aarvee denim

CURRENT PRICE :125
EPS:18-20
TARGET:200-250

Result highlights
The results of Aarvee Denims & Exports (Aarvee) for Q2FY2006 are in line with our expectations. The company''s net sales grew by 17.79% from Rs66.38 crore in Q2FY2005 to Rs78.19 crore in Q2FY2006.The operating profit grew by 41.26% from Rs12.81 crore in Q2FY2005 to Rs18.09 crore in the quarter. This was primarily on account of the operating profit margin (OPM), which improved by 384 basis points from 19.30% to 23.14%.
The spurt in the OPM is mainly on account of a 411-basis-point savings due to lower raw material cost. The raw material scenario was favourable as a result of lower cotton prices, thanks to a bumper cotton crop. The company''s profit before tax (PBT) grew by 46.79% from Rs9.84 crore in Q2FY2005 to Rs14.45 crore in the quarter. The reported net profit was higher by 77.88% to Rs9.12 crore as compared with Rs5.13 crore in Q2FY2005

Aarvee''s performance for H1FY2006 has been healthy. Its net sales have grown by 22.13% from Rs117.22 crore in H1FY2005 to Rs143.15 crore in H1FY2006. The operating profit has increased by 59.54% from Rs20.91 crore in H1FY2005 to Rs33.36 crore in H1FY2006. The reported profit grew by 95.09% from Rs9.01 crore in the first half of FY2005 to Rs17.57 crore in the first half of FY2006. The company has declared an interim dividend of 5%. This has been in addition to the 5% interim dividend announced after the Q1FY2006 results.

Easing cotton prices help improve OPMThe country is heading for a bumper cotton crop for the second year in a row. The cotton output in the 2004-05 season stood at 21.5 million bales, thanks to favourable weather conditions, increased area under cultivation and the extensive use of BT cotton seed. The average cotton prices for the quarter under review were Rs45-46 per kilogram as against Rs55-57 a kilogram for the corresponding period in the last year. The softening cotton prices have helped Aarvee to improve its OPM. There has been a cost savings of 411 basis points on account of lower cost of raw materials (excluding colour and chemicals), which has declined from 51.14% in Q2FY2005 to 47.02% in Q2FY2006. The new arrivals of the 2005-06 season are just around the corner and it is expected that the production would reach 23.5 million bales and the cotton prices would stabilise in the range of Rs45-50 a kilogram.
For Q2FY2006 the realisations stood at Rs90.15 per metre, similar to that in the corresponding period in the last year. Thus the major reason for the increase in the OPM is lower raw material cost as the realisations are flat on a year-on-year basis.
Higher contribution from the domestic market, lower contribution from exportsIn Q2FY2006 the company''s domestic sales stood at Rs65.25 crore as compared with Rs49.82 crore in the corresponding period of the last year, a growth of 30.98% year on year. For the first six months the domestic sales have grown by 41.85% from Rs84.19 crore in H1FY2005 to Rs119.43 crore. If you remember, in our report titled "Dressed to Kill" and dated October 4, 2005, we had made a point about Aarvee''s dominant presence in the domestic market. As the Rs1,000-crore domestic denim market is poised to grow at the rate of 10% for the next three to four years at least, the company is well positioned to tap this positive trend.
However for Q2FY2006 the exports are lower at Rs12.20 crore as compared with Rs16.91 crore a year ago, as the same have fallen by 27.88%. For H1FY2006 the exports were down by 31.65% from Rs33.02 crore a year ago to Rs22.59 crore. This drop can be attributed mainly to the release of the piled-up denim inventory from Turkey. The importers preferred to procuring denim from Turkey as a result of which the exports were down. However the management believes this trend is a temporary phenomenon lasting for six to seven months and the things would improve after that. On a quarter-on-quarter basis however the exports grew by 17.66% from Rs10.40 crore in Q1FY2006 to Rs12.20 crore in Q2FY2006.
Additional 30 looms to go on stream wef Q3FY2006Aarvee has installed 30 new looms as part of its existing capacity of 47 million metre per year and the same are supposed to go on stream from Q3FY2006. These are superior, high-resolution looms with a better capacity. The trial production is already on and the looms would go fully on stream from November 2006. Thus these looms would generate incremental revenues from Q3FY2006. This fact has been factored in our financial projections.
The capex programme is running on scheduleAarvee is currently undergoing a major capex plan. The Rs130-crore capex will see its installed capacity increase by more than 50% from the existing 47 million metre per year to 72 million metre a year; correspondingly the spinning capacity would increase from 18,500 metric tonne (MT) to 28,500MT. This capex exercise is scheduled to get over by H1FY2007. It is on schedule and the civil work is currently going on, as the floor space at the current shop floor is full. The orders for the looms (as a part of this capex programme) have already been placed and the management expects the new capacities to become operational as per schedule. ValuationsAt the current market price of Rs133 Aarvee is available at a price/earnings ratio of 8x FY2006E (5x FY2007E) and enterprise value/earnings before interest, depreciation, tax and amortisation of 4.74x FY2006E (3.36x FY2007E)