Grasim Industries - Earnings outlook deteriorates

Grasim's ongoing capex should raise its cement capacity by 59%, but the underlying demand outlook has weakened. We expect just 75-80% utilisation in both its VSF and cement businesses, as well as margin pressure. We cut our FY09-11F earnings by 6-37%, and downgrade to Sell.

Grasim to capitalise Rs110bn of assets in the next few months
Grasim says it plans to raise its cement capacity by 18.1mmt to 48.8mmt in the next few months by commissioning capacity in three greenfield locations. However, this comes as the outlook for industry demand growth has weakened due to the ongoing global financial crisis and consequent capex slowdown in many sectors. The slowing of textile exports has weakened the volume outlook even at Grasim's viscose staple fibre (VSF) business, where the company recently raised capacity to 334,000mt per year (from 270,000mt). We expect Grasim's capital-related costs to rise, straining profits.

We see cement oversupply persisting for more than two years
We have lowered our FY09-10 demand growth expectation from 9-10% to 7-8%. FY09 trends, so far, indicate growth of just 6.5%. We expect incremental cement capacity addition of 89mmt till FY11 vs incremental demand growth of just 46.3mmt, which, we believe, will put pressure on prices in FY10 and FY11.

VSF earnings could stabilise after the sharp fall in FY09F
The VSF business, which competes with polyester staple fibre and cotton, has faced slowing volumes due to weak global textile demand. Prices of sulphur, a key raw material, have fallen from US$850 in June 2008 to US$85 currently, reducing overall VSF costs by 12%. However, the recent weakness in both cotton and PSF prices will force Grasim to reduce VSF prices as well. We expect VSF EBITDA to fall 49% in FY09, although they should recover gradually from there on.

We cut earnings sharply, downgrade to Sell
We have reduced our FY09-11 cement volume forecast due to macro factors, and adjusted EBITDA to factor in lower cement and coal prices. We have cut our FY09-11F EPS by 6-37% and lowered our DCF-based target price to Rs919. Trading at 0.8x FY09F book and at an EV/mmt of US$66 (vs replacement cost of US$110) on cement, Grasim looks cheap, but we see more downside risk to earnings in next two years, given the large capacity creations.