Grasim Industries’ (Grasim) Q3FY21 standalone EBITDA grew strong by 68% YoY to Rs6.5bn – better than our / consensus estimates led by sharp improvement in VSF profitability. VSF EBITDA margin almost doubled YoY to 22% led by lower inputs costs YoY and better realisation QoQ. With sharp demand recovery and increasing cotton / yarn prices, global VSF prices rose 20% QoQ in Q3FY21, which further increased by 27% MoM in Jan’21. Factoring better VSF profitability, we raise our FY22-23E EBITDA 4-11% and increase our target multiple for core business to 7xEV/E (earlier 6x). Coupled with the recent run-up in stock prices of its various holdings, we increase our target price to Rs1,330/sh (earlier: Rs1,140) based on 7x FY23E EV/E (half-yearly rollover), assuming unchanged 50% holdco discount. Maintain ADD. Key risk: lower demand / pricing in VSF / chemicals.

– VSF revenue (including VFY) declined 2% YoY to Rs21.5bn. It operated at 100% utilisation and posted 3% YoY volume growth. Realisation improved 4% QoQ though still down 5% YoY. In China, VSF inventory declined significantly from 45days in Apr’20 to 10days in Jan’21. Coupled with strong demand recovery and huge price gap vs cotton, China VSF prices rose sharply from 8,500RMB in Sep’20 to 10,900RMB in Dec’20 and further to 13,800RMB in Jan’21. VFY utilisation rose from 39% in Q2FY21 to 89% in Dec’21. VSF EBITDA (including VFY) rose 89% YoY to Rs4.8bn (or Rs27/kg) led by lower input costs and 29% YoY decline in fixed costs.

– Chemical revenue declined 6% YoY to Rs12.8bn, while EBITDA declined 4% YoY to Rs1.8bn owing to weakness in ECU realisation which declined 18% YoY/ 6% QoQ in Q3FY21 due to excess domestic capacity. Caustic soda utilisation gradually improved to 89% in Q3FY21 from 80% in Q2FY21.

– Strategic choice to enter paints business as the management believes it will add size, scale, diversity and stability to cash flow of the existing business portfolio of VSF and chemicals. The company recently announced huge capital outlay of Rs50bn over the next three years with ambition to be strong no.2 player both in terms of market share and profitability over ‘reasonable’ period and target of 20% IRR. It intends to leverage strong Birla White brand and large white cement/putty dealers’ network of its subsidiary UltraTech Cement (UTCEM). Accordingly, Grasim seems to be undergoing strategic transformation as seen by divestment of fertiliser business and its plans to enter high RoCE B2C paints business.

– Net debt declined by Rs8.8bn during 9MFY21 to Rs20.9bn despite incurring capex of Rs8bn, aided by working capital release. Divestment of fertilisers for a consideration of Rs26.5bn is likely to consummate by Jun’21. The company will be augmenting VSF capacity by 38% to 801ktpa by Q3FY22 and chemicals capacity by 27% to 1,457ktpa by Q1FY22, and is likely to incur balance capex of Rs15-20bn on the same. Grasim is likely to generate OCF of >Rs25bn p.a and hence, net debt is unlikely to increase from the current levels even after factoring-in Rs50bn capex for paints over the next three years.