Analyst Corner: Grasim Industries rating – ‘hold’; COVID-19 has worsened outlook for VSF business

The key takeaways from our discussion were: COVID-19 has severely impacted apparel demand.

We spoke with Lenzing (LNZ AV, EUR49.50, not rated), a leading global VSF producer, to better understand the current demand and pricing environment for viscose staple fibre (VSF). The key takeaways from our discussion were: COVID-19 has severely impacted apparel demand

With retail stores accounting for 75% of apparel sales in the US and Europe, textile and hence fibre demand has been significantly impacted due to COVID-19. Physical store sales in the US have completely evaporated in the last four weeks. Although online sales have been resilient, it has only partially offset the impact of physical stores being shut.

Lenzing believes apparel demand in the APAC region should reach pre-COVID levels by Q3CY20, while Europe and North America will reach those levels only in January 2021. However, given the uncertainty surrounding the pandemic any assessment of the impact is fraught with risks. Lenzing had earlier guided for its 2020 results to be below 2019. However, current uncertainty has resulted in Lenzing suspending its guidance for 2020.

China VSF inventory at record levels

VSF inventory in China, which accounts for more than 50% of VSF production, has reached record levels with current inventory at 45 days; three times the long-term average of 15 days. Prices have fallen further in the last two weeks in China with standard VSF currently trading at RMB9,200/t. Lenzing believes the situation remains dire for several VSF producers in China as they are making cash losses of more than RMB2,000/t at spot prices.

As a result, capacity utilisation continues to decline from 80% in January 2020 to 65% currently. Lenzing believes there is a high probability of 500kt (c8% of global VSF capacity) expansion in 2020 getting deferred. However, the outlook for VSF prices looks challenging unless there are further capacity cuts or a sharp recovery in demand, as per Lenzing.

Negative read-across for Grasim’s VSF business; reiterate Hold

Our discussion with Lenzing further reinforces our negative outlook for the VSF business, as highlighted in our recent note. We believe COVID-19 has further deteriorated the already fragile outlook for VSF and the Caustic Soda business. We fail to see any catalysts that can narrow the holding company (holdco)/conglomerate discount that has risen by 10% in the past year. We maintain our Hold rating on Grasim Industries’ stock with an unchanged target price of Rs 550. We continue to value the standalone business at 7x FY22e Ebitda. We apply a conglomerate discount of 55% to Grasim, in line with the spot discount.