>BOMBAY RAYON FASHIONS LIMITED (NOBLE RESEARCH)

The fittest has survived, now it can thrive

BRFL has continued to see strong margins and a full export order book, as buyers reward its superior design and execution skills. With increasing confidence in its margin sustainability, we upgrade our forecasts and valuation on BRFL and reiterate our Positive stance

We turned Positive on BRFL in April after the company’s fund raising gave us increased confidence on the firm’s ability to weather the downturn. Subsequent results have reinforced this with continuing strength in margins, a full order book and better than expected cash conversion in FY09. We met management earlier this week and came away impressed by the company’s prospects.

STANDING TALL
Amidst the turmoil in the global textiles sector, BRFL has continued along a relatively steady course, going ahead with its capacity expansion (2x in garments, 4x in fabrics) and continuing to deliver steady margins.

• Design capabilties: BRFL’s design skills are widely known and underpin its expansion into garments. This is reflected in the company creating ~5 new designs per day and working closely with leading retailers like Zara in assisting their design efforts. These skills, coupled with the company’s ability to deliver high design content products (underpinned by its integrated operations), give the company access to a slightly premium segment with lower pricing
pressures (due to less commoditisation – visible in high margins). This also gives greater bargaining power in the domestic market, where more sophisticated designs often attract a premium.

• Distribution advantage: The BRFL promoters are well liked and respected in the wholesale textile market in India, giving them access to a robust domestic channel for surplus fabric (current dealings through ~20 distributors). The relationships also pave the way for BRFL’s plans to begin supplying to domestic brands as well, currently being piloted with Mufti.

• Strengths underpin share gain: BRFL has continued to grow (exports almost doubled in FY09) amidst a shrinking global textiles market (~3%+ decline in CY2008). This growth has been underpinned by tight execution (visible in low turnaround time of 60-90 days and low rejection rates of ~1%) and the ability to offer design support. This has allowed BRFL to continue to thrive at the cost of higher cost manufacturers in Europe (CIS countries, Turkey and Italy).

RISKS – DILUTION
BRFL has highlighted its intention to do a fresh round of equity raising later in FY10 (we expect ~Rs.2bn, 10.5% dilution at the current share price). This round of dilution is intended to finance a part of the working capital requirements (over Rs.5.5bn in FY10) for the increased capacity with a view to keeping debt at a reasonable level (target debt/equity of 1.5x).

VALUATION
We have downgraded our forecasts for Guru but upgraded our earnings for the core textiles business (21% EBITDA upgrade for FY10 and FY11) as we now expect the company to be able to sustain ~23%+ EBITDA margins in the core textiles business. Our FCFE based valuation for BRFL is Rs.299, 41% upside and 65% higher than our previous valuation. The valuation upgrade has been driven by earnings upgrades (42% in FY10) as well as better cash conversion on the back of improvements demonstrated in FY09 (FY10 net working capital to sales ratio reduced by 480bps). On a relative basis, BRFL trades at a 19% discount on EV/EBITDA and a 63% discount on P/E (59% assuming equity issues of Rs.2bn). Even if we factor in 10% dilution, BRFL seems relatively cheap despite its very visible strategic superiority to domestic peers.

To see the full report: BRFL