Investment Idea. Alok Industries Ltd. Alok Industries Ltd. INVESTMENT IDEA. 2 February Investment Argument. Recommendation. Risks and Concerns

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1 Web: Risk Price (Rs.) Market Cap (Rs.Crs.) 52 High / Low (Rs.) Sales/MCap Book Value (Rs.) BSE NSE Reuters Bloomberg Public & Others 21% Promoters 36% Technical Trends Share Holding Pattern Low / ALOKTEXT ALOK.BO ALOK IN Foreign 22% Corp. Holding 8% Institutions 13% Investment Argument The 9 month result is in line with our expectations. The company will earn ~Rs.4 EPS for FY10 going forward with top line of Rs. 3850crs and a profit of Rs. 240crs. In this quarter Alok has also striked a PE deal with Asia Bridge for Rs. 45cr for its retail subsidiary Alok H&A. We maintain HOLD and BUY at dips. Alok Industries is one of the largest and fully integrated textile manufacturers with widest range of products from - Home textiles, Apparel fabric Garments and Polyester Yarn; across cotton, blended and synthetic segments. It has latest state of art machinery for manufacturing and processing of yarn and fabric. The company has completed its capacity addition phase, with an investment of Rs 6000crs in last 5years and has started reaping benefits of this expansion. Cash flow from operations will increase from this year onwards and these cash earnings could be used to pre pay debt, which is high and is a major concern for the investor s. They are currently at 75% utilization levels and expect to increase it to 85-90% in coming 2 years. They are also strengthening their foothold in retail franchise business; by increasing their H&A retail outlets which they have converted to cash and carry model, from current 150 outlets to 1000 in next 2 years. The order book is full for next few quarters for both apparels & Home textiles. Order book outlook is also better and this offers revenue visibility for the coming couple of quarters. Completion of expansion and up gradation will fetch increased revenues and margins, through growth in volumes and increased share of value added products and retail foray. This will further drive up the earnings growth and valuations. The improving domestic outlook on retail and institutional sales front [driven by widest range of specialty fabrics & Garments] and global consolidation of vendors from overseas buyers [reversing the last year s de-stocking], will lead to strong volume growth and increasing utilization levels. Going forward this will lead to increased cash flows, which can be used to repay loans. Not only cash flows from textiles, company intends to book profits by selling its premium realty projects and use the proceeds to reduce leverage Reduced debt will lower interest costs and boost margins further, leading to still better PAT growth in coming years. Recommendation We recommend to Hold and Accumulate stock at all dips with a target price of Rs within next 1-2 years and in 2-3 years. Risks and Concerns High debt burden and currency fluctuations are key risks for this company. Plus Promoters have also pledged high proportion of shares for company s expansion projects.

2 Customer base Background Alok Industries is one of the largest integrated textile manufacturers in the country with latest technology plants installed. It has been catering to international markets (35% exports) as well the domestic markets (65%) with its varied product portfolio from Home textiles, Apparel fabric, Cotton and Polyester yarn and Garments. Its plants are located at Silvassa and Vapi. Silvassa has all the operations like - spinning, weaving, texturising, and knitting. Vapi plant does processing for yarn & fabrics. Its customer base is spread across 70 countries, The company is better placed in export market with its quality, scale and competitive pricing. It is fully integrated from the initial spinning levels to garmenting. Work force at Alok industry is young and well trained. The company plans to roll out 1000 retail outlets in next 2 years. Their acquisition of Mileta has provided them technical know-how especially in the high value added yarn dyed shirting segment. Customer base Their customer base ranges in domestic market from Raymond, Pantaloons, Wills Lifestyle, Gokaldas exports, Creative garments, Zodiac, BRFL, Coats, etc. to international markets from KOHL S, Mothercare, Target, C&A, Wal-mart, Ikea, GAP, M&S, Kmart, Nordstrom, etc.

3 Capacity and expansion details and future plans With total investments of Rs. 6000cr in last 5 years, they have built sizeable capacities in spinning, weaving and knitting. All the installed capacities have the latest technology with minimal human intervention; the machines are imported and procured from the well known brands in the world, with high quality output assurance. As the expansion phase is complete the operations are in the process of streamlining in next one year. This will enable to provide widest variety of fabrics for consumers across various user segments. The current average utilization levels for these machines are 75%, and they intend to take it to 80-85% in next year. They have a wastage of around 30%in the initial stage of spinning where the cotton is cleared from the foreign particles,which is again used in as filling for the made ups thus converting waste into value added products. The wastage in the later stages is around 5%. There is quality check and assurance at each and every stage and they also have training facility for workers. Sized Capacities and Expansions Divisions Units Capacities Capacities Capacity post as on 30/09/09 under implementation expansion Spinning tons Home textiles Processing mn. Mtrs Weaving mn. Mtrs Terry Towels Tons Apparel Fabric Processing woven mn. Mtrs Weaving mn. Mtrs Knits Tons Garments Mn. Pcs Polyester Yarn Tons POY Tons Total Investments of about Rs. 6000cr in last 5 years. On retail front company plans to focus on the Franchise model as it is asset light model. It wants to roll out 1000 retail outlets in next 2 years. The H&A format of the company has been changed to cash and carry business in Dec 2009 where they sell to the dealers and further dealers sell it to the consumers. They project around 200 dealers till March 2010 with revenue of ~Rs.35 lac per annum per dealer. They expect to break even by 2011 with at least a margin of 5%. Further they plan to have minimal capex of Rs. 300cr per annum for any maintenance or debottle necking.

4 Peer comparison ALOK Arvind WELSPUN IND. Mills IND. CMP MKT. CAP EQUITY F.V Sales EBITDA PAT ROE# 11.82% % EPS* PE* BV P/BV DIV. YIELD 1.20% D/E 3.88% Interest coverage 2.70% * Expected for FY10 # ROE FY09 ending Alok Industries with CMP of 26 and a market cap of 1573cr is trading at 6.5x PE with EPS of 3.97 for FY10. The EPS looks a concern when seen in relation with its peers but this is because of the equity dilution in Sep 2009 quarter mainly for working capital usage. As the expansion plans are complete, the coming years will give earnings visibility and positive free cash flow will begin from FY11. Alok stands apart in terms of size in sales among its peers as it has huge capacity which leads to higher top line and bottom line growth. Comparing the BV, Alok industries stand at 0.78x which is lower comparing to its peers therefore it shows that it is undervalued and has potential for growth going forward. It has a dividend yield of 1.20%. Debt to equity of Alok is a concern for the company as it is comparatively very high among its peers and on the other hand interest coverage ratio is lower compared to its debt size and its ability to pay the interest obligation. So, once Alok takes care of its high debt, by repaying major portion of commercial loans [out of Rs 7,000 Crs debt, almost 3000 crs is TUF loan which enjoys a 5% interest subsidy, only Rs 3000 crs is commercial loan, rest is ECBs] from free cash flows of core textiles business as also from Reality business, its interest costs will go down significantly. This will boost margins and reduces risk to business.

5 Revenue Contribution Alok Industries has been catering to international markets (35% exports) as well the domestic markets (65%) with its varied product portfolio from Home textiles, Apparel fabric, Cotton and Polyester yarn and Garments. The revenue contribution by these segments: Apparel Fabric, Polyester Yarn, Home textiles, Cotton yarn and Garments are: Revenue Contribution Home Textiles 16.75% Cotton Yarns 4.66% Garments 3.73% Polyester Yarn 20.80% Apparel fabric 54.06% The contribution by each country in total exports is, US 42.98% being the most significant market followed by Asia and Asian Pacific 23.97%, Europe 18.39% and South America 10.66%. EBITDA Enhancement through Integration and Optimization From cotton to Finished fabric Particulars Amount (Rs. Per kg) Raw Material cost Raw cotton cost 73 (+) additional cotton consumed (0.33%) 24 Sub - Total 97 (-) Waste Realised 12 Total raw material cost (a) 85 Conversion cost - Spinning (Conversion from cotton to cotton yarn) 32 - Weaving (Conversion from cotton yarn to fabric) 32 - Processing ( for processing and fininshing of fabrics) 50 Total conversion cost (b) 114 Sub - Total (a+b) 199 (+) wastage about 5% 10 Total cost 209 Average Selling Price 330 Contribution 121 Contribution as a % of sales 36.70% Note: Per kg gives 4 mtrs of fabric Avg Selling price is Rs per mtrs This segment is the major contributor to the revenue of the company as shown in the above chart this segment also gives maximum contribution or margins to the company therefore it plans to focus on this apparel fabric segment going forward.

6 From Finished fabric to Garment Particulars Amount (Rs. Per garment) Raw material cost Fabric cost 82.5 (+) additional fabric coat (1.6mtrs per garment) 49.5 Total raw material cost (a) 132 Conversion cost - Accessories 30 - Labour 70 Total Conversion cost (b) 100 Sub Total (a+b) 232 (+) 2% 5 Total cost 237 Average Selling Price (USD 5.5 per garment) 270 Contribution 33 Contribution as a % of sales 12.20% Garments are a smaller part of the revenue ~4% and as we see they have 13.1% contribution. From PTA to DTY Particulars DTY POY (Rs. Per kg) (Rs. Per kg) Raw material cost PTA/MEG cost Conersion cost - From PTA/ MEG to POY 6 6 Sub Total Conversion cost - From POY to DTY 9 - Total cost Average selling price Contribution Contribution as a % of sales 21% 20.30% POY is used for captive consumption.

7 Financial highlights as per Du pont Model Debt profile (Amt. in crs.) TUF scheme ECB's Regular Loan Working Capital Working Capital, 2000 TUF scheme, 3000 Regular Loan, 2000 ECB's, 1000 The major concern for the company is their debt burden which was taken during the expansion phase. The debt profile of the company is, total debt is about Rs. 8000cr out of which Rs is a low cost debt at (6%) under TUF scheme, Rs. 1000cr from ECB s at (5% interest rate), Rs. 2000cr as long term loans at (11% interest rate) and Rs. 2000cr as working capital at (7% interest rate). Now their focus is reducing this debt burden by inflows from realty business, selling stake in their UK retail chain and internal accruals. Their primary investment in real estate is Rs. 400cr including subsidiary. They have sold one floor of Peninsula tower for Rs /sq ft. They expect around Rs. 67cr realization as the building is under construction and will be ready by Dec 2010 and they will receive Rs cr immediately on pro rata basis. The other project at Bhandup will be launched in Feb So they have a proper plan chalked out to come out of the realty in next 2 years. The inflow from real estate for this year would be minimal amount, next year for FY11 it is expected to be around Rs. 200cr, and by FY12 when they plan to exit the business is expected to be around Rs. 1400cr. They plan to use this real estate cash income for debt repayment. Debt repayment schedule is as under: Year Amount (in crs) FY FY FY FY FY After FY14 the repayment amount will go on decreasing gradually as the debt will also reduce.

8 Debt/Equity 17.9 ROE (%) (%) (Year) 8 We see that the Debt to Equity ratio has been increasing over the years and highest at 3.88% in FY09 as it is a capital intensive industry. And in last few years company has also been in expansion mode due to which it has been increasing its debt burden though now going forward it plans to focus on reducing the debt. ROE has been reduced in year ending FY09 which has been comparatively same for all the other peers as well. But now if we see the ROE it has been reduced further due to equity dilution but it s not a concern as now onwards the company will reap the benefits of its expansion phase. Performance over the years Net Sales EBIDT PAT Value in crs Year Looking at the last 5 years performance we see that the sales of the company have been increasing at CAGR 25% and EBIDT increasing at CAGR 35% and PAT has been increasing at CAGR 21%. We see that PAT has not been increasing in line with the sales because as the years have passed the debt burden was increasing on the company as it was in capacity expansion mode so interest cost was eating up the bottom line. Now the expansion phase is over and all the capacities will get streamlined in next 2 years and therefore now the company is expected to post around Rs. 3850cr sales in FY10 with Rs. 240cr bottom line and 30% EBIDT.

9 450 Interest Depreciation Value in crs Year We can see that the interest cost and depreciation has been increasing in last 5 years due to increasing debt of the company to finance the expansion plans as well the fixed assets of the company due to capacity addition during this period. In FY10 also we assume that the company will have Rs. 450crs of interest liability and Rs. 380crs of depreciation. Further going they plan to reduce their interest burden by offloading their stakes from their investments in properties and listing of UK Retail subsidiary. Depreciation may be higher for the initial years after expansion as fixed assets have been added. 13 EPS PE (%) Year We see that EPS has been declining from FY08 as the Company came out with a Rights Issue offering in March 2009 which has increased its equity and accordingly the price is also discounting the earnings.

10 Interest coverage (%) Year Interest coverage of the company is again a concern as it has been decreasing over the years and it shows how the company is able to pay off its obligation, though the debt burden has been increasing. But now company plans to address this issue as it plans to unlock its investments in properties and invest the same in the business.

11 Other Developments Focus on Specialty Fabrics The company has recently come up with specialty fabrics which are an extension to their product development in Apparel. This segment contributes around 15% to apparel revenues and they plan to increase it to 30% in next two years. The specialty fabrics are Stain Guard, Anti static, Soil Release, Brushed Fabric, Anti bacterial fabric, Flame retardant, Water Repellent, Infra red finish, High Visibility and Aroma finish which cater to various industries like Defense, Aviation, Hospitality, Health care, Industrial, Fire Brigades, Oil refineries, Petrol Pumps, Welding Industry, Coal mines and. As it is a new concept, people are getting aware of it and the segment will pick up in coming years. Value addition is higher in all these products and this will boost institutional sales. Organic Cotton Initiatives The demand for organic cotton is increasing globally and Alok is very well placed to take the initiative. After Turkey, India is the largest producer of organic cotton. They are addressing concerns regarding global warming. They have a tie up with NGO called Zameen organic for complete supply chain and product development. The machineries are procured from European countries, USA, Japan etc, who are leaders in their respective segments. The sales in this category are just picking up but will take time to be fully active. The margins are higher in this category as is targeted to the premium segment. So the company is trying to increase this category s share in the total revenue.

12 Industry outlook Global trade in textiles and clothing has increased to US$583bn from US$ 334bn in 1999 CAGR of 7%. Going forward global trade is expected to grow to US$650bn from US$583bn in 2007 CAGR of 4%. Top Exporters Amt. US$bn % Indian Textile Industry Europe % China % Turkey % India % US % Others % Total % Size (USD bn) Particulars Domestic Export Total Imports Clothing Home Textiles Others Total Indian Textile Vision 2012 The Indian textile and apparel market is currently valued at $40bn and is growing at 14%. Indian textiles and apparel exports, which is worth $22bn is expected to register a four fold increase to touch $ bn in next 25yrs. Atleast 60% of textile exports are to the US and EU market. (FY10- FY12 Projections) Exports Domestic Markets From the current status of the industry which is around $63bn and government projects it to double by next with a capex of $32-35bn. And it is supported by the improving outlook as most of the companies order books are full till March next year. Government has also expanded tuff schemes and subsidies and support like 5% interest subsidy on loans and 10% on capital, is proving viable for the sector. After removal of license Raj in 2005 many companies will start benefiting from now onwards as now they are ready with major capacities and optimum utilization levels. Many companies future expansion plans will help them to perform at maximum utilization levels which will further improve the overall industry outlook.

13 Key Financials PROJECTIONS (Rs Crores) FY09 FY10E FY11E Gross Sales PBIDT Other Income Interest Depreciation Tax Net Profit EPS (Rs) CEPS (Rs) F.V. (Rs) Dividend (%) Equity Capital PE (x) Monthly results (Rs Crores) 9m m % chg Gross Sales PBIDT Net Profit Equity EPS The company is expected to post Rs. 3850cr of sales in FY10 as its 9 monthly numbers have been strong compared to last year. In 9 months sales were recorded at Rs. 2843cr and since its capacity expansion phase is over it will start reaping its benefits from now onwards. Most of the operations have been streamlined and have been working at an average of 75% utilization levels and the company plans to take the utilization levels to 80% next year. It expects to post 30% EBITDA with and interest cost of Rs. 450cr and depreciation of Rs.382cr. interest cost is high and this is a major concern for the company but the company is addressing this concern as it plans to offload its investments from property business and list its UK retail subsidiary. Now Alok Infra 100% owned subsidiary of Alok Industries plans to raise 700cr debt for their deal with Peninsula land. Tax rate of the company would be 33% out of which 20% is the direct tax and 13% would be for deferred tax. On profits of Rs. 240cr it will post around lower earnings of Rs and cash earnings of Rs as their equity would be Rs cr. We expect that since its expansion phase is over it may come up with dividend of 10% and would trade at a PE of 6.55x. From the current status of the huge capacity, Alok has strong position in inviting attention of the international players to place sizable orders; therefore the stock is expected to double in next 2-3 years from the current price as the value story unfolds slowly. We recommend to Hold and Accumulate stock at all dips with a target price of Rs within next 1-2 years and Rs in next 2-3 years.

14 SUMMARY BALANCE SHEET PARTICULARS AS ON 31 MARCH 2009 AS ON 31 MARCH 2008 GROSS FIXED ASSETS NET FIXED ASSETS CURRENT ASSETS INVESTMENTS FOREIGN CURRENCY MONEY TRANSLATION ACCOUNT TOTAL ASSETS EQUITY SHARE CAPITAL RESERVE & SURPLUS APPLICATION MONEY/WARRANTS/FCD TANGIBLE NET WORTH DEFFERED TAX LIABILITY TOTAL BORROWINGS CURRENT LIABILITIES TOTAL LIABILITIES