From THE HINDU group of publications
Sunday, July 08, 2001


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Indian Rayon: Hold

Recommendation: Hold

Reshma Krishnan

INDIAN Rayon has made a fine attempt to restructure its business portfolio, trying to reposition itself higher up the value chain. This is part of its continuing effort to enter new areas after the sale of its cement business.

The company is a widely diversified conglomerate with presence in viscose filament (VFY), worsted synthetic and flax yarns, readymade garments, insulators, carbon black and argon gas.

A look at the company's business life-cycle: Indian Rayon's carbon black division is stagnating, contributing to topline volume but not to bottomline growth. The VFY and insulator divisions are mature businesses and contribute to cash flows, but their outlook on growth is limited.

Indian Rayon's share price has been stable in the last six months and its perception has improved since it wrote off the sea magnesia unit and entered the readymade garments industry. With restructuring possibilities, involving Grasim, and the prospect of better valuation, shareholders can stay invested.

Following its foray into readymade garments and insurance investments recently, Indian Rayon's boldest move has been the acquisition of PSI Data Systems. The former has decided to buy a controlling stake in the latter from Groupe Bull SA of France for Rs 71 crore ($15 million).

Indian Rayon is now entering a crucial second year after restructuring, when the real benefits of its being a diversified company will be tested.

Parting with cement

The company began the restructuring exercise by hiving off its cement division to Grasim (also part of the Aditya Birla group) in September 1998. This was part of the Aditya Vikram Birla group's decision to consolidate its cement business.

Then, the company wrote off its Rs 323-crore sea magnesia unit. Entering the sea magnesia business was a mistake, as imports made it unviable. However, Indian Rayon did well to write it off in 1999-2000 after sinking close to Rs 325 crore. Though this left a gaping hole in the balance-sheet, it improved the company's market perception, as reflected in the subsequent jump in share price.

The next was Indian Rayon's foray into the retail market, signalling its move away from being a purely commodity conglomerate. It acquired Madura Garments (formerly a division of Madura Coats) for Rs 187.75 crore in January 2000. Madura Garments has a 30 per cent share of the readymade garments market.

With the VFY and the carbon black segments looking at single-digit growth figures, the readymade garments business was to be the key driver of growth.

Has garments delivered?

A lot was expected of the readymade garments sector to boost the bottomline. However, this has not happened. Topline growth has been achieved, but financial comparisons are not really possible due to the heavy restructuring in both years. However, despite the general economic slowdown, the individual divisions have done reasonably well.

Net sales moved up 32.10 per cent to Rs 1,416 crore for the year-ended March 2001 from Rs 1,072.09 crore the previous year. The readymade garment division contributed 22 per cent of the total sales (net of excise) and was the driver of volumes. This could be good augury for the long term, notwithstanding the imposts on readymade garments introduced recently.

Operating profit rose 29.21 per cent to Rs 198.47 crore in 2000-01 from Rs 153.60 crore the previous year. This was on the back of a drop in the operating profit margin to 14.01 per cent in 2000-01 from 14.33 per cent the previous year. As expected, garments contributed to topline growth but the margins of the division were not impressive.

VFY and carbon black performed well, despite falling realisations and demand. The VFY division accounted for about 17 per cent of the total turnover, followed by carbon black and insulators at 16 per cent and 12 per cent, respectively.

In carbon black, though the realisations were up, the operating profit margin fell from 23 per cent to 21 per cent.

Garments of many hues

The company is now entering a crucial year which will test its growth prospects and also reveal the scope of the readymade garments division. One advantage for the company is that it has readymade garment brands across price levels, allowing it to compete at every level and get economies of scale. All the key brands -- Louis Phillipe, Van Heusen, Byford and Peter England -- are leaders in their segments. It has a strong distribution network from both Grasim and Madura Garments, and a geographical presence that covers most markets in India. The company recently acquired global brand rights for all markets but the US and the UK.

But the readymade garments industry is facing quite a few challenges, as the 2001-02 Budget removed the excise-duty exemption. This means the company has the added pressure of 16 per cent, which it will have to distribute between costs (absorb a portion, at least for some time) and prices.

Riding on cash flows

The readymade garments division is expected to grow faster than the industry rate of 15 per cent. With the de-reservation of small-scale industry introduced in the Budget, the company can now plough funds from the mature divisions into the growth areas and increase efficiency.

Indian Rayon has strong cash inflows, which increased by Rs 190.4 crores in 2000-01. The company plans to give this back to the shareholders through a second round of buyback. This is on the backburner, following the acquisition of PSI Data Systems.

The acquisition

The first big acquisition for Indian Rayon was readymade garments -- a growth sector -- followed by PSI Data System. Indian Rayon has now announced its intention to buy the 50.35 per cent stake held by Groupe Bull SA of France by PSI Data. This will set the company back Rs 71 crore, but it can comfortably afford this. It is also obliged to make an open offer of 20 per cent under the SEBI Takeover Code.

PSI Data Systems has decent fundamentals. The company earned profits of Rs 18.2 crore on revenues of Rs 83 crore in the year-ended December 2000. In the last two quarters of the year-ended December 2000, the company's revenues rose 40 per cent. Though substantially lower than the industry average, it is still healthy. Around 42 per cent of the company's revenues were accounted for by offshore software development.

Where does a software company such as PSI Data Systems fit in for an Old Economy company like Indian Rayon? It gives the company an entry into IT. But, at the same time, there are doubts if Indian Rayon is not biting off more than it can chew. Though it is unlikely that PSI Data Systems will be merged into the company, it will have the strong backing of Indian Rayon.

What can happen to PSI Data Systems is consolidation with another group subsidiary in line with recent trends. The Aditya Vikram Birla group has been in the process of aligning its companies into industry segments. PSI Data Systems could, in due course, be grouped with Grasim's subsidiary, Birla Technology. This merged entity might act as the frontline IT company of the group.

Emerging Indian Rayon

As for Indian Rayon's structure in the coming years, garments should contribute to at least 40 per cent of the topline growth. The contribution of other divisions may be of less importance. The export market for insulators is still lucrative and will certainly contribute to the topline growth.

But all is not rosy. The company faces many a challenge. The VSY realisations were down in the last year due to cheaper substitutes and the fabric industry is not doing well on the whole. The carbon black industry is stagnating on lack of demand (with a slowdown in demand for tyres), and imports.

More than anything, the acquisitions will underline the company's focus on growth. This will definitely improve the stock market perception. Future valuations of the stock will depend on the PSI acquisition details which are still unknown. Questions on how much of the existing client base it will retain, how many employees it will take in, the assets and so on linger. Investors can wait and watch and hold on to their investments until details of the deal unfold.

Pic.: Mr Kumar Mangalam Birla, Chairman, Indian Rayon.

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