KPR MILLS. Timing capex to perfection. Increase in captive power capacity to keep power cost low. Higher spreads to keep EBIDTA margins higher

Transcription

1 India Midcap Research Initiating Coverage KPR MILLS Spinning a growth story Timing capex to perfection KPR Mills (KPR) has chalked out an aggressive capex plan of INR 4,760 mn over FY11-FY12, to expand its capacity from the existing 212,064 spindles to 333,696 (103,680 for compact spinning and 17,952 new spindles) at Satyamangalam, Tamil Nadu.The capex will also involve modernisation of 30,240 existing spindles. The entire capex is likely to come on stream by August With cotton yarn prices, expected to remain firm, we believe the timing KPR s capex is apt for it to benefit from the next upcycle in yarn prices. Increase in captive power capacity to keep power cost low The company has increased its power capacity from 40MW to 62MW in Jan 2011 in order to support its capacity expansion in spinning activities which is expected to come onstream by August 2011 thereby supporting 75 % of its power needs operating at full capacity. This strategy has helped company in becoming selfreliant in power consumption needs and to reduce its power cost which stood at 3.1% in FY10, significantly low against 12.4% for its peers. Higher spreads to keep EBIDTA margins higher KPR has enjoyed average spread INR 35 per kg over FY07-FY10.Recently cotton yarn prices have increased at a faster pace than raw cotton prices due to increased demand from China and Bangladesh thereby leading to increase in spreads. KPR also enjoys higher realization than its peers because of high quality product and its presence in Tirupur markets. We expect net spreads over cotton to be at INR 54 per kg and INR 48 per kg for FY12 and FY13 respectively, higher than the historical average. We believe that these higher spreads are sustainable given that the company will produce higher count yarn post compact spinning capacity coming onstream, thereby helping achieve higher spreads. March 7, 2011 Reuters : KPRM.BO EDELWEISS RATING Absolute Rating Bloomberg : KPR IN BUY MARKET DATA CMP : INR week range (INR) : 246 / 104 Share in issue (mn) : 37.7 M cap (INR bn/usd mn) : 5.9 / Avg. Daily Vol. BSE/NSE ( 000) : 74.6 SHARE HOLDING PATTERN (%) Promoters* : 74.5 MFs, FIs & Banks : 2.7 FIIs : 8.9 Others : 13.9 * Promoters pledged shares : Nil (% of share in issue) RELATIVE PERFORMANCE (%) Sensex Stock Stock over Sensex 1 month 2.5 (1.6) (4.1) 3 months (7.5) (15.2) (7.7) 12 months Outlook and valuations: Attractive; initiating coverage with BUY With incremental spinning capacities coming on stream, complemented by higher cotton yarn realization makes KPR attractive at current levels. Due to higher depreciation and interest cost we have valued KPR on EV/EBIDTA basis. KPR is currently trading at 3.7x FY12E EV/EBIDTA and 3.3x FY13E EV/EBIDTA. We have valued KPR at 4.2x FY12E EV/EBIDTA and arrive at a fair value of INR 215 per share. We initiate coverage on the stock with BUY. Financials Year to March FY09 FY10 FY11E FY12E Net revenues (INR mn) 7,403 8,340 11,143 14,667 Revenue growth (%) EBITDA (INR mn) 1,027 1,641 2,629 3,081 Net profit (INR mn) ,273 1,467 Share outstanding (mn) EPS (INR) EPS growth (%) (87.2) P/E (x) EV/EBITDA (x) ROAE (%) Note: FY09 numbers are standalone Niket Shah niket.shah@edelcap.com Manoj Bahety, CFA manoj.bahety@edelcap.com Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

2 Investment Rationale Increasing spinning capacity from 212,064 to 333,696 spindles, modernization of 30,240 spindles and increasing power capacity from 40MW to 62MW Timing capex to perfection Anticipating better domestic and export demand, going forward, KPR is augmenting its capacity by 121,632 spindles, which will take its total capacity to 333,696 spindles from the existing 212,064 (up 57.4%). This capex is likely to cost the company INR 4,760 mn, and will involve installation of 103,680 spindles for compact spinning capacity and addition of new 17,952 spindles, at Satyamangalam. The capex also includes modernization of spindles at Satyamangalam unit in a phased manner over FY11- FY12. The company has already increased its power generation capacity from 40 MW to 62 MW to support the expanded spinning capacities; which will meet 75% of its power requirement captively. The company plans to fund this capex by raising INR 3430mn debt under TUFS (interest subvention of 4% for spinning) and balance by internal accruals and balance IPO funds. The company had raised INR 1330 mn through an IPO in August 2007 of which, as on 31 st March 2010 the company has used INR 620mn out of these proceeds for expansion in garment, processing and knitting facilities. The remaining INR 710mn would be utilized for expansion of compact spinning capacity. Table 1: Details of Capacity Expansion Purpose Location Value (INR mn) Addition of spindles (Compact Karumathampatti Unit 3,100 spinning Capacity) Modernisation and addition of Satyamangalam Unit 380 spindles 22MW wind power capacity Tirunelvelli, Tenkasi and 1,280 coimbatore district Total capex 4,760 Source: Company, Edelweiss research Total capex of INR 4760mn to be funded by 70:30 debt to equity Table 2: Means of funding capacity Expansion Means of Finance Value (INR mn) Balance from IPO funds 710 Internal accruals and proposed preference shares 620 TUFS loans sanctioned 3,430 Total 4,760 Source: Company, Edelweiss research Table 3: Capacity Overview Units FY07 FY08 FY09 FY10 FY11E FY12E Spindles 128, , , , , ,696 Circular Knitted Machines Sewing Machines 800 1,450 1,750 1,750 1,750 1,750 wind mills (MW) Source: Company, Edelweiss research With the aforementioned capex coming on stream by August 2011 and with cotton and yarn prices expected to remain firm over next 2 years, KPR s margins and profitability could improve substantially, going forward. We also believe that timing of capex is apt for the company to benefit from the next upcycle in yarn prices rates. 2 Edelweiss Securities Limited

3 Change in raw material procurement policy to reduce risk of inventory losses The company, aided by its specialist procurement advisory team based in Gujarat, procures majority of its cotton requirement during December to January, when the availability is at its peak. This policy ensures that KPR obtains the highest grade and uniform quality cotton, most economically. Reduce inventory cycle from 7 months to 2-3 months currently thereby reducing risk of substantial inventory losses However, of late, the company has however prudently changed its inventory policy by reducing its raw material inventory cycle to two to three months compared with seven months earlier due to sharp increase in cotton prices. This in our view not only reduces the risk of substantial inventory losses in case of sharp fall in cotton and yarn prices but also helps company sustain its margins. However any significant rise in cotton prices during remaining part of the year might affect the margins of the company. The company resorted to imports of cotton when the Commission for Agriculture Costs and Prices (CACP), an agency under the Union agriculture ministry which fixes the MSP for agriculture produce, in substantially increased the MSP (Minimum support price) of cotton in order to benefit the farmers. The company imported around 31% of its total cotton in FY10 thereby resulting in lower raw material cost. However going forward we do not expect company to go for import of cotton as the current prices of Shankar 6 is around INR per candy (360kgs) substantially higher than the MSP of INR per candy set by the CAPC. Increased power capacity from 40MW to 62MW to support new spinning capacity Increasing power generation capacity to reduce costs Tirupur, the biggest textile hub in India, accounting for ~47% of India s spinning capacity and more than 40% of yarn exports, has been constantly facing acute shortage of power supply over the past few years. Power cuts, lasting for ~4-5 hours a day, have left players with no option but to use diesel generators, which has increased their production cost by ~INR per kg (raising cost per unit from INR 5 to INR 12). Consequently, several spinning mills have shut down and above 20,000 workers have lost jobs. KPR has been constantly increasing its power capacity simultaneously with increase in its spinning capacity. The company has increased its power capacity from 20MW in Aug 2005 to 40MW in The company in January 2011 has further increased its captive power generation capacity by setting up additional 22MW wind power generation capacity with an outlay of INR 1280 mn in order to support its capacity expansion in its compact spinning capacity. This addition has taken the company's total captive wind power generation capacity to 62 MW from 40 MW, supporting 75 % of its power needs operating at full capacity. This strategy has helped company not only to reduce it power cost but also helped in becoming self- reliant in power consumption needs and combat the excessive power shortage in the state of Tamil Nadu which was hampering performance of other small spinning players. Power cost (as % of sales) for KPR stood at 3.1% in FY10, significantly low against 12.4% for its peers. This not only helps company improve its overall margins vis a vis its peers but also helps to achieve 90% capacity utilization going forward due to uninterrupted power supply. Edelweiss Securities Limited 3

4 Chart 1: Power cost as compared to peers (%) KPR Mills RSWM Vardhman Textile Nahar Spinning Power cost % Sales Source: Annual Reports, Edelweiss research Low employee cost model and lower attrition to keep costs under control:- KPR uses a balanced approach towards attracting, training and retaining its employees by providing employee education and other welfare programmes. The company provides boarding and lodging to its workers and other amenities like higher education, yoga, swimming pool, etc. It strictly enforces an 8 hour workday policy without overtime. The employees have to go through a fitness test before joining and 3 months on the job training. The workforce comprises of 90% women staff most of them coming from rural areas of Tamil Nadu.With most of the labourers coming from rural Tamilnadu which otherwise would have remained unemployed, reduce the chance of the strike by labour unions. This model helps to keep a check on the staff costs of the company and also increase their over-all productivity keeping the attrition rate below 1% for the company. KPR has a workforce of around 9,000 full time employees in management and administration, research and development, technical functions, marketing and manufacturing amongst others. This low employee cost model helps KPR not only increase productivity but also helps in keeping employee cost under control thereby leading to margin expansion. All manufacturing facilities located within 50km radius of Tirupur to help reduce transportation cost Strategically located manufacturing facilities All of KPR s manufacturing facilities are located within 50 km radius in Tirupur, which is known to be conducive for spinning operations. This helps in significant savings in production, labour and transportation costs and helps the company to utilize the key technical personnel across the manufacturing facilities. KPR s operations are spread in the Tirupur-Coimbatore belt, which is regarded as one of Asia s largest apparel manufacturing clusters. The close proximity to buyers helps to reduce the material handling costs and facilitates immediate feedback regarding the quality of the product. KPR is the only player in the industry to set up a large exclusive showroom of over 7,000 sq ft to facilitate buying for its clients. 4 Edelweiss Securities Limited

5 Enjoys higher spread due to its presence in Tirupur markets and manufacturing high quality yarn KPR enjoys higher spreads thereby benefitting their margins:- Average spreads enjoyed by KPR over FY07-FY10 have been at 45% and INR 35 per kg in value terms. However over last few quarters with sharp increase in cotton prices the yarn prices have also increased but faster than the cotton prices due to increase demand from domestic markets as well as China and Bangladesh thereby leading to higher spreads. KPR also enjoys a higher realization as compared to other peers primarily due to its high quality products and its presence in Tirupur markets. However we believe that the spreads might come down post H1FY12 and FY13 due to expectation of softening in cotton prices and also yarn prices. We have assumed the raw cotton raw material procurement prices at INR 122 per kg and INR 103 per kg for FY12E and FY13E respectively and cotton yarn realisations at INR 200 per kg and INR 170 per kg for FY12 and FY13 respectively thereby reducing the spreads to 37.4% and 39% and INR 54 per kg and INR 48 per kg for FY12 and FY13 in value terms respectively. Chart 2: Quarterly spreads enjoyed by KPR (Kg) (Kg) Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY12 Cotton prices Yarn prices Spreads (RHS) 0 Source: Company, Edelweiss research Chart 3: Yearly spreads enjoyed by KPR (Kg) (Kg) FY07 FY08 FY09 FY10 FY11E FY12E FY13E Cotton prices Yarn prices Spreads (RHS) Source: Company, Edelweiss research Edelweiss Securities Limited 5

6 Table 4: Yearly spreads enjoyed by KPR FY08 FY09 FY10 FY11E FY12E FY13E Sales (MT) Yarn 32,793 32,440 32,882 36,310 43,178 47,501 Knitted Fabric 7,325 9,029 10,690 7,931 10,078 12,564 Cotton Waste 7,851 8,651 8,466 9,386 12,202 14,643 Garments (Lac pieces) Dyed Fabric 13 1,781 1, Raw material price (Per kg) Cotton price Realisations (Per kg) Yarn Knitted Fabric Cotton Waste Garments Dyed Fabric Conversion ratio Spread (Value terms) Spread (% terms) Segment revenue (INR mn) Cotton Yarn 3,335 3,654 4,088 6,608 8,636 8,075 Knitted fabric ,139 1,142 1,566 1,651 Cotton Waste Garments 1,394 1,757 2,301 2,667 3,466 3,856 Dyed Fabric Other operating income Net revenue (INR mn) 5,984 7,403 8,340 11,143 14,667 14,696 Source: Company, Edelweiss research 6 Edelweiss Securities Limited

7 Valuation We believe it is appropriate to analyse valuations of spinning companies on EV/EBIDTA basis as spinning is highly capital intensive business and also depreciation and interest element for textile companies is significantly higher. Hence we have valued KPR on EV/EBIDTA basis. KPR has traded at peak valuation of 12x 1 year forward EV/EBIDTA and trough case valuation of 2.7x 1 year forward EV/EBIDTA.KPR is currently trading at 3.7x FY12E EV/EBIDTA and 3.3x FY13E EV/EBIDTA with the peers trading at 4.5x FY12 consensus EV/EBIDTA.We have valued KPR at 4.2x FY12E EV/EBIDTA and arrive at a fair value of INR 215 per share. Valuing company at 4x FY13E EV/EBIDTA to arrive at fair price of INR 218 for the stock Table 5: KPR Valuation Particulars Value (INR mn) FY12E EBIDTA 3,081 Target EV/EBIDTA (x) 4.2 Target Enterprise value 12,941 Less :- Debt 5,663 Add:- Cash 836 Target mcap 8,114 No of shares 37.7 Value per share (INR) 215 Source: Edelweiss research Chart 4: 1 yr forward EV/EBIDTA 27,500 8x (INR mn) 22,000 16,500 11,000 6x 4x 5,500 0 FY08 FY08 FY08 FY09 FY09 FY09 FY09 FY10 FY10 FY10 FY10 FY11E FY11E FY11E FY11E 2x Source: Edelweiss research Edelweiss Securities Limited 7

8 Table 6: - FY12E Sensitivity analysis to yarn prices and spreads Yarn prices Cotton prices Adjusted cotton prices Adjusted spread Revenues 13,654 14,160 14,667 15,787 16,329 EBIDTA 2,173 2,627 3,081 3,692 4,179 Margins (%) PAT 770 1,119 1,467 1,890 2,264 EPS Valuations Target EV/EBIDTA multiple Target EV 9,126 11,034 12,941 15,506 17,551 Less :- debt 5,663 5,663 5,663 5,663 5,663 Add :- Cash Target mcap 2,957 6,206 8,114 10,679 12,724 No of shares Target price Source: Edelweiss research Table 7: - FY13E Sensitivity analysis to yarn prices and spreads Yarn prices Cotton prices Adjusted cotton prices Adjusted spread Revenues 13,763 14,330 14,897 15,263 15,829 16,597 EBIDTA 1,987 2,483 2,979 3,437 3,933 4,468 Margins (%) PAT ,363 1,802 2,073 2,507 EPS Source: Edelweiss research 8 Edelweiss Securities Limited

9 Key Risks Increase in prices of raw material can reduce spreads:- Cotton, the primary raw material constitutes a significant percentage of total expenses incurred by the company. Therefore, any increase in cotton prices and unability to pass on the increase in raw material price could reduce the spreads for the company thereby affecting its revenues and profitability. Power shortage in the region leading to lower capacity utilization Companies have been facing the problem of significant power outages in the state of Tamil Nadu which is having an adverse effect on the overall capacity utilization and therefore impacting the revenues and profitability of the company. KPR having Competition from domestic players and other low cost countries KPR competes with number of organized and unorganized players in the textile industry. Pricing is one of the factors that play an important role in selection of the products. Stiff price competition from domestic players as well as international players from countries like Bangladesh, Indonesia and China with lower labour costs can adversely impact operations and profitability. Economic slowdown in global markets The company derives majority of its export revenues from the European markets which are facing economic slowdown due to the global financial crisis. This could adversely affect the business of the company. Changes in technology may render current technologies obsolete The apparel industry has experienced rapid improvements in technology and sophistication in production equipment, the use of which is essential to reduce costs and accelerate execution. The company may be required to implement new technology or upgrade the machinery at regular intervals, requiring significant capital investment. Increase in Employee costs The wages in Tamil Nadu have increased to INR from INR a year ago. Any significant increase in wages from current levels can affect the margins and thereby profitability of the company Edelweiss Securities Limited 9

10 Company Description K.P.R. Cotton Mills Private Limited, now known as K.P.R. Mill Limited, was originally incorporated on March 19, In order to further rationalize operations and better leverage capacities, with effect from April 1, 2005, K.P.R. Cotton Mills Private Limited purchased K.P.R. Knits as a going concern, and K.P.R. Mill Private Limited and K.P.R. Spinning Mill Private Limited were consolidated into K.P.R. Cotton Mills Private Limited through a merger process approved by the High Court of Madras. On October 5, 2006, K.P.R. Cotton Mills Private Limited was renamed K.P.R. Mill Limited. Presence across value chain with more than 1000 customers K.P.R. Mills Limited is one of the largest vertically integrated textile players in India having presence across the entire value chain - from Fiber to Fashion, including production of yarn and fabric, designing, dyeing and manufacturing of readymade garments. The company has marquee relationships of over 15 years with about 1,000 regular domestic clients for yarn and fabric and around 40 international apparel retailers The company has state-of-the-art production facilities in Tamil Nadu at Sathyamangalam, Tirupur, Perundurai and Coimbatore. The yarn capacity has been increased from 27,000 million tonnes (MT) to 54,000MT in with the installment of new spindles and now, the total number of spindles stands at 212,064 to produce 54,000 MT of yarn per annum, 205 circular knitting machines to produce 21,000 MT of fabrics per annum and 62 million pieces of readymade knitted apparel per annum along with dyeing facility to process 23 MT of fabric per day. It also has 40 wind mills with a total captive power generation capacity of 40 MW. In November 2006, a consortium of private equity funds including Ares Investments, Brandot Investments and Argonaut invested INR 105cr approx to acquire a combined stake of 11% in the company. It further raised INR 1330mn through an IPO of 59.1 lakh equity shares of INR 10 each at INR 225 per share in August 2007 for its expansion plans. It is the first spinning mill in India to obtain all three international certifications including ISO 9001:2000, ISO 14001:2004 and SA 8000:2001 for production facilities; demonstrating strong commitment towards process excellence. Business Segments KPR has presence across the value chain from fiber to garments. The integrated manufacturing operations help the company to provide better products to the clients as per their specifications thereby ensuring optimum and consistent quality assurance. Revenues from yarn segment to increase going forward Yarn: Yarn is the largest revenue contributing segment of the company contributing around 49% of FY10 sales. The company currently has 212,064 spindles and is expanding it to 333,696 spindles by August KPR produces both carded and combed yarn. KPR consumes about 20 % of its yarn production in-house and the remaining 80% is sold in the domestic markets to hosiery manufacturers. KPR produces yarn in the count range of 16s 34s.However post compact spinning capacity coming onstream KPR will be able to produce yarn with higher count of 30s 50s.However we expect cotton yarn contribution % sales to increase from 49% in FY10 to 54.2% by FY13E due to new capacities coming on stream. Fabrics: Fabric contributes about 17.3% of KPR FY10 revenues. Fabric segment includes knitted cotton fabric ass well as dyed fabric in the count range of 16s-34s.These fabrics are largely used for manufacture of garments like T Shirts, polo shirts, sweatshirts etc. KPR consumes about 25% of its fabric production for in-house for garmenting and the remaining 75% is sold in domestic markets. 10 Edelweiss Securities Limited

11 Garments: Knitted Garments segment contributed 27.6% to the total revenues in FY10. KPR has total garment capacity of 63mn (51mn capacity in Quantum Knits operating on double shift) including 12mn pieces of the garment being outsourced through the Tirupur facility and the remaining is produced in-house. The company outsources small orders and executes bulk orders in-house in order to achieve efficiency % of the garment production is exported to the US and European countries. The garments are exported to a diversified customer base in Europe, USA, Australia and Asia. Table 8: Product wise revenue break up of sales (%) Product FY07 FY08 FY09 FY10 FY11E FY12E FY13E Cotton yarn Knitted fabric Garments Cotton waste and others Total Quantum Knits wholly owned subsidiary of KPR mills:- Source: Company, Edelweiss research KPR formed a wholly owned subsidiary, Quantum Knits Pvt Ltd in June 2009, to provide independent and exclusive control of all operations, management and transactions of the Garment Unit at Arasur to this subsidiary. Quantum Knits is KPR exclusive knitted garment manufacturing unit, knitting fashion trends for Men, Women and Children across the world. It is among the largest garment manufacturing facilities in India, with capacity to produce 52 million pieces per annum in double shift. Geographical revenue break up KPR derives around 70.8% of its revenues from domestic market and rest from Exports. However with incremental capacities in spinning coming on stream, we expect revenues from domestic market to increase from 70.8% in FY10 to around 73% by FY13E. Chart 5: Geographical break up of revenue (%) FY07 FY08 FY09 FY10 Q1FY11 Q2FY11 Domestic sales Export sales Source: Company, Edelweiss research Edelweiss Securities Limited 11

12 Shareholding pattern The promoter s stake in the company stands at 74.5%. The FII s and mutual funds stake combined in the company stands at 15.8%, whereas, public holding stands at 9.7% as on Sept 30, 2010.The promoters have increased their stake from 73.1% in March 2010 to 74.5% in Sep Chart 6: Shareholding pattern FIIs and Mutual Funds 11% Public 10% Corporate bodies 5% Promoters 74% Source: Company, Edelweiss research 12 Edelweiss Securities Limited

13 Management Overview Mr. K. P. Ramasamy - Chairman Mr. Ramasamy, 60 years, is the Chairman of the company. He has over 38 years of experience in the apparel business, particularly in the production and marketing of woven fabric, knitted apparel, cotton yarn and hosiery fabric as well as in dyeing of yarn and fabric. Mr. Ramasamy spearheads the strategic expansion plan initiatives of the company and supervises manufacturing and human resources related functions. Mr. K.P.D Sigamani - Managing Director Mr. Sigamani, 55 years, is the Managing Director of the company. He has over 25 years of experience in the apparel industry, including the hosiery, apparel, fabric and yarn export business with specialized experience in the production and marketing Knitted apparel. He heads the apparel division and also supervises the export business of the company. Mr. P. Nataraj - Managing Director Mr. Nataraj, 51 years, is also the Managing Director of KPR. He has over 2 decades of experience in the apparel industry and is also experienced in internal control, project implementation and tax planning. He was a special invitee at the South India Mills Association and was also the President of the Coimbatore chapter of the Indian Institution of Industrial Engineering He manages the finance function and also oversees cotton procurement and yarn marketing activities of the spinning division of the company. Mr. Nataraj is a Chartered Accountant and holds a Bachelor of Science degree Mr. Shujaat Khan - Non-Executive Director Mr. Khan, 39 years, is the nominee of Ares Investments' on the Board and is associated with the company since November 2006 as a non-independent director. He has over 16 years of experience in investment banking and private equity activities. He was the Managing Director of ChrysCapital for 4 years from 2000 and worked with Merrill Lynch International in Asia for 4 years from 1997 and with the Travelers Group in New York for 5 years from He is the Managing Director of Blue River Capital Advisors (India) Private Limited since 2005.Mr Khan is an MBA from Harvard University Mr. G.P. Muniappan Non-Executive Director Mr. Muniappan, 68 years, is an independent director of the company. He joined R.B.I. during 1965 as Junior Officer and elevated to prestigious position of Deputy Governor of R.B.I.' in He also held high positions such as Chairman of Bank of Madura, R.B.I.'s Nominee on the Boards of SEBI, Indian Overseas Bank, Indian Bank and as a Trustee of U.T.I. He has specialized in the areas of forex management, banking operations, banking regulations and supervision. Mr. Muniappan is a University rank holder in M.A. Economics and also holds professional qualifications such as C.A.I.I.B., Post Graduate Diploma in Bank Management etc. Edelweiss Securities Limited 13

14 Industry Overview Fig. 1: Textile Value Chain Natural fibres Cotton Wool Silk Synthetic fibres VSF PSF Acrylic fibres Stage I Spinning Spindles and rotors Spun yarn Filament yarn Stage II Weaving/knitting Looms Fabric Stage III Processing (Bleaching, Dyeing, Printing, etc.) Processed fabric Stage IV Manufacturing of value-added Sewing machines, cutting machines, etc. Stage V Distribution Own stores Discount stores Retailers Distributors Exports Multibrand outlets Source: Edelweiss research 14 Edelweiss Securities Limited

15 Indian Textile Industry on cusp of high growth Indian textiles industry contributes around about 14 percent to industrial production, 4 percent to the GDP, and 17 percent to the country's export earnings. It provides direct employment to over 35 million people. Indian textile Industry to grow at 11% CAGR over next 10 years to reach $220 bn by The Indian textile industry (Domestic and exports) is currently pegged at $78bn and is expected to grow at 11% CAGR over next 10 years to reach $220bn.The growth is largely due to strong domestic demand arising out of increasing population, increasing income levels, rapid urbanization, improving demographics and increased organized players and increasing penetration of retailers into smaller cities. The share of domestic demand is likely to increase from $26bn in FY10 to around $80bn by FY2020 whereas exports are likely to grow from $50bn in FY10 to $140 bn by FY2020. However the domestic share in total textile industry is expected to go up from 33.3% in FY10 to 36.3% in FY20 whereas exports share is expected to come down from 66.7% in FY10 to 63.6% in FY20.Given that the textile industry is on cusp on entering into high growth phase we believe that it will benefit the cotton yarn and fabric industry in a big way going forward. Chart 7: Indian textile and apparel industry size (USD bn) E 2015E 2020E Source: Technopak, Edelweiss research Cotton Introduction Cotton, the key input in manufacturing of cotton yarn, accounts for about 55 per cent of the operating income of cotton yarn producers. In India, the cotton season is from November - February, with most of the companies purchasing cotton during these months because the availability of cotton is at its peak and also to maintain uniformity in quality. Introduction of BT Cotton helped increased productivity and yield On an average, Bt cotton seeds provided cotton farmers with yields of kg. per acre vs kg. per acre with conventional seeds. BT cotton is the first and only transgenic crop approved by Genetic Engineering Approval Committee (GEAC) for commercial cultivation in six states - Andhra Pradesh, Gujarat, Karnataka, Madhya Pradesh, Maharashtra and Tamil Nadu. Shankar 6 is the most widely used cotton in India, well known for its quality worldwide and is largely produced in Gujarat. Edelweiss Securities Limited 15

16 Cotton acreages in India to increase going forward to 11mn hectares by CS Table 9: India has the highest acreage under cotton Mn. Ha CS04 CS05 CS06 CS07 CS08 CS09 CS10P China India USA Pakistan Brazil Uzbekistan Others Total Source: International cotton advisory Committee Table 10: India has the lowest yield Kg/Ha CS04 CS05 CS06 CS07 CS08 CS09 CS10P China 953 1,119 1,129 1,251 1,238 1,270 1,255 India USA Pakistan Brazil 1,204 1,097 1,200 1,390 1,423 1,446 1,524 Uzbekistan Rest of the World Source: International cotton advisory Committee Yields lower due to lack to better irrigation facilities India has experienced lowest yield compared to other countries like United States of 911 kg per hectare, Brazil with yields of 1446 kg per hectare in CS This is also significant lower then world average of 763 kg per hectare primarily due to the low yielding state of Maharashtra, which accounts for 21% of total production and 34.4% of total area under cultivation in the country. Due to poor irrigation facilities, cotton yield is very low in states like Maharashtra (296 kg per hectare), Karnataka (375 kg per hectare) and Rajasthan (422 kg per hectare) as compared to other cotton growing states Gujarat, which contributes 34% of total domestic cotton production have seen higher yields of around 650 kg per hectare and Andhra Pradesh which contributed around 17.1% of total domestic cotton production have seen higher yields of around 644 kg per hectare primarily due to weather conditions in these states being more favourable for cotton cultivation and also due to better irrigation facilities. Production to increase to record high levels of 32.5mn bales India cotton balance sheet India s cotton consumption too has been growing on the back of rising textile consumption in the country. India s cotton production has increased at a CAGR of 8.7% from 3,043 million kg in FY to 5,015 million kg in FY E. India total consumption has increased at a CAGR of 6.9% from 3011 mn kg in FY to 4250 mn kg in E with mill consumption in India marking 6.3% CAGR over FY to FY Going forward, CAB expects production to further increase by 10.2% to 5.5 billion kg in FY E from 5 billion kg in FY E, the highest production ever recorded in the country. The rise in production would be mainly due to larger acreage under cotton. Area under cotton cultivation is expected to increase to 11 million hectare in FY E, due to higher cotton prices received by the farmers in FY Despite higher production, inventories are projected to remain low in FY due to rising domestic demand and buoyant exports on account of attractive international prices. Domestic consumption of cotton is expected to increase by 9.2% YoY to 4.2 billion kg in FY E and further by 6.4 % YoY to 4.5 billion kg in FY E thereby keeping cotton prices at higher levels. 16 Edelweiss Securities Limited

17 Table 11: India cotton balance sheet (Mn kg) FY04 FY05 FY06 FY07 FY08 FY09 FY10E FY11E Opening stock , , Production (crop size) 3,043 4,131 4,097 4,760 5,219 4,930 5,015 5,525 Imports Total availability 3,573 4,695 5,406 5,738 6,135 5,703 6,349 6,298 Mill consumption 2,557 2,788 3,060 3,313 3,326 3,230 3,519 3,766 Small Mill consumption Non Mill consumption Total domestic consumption 3,011 3,316 3,723 3,945 4,027 3,893 4,250 4,522 Exports , , Total demand 3,217 3,471 4,522 4,931 5,531 4,488 5,661 5,364 Closing stock 357 1, , Total area (million ha) Yield (kg/ ha) Average prices for shankar 6 (Rs/ kg) Source: Cotton Advisory board Note: 1 bale = 170 kgs Expected but not included in report China contribution to world s production to decrease from 34.4% in CS to 31.5% in CS E. World cotton scenario World cotton production decreased by 6.6% in CS , after declining by 10.4 % y- o-y in CS The production is expected to be around 21.7 billion kg in CS , the lowest in the last six cotton seasons due to reduced production from USA and other countries like Pakistan, brazil etc.china which contributed 34.4% of the production in CS is expected to come down to 31.5% in CS E because of worst flood in a decade. On the other hand, in CS world consumption declined by around % to 23.5bn kg from 26.5bn kg in CS due to financial crisis. China, being the world s leading producer of textile, is also the major user of cotton over the years. At present, it consumes more than one-third of world production. China has been a major driver of consumption which has increased from 33% of world consumption in CS to 39% of world consumption in CS and is expected to sustain around 40% of total world consumption for the next few years. India and Pakistan have increasingly become major users of cotton as well; due to their relatively larger textile industries. Demand also has been strong from countries like Bangladesh and Vietnam which led to higher demand for cotton in the global market thereby leading to sharp rise in cotton prices. Table 12: Country wise world cotton production (Mn kg) Production CS07 CS08 CS09 CS10E CS11E CS12E China 7,975 8,071 8,025 6,850 6,400 7,210 India 4,760 5,219 4,930 5,050 5,720 6,010 USA 4,700 4,182 2,790 2,654 3,980 4,050 Pakistan 2,121 1,876 1,891 2,019 1,830 2,180 Brazil 1,524 1,602 1,214 1,194 1,840 1,950 Uzbekistan 1,171 1,206 1, ,100 1,100 Others 4,506 3,873 3,474 3,161 4,280 4,810 World total 26,757 26,029 23,324 21,778 25,150 27,310 Source:-International cotton advisory committee Edelweiss Securities Limited 17

18 Table 13: Country wise world cotton Consumption (Mn kg) Consumption CS07 CS08 CS09 CS10E CS11E CS12E China 10,600 10,900 9,265 9,867 9,820 10,110 India 3,908 4,050 3,863 4,222 4,560 4,880 Pakistan 2,633 2,649 2,428 2,307 2,200 2,270 East Asia and Australia 1,864 1,835 1,680 1,829 1,780 1,790 Europe and Turkey 2,084 1,744 1,409 1,550 1,480 1,490 Brazil 992 1, ,002 1,040 1,060 USA 1, CIS Others 2,593 2,662 2,501 2,476 2,450 2,470 World total 26,429 26,509 23,517 24,614 24,640 25,330 Source:-International cotton advisory committee Table 14: World Cotton Balance Sheet Summary (Mn kg) CS07 CS08 CS09 CS10E CS11E CS12E Opening stock 12,559 12,792 12,231 11,952 8,880 9,360 Production 26,757 26,029 23,324 21,778 25,150 27,310 Consumption 26,429 26,509 23,517 24,614 24,640 25,330 Closing stock 12,792 12,231 11,952 8,877 9,360 9,970 Closing stock/consumption (%) Closing stock/consumption (excl. China) (%) Average cotton prices (per kg) * Source: International cotton advisory committee China imports to increase by 16.6% CAGR over CS E Cotton prices to remain firm going forward According to ICAC, world cotton production is expected to increase by 12% CAGR to 27.3 bn kg over CS E to CS E due to increase in area under cultivation in major producing countries like US and China due to current rise in cotton prices. Cotton consumption is expected to grow at 1.4% CAGR from 24.6bn kg to 25.5 bn kg over CS to CS E primarily due to robust domestic demand and higher demand and China whose consumption is likely to reach near all time highs recorder in CS We expect world cotton prices to remain firm, due to continued tightness in global market and with demand likely to remain strong from China and Bangladesh. Chart 8: Domestic and International cotton prices (Per kg) (INR/Kg) (USD Cents/Pound) 0 0 Apr-01 Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Domestic prices International prices (RHS) Source: ICAC, Crisil, Edelweiss research 18 Edelweiss Securities Limited

19 Spinning highly capital intensive and organized segment as compared to other processes in textile value chain Cotton yarn industry - Highly capital intensive The cotton yarn industry is relatively organised and highly capital intensive unlike the fabric industry which is largely unorganised. The largest cost component for a cotton spinning unit is the raw material i.e. cotton cost, which accounts for % of the operating income of players. As cotton is a seasonal commodity, procuring cotton at the right time and at the right price is crucial for a spinning company, as this directly impacts the operating margins. Spinning capacities are mainly concentrated in Tamil Nadu, Maharashtra, Gujarat, Andhra Pradesh and Punjab. These states together account for around 75 % of the total spinning capacity in India. Table 15: Region-wise spinning capacities Region Spindles (mn) Share (%) Spindles (mn) Share (%) Tamil Nadu Maharashtra Gujarat Andhra Pradesh Punjab Uttar Pradesh Rajasthan Madhya Pradesh Karnataka West Bengal Kerala Himachal Pradesh Other states Total Source: Crisil, Textile Commissioner's Office There is notable difference in the regional production of cotton and cotton yarn. Although Gujarat accounts for almost 33.6 % of the total cotton production in the country, its contribution to the total spinning capacity is only 5.8 %. On the other hand, Tamil Nadu has the largest spinning capacity in India with 47% market share, but its share in total cotton production is only 2 %. This disparity can be attributed to the fact that the weather conditions in Gujarat are more favourable for cotton cultivation as compared to Tamil Nadu. The costs involved in transporting cotton are not very high, so Tamil Nadu procures cotton from other states and converts it into yarn with its huge spinning capacities. Cotton yarn Balance sheet India's cotton yarn production had declined at a CAGR of 1.7 % between and But post the removal of quotas in 2005, production increased at a CAGR of 6.8 % from around 3,223 million kg in to around 4,187 million kg in Cotton yarn production declined marginally by 1.7 % to 2,898 million kg in primarily due to the global economic slowdown. However, with revival in export demand and strong domestic demand, cotton yarn production is estimated to have increased by around 6 % to 3,073 million kg in and is expected to further increase by 9.6% for P. Edelweiss Securities Limited 19

20 Table 16: India cotton yarn Balance Sheet (Mn kg) Year Opening stock Production Imports Total Supply Exports Domestic demand Closing stock Exports % (production) Domestic availability , , , , , , , , , , , , , , , , , , , , , , , ,740 Source: Cotton yarn Advisory Board Bangladesh continues to be the highest export destination for cotton yarn Table 17: India s direct yarn export destinations (INR mn) FY05 FY06 FY07 FY08 FY09 FY10 Bangladesh 6,370 7,923 8,210 10,953 10,621 6,294 Korea 7,250 9,034 9,070 6,707 6,087 6,395 Egypt 2,471 3,298 4,445 3,901 5,001 2,385 China 2,616 4,102 3,970 2,820 4,158 3,836 Italy 3,783 5,231 6,136 4,706 3,623 2,025 Turkey 1,475 1,636 2,493 7,569 2,084 1,371 Portugal 1,193 1,696 2,730 3,000 2,244 1,584 Sri Lanka 1,149 1,603 1,857 1,794 1,772 1,481 Japan 2,675 2,515 3,418 2,328 2, Hong Kong 3,574 3,138 2,263 1,499 1,238 1,121 Mauritius 2,574 1,995 2,445 1,907 1, Israel 1,266 1,706 1,708 1, Other countries 17,651 19,672 25,950 27,617 27,645 20,488 Total 54,935 64,433 74,695 76,030 68,733 49,240 Source: Textiles commissioners office 20 Edelweiss Securities Limited

21 Financial Outlook Revenues to grow at 20% CAGR over FY10-FY13E due to increase in spinning capacities Consolidated revenues to grow at 21.1% CAGR over FY10-FY13. We expect KPR to post 21.1% revenue CAGR over over FY10-FY13E primarily driven by increase in spinning capacities from to and with firmness expected in yarn prices. We believe that KPR is attractively poised to take benefits of next upcycle in yarn prices. Our realization assumption for yarn stands at INR 182 per kg for FY11E, 200 per kg for FY12E and INR 170 for FY13E and for fabric INR 192 for FY11E, INR 210 for FY12E and INR 180 for FY13E. Chart 9: Consolidated sales growth 17, , (INR mn) 10,500 7, (%) 3, FY07 FY08 FY09 FY10 FY11E FY12E FY13E Sales Growth (RHS) 0.0 Source: Edelweiss research ROCE and ROE set to improve from lows due to increase in margins driven by improvement in yarn realisations ROCE and ROE set to improve KPR has reported average ROE and ROCE of 16.4% and 11.7% respectively over FY07- FY10. With significant improvement in realizations of cotton and cotton yarn prices and with timely capex expected to come onstream by August 2011, we believe ROE and ROCE will improve significantly. We expect KPRs ROE to expand from 9.6% in FY10 to reach 16.4% in FY13E and ROCE to expand from 8.8% in FY10 to high of 13.1% in FY13E. Chart 10: ROCE and ROE (%) FY07 FY08 FY09 FY10 FY11E FY12E FY13E ROCE ROE Source: Edelweiss research Edelweiss Securities Limited 21

22 EBIDTA margins to sustain at higher levels due to higher cotton and yarn prices EBIDTA margins to sustain at higher levels :- KPR has reported average EBIDTA margins of 20.6% over FY07-FY10 with peak margins of 27.2% in FY07 and trough margins of 13.9% in FY09 due to financial turmoil. However sharp improvement in yarn prices margins for KPR have improved from 13.9% in FY09 to 19.7% in FY10.The Company has prudently reduced its inventory cycle from 7 months initially to around 2 months to avoid an significant inventory loss which might arise in case of correction in yarn prices thereby avoiding an erosion in EBIDTA margins. We believe that going forward the company will be able to achieve margins of around 23.5% for FY11E, 21% for FY12E and 20% for FY13E primarily due to higher cotton and yarn prices. We expect company to declare 20% of its profits as dividend over next 3 years. Chart 11: EBIDTA Margins to improve 4, , (INR mn) 2,520 1, (%) FY07 FY08 FY09 FY10 FY11E FY12E FY13E 0.0 EBIDTA EBIDTA margins (RHS) Source: Edelweiss research Debt to Equity to come down to 0.7x by FY13E due to strong operating cash flows Debt to equity to come down We expect debt to equity for KPR to remain below 1:1 for FY11E and FY12E inspite of significant amount of capex coming on stream. We expect debt to equity to fall to 0.7x by FY13E due to strong operating cash flows of about INR 2400mn in FY13E due to capacities coming on stream and firmness expected in cotton yarn prices. Chart 12: Debt to equity to remain below 1: (%) FY07 FY08 FY09 FY10 FY11E FY12E FY13E Debt to equity Source: Edelweiss research 22 Edelweiss Securities Limited

23 Financial Statements Income statement (INR mn) Year to March FY09 FY10 FY11E FY12E FY13E Net revenues 7,403 8,340 11,143 14,667 14,897 Raw material costs 5,116 5,010 6,765 9,312 9,176 Gross profit 2,287 3,330 4,378 5,354 5,720 Employee expenses ,100 1,311 Other expenses 767 1, ,173 1,430 Operating expenses 1,260 1,689 1,749 2,273 2,741 Total expenditure 6,376 6,699 8,514 11,586 11,917 EBITDA 1,027 1,641 2,629 3,081 2,979 Depreciation & amortisation EBIT ,891 2,183 1,994 Interest expense Other income Profit before tax ,697 1,956 1,803 Provision for tax Core profit ,273 1,467 1,353 Profit after tax ,273 1,467 1,353 Profit after minority interest ,273 1,467 1,353 Equity shares outstanding (mn) EPS (INR) basic Diluted shares (mn) EPS (INR) diluted CEPS DPS Dividend payout (%) Common size metrics (% net revenues) Year to March FY09 FY10 FY11E FY12E FY13E Cost of goods sold Operating expenses EBITDA margins Depreciation & amortisation Interest Net profit margin Growth metrics (%) Year to March FY09 FY10 FY11E FY12E FY13E Revenues EBITDA (21.3) (3.3) PBT (77.8) (7.8) Net profit (87.2) (7.8) EPS (87.2) (7.8) Note: FY09 numbers are standalone Edelweiss Securities Limited 23

24 Balance sheet (INR mn) As on 31st March FY09 FY10 FY11E FY12E FY13E Total equity capital Reserves & surplus 4,722 4,985 6,038 7,284 8,417 Shareholder's equity 5,099 5,362 6,414 7,661 8,793 Secured loans 5,099 4,392 5,542 6,472 5,722 Unsecured loans Total debt 5,289 4,550 5,663 6,561 5,784 Deferred tax liability (net) Sources of funds 10,784 10,446 12,697 14,939 15,384 Gross fixed assets 9,924 10,104 12,614 15,014 15,314 Accumulated depreciation 1,719 2,414 3,152 4,050 5,035 Net fixed assets 8,206 7,690 9,462 10,964 10,278 Capital work in progress Total fixed assets 8,209 7,945 9,596 10,981 10,278 Inventories 2,070 1,360 1,853 2,500 2,640 Accounts receivable 1,164 1,161 1,557 2,090 2,163 Cash and cash equivalents ,893 Loans and advances Other current assets Current assets 4,457 3,860 5,174 6,602 7,790 Current liabilities 1,792 1,117 1,853 2,424 2,464 Provisions Current liabilities & provisions 1,882 1,359 2,074 2,644 2,684 Net current assets 2,575 2,501 3,101 3,958 5,106 Uses of funds 10,784 10,446 12,697 14,939 15,384 Book value per share (INR) Free cash flow (INR mn) Year to March FY09 FY10 FY11E FY12E FY13E Net profit ,273 1,467 1,353 Add: Depreciation Add: Others Gross cash flow 1,037 1,551 2,301 2,701 2,630 Less: Changes in working capital (285) (722) (227) Operating cash flow 1,547 1,574 2,015 1,979 2,402 Less: Capex (300) (444) (2,390) (2,283) (283) Free cash flow 1,246 1,130 (374) (304) 2,119 Cash flow metrics Year to March FY09 FY10 FY11E FY12E FY13E Operating cash flow 1,547 1,574 2,015 1,979 2,402 Financing cash flow (1,453) (1,100) (1,306) Investing cash flow (225) (414) (2,339) (2,215) (176) Net cash flow (132) Capex (300) (444) (2,390) (2,283) (283) Dividends paid (113) (75) (255) (306) (309) Note: FY09 numbers are standalone 24 Edelweiss Securities Limited