Siyaram Silk Mills Ltd.

(SSML)
Management Interaction Note HDFC Sec Scrip code SIYSILEQNR Business Profile Industry Textiles CMP (Rs.) 389

(CMP: Rs. 389)

April 23, 2011 Recommended Action Buy at CMP and add on dips Averaging Price Band (Rs.) 343-359 Sequential Targets (Rs.) 436 & 468 Time Horizon 2 quarters

Incorporated in 1978, Siyaram Silk Mills Ltd. (SSML) is an integrated textile producer with a domestic presence. The company belongs to the Siyaram-Poddar group. Initially, SSML started as a textile trader & gradually moved to manufacturing in 1981. Its in-house integrated facility consisting of spinning, dyeing, weaving and finishing plus garments enable it to present wide offerings of yarns, fabric, home textiles and apparels. The company is one of the leading manufacturers of blended fabric in India (mainly polyviscose) Branded fabric is the biggest segment, contributing ~85% to the company's revenue. Ready Made Garments (RMG) & Dyed Yarn accounts for the balance ~10% & ~5% respectively. The company has a strong distribution network of around 60,000 franchise and retail outlets, 1500 dealers & 500 agents. This ensures that its brand remains one of the preferred choices of the masses. SSML mainly buys yarn from yarn producers, converts it into fabric and sells it under its brand. Some part of fabrics manufactured is further processed into ready-made garments. In the Fabrics segment, the company has a portfolio of well-known brands like Siyaram (value for money brand), J Hampstead (premium), Mistair (high-end value for money). Some of the other fabric brands include Featherz and Zenesis & Moretti. Siyaram is a flagship brand, which accounts for ~75% of the total fabrics sales [Suiting: 76%; Shirting: 22% & Furnishing (curtains & upholstery) 2%]. Mistair accounts for ~18%, while J Hampstead contributes 5%. Zenesis & Moretti and Featherz contribute the balance 2%. In the RMG segment, the major brands include Oxemberg (Formal), MSD (Monday to Sunday Dressing, Casual) & J Hampstead (formals). Oxemberg (value for money brand) contributes ~80% to the total RMG sales, while the balance ~10% each is contributed by MSD (value for money brand) & J. Hampstead (premium). Brand Portfolio Segment Fabrics Brands Siyaram Mistair J Hampstead Zenesis & Moretti Featherz Oxemberg MSD J Hampstead Category Value for money Higher end value for money Premium Value for money Value for money Formal, Value for money Casual, Value for money Formals, Premium Segmental Revenue Contribution* 75%
(Suiting: 76%, Shirting: 22%, Furnishing: 2%)

18% 5% 2% 80% 10% 10%

(Source: Company)

Ready Made Garments

*Approx

The companys facilities are located at Tarapore, Silvassa & Daman. At Tarapore, the company has 5 weaving units & 1 dyeing unit. Daman has 2 RMG units, while Silvassa has four weaving units. The company currently has 479 looms, 645 stitching machines & 6000 TPA yarn dyeing capacity. The current fabric weaving and garment capacities stands at ~60 mn metres (35 mn meters own production, balance outsourced) and ~2.4 mn pieces p.a. The fabric weaving facilities operate at ~92% capacity utilisation, while the RMG & Yarn Dyeing facilities operate at ~80% & ~60% utilisation respectively. The company is also engaged in some trading of Fabrics & RMG. In FY10, the purchase of finished goods stood at Rs. 712.3 mn, which has increased to Rs. 680.4 mn in 9MFY11. Installed Capacity FY09 Loom (nos) Stitching Machines (nos) Yarn Dyeing Capacity (TPA) 409 643 6000 FY10 479 645 6000 Till Date 479 645 6000

(Source: Company)

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SSML is predominantly a domestic player, with ~95% of the revenues derived from domestic markets. Further, within India, SSML mainly focuses on Tier II & III cities which along with rural India contributes ~75% of the domestic revenues. Revenue Break-up Urban-Rural Revenue Break-up

Exports 5%

Urban 25%

Domestic 95%

Rural 75%

Shareholding Pattern: (As on Dec 31, 2010)

Particulars Institutions Non Promoter Corporate Holding Promoters Public & Others Total No of Shares (In Mn) 0.34 0.47 6.28 2.28 9.37 % Holding

3.63 5.02 67.02 24.33 100.00

Investment Rationale Market Leadership in blended fabrics, focus on brand building, buoyant industry outlook Indian Retail Industry set to grow at a robust rate - Fabric & Apparel occupy a significant portion
India is among the attractive market destinations for apparel retailers. Apparel and Fabric is the second largest retail category with total size of $29bn, representing 10% of total retail market. Organised retail penetration in the category is ~23%. Indian retail industry is expected to grow from $410bn to $535bn by 2013. Organised retail share in the total retail market is likely to grow from 7% to 10.4% by 2012. Rural market is projected to dominate the retail industry landscape in India by 2012 with total market share of over 50%. Rising disposable income in the hands of rural consumers due to rising agriculture Income, increased employment generation through NREGA and PMGSY is likely to boost demand for low-ticket items like textiles. SSML, having focussed on the mid range segment, accrues major revenue from rural markets which is growing at fastest rate.

Indian Textile & Apparel Industry is 6% of Indias GDP & 16% of total export earnings
The Indian Textile and Apparel Industry, an integrated sector, occupies a significant position in Global Trade. It accounts for 6% of the total Indias GDP and 16-17% of the total export earnings. The present size of Indian Textile and Apparel market is US$ 62 bn out of which domestic market is worth US$ 40 bn, while export accounts for US$ 22 bn.

Indian Fabric Market - organised blended fabrics outspacing the unorganised segment in terms of growth
The Indian fabric market is highly fragmented, comprising of cotton, blended, 100% non-cotton, wool, silk & khadi. As per the textile ministry, the total fabric production in FY10 is estimated to be 59,765 mn sq mtrs. Of this, the blended fabric market is estimated to be ~12% of the total fabric market in FY10, while the 100% non-cotton, 100% cotton & Khadi, Silk & Wool account for ~38%, ~48% & 2% respectively. The blended fabric market has grown at a CAGR of 5.2% over FY05-10, with organised sector having driven the volume growth, which stood at 14.3% CAGR over FY05-10, thus outspacing the unorganised sector growth of 4.7% over the same period. The organised sector in blended fabrics accounts for ~6% of total blended fabrics production & contributes less than 1% of the total fabric production in India.

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Total Fabric Production 59,765 mn sq meters

100% non-cotton fabrics 38% of total production

100% cotton fabrics 48% of total production

Blended Fabrics 12% of total production

Khadi, Silk, Woolen 2% of total production

Organised Sector 6%

Unorganised Sector 94%

SSMLs major presence

CAGR Volume Growth 14.3% over FY05-10

CAGR Volume Growth 4.7% over FY05-10

Large presence in organised blended fabrics market, better brand building, strong domestic presence augers well for SSML
SSML primarily operates in the blended fabrics segment with a portfolio of well-known brands like Siyaram, J Hampstead & Mistair. Its 30-year-old flagship brand Siyaram accounts for a major portion of total fabrics sales (~75%) & is well established locally and has a strong hold in Tier II and Tier III cities. Positioned as a value-for-money brand, Siyaram uses sub-brands to cater to the changing trends in fabric material and design. The company sells suiting, shirting and furnishing products under this brand. The company entered into furnishing products fabrics in FY06 (within Siyaram brand). Strong distribution network & absence of many branded players led to robust sales growth of furnishing products over FY06-10. This coupled with high growth in shirting enabled the Siyaram brand to grow at a CAGR of ~14-15% over FY05-10. J Hampstead is a premium fabric brand, which has grown at a CAGR of 20% during FY05-10 period, largely owing to a growth in volumes. In order to position its products across the value chain, SSML introduced Mistair, which is a higher-end value for money brand. This brand received good response in the market & reduced the self-space of competitor brands, thus driving SSMLs sales further. The brand has grown at a CAGR of ~23-24% over FY05-10 (largely driven by volumes). Within India, SSML mainly focuses on Tier II & III cities which along with rural India contributes ~75% of the domestic revenues. This market prefers fabrics to RMG on the back of lower cost of stitching fabric (compared to buying a ready made garment) & customised fitting to consumers. SSML has reported consistent growth in revenues and profits, even during the tough economic conditions during 2008 & 2009. This has been possible due to strong performance from its fabric division. SSMLs fabric divisions revenues have grown at a CAGR of 17% during the FY05-10 period, outpacing the organised sectors 14% growth within the blended fabric market. The division currently contributes 85% to the total net sales & ~90% to the net profits. The companys market share in organised blended fabric market stood at ~11% in FY10. The divisions growth has been driven by more focus on brand building, rather than focusing only on volumes in a price sensitive market. This stratergy of brand building has actually worked out well for the company over the years. While most of the textile companies expanded their capacities & increased their overseas presence during FY03-07 to take advantage of government incentives, SSML on the other hand increased its focus on brand building & domestic market. This has enabled SSML to fetch better realisations compared to local players & drive volumes through better brand recall. Over the next few years, we expect the organised blended fabrics market to continue to grow at a robust pace. Domestic market is to grow at a healthy pace supported by rising disposable incomes, rising aspirations and favourable demographies, which is expected to stimulated demand for SSMLs branded products in Tier II & III cities. Rural India is expected to benefit from governments increasing thrust on rural infrastructure. With market leadership in the blended fabrics, strong brand building, strong presence in the domestic market with more focus on rural India & aggressive expansion plans, SSML would be able to capitalize on the opportunities, consolidate its position and effectively tackle unorganised competition in this space. This would boost the revenues and profitability of SSMLs fabric division going forward. Strong brand building over a period of time would provide SSML a competitive edge & help in improving the volumes.

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Likely to benefit from shift from cotton to blended fabrics & towards branded players in Tier I, Tier II cities
The blended fabrics market is largely dominated by the unorganised sector, which commands 94% market share. Over the last one year, the fabric market has witnessed a shift from cotton to blended fabrics on the back of higher cotton pries. Polyviscose fabric has become a cheaper substitute to cotton fabric. Though the polyester & viscose prices have increased over the last 12 years, the extent of rise has been relatively lower than increase in the cotton prices. If the cotton prices continue to increase further, then the demand of blended (polyviscose) fabrics would improve further and would benefit SSML immensely. The current price difference between the cotton and blended fabric is 25-30%. Cotton prices have been soaring since April 2010. Price of Indias common variety of Cotton DCH-32 [A] has increased by almost ~60% since Dec 2010 & ~98% since April 2010. On the other hand, the polyester staple fibre prices have increased by 57% since April 2010, (till March 2011) & 25% since Dec 2010 (till March 2011). Despite the bumper cotton production of ~32.5 mn bale expected in FY11, we feel that the domestic cotton prices could continue to remain firm in the medium term on the back of depleting global inventory of cotton and increasing domestic & global demand. India exported almost 30% of the domestic production of cotton and this proportion could increase further on the back of higher global demand, thus keeping the domestic cotton prices firm. On the other hand, if the crude oil prices increase significantly, polyester prices might not increase in the same proportion, since the polyester capacity is huge. This would keep the blended fabric prices less volatile as compared to the cotton prices. While due to the expected rise in the area under cultivation in India and China, the cotton prices have begun to soften from the lofty levels reached earlier, even at lower levels, the difference between PSF and cotton prices could be wide enough for consumers to look at buying more of PV fabrics than cotton fabrics.

Raw Cotton DCH 32 - (A) price trend since April 2010:

250 230 Rs. per kg 210 190 170 150 130 110 Jul-10 Feb-11 May-10 Sep-10 Nov-10 Aug-10 Dec-10 Mar-11 Feb-11 Jun-10 Apr-10 Jan-11 Oct-10 Apr-11 Mar-11

Month

Polyester Stable Fibre price trend since April 2010:

120 110

Rs. per kg

100 90 80 70 May-10 Jun-10 Jul-10 Sep-10 Nov-10 Aug-10 Dec-10 Apr-10 Jan-11 Oct-10

Month

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Besides the shift in demand from cotton to blended fabrics, the Tier II & Tier III cities have witnessed a shift towards the branded blended fabric players from unbranded players on the back of improved standard of living and rising disposable income. With Indias domestic growth story remaining intact, the demand scenario for branded blended fabrics is expected to remain buoyant going forward. With a portfolio of brands like Siyaram, J Hampstead & Mistair in its Fabric basket and strong brand penetration, SSML is well placed to cater to the increasing demand for polyviscose fabrics.

Decent presence in RMG, adverse impact unlikely in case of shift towards ready-to-wear apparel
Besides Fabrics, SSML also has a good presence in RMG segment, which contributes 10% to the total revenues. The segment has grown at a CAGR of ~28% during the FY05-10 period. The segment has well-known value for money brands like Oxemberg (formal), MSD (casual) and also has premium brand J Hampstead (formal). Oxemberg is a major revenue contributor, accounting for 80% of the total RMG sales, while the balance 20% is accounted equally by MSD & J Hampstead. Oxemberg was introduced around 15 years back & has grown at a CAGR of around 24% over FY05-10, which has been largely volume driven. MSD was launched in 2007 & has grown at a decent rate thereafter. The increase in the textile spending is likely to boost the RMG segment. As per Crisil, the RMG market is likely to outspace the overall textile industry growth and is expected to grow at a CAGR of 7.4% over the next four to five years. There could be a shift in consumer preferences towards ready-to-wear apparel on the back of range of choice in design, colour & sizes being offered by RMG manufacturers and due to boom in the organised retailing. Though SSML has a significant presence in the fabrics segment, such changing dynamics is unlikely to adversely affect the companys growth since the company has a decent presence in the RMG segment as well and would look to expand it further. Moreover, it can even shift its model from business to consumer to business to business, where it will supply fabrics to large RMG brands across the nation.

Capacity expansions & improvement in utilisation to drive the growth

In order to cater to the increasing demand, SSML has chalked out Rs. 2100 mn CAPEX plan, which is likely to be implemented in phases. The company would add 286 looms at Silvassa & Tarapore to the existing capacity of 479 looms in the coming quarters in a phased manner: 78 looms by September 2011, 120 looms by March 2012 and 88 looms by September 2012. With this the companys fabric weaving capacity would increase by 26.4 mn meters from 60 mn meters p.a. to 86.4 mn meters by September 2012 (7.2 mn mts by Sept 2011, 13.2 mn mts by March 2012 & 6 mn mts by September 2012). The company is also in the process of adding 400 stitching machines at Daman to the existing capacity of 645 stitching machines by Dec 2011. The RMG manufacturing capacity is expected to increase by 0.5 mn pieces p.a. from 2.4 mn pieces p.a. to ~2.9 mn pieces p.a. Of the total CAPEX, Rs. 1500 mn would be for the expansion of plant & machinery (for expanding the looms & stitching machines) and the balance Rs. 600 mn would be incurred towards setting up of new office premise, land & building & warehouses. The entire CAPEX is expected to be funded through a mix of borrowings (TUF loan) & internal accrual. Rs. 1500 mn would be funded through technology upgradation fund and hence the company's cost of funds would be economical in the range of 56%. This would ensure that the company's interest burden remains low. At present, SSMLs fabric weaving facility is operating at 92% utilisation, while the RMG & Yarn Dyeing capacities are operating at 80% & 60% utilisation respectively. The timely ramp up of new facilities (Fabric weaving & RMG) would enable SSML to meet the increasing demand from the user industries. Further, with uptick in demand, the utilisation is likely to improve going forward (on expanded capacity). The yarn dyeing business has operated at a lower capacity utilisation despite having installed capacity over two years back. This was due to a shift in the plant venue and because of construction activity taking place within the plant. However, this issue has been sorted out now and we expect the utilisation of the yarn dyeing capacity to improve from the current levels going forward. Timely ramp up of new facilities & improved utilisation is likely to drive SSMLs revenues & profits going forward.

Strong Distribution network

SSML has a strong distribution network of around 60,000 franchise and retail outlets, 1500 dealers & 500 agents across the nation. This ensures that its brand remains one of the preferred choices of the masses. The company has improved its distribution network significantly over the years with the number of dealers & agents increasing from 550 & 180 respectively since FY05, thus growing at a CAGR of 24% & 23% respectively. This has enabled the company to have a strong foothold in the domestic markets and to cater to the demand of middle and lower income class. The launch of Mistair in 2007, which is a higher-end value for money fabric brand was a success & further strengthened its relationship with the dealers, since they prefer buying the products spread across the value chain from the same supplier. Strong distribution network acts as a strong entry barrier in this business, since a new entrant could take time to establish a good network with dealers & agents. Further, it also reduces the time line for new products / designs to reach the masses.

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Prudent working capital policy, low debt-equity, healthy return ratios, consistent dividend payment
The company has managed to improve its working capital cycle since FY08. A disciplined approach to debtor collection (like offering 2% discount on cash transactions) and inventory management (by having a good network with dealers) has improved the debtors collection & inventory holding period significantly. Debtor days have improved from 82 in FY08 to 53 in FY10, while inventory days have improved from 67 in FY08 to 41 in FY10. This has helped the company to free up its cash & repay its short-term loans, thus enabling it to keep its debt-equity ratio at lower levels. Current debt-equity ratio of SSML is 1:1 (reduced from 2:1 in FY08), which is much lower as compared to the industry average (3.1:1) and its peers like Sangam India, Donear & RSWM, which have debt-equity ratio of 3.6:1, 3.4:1 & 4.4:1 respectively (in FY10). We expect the working capital position to remain at current levels or improve going forward. Debt-Equity ratio is expected to improve to 1:1 in FY11 (from 1.1:1 in FY10) but is likely to increase to 1.2:1 in FY12 on the back of incremental borrowings for funding the expansion plans. Even then it would be much lower than the industry average & its peers.

3500.0 3000.0 Debt (Rs. in Mn) 2500.0 2000.0 1500.0 1.1 1000.0 500.0 0.0 FY08 FY09 FY10 Year End FY11E 1.0 2704.7 2327.2 2.0 1.6 1897.4 2248.6

3287.9

2.5 2.0 1.5 Debt-Equity (x)

1.2

1.0 0.5 0.0

FY12E

Besides lower debt-equity, SSML also commands healthy return ratios, which is superior to its peers. The companys ROCE & ROE have increased from 5.7% & 7.1% respectively in FY08 to 17% & 20% respectively in FY10. This is expected to further improve to 20.4% & 24.2% respectively in FY11. While return ratios could be under some pressure in FY12 on the back of huge CAPEX plans lined up, we expect them to stabilise or improve once the new facilities start yielding the benefits. The company has also rewarded its shareholders with consistent dividend payments since 1990 (every year) despite temporary hit in fortunes of the company. The dividend paid has increased significantly from Rs. 25 mn in FY05 to Rs. 56.2 mn in FY10. Going forward, we expect the company to continue to enrich its shareholders wealth with decent dividend payments.

Net Sales to grow by 20.5% over FY10-12, operating margins to improve

SSMLs net sales have grown at a CAGR of 13.4% over FY07-10, driven by fabric segment. The division has been a major growth driver for SSML over the years. Even the RMG segment has done well over the past few years. The company has managed to report a positive growth in revenues even during the recession time in 2008 & 2009. This was mainly because of its focus on domestic market & better brand building. We expect SSMLs net sales to grow at a CAGR of 20.5% over FY10-12, which is likely to be driven by capacity expansion in Fabrics & RMG, improvement in utilisation in all its segments viz; Fabrics, RMG & Dyed Yarn on the back of buoyant industry outlook and distribution expansion. The brand product mix is likely to remain almost the same with all its fabric brands (Siyaram, Mistair, J Hampstead, Zenesis & Moretti & Featherz) expected to grow at a robust rate, with Siyaram expected to be a major growth driver. The management expects robust growth in Siyaram shirting & suiting and is also focusing on leveraging its network for the furnishings segment, which is likely to add to the revenues. RMG brands are also expected to do well with Oxemberg expected to drive growth.

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Given below is an overview of SSMLs net sales since FY08 along with our future projections:
Value 12000 Sales Vaue (Rs. In Million) 10000 8000 6000 4000 2000 0 FY08 FY09 FY10 Year End FY11E FY12E 8.8 9.1 4861.0 5301.2 24.4 % growth rate 30 9576.5 8240.6 6597.3 16.2 10 5 0 25 20 15 Growth rate (%)

24.9

SSMLs operating profit & PAT has grown by 23.4% each on a CAGR basis over FY07-10. De-bottlenecking strategies coupled with cost control measures adopted has resulted in significant expansion in OPM from 6.6% in FY08 to 10.7% in FY10. We expect the operating profit to grow at a CAGR of 28.9% over FY10-12, while the margins are likely to improve to 12.1% in FY11 & further to 12.2% in FY12 on the back of better realisation (due to focus on brand building) & improvement in utilisation. PAT is expected to grow at a CAGR of 33.9%, while the PAT margins are expected to improve from 4.9% in FY10 to 6.3% in FY11 on the back of higher OPM & relatively lower rise expected in the interest & depreciation cost. However, in FY12, we expect the PAT margins to decline to 6.1% on the back of higher depreciation & interest expected due to huge CAPEX likely to be incurred by the company in FY12. Overview of SSMLs operating profit & PAT since FY08 along with our future projections:

Operating Profit (Value) 1400 1200 Opt. Profit (Rs. in Mn) 1000 800 600 400 200 0 FY08 FY09 FY10 Year End 322.4 6.6 445.2 8.4 703.1 10.7

% of sales 12.1 993.8 1167.4 14 12

PAT (Rs. in Mn) 700 600

PAT (Value)

% of sales 6.3 4.9 521.9 7 6 Percentage (%) 6.1 5 4 326.1

584.2

Percentage (%)

12.2 10 8 6 4 2 0

500 400 300 200 100 0 FY08 FY09 FY10 Year End 90.3 105.0 1.9 2.0

3 2 1 0 FY11E FY12E

FY11E FY12E

Competitive Profile:
SSML is mainly into branded polyviscose fabrics & with focus in the Tier II & Tier III cities. Its nearest competitors in this segment are Sangam India, Donear & RSWM. Their business model is not completely same but quite similar. In the unorganised sector (which dominates the blended fabrics market), the company faces competition from local players. The company cannot be compared with players like Raymond & OCM, as they are mainly into polywool and/or cotton fabric, where product prices are higher than that of polyviscose. At CMP, SSML trades at 7xFY11E EPS, which is at a premium to Sangam & RSWM, but at a discount to Donear.

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Over the last 20 years, SSML has created very strong brand in the semi-urban and rural areas. This has enabled SSML to have a competitive edge over its peers. Strong distribution network has acted as a strong entry barrier, since a new entrant could take time to establish a good network with dealers & agents. Further the companys debt-equity is much lower than its peers and the industry average and also commands better return ratios as compared to its peer. Hence SSML deserves to trade at a premium to its peers. Moreover, due to problems like high power cost, quality concerns, yuan appreciation etc faced by the China, the Chinese textile manufacturers are finding it tough to compete with Indian textile companies. This is also an advantage to SSML.
Peer Comparison: Company Name FY10 Sales Mkcap/Sales EV / EBIDTA (x) (x) OPM (%) NPM (%) EPS (Rs) PBV PE (Rs. in Mn) 10.7 4.9 34.8 2.1 11.2 6597.3 0.6 6.9 15.0 2.0 4.4 1.0 11.1 8522.5 0.2 5.9 11.5 2.0 14.6 1.9 11.6 16631.4 0.2 6.5 8.6 -7.5 -3.5 2.2 2428.4 0.6 14.0
(Company, HDFC Sec)

SSML Sangam India RSWM (Consolidated) Donear

Company Name

FY11E OPM (%) NPM (%) EPS (Rs) PBV 12.1 6.3 55.7 1.7 16.6 4.3 11.9 0.8 15.6 5.7 33.6 1.2 14.6 2.7 1.6 1.9 Sales PE (Rs. in Mn) Mkcap/Sales (x) 7.0 8240.6 0.4 4.1 10842.1 0.2 5.1 18094.5 0.2 16.4 3084 0.4
(Consensus, HDFC Sec Estimates)

SSML Sangam India RSWM (Standalone) Donear

Risks and concerns

SSML operates in a highly fragmented industry, which is facing heightened competition due to low entry barriers coupled with high dominance by unorganized sector. In the organised fabrics market (polyviscose), the company faces competition from Sangam India & Donear. In order to remain in competition, the company has to incur huge amount on A&P to create brand awareness and also needs to constantly invest in R&D and come out with new products, which could put pressure on its margins going forward. However, the company uses a smart strategy of tying up with brand ambassadors at an early stage in their career (signed Dhoni in 2006 & upcoming boxing star Vijender Singh in 2010). SSMLs fabric facility is operating at 96% utilisation, while RMG is operating at 80%. Hence to maintain the growth momentum and to meet the demand requirements, the company has lined up a huge CAPEX of Rs. 2100 mn over the next 2-3 years, which is likely to be funded through a mix of internal accruals & borrowings (under TUF scheme). Any delay in the ramp up of new capacities could affect the revenue & profit growth and impact the return ratios significantly. SSMLs yarn dyeing business has operated at a lower capacity utilisation level of around 60% despite the capacity having been set up two years back. This is due to a shift in the plant venue and because of construction activity taking place within the plant. Any delay in scaling up operations in the yarn division could affect SSMLs revenue growth & margins. While the TUF scheme has been extended in FY12 Union Budget, any withdrawal of the same going forward could increase the interest liability significantly (The TUF scheme offers 5% interest subsidy to textile companies on expansion cost). Out of Rs. 2250 mn debt at present, the TUF loans are ~Rs. 1000 mn. Since SSML is mainly into manufacturing polyviscose fabrics, polyesterviscose yarn is a major raw material, accounting for 80-85% of the total input requirements. Since polyester is a product of derivative of crude oil, any substantial rise in the crude oil prices could result in jump in the polyviscose yarn prices, which could hurt the SSMLs margins if it is unable to pass on the price hike to its customers, given a highly competitive textile market. Till now, SSML has benefited from higher cotton prices, since there has been a shift in demand from cotton to blended fabric. However, going forward, any sharp reversal in the cotton prices could increase the demand for cotton fabrics, which could hamper the growth visibility of SSML. Exports account for around 5% of SSMLs total revenues, while the company imports only 2% of the total input requirements (0.9% of the revenues). Hence any sharp rupee appreciation is likely to impact SSMLs export revenues. SSML derives majority of its domestic revenues from the rural areas (~75%) with presence mainly in Tier II & Tier III cities. While the company is less exposed to overseas markets, any slowdown in the Indian economy could harm the rural prosperity & reduce the demand for companys products, which in turn could slow down the revenue & profit growth significantly going forward. Q1 is generally a weak quarter for the company, while Q4 is the best quarter. However, the company has indicated that Q4FY11 is expected to be subdued both in terms of revenue & profits. The same has been factored in our FY11 projections.

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Q3FY11 Result Update:

Quarterly Y-o-Y:

SSMLs Q3FY11 results were impressive. Net Sales improved by 38% to Rs. 2266.9 mn [Q3FY10: Rs. 1642.4 mn], driven by both volume & realisation. The fabrics segment grew by 38% Y-o-Y, largely driven by robust volume growth of 25%. The garments divisions revenue grew by 44% Y-o-Y, largely driven by 44% increase in realisation. The yarn division reported 10% growth in sales, driven by 15% rise in realisation. The operating profit grew by 70.1% to Rs. 285.2 mn [Q3FY10: Rs. 167.7 mn], while the OPM improved by 237 bps Y-o-Y to 12.6% on the back of higher realisations, improvement in capacity utilisation & advantage of operating leverage. The material cost as a % of net sales fell by 73 bps Y-o-Y to 50.1%. The other expenditure as a % to net sales fell significantly by 235 bps Y-o-Y to 31.7% in Q3FY11. However, higher employee cost (up 57.8% Y-o-Y) restricted further margin expansion. Marginal growth in depreciation (up 4.3% Y-o-Y), relatively lower rise in the interest expense (up 24.1% Y-o-Y), higher other income (up 61% Y-o-Y incl. other operating income) and lower effective tax rate (down 800 bps Y-o-Y to 30.7%) boosted the net profit, which grew by 139.5% to Rs. 159 mn [Q3FY10: Rs. 66.4 mn]. PAT margins improved by 297 bps Y-o-Y to 7%. EPS for the quarter stood at Rs. 17 vs. Rs. 7.1 in Q3FY10.
Q-o-Q:

Sequentially the net sales grew by 5.7%, while operating profit & PAT increased by 8.2% & 9.5% respectively. OPM improved marginally by 29 bps Q-o-Q, supported by relatively lower growth in the other expenses (up 4.2% Q-o-Q). PAT margins improved by 24 bps, supported by lower effective tax rate (down 108 bps Q-o-Q) & relatively lower growth in the depreciation expense (up 3.7% Q-o-Q).

Conclusion & Recommendation:

We expect SSMLs net sales & PAT to grow by 20.5% & 33.9% over FY10-12. Capacity expansions, improvement in utilisation, continuing focus on brand building & strong distribution network is likely to drive the growth in terms of both volumes & realisation. The demand for polyviscose fabric (major growth driver for SSML) would continue to remain buoyant, especially in the Tier II & Tier III cities (where the company has a niche presence and where majority of population is lower & middle class) on the back of firm cotton prices. With a portfolio of well-known brands like Siyaram, Mistair, J Hampstead, Zenesis & Moretti & Featherz, the company is well-positioned to leverage its potential & exploit the opportunities arising in the fabrics market. The company is also established in the RMG segment (though not on a very high scale) and is looking forward to strengthen its presence here by leveraging its existing brands like Oxemberg & MSD. Domestic market, especially the Tier II & Tier III cities and rural areas would continue to remain main focus of SSML going forward. The operating margins are expected to improve on the back of better realisation (due to focus on brand building) & improvement in utilisation. While huge expansion plans are likely to put pressure on PAT margins in FY12 (due to higher interest & depreciation), the impact would be felt marginally on the back of higher OPM. With higher proportion of TUF loans expected to total borrowings, the interest cost is expected to remain under control and not increase significantly, since The TUF scheme offers 5% interest subsidy to textile companies on expansion spree. At CMP, SSML trades at 7xFY11E EPS, which is at a premium to Sangam & RSWM, but at a discount to Donear. Though the revenue & profit growth in FY12 is likely to be subdued on an elevated base of FY11, the company still deserves to get better valuations. Over the last 20 years, SSML has created very strong brand in the semi-urban and rural areas. This has enabled SSML to have a competitive edge over its peers. Strong distribution network has acted as a strong entry barrier, since a new entrant could take time to establish a good network with dealers & agents. Further, the companys debt-equity is much lower than its peers (close to 1:1 vs. 3-4:1 in the case of peers) and the industry average and also commands better return ratios as compared to its peers. The management is conservative and has a good reputation in the textile industry. Hence SSML deserves to trade at a premium to its peers. Considering its sound financials and robust future prospects, the stock looks attractive at the current valuations. We feel that the company is capable of trading at 7-7.5xFY12E EPS, which gives us sequential price targets of Rs. 436 & Rs. 468. We recommend investors to buy this stock at current levels and average it on dips in the price band of Rs. 343-359 (5.5-5.75xFY12E) for the above-mentioned price targets over the next 2 quarters.

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Quarterly Financial Performance:

Particulars Net Sales (Rs. In Million) VAR [%] VAR [%] Q3FY11 Q3FY10 VAR [%] Q2FY11 Q2FY10 Q1FY11 Q4FY10 (Q-o-Q) (Y-o-Y) 2266.9 1642.4 38.0 2144.1 5.7 1731.2 23.9 1687.9 1881.0

Other Operating Income Other Income Total Income Total Expenditure Raw Material Consumed Stock Adjustment Purchase of Finished Goods Employee Expenses Other Expenses PBIDT Interest PBDT Depreciation PBT Tax (incl. DT & FBT) Reported Profit After Tax Extra-ordinary Items Adj. Profit After Extra-ord item EPS (Rs.) Equity Face Value OPM (%) PATM (%)

13.1 20.7 2300.7 1981.7 980.6 -88.8 243.8 127.8 718.3 319.0 36.1 282.9 53.5 229.4 70.4 159.0 0.0 159.0 17.0 93.7 10.0 12.6 7.0

5.0 16.0 1663.4 1474.7 632.0 56.2 146.4 81.0 559.1 188.7 29.1 159.6 51.3 108.3 41.9 66.4 0.0 66.4 7.1 93.7 10.0 10.2 4.0

162.0 29.4 38.3 34.4 55.2 66.5 57.8 28.5 69.1 24.1 77.3 4.3 111.8 68.0 139.5 139.5 139.5 0.0 0.0 23.2 73.5

10.5 22.8 2177.4 1880.5 944.8 -92.2 217.7 120.8 689.4 296.9 32.5 264.4 51.6 212.8 67.6 145.2 0.0 145.2 15.5 93.7 10.0 12.3 6.8

24.8 -9.2 5.7 5.4 3.8 12.0 5.8 4.2 7.4 11.1 7.0 3.7 7.8 4.1 9.5 9.5 9.5 0.0 0.0 2.3 3.6

12.0 14.1 1757.3 1563.4 745.0 -51.4 214.4 92.0 563.4 193.9 31.3 162.6 52.2 110.4 29.8 80.6 0.0 80.6 8.6 93.7 10.0 9.7 4.7

-12.5 61.7 23.9 20.3 26.8 1.5 31.3 22.4 53.1 3.8 62.6 -1.1 92.8 126.8 80.1 80.1 80.1 0.0 0.0 26.8 45.5

9.5 10.2 1707.6 1502.0 800.4 -210.5 218.9 101.0 592.2 205.6 28.1 177.5 51.7 125.8 40.7 85.1 0.0 85.1 9.1 93.7 10.0 11.0 5.0

5.0 41.5 1927.5 1622.9 663.3 91.5 214.8 118.4 534.9 304.6 29.3 275.3 49.7 225.6 70.8 154.8 7.8 147.0 15.7 93.7 10.0 13.7 7.8

(Source: Company, HDFC Sec)

Financial Estimations: Profit & Loss A/c

YE March Net Sales FY08 4861 FY09 5301 FY10 6597 (Rs. In Million) FY11E FY12E 8241 9576

Other Income Total Income Material Cost Employee Cost Other Expenditure Total Operating Expenses EBITDA (incl. other inc) EBITDA (excl. other inc) Interest Depreciation PBT Tax (including FBT & DT) PAT Adjusted PAT (net of exceptional item)

75 4936 2408 300 1831 4539 397 322 107 166 125 28 97 90

61 5363 2687 332 1837 4856 507 445 168 192 146 32 114 105

109 6706 3383 386 2126 5894 812 703 120 202 491 153 337 326

117 8358 4090 482 2675 7247 1111 994 137 213 762 240 522 522

123 9700 4764 561 3084 8409 1290 1167 183 255 853 269 584 584

(Source: Company, HDFC Sec Estimates)

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Balance Sheet
YE March FY08 FY09 FY10 FY11E (Rs. In Million) FY12E

Share Capital Equity Warrants Reserves & Surplus Shareholders Funds Minority Interest Secured Loans Unsecured Loans Loan Funds Deferred Tax Liability Capital Employed Gross Block Less: Depreciation Net Block CWIP Goodwill Investments Inventories Sundry Debtors Cash & Bank Loans & Adv. & other current assets Total Current Assets Current Liabilities & Provisions Working Capital Miscellaneous Exp not w/off Capital Deployed

94 0.0 1270 1364 0 1859 846 2705 175 4243 3028 1013 2015 48 0 2 1089 1326 11 335 2761 583 2178 0 4243

94 0.0 1330 1423 0 1820 507 2327 180 3930 3251 1201 2050 18 0 0 972 1138 21 345 2476 614 1862 0 3930

94 0.0 1605 1699 0 1546 352 1897 183 3779 3372 1370 2001 5 0 282 893 1168 29 423 2514 1022 1492 0 3779

94 0.0 2061 2155 0 1932 317 2249 187 4590 3709 1583 2126 420 0 225 1117 1401 43 444 3006 1186 1819 0 4590

94 0.0 2580 2673 0 2987 301 3288 190 6151 5090 1838 3253 593 0 203 1295 1626 58 500 3480 1376 2103 0 6151

(Source: Company, HDFC Sec Estimates)

Key Ratios
YE March FD EPS (Rs.) PE (x) FY08 9.6 40.4 FY09 11.2 34.7 FY10 34.8 11.2 FY11E 55.7 7.0 FY12E 62.4 6.2

Book Value (Rs.) P/BV (x) OPM (%) PBT (%) NPM (%) ROCE (%) RONW (%) Debt-Equity Current Ratio Mcap/Sales (x) EV/EBITDA

145.5 2.7 6.6 2.6 1.9 5.7 7.1 2.0 4.7 0.8 17.0

151.8 2.6 8.4 2.8 2.0 8.4 8.0 1.6 4.0 0.7 12.2

181.2 2.1 10.7 7.4 4.9 17.0 19.9 1.1 2.5 0.6 6.9

230.0 1.7 12.1 9.2 6.3 20.4 24.2 1.0 2.5 0.4 5.3

285.3 1.4 12.2 8.9 6.1 17.4 21.9 1.2 2.5 0.4 5.5

(Source: Company, HDFC Sec Estimates)

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Cash Flow Statement

YE March FY08 FY09 FY10 FY11E (Rs. In Million) FY12E

Profit Before Tax Net Opt Cash Flow Net Cash from Investing Activities Net Cash from Financing Activities Cash & Cash Equivalents Net Inc/(Dec) in Cash

125 -146 -411 554 11 -3

146 786 -186 -589 21 10

491 1034 -401 -625 29 8

762 561 -696 149 43 13

853 757 -1532 791 58 16

(Source: Company, HDFC Sec Estimates)

Analyst: Mehernosh K. Panthaki (Mehernosh.Panthaki@hdfcsec.com)

RETAIL RESEARCH Tel: (022) 3075 3400 Fax: (022) 2496 5066 Corporate Office
HDFC Securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone: (022) 3075 3400 Fax: (022) 2496 5066 Website: www.hdfcsec.com Email: hdfcsecretailresearch@hdfcsec.com Disclaimer: This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for Retail Clients only and not for any other category of clients, including, but not limited to, Institutional Clients

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