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Aarvee Denims & Exports Limited

Explanation of CRISIL Fundamental and Valuation (CFV) matrix

The CFV Matrix (CRISIL Fundamental and Valuation Matrix) addresses the two important analysis of an investment making process Analysis of Fundamentals (addressed through Fundamental Grade) and Analysis of Returns (Valuation Grade)

FundamentalGrade
CRISILs Fundamental Grade represents an overall assessment of the fundamentals of the company graded in relation to other listed equity securities in India. The grade facilitates easy comparison of fundamentals between companies, irrespective of the size or the industry they operate in. The grading factors in the following: Business Prospects: Business prospects factors in Industry prospects and companys future financial performance Management Evaluation: Factors such as track record of the management, strategy are taken into consideration Corporate Governance: Assessment of adequacy of corporate governance structure and disclosure norms The grade is assigned on a five-point scale from grade 5 (indicating Excellent fundamentals) to grade 1 (Poor fundamentals) CRISILFundamentalGrade 5/5 4/5 3/5 2/5 1/5 Assessment Excellent fundamentals Superior fundamentals Good fundamentals Moderate fundamentals Poor fundamentals

ValuationGrade
CRISILs Valuation Grade represents an assessment of the potential value in the company stock for an equity investor over a 12 month period. The grade is assigned on a five-point scale from grade 5 (indicating strong upside from the current market price (CMP)) to grade 1 (strong downside from the CMP). CRISILValuationGrade 5/5 4/5 3/5 2/5 1/5 Analyst Disclosure
Each member of the team involved in the preparation of the grading report, hereby affirms that there exists no conflict of interest that can bias the grading recommendation of the company.

Assessment Strong upside (>25% from CMP) Upside (10-25% from CMP) Align (+-10% from CMP) Downside (negative 10-25% from CMP) Strong downside (<-25% from CMP)

Disclaimer:
This Company-commissioned Report (Report) is based on data publicly available or from sources considered reliable. CRISIL Ltd. (CRISIL) does not represent that it is accurate or complete and hence, it should not be relied upon as such. The data / Report are subject to change without any prior notice. Opinions expressed herein are our current opinions as on the date of this Report. Nothing in this Report constitutes investment, legal, accounting or tax advice or any solicitation, whatsoever. The subscriber / user assumes the entire risk of any use made of this data / Report. CRISIL especially states that it has no financial liability, whatsoever, to the subscribers / users of this Report. This Report is for the personal information only of the authorized recipient in India only. This Report should not be reproduced or redistributed or communicated directly or indirectly in any form to any other person especially outside India or published or copied in whole or in part, for any purpose.

Independent Research Report Aarvee Denims & Exports Limited

Tailor-made for growth Industry: Textiles Date: August 10, 2010 CFV matrix
Excellent Fundamentals

Gujarat-based Aarvee Denims & Exports Limited (Aarvee Denims) is the second largest manufacturer of denim fabric in India. We assign Aarvee Denims a fundamental grade of 3/5, indicating that its fundamentals are good relative to other listed securities in India. We also assign a valuation grade of 3/5, indicating that the current market price is aligned with our fair value. Narrowing demand-supply gap favourable for denim fabric manufacturers Over the FY06-FY08 period, major denim manufacturers had lower operating rates due to excess capacities. However, since then, there has been a revival in demand for denim fabric driven by rising income levels and growing acceptance of denim jeans among semi-urban population. We expect the supply to remain steady with no major capacity expansion planned in the next year or so. Hence, the demand-supply gap for denim fabric has narrowed, auguring well for manufacturers like Aarvee Denims. Strong distribution network in the North - key to revenue growth Aarvee Denims is promoted by the Arora Group and the VB Shah Group. The Arora Group is one of the major distributors of Aarvee Denims denim fabric in the domestic market. It has an extensive distributor base in Northern India; this region consumes almost ~60% of denim fabrics produced in the country. Strong dominance in the domestic market compared to peers Arvind and Aarvee Denims are the two largest players in the denim industry in India. Denim fabric production is not Arvinds core business as it earns more than 50% of its revenues from shirting fabric, apparels and retail. Further, it mainly caters to the export market. Thus, in the absence of any other large player and continued focus on denim fabric production, Aarvee Denims enjoys a strong dominance in the domestic market. Revenues to grow at a CAGR of 13.8%, EBITDA margin to improve We expect Aarvee Denims revenues to grow at a CAGR of 13.8% from Rs 3.8 bn in FY10 to Rs 4.9 bn in FY12. We expect EBITDA margin to improve to 17.3% in FY12 from 16.5% in FY10 on account of increase in realisations. Adjusted EPS is expected to double from Rs 6.0 in FY10 to Rs 12.3 in FY12. Key monitorables: Ability to pass on cotton price hike, capacity expansion The key monitorables are: i) The companys ability to pass on the hike in cotton prices; ii) capacity addition by existing players and possible entry of new players due to low entry barriers, which will worsen the overcapacity situation in India; and iii) refinancing the repayment of US$ 7.5 mn worth of FCCBs due for redemption in FY12. Aligned valuations We have valued Aarvee Denims based on the price-to-earnings ratio (PER) method. We assign the company a PER of 5.5x, which translates to a one-year fair value of Rs 68 per share based on FY12 adjusted EPS of Rs 12.3. We initiate coverage on Aarvee Denims with a valuation grade of 3/5, indicating that the current market price of the company is aligned with our fair value of Rs 68. Key forecast (Rs mn) Operating income EBITDA Reported net income Adj net income Reported EPS-Rs Adj EPS-Rs Adj EPS growth (%) PE (x) P/BV (x) RoCE (%) RoE (%) FY08 2,459 326 50 (41) 2.1 (1.7) (113.7) (55.8) 1.4 3.7 (2.5) FY09 3,252 442 25 65 1.1 2.8 NA 11.7 0.5 5.8 4.2 7.1 FY10 3,785 624 181 140 7.7 6.0 115.4 9.5 0.8 9.8 9.0 6.0 FY11E 4,741 761 264 225 11.3 9.6 60.8 6.9 0.8 12.7 13.0 5.2 FY12E 4,905 849 288 288 12.3 12.3 27.7 5.4 0.7 14.5 14.7 4.3

Fundamental Grade

5 4 3 2 1

Poor Fundamentals

Strong Downside

Valuation Grade
Strong Upside

Fundamental grade of '3/5' indicates 'good' fundamentals Valuation grade of '3/5' indicates aligned market price

Key stock statistics

NSE Ticker Fair value (face value Rs 10) Current market price (as on Aug 09, 2010) Shares outstanding (mn) Market cap (Rs mn) Enterprise value (Rs mn) 52-week range(Rs)(H/L) PE on EPS estimate (FY11E)(x) Beta Free float (%) Average daily volumes AARVEEDEN 68 67 23.5 1,572 3,752 82.2/24.0 6.9 1.0 41 5,384

Share price movement

2000

1500

1000

500

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1-Aug-09

Aarvee Denims

Nifty

- Indexed to 100

Analytical contact
Chetan Majithia (Head, Equities) Neeta Khilnani Email: clientservicing@crisil.com +91 22 3342 4148 +91 22 3342 1882 +91 22 3342 3561

EV/EBITDA (x) 13.0 Source: Company, CRISIL Equities

Nihag Shah

+91 22

*Adjusted PAT includes provision for redemption of FCCBs. W e have assumed that the remaining FCCBs will be redeemed in FY12. Forex gain/loss not accounted f or in adjusted PAT . All ratios calculated on adjusted PAT .

CRISIL Equities

1-Aug-10

Aarvee Denims & Exports Limited

Table 1: Business environment

Readymade garments (RMG), non-denim fabrics Parameter Revenue contribution (FY10) Revenue contribution (FY12) Product / service offering Denim fabric 85% 90% Denim fabric and retail 15% 10% i)Readymade garments for men, women and kids under the brand 'De-Extase' ii)Marginal proportion of non-denims viz. job-work processing of fabric Capacity Weaving capacity of 60 mn meters per annum as of FY10; capacity utilisation:~70% levels; April 1, 2010 onwards Geographic presence (revenue share as of FY10) Market position Domestic 81.7% Exports 18.3% i) Second largest manufacturer of denim fabric in India; ii) Market share of ~12% in the denim fabric industry, only next to Arvind Mills having a share of ~24% i) Entered the readymade garments business in 2006; yet to establish itself in the highly fragmented domestic RMG industry ii) A very small and new player in the retail space; most of the stores are operated through franchise Industry growth expectations End market Sales growth (FY08-FY10 2-yr CAGR) Sales Forecast (FY10-FY12 2-yr CAGR) Demand drivers i) Increased demand for jeans as it has evolved from a luxury fashion product to a comfortable stylised dailywear product ii) Denim wear is gradually taking over the share of cotton wear iii) Increasing shift from traditional wear to western wear amongst women iv) Revival in the economy and rising per capita income Key competitors Margin drivers Key risks Arvind Mills, Raymond UCO Denim, KG Denim Cotton prices, which constitute 50-55% of the total raw material costs i) Volatile cotton prices ii) Overcapacities in the denim industry in India Source: Company, CRISIL Equities Kewal Kiran Clothing Limited, Zodiac Cotton prices, which constitute 50-55% of the total raw material costs i) Intense competition in the readymade garment segment ii) Vulnerability to changing fashion trends i) Revival in the economy and rising per capita income ii) Growing preference for ready-to-wear apparel against tailored ones iii) Growth in organised retailing 16% -1% Apparel manufacturers 20% 8-9% End consumer 56% 8-9% weaving capacity increased to 68 mn meters per annum from i) 1.5 mn garment pieces per annum ii) 75 EBOs across India

CRISIL Equities

Aarvee Denims & Exports Limited

Grading Rationale
Narrowing demand-supply manufacturers gap favourable for denim fabric

The domestic denim fabric capacity in India was 500 mn meters as against the consumption of 400 mn meters at the end of 2009. The demand for denim fabric has picked up at healthy rate of ~10% per annum over the past two-three years.
Figure 1: Timeline of the domestic denim industry

Evolution of Denim Industry in India

Pre-2006

2006-2008

Post-2009

- Demand for denim fabric steadily

increased due to growing preference for jeans as a daily-wear product - Three companies - Arvind Mils, Aarvee Denims and Rainbow Denim Limited accounted for around 50% of the total domestic denim fabric capacity - Many players entered the industry anticipating strong growth in demand - Existing players undertook capacity addition

emerged as the leading producer of denimin the global market - Strong competition from Chinese lowcost denim fabrics in the domestic market - Eventually, supply overshot the demand by a large extent. Buyers enjoyed a high bargaining power; denim fabric realisations reached very low levels of Rs 60 per meter compared to the normal level of Rs 80 per meter - Average operating rate of major players reached 40-50% levels; many players reduced their capacities - Global recession added to the woes, no further capacity expansion was undertaken by the large players

-Turkey

-Rapid recovery in the economic condition

improved consumer sentiments - With the demand picking up and no capacity additions planned by the existing players in the next year or so, the demand-supply gap is gradually narrowing - Major international players started outsourcing their requirements from Asia to reduce the cost of production - Going forward, rise in income levels and a large number of young population in the Indian demographics is expected to drive the growth in the domestic denim industry - Arvind, Aarvee Denims and KG Denims account for ~40% of the total domestic fabric capacity as of FY10

Source: Company, Industry sources

During the FY06-FY08 period, the denim industry had excess capacities which led to lower operating rates of major players in the industry. However, since then, there has been a revival in demand for denim fabric driven by rising income levels, gradual substitution of cotton wear with denim wear and increasing acceptability of western wear (especially jeans) amongst women. On the supply side, the capacity is expected to remain at the same levels as there are no major capacity additions planned by the large players in the next year or so. As a result, the demand-supply gap for denim fabric has narrowed, auguring well for the revenue growth of denim fabric manufacturers like Aarvee Denims.

CRISIL Equities

Aarvee Denims & Exports Limited

Rising income levels will drive demand for denim

Indias GDP is forecast to grow at a higher rate from 7.4% in FY10 to 8% in FY11. Average household income is expected to grow by 35-40% in FY14 over FY09 levels, which will increase disposable income. With improving consumer sentiments, consumer spending on clothing is expected to increase, which will translate into a higher demand for cotton and denim fabrics.
Figure 2: Indias per capita income has been rising Figure 3: Indias per capita textile expenditure has also been rising
(Rs) 50,000

(Rs) 1,500

40,000

1,250

30,000

1,000

20,000

750

10,000 2003-04 2005-06 2007-08 2009-10 P 2011-12 P 2013-14 P

500 2003-04 2005-06 2007-08 2009-10 P 2011-12 P 2013-14 P

Per capita income

Per capita expenditure on textiles

Source: CRISIL Research

Source: CRISIL Research

Global denim fabric production base has shifted to Asia due to low cost of production
America and Europe are the major consumers of denim fabric in the world; Asia is emerging as one of the fastest growing consumers. The 2008-09 economic recession increasingly saw many international apparel manufacturers sourcing their denim fabric requirement from low-cost producers like India and China to reduce their cost of production. Eventually, the production base of denim has shifted from America and Europe to Asia, which today is the largest manufacturer of denim fabric in the world, with India and China as the main contributors.

Domestic denim fabric industry dominated by three large players

Unorganised sector accounts for ~60% of the domestic denim industry

The capacity in the domestic denim industry, which currently is 500 mn meters, has grown steadily at a 10-year CAGR of 13%. Arvind, with a capacity of 110 mn meters, enjoys the largest share (24%) in the industry, followed by Aarvee Denims with a capacity of 60 mn meters and a share of 12% as of FY10. The three large players in this industry - Arvind, Aarvee Denims and KG Denims - command ~40% of the total domestic denim fabric production capacity; the unorganised sector accounts for the rest.

CRISIL Equities

Aarvee Denims & Exports Limited

Figure 4: Denim fabric capacity in India grew by 13%

Figure 5: Market share in the domestic denim industry

70% 60% 50% 40% 30% 20% 10% 0% 35% 46% 49% 58% 53% 59%

31% 27% 14% 6% 14% 5% FY08 FY09 KG Denim 24% 13% 4% 24% 12% 5% FY10 Others

13% 6%

FY06 Arvind

FY07 Aarvee

Source: CRISIL Equities, Industry sources

Source: CRISIL Equities, Industry sources

The presence of a huge unorganised segment typically leads to competitive pricing. However, the large players in this industry enjoy good bargaining power with the apparel manufacturers due to superior quality of fabric and a strong distribution network.

Aarvee Denims - strong distribution network in North India, key to revenue growth
Denim fabric is a commoditised product. The manufacturers cannot differentiate
Aarvee Denims has the advantage of strong promoters - the Arora Group and the VB Group

themselves by substantiating a unique selling proposition in the denim fabric. Hence, the distribution network plays an important role in successful business operations of denim fabric manufacturers. Aarvee Denims enjoys a clear advantage in the form of an extensive and loyal distribution network in the domestic market through its promoters the Arora Group and the VB Shah Group. The Arora Group has been involved in the marketing of denim fabric for over 35 years and the VB Group has been in textile trade for over 50 years. The Arora Group is one of the major distributors of Aarvee Denims denim fabric in the domestic market. It has an extensive distribution network across Northern India; this region is Asias biggest readymade garments/ textile market and consumes almost ~60% of the denim fabric produced in India. Apart from its strong in-house distribution network, Aarvee Denims has built a loyal base of around 9-10 dealers across India, who supply to the apparel manufactures. It has a uniform pricing policy and payment terms for all its distributors both in-house and external.

CRISIL Equities

Aarvee Denims & Exports Limited

Aarvee Denims is strong in the domestic market, while Arvind focuses more on exports

Dominant position in the domestic market compared to peers

Arvind and Aarvee Denims are the two largest players in the denim industry in India. Aarvee Denims major thrust is on the domestic market with domestic sales constituting ~80% of the total revenues while Arvinds domestic sales constituted ~65% of FY09 revenues. Hence, Arvind mainly caters to the demand for denim fabric in the export market. Further, Arvind has diversified into readymade garments and retail, with the share of fabric declining from 60% of FY07 revenues to 50% of FY09 revenues. Hence, Arvinds core business is not manufacturing denim fabric as it earns a significant portion of its revenues from shirting fabric, apparels and retail. Thus, in the absence of any other large player in the domestic market and continued focus on denim fabric production, Aarvee Denims enjoys a strong dominance in the domestic denim fabric industry.

Comparison - volumes and realisations

In terms of volumes, Aarvee Denims sales are on an upward trend with improving domestic market conditions, whereas Arvinds volume sales declined with the deteriorating global economic conditions in 2009. Arvind commands the highest realisations among the three largest players. Arvind is increasingly focusing on the premium brands in the US and Europe, which enables it to command higher realisations.
Figure 6: Volumes and realisations of players
in mn meters 100 90 80 70 60 50 40 30 20 10 0 FY07 Arvind Volume (LHS) KG Denims Volume (LHS) Aarvee Realisations (RHS) FY08 94 93 80 97 85 125 115 in Rs. 130 120 110 90 77 100 90 80 70 60 50 FY09 Aarvee volume (LHS) Arvind Realisations (RHS) KG Denim Realisations (RHS)

Figure 7: Trend of denim fabric revenues of companies

40% 30% 20% 10% 0% -10% -20% -30% -2% -14% -20% FY07 Arvind FY08 Aarvee FY09 KG Denim 16% 6% 28%

7%

-6% -13%

Source: Prowess, Industry sources

Source: CRISIL Equities, Industry sources

CRISIL Equities

Aarvee Denims & Exports Limited

Aarvee Denims reported an EBITDA margin of 9.3%, net margin of 0.7% and RoE of 1.6%, the highest amongst its peers in FY09.
Table 2: Peer comparison
FY09 Aarvee Indicators Capacity (denim fabric) Sales volume (denim fabric) Realisation (denim fabric) Operating income* EBITDA margins* Net margins* RoCE* Gearing* EPS* Units mn meters mn meters Rs /mtr Rs mn % % % Times Rs Arvind 120 67 115 27,015 5.2 -3.6 -5.3 2.2 -4.6 -8.4 Denims 60 34 85 3,196 9.3 0.7 0.5 1.6 1.0 1.6 KG Denims 24 21 97 2,425 -0.1 -5.6 -9.8 3.3 -5.2 -28.9

ROE* % * Represents financials for all divisions Source: Prowess (reported numbers)

Retail foray - treading cautiously

As a de-risking strategy, Aarvee Denims forayed into the readymade garment business in 2007. It has an operational capacity of 1.5 mn pieces per annum as of FY10. The
It is not looking to expand the number of retail stores aggressively

garments are sold under the brand name De Extase at 75 EBOs across the country; 35 are in Gujarat and 40 in other parts of India. The company operates three stores through the company owned-company managed model, 47 through the company owned-franchise operated model and 25 through the franchise owned-franchise operated model. The company entered the garment business and the retail space mainly to build a brand name for itself in the export market. Its strategy is to attract the major international denim wear manufacturers as customers for its core product, i.e. denim fabric, by showcasing its strong presence across the entire textile value chain right from spinning to readymade garments. Thus, the company is not looking to aggressively expand the number of EBOs and manufacturing of denim fabric will continue to remain the core area of business. We believe that foray into retail is a well thought-out strategy which will help open new doors in the export realm as well as help maintain a dominant position in the domestic market.

CRISIL Equities

Aarvee Denims & Exports Limited

Relatively low debt-equity ratio favourable for future growth

The debt-equity ratio of Aarvee Denims is 1.5x as of FY10 and is expected to reduce to
Higher profitability and redemption of FCCBs to reduce D/E ratio

1.0x by FY12. In April 2007, the company had issued foreign currency convertible bonds (FCCBs) of US $20 mn for setting up the wind power plant. The bonds are redeemable in 2012 at a conversion price of Rs 148 (the market price of the stock is Rs 67 as on August 09, 2010). Of the total amount, it bought back US $7.5 mn in FY10 and $ 5.0 mn in Q1FY11 at a discount of 25% to the face value. The company had also issued 14.9 mn 13% cumulative redeemable non-convertible preference shares of Rs 10 each which have been redeemed this year. With increasing profitability and post the redemption of FCCBs in 2012, we expect the debt-equity structure of the company to improve significantly.

Figure 8: Aarvee Denims has operated at low D/E historically compared to peers
D/E Ratio (x)

Figure 9: Increase in profitability to reduce D/E ratio significantly

Rs. Mn (x) 2.0 1.6 3,000 1.5 1.3 1.3 1.8 1.6 1.4 1.2 1.0 2,281 1,906 2,440 2,430 2,099 1.0 0.8 0.6 0.4 500 0.2 0.0 FY08 FY09 Debt (LHS) FY10 FY11E Debt/Equity (RHS) FY12E 3,500

3.5 3.0 2.5 2.1 2.0 1.5 1.0 0.5 0.0 FY06 FY07
Arvind

3.3 3.2 2.5 2.2

2,500 2,000

1.8 1.4 1.5

1.6 1.6 1.3 1.4 1.3

1,500 1,000

0.6

0.6

FY08
Aarvee

FY09
KG Denims

FY10

Source: Prowess

Source: Company, CRISIL Equities estimate

CRISIL Equities

Aarvee Denims & Exports Limited

Key Monitorables
Overcapacity in the domestic denim industry
The global denim industry is characterised by overcapacity. Total capacity is estimated at 6,000 mn meters and consumption at around 4,500 mn meters as of 2008-09. The Indian denim industry is currently facing an oversupply scenario, with estimated capacity of around 500 mn meters as against a demand of 400 mn meters at the end of 2009. However, with the expected growth in the economy and a rise in disposable income, the demand for denim fabric is steadily increasing, which has helped correct the demand-supply mismatch to an extent. Entry of new players, capacity expansion by existing players and general consumer sentiments are the key monitorables for players like Aarvee Denims.

Ability to pass on hike in cotton prices

Cotton is the major raw material in the production of denim fabric and accounts for ~70% of the total raw material costs. Cotton prices have historically remained very volatile and are currently on an upward trend with a 40% hike in the minimum support price announced by the government in 2009.
Figure 10: Trends in cotton prices and EBITDA margins
in Rs. 80 70 60 50 40 30 20 10 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 5% 0% 20% 15% 10% 30% 25%

Cotton prices (LHS)

EBITDA margin (RHS)

Source: Company

Higher cotton exports, moderate growth in local demand and firm international prices are expected to drive domestic cotton prices upwards. CRISIL Research projects domestic cotton prices to be at Rs 69-73 per kg in 2010-11 cotton season compared to an average of Rs 63 per kg in 2008-09. Aarvee Denims EBITDA margins are highly sensitive to cotton prices and, hence, its ability to pass on any adverse increase in cotton prices is a key monitorable for the company.

Ability to refinance payment of FCCBs

The ability of the company to finance the repayment of US$ 7.5 mn worth of FCCBs due for redemption in FY12 is another key monitorable for the company.

CRISIL Equities

Aarvee Denims & Exports Limited

Financial Outlook
Revenues to grow at a CAGR of 13.8% to Rs 4.9 bn by FY12
Revenues to grow at a two-year CAGR of 13.8% to touch Rs 4.9 bn

In FY10, Aarvee Denims total revenues grew by 16% y-o-y to Rs 3.8 bn compared to Rs 3.3 bn in FY09 driven by a healthy 9% growth in volumes and 3.5% growth in realisations. We expect the companys revenues to grow at a two-year CAGR of 13.8% from Rs 3.8 bn in FY10 to Rs 4.9 bn in FY12. We expect the volumes and realisations to grow at a two-year CAGR of 11% and 5%, respectively, driven by rising income levels and the narrowing demand-supply gap in the industry which will translate into higher operating levels for the company.

Figure 11: Revenues and revenue growth trends

Rs Bn 6 5 4 3 2 1 0 FY08 FY09 FY10 Revenue (LHS) FY11E FY12E Revenue growth (RHS) -13 2.5 -1 3.3 4.7 3.8 4.9 3 0 16 13 32 25

Figure 12: Volume and realisation trends

(%)
38

in mn meters 50 45 97.3 85.8 76.8 88.4 95.3

in Rs. 120 100 80 60 45 29 33 36 45 40 20 0 FY08 FY09 FY10 FY11E Realisation (RHS) FY12E

25

40 35 30 25 20 15 10 5 0

Volume (LHS)

Source: Company, CRISIL Equities estimate

Source: Company, CRISIL Equities estimate

EBITDA margins to improve due to higher utilisation levels

Margins to improve due to the narrowing demand-supply gap and increase in utilisation levels

The textile industry faced a setback in 2008-09 due to higher raw material prices and global economic downturn. In line with the state of the industry, Aarvee Denims EBITDA margins fell from 22.4% in FY07 to 13.3% in FY08 and further to 13.6% in FY09. However, with a pick-up in volumes, improving realisations and lower raw material costs, the company has been able to register a healthy revenue growth and improve its EBITDA margin to 16.5% in FY10. We expect the EBITDA margin to remain flat at 16.1% in FY11 on account of a hike in cotton prices. However, the EBITDA margin is expected to increase to 17.3% in FY12 on account of higher utilisation levels following the increasing demand for denim fabric, subsequent higher volume sales and savings in power costs due to the captive power plant set up by the company. Further, we believe that it will be able to partially pass on the hike in cotton prices to end users due to its reasonably good bargaining power in the industry.

CRISIL Equities

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Aarvee Denims & Exports Limited

Figure 13: EBITDA and EBITDA margins

Rs Mn 900 800 700 600 500 400 300 200 100 0 FY08 FY09 EBITDA (LHS) FY10 FY11E FY12E EBITDA margin (RHS) 326 624 442 761 849 13.3 13.6 16.5 16.1 17.3 (%) 20 18 16 14 12 10 8 6 4 2 0

Source: Company, CRISIL Equities estimate

Provision for FCCB redemption accounted for in profits

Aarvee Denims had raised FCCBs worth $ 20 mn in April 2007. The bonds are redeemable in 2012 at a conversion price of Rs 148 (the current market price of the stock is Rs 67 as on August 09, 2010). Of the total amount, it bought back US $ 7.5 mn in FY10 and $ 5.0 mn in Q1FY11 at a discount of 25% to the face value. We have assumed that the rest of the FCCBs will be redeemed in FY12 and have accordingly provided for the redemption of around Rs 1,019 mn for the FY08-12 period. The company has made provisions for FCCB redemption in the balance sheet while we have debited the same to the interest component in the P&L. Hence, there is a difference in the company reported PAT and CRISIL Equities numbers. Aarvee Denims registered adjusted PAT margins of -1.7% and 2.0%, respectively, in FY08 and FY09 due higher interest costs which include the provision for redemption of FCCBs. Higher depreciation costs due to capacity additions also adversely impacted the PAT margin. The adjusted PAT margin improved significantly in FY10 to 3.7% due to strong revenue growth. Correspondingly, EPS improved from Rs 2.8 per share in FY09 to Rs 6.0 per share in FY10.
Figure 14: PAT, PAT margins and RoE
Rs Mn 400 300 200 100 0 -100 -200 (%) 20

14.7 13.0 9.0 4.2

3.7 2.0 4.8 5.9

15 10 5 0 -5 -10

-2.5
-1.7

FY08

FY09
PAT (LHS)

FY10
ROE (RHS)

FY11E

FY12E

PAT margin (RHS)

Source: Company, CRISIL Equities estimate

CRISIL Equities

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Aarvee Denims & Exports Limited

We expect Aarvee Denims PAT margins to improve from 3.7% in FY10 to 5.9% in FY12 due to revenue growth, improvement in margins and savings in interest cost following the redemption of FCCBs in FY12. The company is expected to report an adjusted EPS of Rs 9.6 in FY11 and Rs 12.3 in FY12. RoE is expected to improve from 9.0% in FY10 to 14.7% FY12.
Asset turnover to improve to 1.1 x in FY12 from 0.9x in FY10

Asset turnover to improve with increase in capacity utilisation

The company had expanded its weaving capacity from 58 mn meters in FY09 to 60 mn meters in FY10 and further to 68 mn meters from April 01, 2010 onwards. We expect the company to operate at 75% capacity utilisation levels in FY11, up from ~73% in FY10. The increase in utilisation rates is on account of growth in the demand for denim fabric coupled with no major capacity additions planned by the existing players in the next two-three years. Consequently, the asset turnover of the company is expected to increase from 0.9x in FY10 to 1.1x in FY12.
Figure 15: Asset turnover ratio to rise with increase in operating levels
in % 80 65 60 58 0.8 0.7 0.6 0.4 0.2 20 FY08 FY09 FY10 FY11E Asset Turnover (RHS) FY12E Capacity Utilization (LHS) 0.0 0.9 73 1.1 75 1.1 75 1.0 0.8 (x) 1.2

40

Source: Company, CRISIL Equities estimate

Debt to remain at the same level but debt-equity ratio to decline

Aarvee Denims total debt-equity ratio was 1.5x in FY10 compared to 1.6x in FY09. The total debt of the company is expected to remain at the same levels as the company will have to refinance its FCCB redemption payment due to insufficient operating cash flows. However, the increase in reserves through increasing profitability is expected to bring the debt-equity ratio down to 1.3x in FY11 and further to 1.0x in FY12.

CRISIL Equities

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Aarvee Denims & Exports Limited

Figure 16: Trends in total debt and debt-equity ratio

Rs. Mn 3,500 3,000 2,500 2,000 1,500 1,000 500 0 FY08 FY09 Debt (LHS) FY10 FY11E Debt/Equity (RHS) FY12E 1,906 2,281 2,440 2,430 2,099 1.0 1.3 1.6 1.5 1.3 (x) 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0

Figure 17: Operating cash flows and debt-equity ratio

in Rs. mn 500 300 100 1.3 -100 -300 -500 -700 FY08 FY09 FY10 FY11E FY12E Operating Cash Flows (LHS) Debt-Equity Ratio (RHS) 1.5 1.3 1.0 (x) 2.0 1.8 1.6 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0

Source: Company, CRISIL Equities estimate

Source: Company, CRISIL Equities estimate

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Aarvee Denims & Exports Limited

Management Evaluation
CRISIL Equities fundamental grading methodology includes a broad assessment of management quality apart from other key factors such as industry and business prospects, and financial performance. Overall, we believe management is relatively good with moderate risk appetite.

Strong management with good experience and domain expertise

Experienced promoters with vast industry experience

Aarvee Denims has a strong and experienced top management consisting of five promoter directors from the Arora and the Shah family. The management is headed by Mr Vinod Arora (chairman and managing director), and Mr Ashish Shah (managing director). Mr Parmanand Arora, the founder of Arora Group companies and the father of Mr Vinod Arora, has more than 62 years of experience in the textile business. He is currently the non-executive director of the company. The Arora and the Shah family share a healthy professional relationship. All the promoter directors have rich experience in the textile business and are well versed with the dynamics of the denim fabric industry. They have played a critical role in elevating Aarvee Denims to the position of the second largest denim fabric manufacturer in India. They are well supported by the younger generation of the promoter group family and other professionals with specialised skills.

Promoter-driven company
Based on our interactions and assesment, we believe the company has a strong second line of management. The senior management team has a varied work experience, ranging from five to over 15 years in their respective fields; most have been with the company for around five years on an average. However, the company is still highly dependent on the promoters for all important strategic decisions. We believe that the top management posts are likely to remain with the family members since Aarvee Denims is fundamentally a promoter-driven company. Going forward, the effective management of the company would likely depend upon continuing good relationship amongst the next generation of family members.

Promoters have ventured into retail, but focus is on the core business
Aarvee Denims recently forayed into the manufacturing of readymade garments, sold through De Extase exclusive retail outlets spread across India. At present, there are 75 EBOs. Based on our discussion with the management, we believe that the promoters do not intend to aggressively expand the number of EBOs and foray into the retail space. They are adopting a cautious approach in retail but are ready to capitalise on opportunities as and when they arise. The companys focus will continue to be on the core business of manufacturing denim fabric.

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Aarvee Denims & Exports Limited

Corporate Governance
Overall, corporate governance at Aarvee Denims presents good practices supported by a strong board

CRISILs fundamental grading methodology includes a broad assessment of corporate governance and management quality, apart from other key factors such as industry and business prospects, and financial performance. In this context, CRISIL Equities analyses shareholding structure, board composition, typical board processes, disclosure standards and related-party transactions. Any qualifications by regulators or auditors also serve as useful inputs while assessing a companys corporate governance. Overall, corporate governance at Aarvee Denims presents good practices supported by a fairly experienced board. We feel that the company's corporate governance practices are adequate and meet the minimum required levels.

Board composition
The board comprises 10 members, of whom five are independent, which is in accordance with the stipulated SEBI guidelines. Given the background of the directors, we believe that the board is fairly diversified.

Board processes
The company has the necessary committees in place - auditors, share transfer, remuneration and shareholders grievance. The company's disclosures are sufficient to analyse its business aspects. Based on interactions with independent directors, CRISIL Equities assesses that the quality of agenda papers and the level of debate of discussions at the board meetings are good.

Others
Based on the level of information and details furnished in annual reports, the company website and other publicly available data, the companys quality of disclosure is good. We feel that the independent directors are aware of the business and are fairly engaged in all the major decisions, reflecting good corporate governance. Further, we assess that the audit committee is chaired by an independent director, and it meets at timely and regular intervals. The major clients of the company are related parties of the promoters. However, the management has indicated that all the transactions with them are carried out on an arms-length basis, and the terms and conditions are on par with those for the external distributors.

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Aarvee Denims & Exports Limited

Valuation Grading
We assign a fair value of Rs 68 per share and initiate coverage with a valuation grade of 3/5

Grade: 3/5

We have used the price-to-earnings ratio (PER) method to value Aarvee Denims. The stock has traded at an average multiple of 5.8x during the 2004-10 period. Accordingly, we have valued the stock at a PER of 5.5 x. Based on FY12 EPS of Rs 12.3, we arrive at a fair value of Rs 68 per share for the company. At the current market price of Rs 67 per share, the stock trades at 6.9x and 5.4x of its estimated EPS of Rs 9.6 (FY11) and Rs 12.3 (FY12), respectively. Consequently, we initiate coverage on Aarvee Denims with a valuation grade of 3/5, indicating that the fair value of Rs 68 per share is aligned with the current market price.
Figure 18: PE band chart
(Rs) 300.0 250.0 200.0 150.0 100.0 50.0 0.0 Apr-04 Apr-05 Apr-06 5.5 Apr-07 7 Apr-08 8 Apr-09

AARVEE DENIMS

Source: CRISIL Equities

Valuation comparison with peers

We note that Aarvee Denims closest competitor Arvind is trading at forward PE multiples of 10.7x FY11 EPS and 8.6x FY12 EPS. At the current market price of Rs 67 (as on August 09, 2010), Aarvee Denims is trading at a discount of about 40% on a PE basis to Arvind. Historically, Aarvee Denims stock has traded at a discount of about 5060% on a PE basis to Arvind.
Table 3: Peer valuation
M Cap. Companies Aarvee Denims Consensus estimates Arvind Ltd 7296 2 2.9 3.6 15.5 -11.0 10.7 na 8.6 na 0.5 0.8 0.5 na 0.3 na na -3. 6.4 na 8.2 na KG Denims 282 -1 na na Source: CRISIL Equities estimate, Industry estimate (Rs mn) 1,572 6.0 EPS (Rs) FY10 FY11E FY12E 9.6 12.3 Price/Earnings (x) FY10 9.5 FY11E FY12E 6.9 5.4 Price/Book (x) FY10 FY11E FY12E 0.8 0.8 0.7 9.0 RoE (%) FY10 FY11E FY12E 13.0 14.7

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Aarvee Denims & Exports Limited

Company Overview
Incorporated in 1988, Aarvee Denims is promoted by the Arora Group and the VB Shah Group. Arora Group has been involved in the marketing of denim fabric since 1980s. In 1991, Aarvee Denims was incorporated as a backward integrated unit of Arora Group and has eventually emerged as the second largest manufacturer of denim fabric in India. Domestic sales accounted for over 80% of the companys revenues in FY10. The company has three integrated manufacturing units in Ahmedabad.
Table 4: Major milestones
1980s 1991 1992-1996 2002-2006 2007-2009 2009-2010 Arora Group commenced the marketing and distribution of denim fabrics manufactured by others Aarvee Denims was incorporated as a backward integrated unit Progressive augmentation of processing and weaving capacities Set up captive wind mills Foray into retail by selling its readymade garments brand 'De Extase' through EBOs Set up captive POY texturising facility and undertaken weaving capacity addition of 10 mn

meters Source: Company

Aarvee Denims forward integrated into the garment business in 2007 in order to diversify its revenue stream. It sells readymade garments under the brand name De Extase through EBOs. Currently, the company operates 75 EBOs, 35 of which are in Gujarat and the rest across India. It also has its own power plant which it uses for captive consumption. It has an extensive in-house distribution network and other external dealers catering to pan-India demand. In FY10, denim fabric sales accounted for 85% of the revenues, readymade garments accounted for 5%, while non-denim fabric sales and job work processing accounted for the rest.
Figure 19: FY10 revenue break-up
Others 10%

Garments 5%

Denim fabric 85%

Source: Company

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Aarvee Denims & Exports Limited

Business Overview
Currently, Aarvee Denims has a spinning capacity of 25,500 metric tonnes and a weaving capacity 60 mn meters per annum. It has expanded its weaving capacity from 28 mn meters in FY05 to 60 mn meters in FY10.
Table 5: Operational capacity of the company
Products Denim fabrics Garments division Processing of non-denim fabric Wind mills Power plant Source: Company Capacity p.a. ( as of FY10) Spinning: 25,500 metric tones Weaving: 60 mn meters 1.5 mn pieces 18 mn meters 20.5MW 2.5MW

Cotton is the key raw material used in the production of denim fabric. Aarvee Denims procures cotton from local vendors as and when the requirement arises. It is also in the process of setting up of a POY texturising unit which will enable it to convert POY into PTY in its manufacturing unit. The in-house conversion will result in ~4% savings in purchase cost compared to purchasing PTY from external vendors.

Figure 20: Aarvee Denims: Presence across the value chain

PTY

Cotton

Spinning

Cotton yarn

Sizing & Dyeing

Processed yarn

Sourced from local vendors

POY
Quality testing

Weaving

Fabric Sales

Denim fabric
Stitching

Readymade Garments
Sales

Retail outlets
POY partiall y orient ed yarn, PT Y pol y t extured yar n

Source: CRISIL Equities

The company earns majority of its revenues through denim fabric sales in the domestic market. In FY10, exports accounted for ~12.5% of the revenues in the domestic market. The major export destinations are North America, Europe and Latin America.

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Aarvee Denims & Exports Limited

Annexure: Financials
Table 6: FINANCIAL STATEMENTS
Income Statement (Rs Mn) Net sales Operating Income EBITDA Depreciation Interest Other Income PBT Reported PAT Adjusted PAT No. of shares Adjusted Earnings per share (EPS) Balance Sheet (Rs Mn) Equity Reserves Total Equity Debt Current Liabilities and Provisions Deferred Tax Liability/(Asset) Capital Employed Net Fixed Assets Capital WIP Intangible assets Investments Loans and advances Inventory Receivables Cash & Bank Balance Applications of Funds FY08 235 1,381 1,616 2,056 368 200 4,239 3,048 123 3 70 548 354 94 4,239 FY09 235 1,239 1,474 2,431 634 200 4,739 3,030 146 2 2 126 756 636 39 4,739 FY10P 235 1,400 1,634 2,440 521 200 4,796 2,867 146 2 2 146 880 726 25 4,796 FY11E 235 1,598 1,832 2,430 640 200 5,102 2,738 146 2 2 183 1,103 909 19 5,102 FY12E 235 1,858 2,093 2,099 648 200 5,039 2,603 146 2 2 190 1,141 941 15 5,039 FY08 2,276 2,459 326 209 164 14 (33) 50 (41) 23 (1.7) FY09 2,939 3,252 442 221 150 (2) 69 25 65 23 2.8 FY10 3,748 3,785 624 233 189 10 212 181 140 23 6.0 FY11E 4,472 4,741 761 230 195 336 264 225 23 9.6 FY12E 4,584 4,905 849 235 185 429 288 288 23 12.3

*Adjusted PAT includes provision for redemption of FC CBs. W e have assumed t hat the remaining FC CBs will be redeemed in FY12. Forex gain/loss not accounted for in adjusted PAT . All ratios calculated on adjusted PAT .

Source: Company, CRISIL Equities estimate

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Aarvee Denims & Exports Limited

Cash Flow (Rs Mn) Pre-tax profit Total tax paid Depreciation Change in working capital Cash flow from operating activities Capital expenditure Investments and others Cash flow from investing activities Equity raised/(repaid) Debt raised/(repaid) Dividend (incl. tax) Others (incl extraordinaries) Cash flow from financing activities Change in cash position Opening Cash Closing Cash Ratios FY08 Growth ratios Sales growth (%) EBITDA growth (%) EPS growth (%) Profitability Ratios EBITDA Margin (%) PAT Margin (%) Return on Capital Employed (RoCE) (%) Return on equity (RoE) (%) Dividend and Earnings Dividend per share (Rs) Dividend payout ratio (%) Dividend yield (%) Earnings Per Share (Rs) Efficiency ratios Asset Turnover (Sales/GFA) Asset Turnover (Sales/NFA) Sales/Working Capital Financial stability Net Debt-equity Interest Coverage Current Ratio Valuation Multiples Price-earnings Price-book EV/EBITDA -55.8x 1.4x 13.0x 11.7x 0.5x 7.1x 9.5x 0.8x 6.0x 6.9x 0.8x 5.2x 5.4x 0.7x 4.3x 1.2 0.7 2.9 1.6 1.5 2.5 1.5 2.1 3.4 1.3 2.7 3.5 1.0 3.3 3.5 0.7x 0.9x 10.9x 0.8x 1.1x 4.4x 0.9x 1.3x 3.6x 1.1x 1.7x 3.4x 1.1x 1.8x 3.1x 0.0 0.0 -1.7 0.0 0.0 2.8 1.0 12.5 1.8 6.0 1.0 10.4 1.5 9.6 1.0 8.2 1.5 12.3 13.3 (1.7) 3.7 (2.5) 13.6 2.0 5.8 4.2 16.5 3.7 9.8 9.0 16.1 4.8 12.7 13.0 17.3 5.9 14.5 14.7 (1.4) (41.6) (113.7) 32.3 35.6 NA 16.4 41.2 115.4 25.2 21.9 60.8 3.5 11.6 27.7 FY09 FY10P FY11E FY12E FY08 (33) (8) 209 (757) (590) (484) (0) (484) (6) 1,118 (1) 1,111 38 56 94 FY09 69 (4) 221 (283) 3 (226) 0 (225) (186) 375 (21) 168 (54) 94 39 FY10P 212 (72) 233 (347) 25 (70) (70) 9 (27) 48 30 (14) 39 25 FY11E 336 (111) 230 (324) 131 (100) (100) (10) (27) (37) (6) 25 19 FY12E 429 (141) 235 (68) 455 (100) (100) (332) (27) (359) (4) 19 15

*Adjusted PAT includes provision for redemption of FC CBs. W e have assumed t hat the remaining FC CBs will be redeemed in FY12. Forex gain/loss not accounted for in adjusted PAT . All ratios calculated on adjusted PAT .

Source: Company, CRISIL Equities estimate

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Aarvee Denims & Exports Limited

Focus Charts
Aarvee Denims has historically performed better than Nifty
2000

Aarvee Denims stock has low liquidity

in '000s 1800 1600 1400 1200 1000 800 600 400 200 0
Feb-07 Feb-08 Feb-09 Aug-06 Aug-07 Aug-08 Aug-09 Feb-10 Aug-10

1500

1000

500

1-Aug-03

1-Aug-04

1-Aug-05

1-Aug-06

1-Aug-07

1-Aug-08

1-Aug-09

1-Aug-10

Aarvee Denims

Nifty

Total Traded Quantity

Source: NSE

Source: NSE

Shareholding as of March 2010

Non-Institutional Investors 25%

Denim fabric capacity in India grew by 13%

Domestic Institutions 16%

Promoter 59%

Source: NSE

Source: Industry

Revenue and revenue growth trends

Rs Bn 6 5 4 3 2 1 0 FY08 FY09 FY10 Revenue (LHS) FY11E FY12E Revenue growth (RHS) -13 2.5 -1 3.3 4.7 3.8 4.9 3 16 13 32 25

EBITDA margin, PAT margin and EPS trends

(%)
38
in % 20 15 10 6.0 5 0 -1.7 2.0 3.7 4.8 5.9 -5 -10 FY08 FY09 FY10E FY11E FY12E EPS (RHS) EBITDA margin (LHS) PAT margin (LHS) 2.8 5 0 13.3 13.6 9.6 in Rs. 20 15 10

16.5

16.1

17.3 12.3

25

0
-5 -10 -1.7

Source: Company data, CRISIL Equities estimate

Source: Company data, CRISIL Equities estimate

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CRISIL Independent Equity Research Team

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