by about 3 per cent from the immediately preceding quarter, while volumes have been more or less stable.

Margins have also dropped from 27 per cent to 25 per cent on a sequential basis, although this can also be explained by poorer realisations in the shirting segment.

Arvind Mills may, however, be better placed than other denim manufacturers in weathering the downturn. Given its scale, it enjoys better efficiencies than other manufacturers and has higher margins.

Driving growth in other segments

In a bid to fully integrate its operations and diversify, Arvind Mills has, in recent years, forayed into shirting (fabric for shirts), knits and garments. Denim, however, has remained its mainstay partly because the denim cycle itself has been on an upswing.

Arvind is now under pressure to ramp up contribution from its other businesses. The knits division, which produces knit fabric and garments, has performed impressively, with robust exports. The company is increasing this division's annual capacity by one million pieces; the project will become operational in March 2006.

It has been tough going, however, for the shirting division, with realisations falling steeply in the July-September quarter over the corresponding previous period. Both volumes and prices show signs of stabilising now. The company's jeans unit has begun operations and should contribute positively to revenues from the third quarter. The management has a positive outlook on volumes in the domestic market. Garments now contribute about 10 per cent to revenues. Arvind is new to garmenting, but it may be able to get a foot in the domestic market with the help of its subsidiary, Arvind Brands.

Arvind Brands

While about half of its revenues are derived from the export market, Arvind Mills is renewing its thrust on the domestic front. It recently bought back a 54 per cent stake in Arvind Brands (ABL) from ICICI Bank, making it a wholly-owned subsidiary.

Shares had originally been pledged with the bank against a loan extended to the company. The stake was purchased for Rs 106 crore, meaning a valuation of about Rs 200 crore for the entire stake. Revenues of ABL were, however, at Rs 315 crore in FY-05, which was reacquired at a reasonable price-to-sales ratio.

Arvind Brands markets a wide range of readymade garments. Included in its product bouquet are prominent brands such as Arrow, Lee, Wrangler and jeans brands with a mass market appeal such as Excalibur and Ruf n' Tuf.

The subsidiary reported a 44 per cent growth in revenues during the quarter and appears poised for robust performance in the future, on the back of booming demand and ramp up in retail space.

Plans to bring more international labels in the domestic market — it already markets Tommy Hilfiger — also augur well, as it would strengthen its presence. We believe that the gains from this acquisition have not been completely factored in the stock price.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page