Sunday, July 19, 2009
Investors can refrain from subscribing to the initial public offer from Raj Oil Mills. Strong demand prospects for edible oils, the company’s established brands in Western India and a record of good profit and revenue growth, are positives to the offer. However, the aggressive nature of the capacity expansion plans peg up execution risks and the asking price for the offer is stiff, if expansion plans make a delayed contribution.
At the two ends of the price band of Rs 100-120, the asking price discounts the company’s fully diluted earnings for the last financial year (ended December 2008) by 12-14.5 times. Assuming the company successfully implements its expansion plans, the multiple would work out to 8-10 times (FY-11) earnings.
That appears high given that competition is intense and margins in this business are susceptible to significant swings, based on input price fluctuations.
Players of a much larger size such as KS Oils (11 times) and Ruchi Soya (8 times) trade at lower trailing multiples. That suggests that the stock may offer opportunities for investment at lower prices, post-listing.
Expansion in sales
Raj Oil Mills has a strong presence in the Western region with brands such as Cocoraj (coconut and ayurvedic oil) and Guinea refined oil (edible oils spanning groundnut, sunflower, mustard, cottonseed and soyabean). The promoter’s long experience in the industry, a diverse product portfolio and the company’s focus on the retail segment through a range of pack sizes have helped it manage consistent growth in recent years.
Over the three years to 2008 (the company adopts a calendar year), the company has managed to ramp up its sales from Rs 85 crore to Rs 317 crore. The expansion in sales has been accompanied by a scaling up of refining capacity from 15,000 to 30,000 tpa over the past two years, funded mainly through debt (debt:equity at 0.2:1).
The company has defied broader industry trends to manage nearly full utilisation of its existing capacity in recent years. Substantial expansion in operating profit margins from under 5 per cent to over 16 per cent helped net profits climb from below Rs 2 crore in 2005 to Rs 29.6 crore for 2008, the latest full year for which financials are available.
Operating profit margins stood way ahead of the industry averages of 8-11 per cent, which the company attributes to a strategic procurement of raw materials and a higher proportion of retail sales.
However, going forward, the company’s operating profit margins may moderate to industry levels, as raw material prices stabilise and the company undertakes capex to adopt a more integrated model of manufacturing. Establishing a Pan-India distribution network and a national brand presence is likely to prove quite expensive and may involve large promotional outlays that could reduce margins as well.
Despite a wide supply deficit for edible oils in the Indian market, the retail segment is very competitive with many national players (Adani Wilmar, ConAgra, Marico) as well as successful regional brands which offer strong price competition. Unlike other FMCGs, edible oils (even the branded segment) is quite price-sensitive, making it difficult for players to pass on input cost increases to consumers without the threat of substitution. The current inflationary scenario for edible oils may make this year quite challenging in this respect.
The proceeds of this Rs 114 crore IPO (at the higher end of price band) are proposed to be used to significantly scale up oilseed crushing capacity (5,000 tonnes per annum to 30,000 tpa) at the existing location at Manor, Thane, and set up new refining capacities (60,000 tpa), palm oil processing (60,000 tpa), vanaspathi (15,000 tpa) and facilities for ayurvedic and cosmetic products.
The added crushing capacity is expected to reduce reliance on third parties for sourcing of crude oil, which could ensure more reliable supply. The bulk of the above capacities are expected to be commissioned this November.
The manifold expansion planned, the lack of external monitoring and the fact that it is to be funded entirely by equity, peg up the execution risks associated with the project. Overall, the company’s fundamentals are reasonable enough to bear watching post-listing; but stiff pricing makes the offer a relatively risky investment.
‘Fortune favours the brave’ — this Latin proverb may well sum up the changing fortunes of Unitech as well as the high risk-return proposition that may be awaiting the prospective investors of Unitech.
Unitech’s unremitting efforts to tide over a precarious state of high leverage, high receivables, plunging sales and low cash during the realty slowdown of the last one year seem to be paying off. Among the larger players, we believe that Unitech has been most proactive in combating the slowdown. There are signals that these efforts would translate into a healthier balance sheet that is low on debt and a more sustainable earnings stream for the company, though margins may moderate.
Investors with a three-year investment perspective can consider buying the stock of Unitech on declines linked to broad markets.
At the current market price of Rs 76 the stock trades at 10 times its earnings for 2008-09. Note that even the FY-09 earnings were aided by reasonably good performance during the first half of that fiscal. This may not be sustained in the current financial year. The valuation only gets marginally expensive at 13 times its expected FY-10 earnings, factoring in an expanded equity base and revenue from new launches accruing over the next couple of years. An investment in the stock, at this stage, could still hold uncertainties. Even as Unitech has done well to tackle company-specific issues, the macro concern over the pace of recovery in realty still remains a matter of conjecture. A longer investment time-frame may, therefore, be needed.
While smaller realty companies took the first hit from the realty slowdown, it wasn’t long before players such as Unitech were also impacted. Unitech has traditionally been high on leverage. However, comfortable revenue growth rates ensured that debt was serviced. Lower sales volume as well as rapid drying up of funding avenues — visible from September 2008 — spelt trouble. By December 2008, the company’s receivables galloped to Rs 1,345 crore from Rs 750 crore in March 2008. Debt increased by over Rs 2,000 crore to Rs 10,900 crore during the December quarter, with higher number of near-term repayment schedules. Sales volume, meanwhile, plummeted over 85 per cent in the above quarter. Added to this, rumours of the company defaulting on payments, made fund raising extremely difficult.
Unitech, unlike its peer DLF, was in a more difficult spot then, as it was more highly leveraged than the latter. As bank credit and customer advances — the key sources of working capital — started drying up, the first positive for Unitech’s came in the form of a stake sale in its telecom venture — Unitech Wireless. While the inflows from the sale came at a later date, Unitech’s consolidated balance sheet received some relief as a part of the debt for the telecom business was shifted from its books.
The next relief came in the form of debt restructuring package allowed to banks by corporates. These events, despite providing some respite to the pressurised balance sheet, did not free up cash for the launches (mostly middle income housing) that the company was resorting to. It was then that Unitech went on an asset monetising spree, selling its hotel and office spaces, freeing up at least Rs 650 crore of cash. The monetising initiative is still on, with the company negotiating to offload more hotel properties.
Unitech was also one of the fist companies to capitalise on the turnaround in the equity markets through two quick successive rounds of qualified institutional placements, through which it is reported to have garnered about Rs 4,400 crore. Besides, the company’s first’s QIP at Rs 38.5 per share left much on the table for investors; this smart strategy led to a successful second QIP offer. Unitech’s debt at Rs 7,800 crore (as of May 2009) and gearing of 1.5 are likely to come down further to these measures. The company has also issued warrants to a promoter group company.
The above de-leveraging/fund raising measures are not only likely to reduce the debt burden significantly, but also ensure execution of projects taken up. In the process, Unitech has also unlocked value from non-core businesses such as telecom (the company is also said be negotiating to sell its tower manufacturing business) thereby lightening its balance sheet as well as conserving resources for the core realty business.
Meanwhile, to revive sales volume, Unitech had resorted to shifting focus to middle-income housing. It stalled many commercial projects where the demand scenario was abysmal and instead concentrated on the residential space. Prices too were slashed by as much as 25 per cent.
While the effect of this was tepid in the March quarter, the company has sold about 3.2 million sq.ft of the close to 14 million sq ft of area launched since April 2009. To put this in perspective, the company sold 3 million sq. ft of properties for the full year ending March 2009. If the company is able to sell properties at the pace at which it has in recent months, the volumes may provide some cushion for the lower realisations from selling mid-income housing/discount properties.
The challenge for Unitech, is in keeping the volumes ticking for at least the next six-nine months not only to grow its revenue but also to revive its working capital cycle. For this, the nascent recovery visible in real-estate may have to be sustained. The near term concern is that the equity expansion of over 40 per cent (excluding warrants) may dilute the earnings over the next one year.
Surprisingly, Unitech has managed a better show than most other larger players for the full year ending FY-09. While revenues declined by 30 per cent to Rs 2,890 crore net profits contracted 26 per cent to Rs 1,198 crore. Operating profit margins expanded marginally to 55 per cent.
Going forward, with an average land cost of about Rs 200 per sq ft, OPMs may gradually contract to 40 per cent unless the company is once again able to command better pricing power. Any improvement in commercial project off take may also support profit margins.
Concerns about an erratic monsoon have beaten down the valuations of fertiliser stocks significantly in recent trading sessions.
Investors can use this opportunity to buy the Coromandel Fertilisers stock (Rs 183), which offers a bargain, trading at a price earnings of just six times its estimated earnings for 2009-10.
Coromandel Fertilisers’ status as one of the largest and cost-efficient producers of fertilisers and its extensive distribution network suggest that its prospects will not be materially impacted by a single deficit-monsoon season. In fact, despite the erratic monsoon, sales of complex and phosphatic fertilisers have already grown by 55 per cent in April-June 2009. There also remains a 25-per cent deficit in domestic supplies of DAP and complexes.
Coromandel Fertilisers’ businesses span phosphatic and complex fertilisers, pesticides, micro-nutrients and other farm inputs, with a marketing presence in 13 States. A wide fertiliser product mix, overseas buys which have secured supplies of raw materials, and scaling up of capacity through the integration of Godavari Fertilisers have enabled Coromandel to sustain strong growth over the past five years, amid the ups and downs of the agricultural cycle.
The company has managed a 50-per cent compounded annual growth rate in both sales and net profit in the past five years, even as the earnings per share have expanded from Rs 5 to over Rs 30.
The year 2008-09 was particularly challenging for Coromandel with a sharp rise, followed by a crash, in prices of raw materials such as ammonia, phosphoric acid and sulphur, which resulted in a dip in realisations starting the fourth quarter.
The Government’s decision to discharge a part of its subsidy obligations through bonds also contributed to a substantial mark-to-market loss. However, the current year appears less challenging on both counts. With raw material prices stabilising and global fertiliser prices correcting (subsidy is linked to import parity prices), realisations and revenues may dip; but volumes will grow and margins may be maintained. A sharp cut in the Government’s subsidy outgo and assurances that these would be paid mainly as cash, may result in better recoveries and lower working capital requirements for players this year.
Over the medium-term, the policy proposal to move from a product-based subsidy to a nutrient-based one, may serve to wean farmers away from cheaper urea and act as a strong demand driver for players such as Coromandel.
Investors can consider accumulating the stock of Texmaco, a leading supplier of wagons to the Railways. Stability on the demand front with the Railways announcing an addition of 18,000 wagons, besides the heightened focus on developing the dedicated freight corridors underscore our optimism.
Texmaco appears well-placed to benefit from these given its established relationship with the Railways and the private logistics players. At the current market price of Rs 101, the stock trades at about 12 times it likely FY-10 per share earnings.
This appears reasonable given the vast business potential in the wagon manufacturing space.
The reiteration of the Railways’ focus on improving infrastructure in the country, with increased budgetary allocation, higher wagon orders and sustained efforts towards setting up of dedicated freight corridors (DFCs), bodes well for Texmaco.
The company’s wagon manufacturing business benefit immensely from that as it is the largest wagon supplier for both the Railways and the private sector.
Besides, the setting up of DFCs will also in the long run translate into higher wagon orders from the private container rail logistics players. That Texmaco had secured orders for the supply of 3,455 wagons from the Railways last year (of the total 11,000 wagons) lends confidence on its execution skills.
But even as increasing wagon orders from the Railways are expected to make up a chunk of Texmaco’s order-book, the demand from the private players is unlikely to improve in the near-term. Save for Container Corporation, which is continuing with its capex plans for the year, most other private container rail logistics players are likely to go slow on their wagon procurement plans.
The global economic slowdown may continue to shadow the sector given its exposure to EXIM traffic. Though there have been slight signs of revival in cargo volumes — even the latest cargo volumes for the month of June have registered growth — it may take at least a couple of months of sustained cargo growth before wagon orders from the private logistics players begin to trickle in.
The company also has a presence in the steel castings and hydro-mechanical equipment space. The castings division, besides meeting captive requirements, also supplies bogies and couplers to the Railways and other wagon builders. Though not a revenue spinner, the division scores well on profit margins and contributes highly to overall cost savings for the company. Texmaco plans to increase the division’s exposure to high-margin export market and has in this respect even established its export base for hi-tech precision castings to serve a few multi-national clients.
The company has received a certificate from the Association of American Railroads for manufacture of Side Frame, Bolster and Centre Plate for the US market. It also has a presence in hydro-mechanical equipment space.
Though the division is yet to make any meaningful contribution to the company, it holds potential to add significantly to revenues. The Government’s increasing focus on improving power infrastructure and the proposed capacity addition in various hydropower projects point to high growth prospects for the division.
While the competition in this space is immense, Texmaco’s proximity to the untapped hydropower potential in North-East India may give it an edge.
For the financial year-ended March 2009, the company reported 15 per cent growth in revenues, while profits grew by 10 per cent. Operating margins dropped by half a percentage point to 15.5 per cent for the year. Deferment of wagon acquisition plans by private players leading and erratic commodity prices could be attributed to the drop in margins. On a segmental basis, the company’s rolling stock division continued to drive growth. Overall, it recorded an impressive performance by turning out 4,701 wagons during the year.
Though in terms of volume, the production was about the same as that of the previous year, the new hi-tech design Indian Railway wagons in stainless steel construction and special wagons for the private industry helped it make substantially higher value-addition over the previous year. It now enjoys an order book of Rs 1,300 crore.
The company is also in the process of raising Rs 200 crore through either preferential allotment of foreign currency convertible borrowing, ADR or GDR.