Grasim's next act

GRASIM IS A COMPANY THAT transforms itself every generation. To those growing up in the 1960s, Grasim Industries was one of India’s largest textile makers. A generation later, it became the country’s largest cement company. Now it’s looking for its next big act.

Though Hindalco is bigger than Grasim (ranked 32 on the Fortune India 500), given its history, the latter is often perceived as the flagship of the Rs 1.35 lakh crore Aditya Birla group. A quick pointer: Grasim doesn’t have a CEO or managing director (unlike other group companies) and chairman, Kumar Mangalam Birla, whose great grandfather started the company in 1947, has been effectively playing the role of chief executive. Senior executives,
however, say that Kumar is not involved in the day-to-day management of the company, and various divisions are managed by respective directors.

Grasim’s viscose staple fibre (VSF, commonly known as rayon) throws up a lot of money. The group is a global leader in VSF, with a market share of nearly 23%. “The division will surely remain the company’s cash cow for decades to come,” says K.K. Maheswari, a Grasim director responsible for VSF, among other things. For long, Grasim has been investing cash from VSF in its cement business. But in October 2009, Grasim demerged this as a subsidiary called Samruddhi Cement. Then, in July 2010, Samruddhi was merged into another group company, UltraTech Cement. Grasim owns 65% of UltraTech, which is now large enough to fund its own expansion. The question is: Where can money from rayon be deployed to keep the company growing at a healthy rate?

Grasim’s chief finance officer Adesh Gupta—who also holds the same position at UltraTech—isn’t giving away any details, although he agrees it’s a valid poser. “Our hands are full right now, with projects to expand capacity in our VSF and cement businesses,” is all Gupta is willing to say.

So far, Grasim has been on a tear. In the last eight years, its consolidated revenues have grown at a compounded annual rate of a little over 20%. Profits have grown even faster, at nearly 38% per annum. Not surprisingly, the company has been a star performer among frontline stocks, and its market capitalisation has jumped nearly 10 times (it is currently around Rs 21,000 crore) against the five-fold growth witnessed by the Bombay Stock Exchange Sensex during the period.

In the last eight years, Grasim’s return on equity (RoE, or net income as a percentage of shareholders’ equity) has averaged around 25%, while return on capital employed has been around 24%. This is much higher than the 14% RoE average of Fortune India 500 companies in their latest financial year.

While Grasim’s stock has held steady, the markets are casting about for clues to its plans. “It will be interesting to see where the management decides to invest the free cash flows from the VSF business, now that the cement business is most likely to be self funded,” says Jinesh Gandhi, an analyst who tracks cement at the Mumbai-based Motilal Oswal Securities.

Grasim’s options to expand VSF output are limited. Global demand is at 3% to 4% per annum. And work is already on to raise the company’s production capacity by nearly 40% by 2013, with an investment of around Rs 3,000 crore.

Technically, the company can keep investing in cement, given its shareholding in UltraTech. Cement consumption is expected to grow at 9% to 10% per annum in the next five years. Indeed, Grasim’s Gupta even hints at the possibilities of scaling up inorganically. “There is a capital expenditure rush in the cement sector and I believe that it will inevitably lead to consolidation as many small and marginal players may face financial difficulty. This will open up interesting opportunities for us to grab 4% to 5% of the additional market share by acquiring a few of them.”

But, as Indiabulls Securities cement analyst Ranjan Kumar argues, UltraTech could well leverage its balance sheet. “We believe UltraTech can comfortably take care of its own capex in future,” he says.

Last April, UltraTech did exactly that during its acquisition of Dubai-based ETA Star Cement. The Rs 1,700 crore buyout was funded through a mix of internal accruals and debt. There is no reason to believe the company can’t follow a similar strategy in future, given strong expected internal accruals and an underleveraged balance sheet with a debt to equity ratio of around 0.35.

In fiscal 2010, the cement business posted a cash profit of about Rs 3,000 crore on a consolidated basis. This figure is likely to decline marginally in fiscal 2011, but expected to improve going forward. “The last few quarters were tough for cement makers as the bunching up of fresh capacity led to a fall in sales realisation. But the worst seems to be behind the cement makers now and we can expect steady improvement in operating margin from here on,” says Ajay D’Souza, cement analyst at Crisil Equity Research.

“Grasim is in an enviable position to take advantage of growth opportunities in India and other emerging markets,” says Prakash Diwan, head of institutional equities at Networth Stock Broking, a Mumbai-based brokerage. “It may either scale up its cement business through acquisitions or enter a new capital-intensive sector such as power. The group is keen on bagging a banking licence as well, and Grasim may even be a founding promoter of its banking foray.”

Birla has set a target of $65 billion (Rs 2.93 lakh crore) in revenue by 2015 for the group, up from around $30 billion today. To make a pro rata contribution to this, Grasim needs to increase its consolidated revenue from $4.5 billion in fiscal 2010 to at least $10 billion in the next five years. That’s an annualised growth rate of 18%.

THOSE WHO KNOW GRASIM well say its actions will be guided by a few basic principles. “The company usually follows a capital allocation strategy that ensures a sufficiently high return on equity. Second, the business should offer it the possibility to emerge as a market leader in due course,” says Motilal Oswal’s Gandhi.

For Grasim watchers on the street, power appears to be the most obvious choice. It’s a sector that fits the Birlas’ temperament. It’s capital intensive with significant entry barriers, and the demand for power is on the rise. Profitability is almost assured at high operational efficiency. Other businesses where the Birlas have been successful—aluminium, cement, and VSF—also show similar characteristics.

Power is not new for the Aditya Birla group. It was one of the early entrants when the sector was opened for private participation in 1992. It exited the business by 2007, frustrated by regulatory delays and policy ambiguity. In 2006 it sold its 1,000 MW project at Rosa (Uttar Pradesh) to Reliance Energy (now renamed Reliance Infrastructure). The following year, its Bina power project in Madhya Pradesh was acquired by Jaiprakash Associates. These projects were jointly promoted by Grasim Industries and Indo-Gulf Fertilisers.

Despite this, the Birlas continue to be one of India’s largest owners and operators of captive power plants with a total installed capacity of nearly 2,000 MW across Hindalco, Grasim, and UltraTech. They are now constructing three large captive power plants with a capacity of 900 MW each to meet the energy requirements of Hindalco’s new projects.

Most believe that if the Birlas can produce power for their businesses, they can definitely run it on a merchant basis. Moreover, reform of the power sector, especially in the area of distribution and merchant sales, takes care of the problem that forced the Birlas to exit power in the first place. Gupta doesn’t comment on this.

Don’t miss the irony here. Last year, the VSF business generated cash profits of a little over Rs 1,000 crore. This year, that’s expected to improve as a global shortfall in cotton led to a rally in VSF prices. “They closely track the movement in cotton prices internationally and cotton prices should remain strong for at least the next few months. This will translate into significantly higher profitability for Grasim’s VSF business for at least the next few quarters,” says Sridhar Chandrasekhar, who tracks the textile sector at Crisil Equity Research. And, with new capacity coming onstream, Grasim’s cash flow from VSF will improve further, leading to greater pressure to diversify.

IT IS, OF COURSE, ENTIRELY possible that Grasim is being coy because the company itself may undergo some restructuring. In 2007, grandfather Basant Kumar Birla bequeathed three of his companies—Century Textile & Industries (revenue of Rs 4,687 crore in fiscal 2010), Kesoram Industries (Rs 5,029 crore) and Century Enka (Rs 1,282 crore)—to grandson Kumar Mangalam.
Century Textile has interests in cement, and pulp and paper, besides textiles. Kesoram is a mid-size cement maker and has aggressively expanded its tyre business recently to emerge as India’s third biggest tyre manufacturer. The two have a combined capacity of around 20 million tonnes of cement which translates into a market share of 8%.

Given the synergies, one school of thought is that the Birlas may want to create a giant cement company.

“This can’t be ruled out, given the Aditya Birla group’s philosophy of creating focussed and vertically integrated companies in whichever sector it operates in,” says Devang Mehta, vice president and head, equity sales, at Anand Rathi Financial Services. If that happens, what route it will take is unclear—consolidate cement through
UltraTech directly or do it through Grasim.

Whatever happens, the VSF business will still generate loads of cash for some time to come. Rarely, perhaps, do problems of plenty appear so vexing.