Demand triggers, expansion to drive growth for Grasim

Deleveraging and traction in paints business key for further gains

The sharp rise in the share price of Aditya Birla group’s Grasim Industries (Grasim) can be explained by changes in the dynamics of underlying commodity markets. The US has just banned cotton imports from Xinjiang in China given persistent allegations of human rights abuses against the local Uighur community including the use of forced labour.

Since the region produces close to 20 per cent of global cotton, it would likely lead to a search for cotton substitutes. This could create more demand for viscose staple fibre (VSF), an artificial biodegradable fibre which would be a boost to Grasim. In the paints and other chemicals segments too, Grasim could gain from a combination of circumstances. There may be a likely drop in raw material costs, if petroleum/gas prices ease down. In addition, the company has instituted a backward integration process, which will give it better margins.

Scaling up capacity will add to margins and deliver more volumes. The company is clearly looking to extend its presence in the paints segment as well as its production of caustic soda. The valuation of its cross-holding in group company, Ultratech Cement, which is a major player, could also see a positive re-rating.

Grasim is increasing its VSF capacity by 37 per cent and the expansion is expected to be completed fairly soon. This is good timing due to the US ban. It is looking to hike caustic soda production by 33 per cent by end of FY23 and targets raising its epoxy capacity. Grasim plans to improve its mix of value-added chemicals to 40 per cent by FY25 (from 28 per cent in FY21) and in VSF, it hopes to increase its value-added product mix to 35-40 per cent by FY25 from 27 per cent in Q2FY22.

Grasim is investing Rs 5,000 crore in the paints segment. This is potentially a high-growth, high return business which insulates it to some extent from the commodity cycles. It has completed the divestment of its fertilizer division. It brings some significant advantages to the table. One is that the existing distribution network for Birla White cement and putty has a major overlap with the paints segment. There is already strong brand recognition for the group.

Management has guided for a 20 per cent internal rate of return in the decorative paints segment and it is hoping to challenge incumbents for the number two position behind Asian Paints. Operating profit margins and return on capital employed are significantly higher in decorative paints than in Grasim’s other business segments and this is less cyclical. Caustic soda is going through a price rebound from October 2021, after a steep price correction of 40 per cent over the past two years. Domestic textiles demand is also expected to improve as the economy recovers. Grasim holds 57 per cent stake in Ultratech and this would contribute to valuations along with its 54 per cent stake in Aditya Birla Capital.

The company has a strong balance sheet; post deleveraging it will be able to cut debt by 65 per cent by the end of FY22. Despite its capex plans, it should be net cash-positive in FY23 except in the new paints division. It has comfortably outperformed the Nifty in the last 12 months as well as the last month registering gains of 82 per cent and 6.8 per cent respectively.