Sunday, January 24, 2010
Investments can be avoided in the initial public offering of Syncom Healthcare, which is engaged in the manufacturing and marketing of pharmaceutical formulations in the domestic market. At the price band of Rs 65-75, the offer is priced at 23-26 times its likely FY10 per share earnings on a post offer equity base. This seems expensive considering that many of the top tier pharmaceutical companies with better business fundamentals, market reach and growth potential are available at much lower valuations. The company's presence in a highly competitive market and it's relatively low experience in manufacturing operations also necessitate a cautious outlook .
Catering primarily to the domestic market, Syncom manufactures and markets pharmaceutical formulation under its own brand name in four product segments — generics, OTC (over the counter), ethical and herbal. The company also undertakes contract manufacturing for various pharmaceutical formulations, neutraceutical products, food supplements and cosmetics for domestic companies such as Lupin and Piramal Healthcare. Further, it recently added other companies such as Wockhardt, Klar Sehen and Canixa Sciences to its existing list of contract manufacturing companies.
Though the growth undercurrents in the domestic formulation business are getting stronger, the presence and increasing focus of bigger players on the domestic market may make it doubly challenging for Syncom to chart its growth path; the bigger players cater to a chunk of the market already. The rest of the market is characterised by many small and unorganised players.
It will be Syncom's distribution reach, brand presence and product launches that would help it scale growth in future. While the company has scored decently on these counts so far, growing its revenues at a compounded rate of over 42 per cent in the two years after it set up a manufacturing facility in Dehradun, it was on a low base and driven by volume increase. High competitive pressure and price sensitivity of the domestic market appears to have kept realisations capped, suggesting this could very well be the way forward too.
The company derives a significant share of its revenues from too few a clients; the top ten made up over 69 per cent of its revenues last fiscal. While this per seisn't reason enough for concern — such high dependence is quite common among companies with smaller scales of operation — what may be discomfiting is its working capital management.
High dependence on a handful of clients and little bargaining power appear to have strained the company's cash flows, with its working capital cycle increasing to 198 days in FY09 from 153 seen a year earlier — over 57 per cent of the total debtors exceeded six months. While an extended credit cycle to some extent is typical of the OTC segment, the company's revenue exposure to the segment was just about 24 per cent in the last fiscal.
Investors can consider giving the initial public offering of Aqua Logistics, an integrated logistics solutions provider, a miss. At the upper price band of Rs 220-230, the offer is priced at about 26 times the company's likely FY-10 per share earnings on a post-offer equity base. Though the high valuations, to a great extent, are a function of the 32 per cent dilution in equity base that this offer would result in, it still appears a tad pricey compared with some of the listed companies in this space.
The company's persisting negative cash flow from operations and its relatively poor margin performance are concerns. Investors looking for logistics sector exposure may be better off investing in existing listed companies, many of which enjoy stronger operations and business models.
Having started as a freight forwarding company, Aqua Logistics has been attempting to evolve into a full-fledged 3PL logistics service provider. Though there's no denying the high-growth potential in this business, the company's ability to weather competition and gain a share in this business is as yet unproven. One indication is this: Though the company has broadened its service offerings to include contract logistics and projects, it still derives a chunk of its overall revenues (91 per cent in FY-09) from freight services only.
While the nascent demand for end-to-end logistics services could partly explain the high revenue dependence on freight services, this also suggests that the company's headway in the high-margin value-add services are likely to be slow.
Despite growing its revenues at enviable rates over the last three years, the company's performance at the operating and net profit margin levels somehow has not been as outstanding. Operating margin hovered at around 11 per cent levels, while net profit margins contracted from 6.5 per cent in FY-07 to 4.6 per cent in FY-09, suggesting a high dependence on volumes and little pricing power.
Given this background, the shift in focus towards contract logistics and projects would help improve margins. Even so, the extent of improvement may be capped given its relatively less-established brand presence in 3PL.
The company may have to price its services competitively to establish market presence especially since the 3PL market is relatively organised and has many established players such as AFL, Kuehne and Nagel and Reliance Logistics. But to its credit, it has over the years managed to get repeat orders from companies such as Ranbaxy, HCL Infosystems, ABB and BHEL.
The company also utilises the services of its associate and group companies for supply-chain consulting, last mile project execution, specialised transport and supply-chain IT. Its asset light model (peers own assets such as warehouses, trucks or rakes), while affording better flexibility in the selection of vendors, may, however, also restrict its ability to control costs.
Though Aqua has scaled double-digit growth rates in revenues and profits (on a low base), its cash flows from operations have continued to remain in the negative. In the last two financial years, the company's receivables position has shown strain. The significantly higher debtor days (about 102 days in FY09) as against creditor days (14 days) may also explain Aqua's strained cash flows.
However, given that the two years gone by had seen the worst of the credit crisis, improvement on this score with better trade undercurrents can be expected. Besides, the company's plan to infuse Rs 45 crore from the offer proceeds towards funding its working-capital requirements might also help.
Despite the testing business dynamics in the last two years, many of its listed peers (helped by PE funding, strong revenue model or relatively higher pricing power) did manage to keep cash flows positive.
The company plans to raise Rs 150 crore at the top end of the price band. The company is also offering Rs 5 per share discount to retail investors on allotment.
Enam, Subhkam Ventures and HT Media hold equity stakes in the company.
Investors can refrain from subscribing to the initial public offer of Thangamayil Jewellery (TJL), a retail jewellery chain in Tamil Nadu, as the risks appear to outweigh the potential rewards. In the price band of Rs 70-75, the valuations are at about 6.3 times the estimated FY-10 per share earnings on a post-issue equity.
Though valuations are reasonable and at a discount to the closest comparable Gitanjali Gems, the business carries a number of challenges and is not a preferred exposure for investors.
Limited geographical reach, reliance on a brand that is yet to be established, focus on gold jewellery which is susceptible to price volatility and slim margins open to cost-pressures are the key risks.
TJL has a chain of four outlets in as many cities in Tamil Nadu. A well- established player in the Madurai jewellery market, TJL penetrated the Karaikudi, Rajapalayam and Ramanathapuram markets in 2008-09. Despite the store additions, the company's overall sales have only gone up 10 per cent to Rs 246.8 crore in FY-09.
Proceeds of the issue will part-finance additions of a store each in seven new cities during 2010-11, with a total investment of Rs 22 crore (including equipment).
For two of these cities, store locations are temporary, shifting to new premises when they come up, requiring higher capex. Location is yet to be decided in the third city. Though it may help topline, scaling up may not contribute significantly to profits in FY-11.
Regional markets no doubt hold substantial purchasing power and may be good for wedding jewellery with national players unlikely to step in.
Still, given that such markets are likely to have established local players, it may take time for a new entrant to make a mark. TJL is well-recognised in Madurai alone; investments in brand-building in new regions may be high in the initial period.
TJL is also susceptible to competition from established regional brands, should they choose to make an entry.
The gold jewellery business inherently has low margins, subject to high working-capital requirements and price volatility. Working capital — purchase of raw material (gold, silver and diamond) — will also be partly funded from this issue.
The company's inventory turnover, though, has dropped from 6.3 times sales in FY-08 to 3.8 times in FY-09, further to 2.7 times in the first half of FY-10, lower than most industry peers.
Sales and net profits registered a 71 per cent and 72 per cent three-year CAGR. Gross margins were at 5 per cent for FY-09 with net margins down to 3 per cent, though these figures are on a par with industry peers. Sales for the first half of FY-10 stood at Rs 209 crore, while net profits were at Rs 7.9 crore, leading to an improvement in gross and net margins rising to 6 per cent and 4 per cent respectively.
This was, however, due to fall in selling expenditure, now set to rise as TJL begins the brand-building exercise. With a larger store network, hike in depreciation is also likely. TJL's practice of trading some of its gold inventory could expose the company to losses on the price front, when there is little cushion to handle price risks.
About 15 per cent of sales come from recycled jewellery on which margins are typically lower by about 2 percentage points. Any increase in this segment could pressure margins.
A degree of risk stems from TJL's dependence on gold jewellery at a time when diamond-studded jewellery is starting to eat into the market for pure gold jewellery. Gold accounted for 97 per cent of TJL's sales in FY-09 (99 per cent in FY-08) with barely 2 per cent contributed by silver and negligible contributions by diamond.
Investors can consider buying the shares of steel pipe maker Maharashtra Seamless.
At the current price of Rs 356, the stock trades at 9.5 times its one-year trailing earnings. In addition to boasting operating margins that have been consistently better than bigger peers such as Jindal SAW and Welspun-Gujarat Stahl Rohren, the company has also consistently provided better returns on capital employed.
It has also weathered the pressure on realisations over the last 16-18 months much better than peers. Jindal SAW and Welspun-Gujarat Stahl trade at 9.7 times and 10.9 times their per share earnings, respectively.
Maharashtra Seamless has a product line that includes seamless and welded tubes with a total capacity of 550,000 tonnes a year. The company is one of the dominant players in the seamless pipe category.
Though currently dependent on external sources for steel billets, the company is also mulling a move towards an integrated model by producing billets. This may offer scope for margin expansion and insulate the company to some extent against volatile steel prices.
Upcoming projects include a facility to produce 200,000 tonnes a year of seamless tubes at Maharashtra, which will be operational by FY11.
Among the pipe makers, Maharashtra Seamless has a balanced 60:40 revenue mix between exports and domestic sales in FY09. The company claims to have a market share of 50 per cent in the OCTG (Oil Country Tubular Goods) segment, line pipes and boilers.
Its order book, which stands at around Rs 430 crore, includes a multi-year deal from ONGC for OCTG products.
Prospects for future order flows appear strong with potential demand from GAIL, Reliance Gas Transportation and other oil and gas distribution companies.
The 60,000 MW of capacity addition planned over the next three years may fuel demand for boilers, and in turn pipes. Globally, too, rising oil and gas prices have also rendered new projects more viable, improving medium-term demand prospects for pipes, casings, etc.
Recently imposed duties on Chinese pipe imports by the US augur well for pipe makers across the globe including Maharashtra Seamless which has already witnessed a spike in export orders.
The last three years have seen the company's sales and net profits grow annually at 27 per cent and 28 per cent respectively.
Operating margins hovered around 20 per cent during this period. The company has low leverage with a debt-equity ratio of 0.07:1, providing good scope for growth using leverage.
The risks include the import threat from China and the still-tentative prospects for global demand including the US. Raw material costs have favoured secondary steel makers through 2009, this is unlikely to remain the case through 2010.
Investors can avoid the initial public offer of Vascon Engineers, a provider of EPC services, for now. Despite a good track record in construction, premium valuations, dependence on related parties for a bulk of the future contract revenues and long gestation of its real-estate projects support our recommendation. At the offer price band of Rs 165-185, the stock is likely to trade at 32-35 times its consolidated annualised earnings for FY-10 on a post-issue equity base. The valuation does appear steep, irrespective of whether it is compared with pure construction contract plays or stocks of established realty companies.
Scaling up of real-estate revenues, winning of significant contracts from external clients or a steep correction in the stock price linked to broader markets can be reasons to take a re-look at this recommendation.
The company and offer
Vascon Engineers provides Engineering Procurement and Construction (EPC) services and is also into real-estate development mostly through the joint development model. Consolidated revenues for FY-09 stood at Rs 519 crore. The company plans to raise Rs 180-200 crore for construction activities.
Following the footsteps of Godrej Properties, Vascon Engineers seeks to showcase an asset-light model in real-estate through joint developments. It also seeks to integrate its construction skills with real-estate development activity. Sales — from third-party construction contracts — from its own real-estate projects and from development of property would be the three main revenue streams.
From deriving a majority of contract revenues from external clients, the company's order backlog is now tilted in favour of real-estate projects developed by itself/related entities. Of its order backlog of Rs 3,227 crore, 37.6 per cent or Rs 1,215 crore are contracts awarded by external customers, while the rest — Rs 2,012 crore —worth of EPC contracts is for its own real-estate development.
This leads to the risk of deriving a chunk of revenues from related entities whether in the form of joint ventures, partnerships or associates; receivables too would be due from such sources.
It may be worth recollecting that DLF's sale transactions with associate company, DLF Assets, was not too well-received by the market and this factor, in fact, hurt the valuation.
Excessive dependence on internal source(s) for revenue — from the point of view of maintaining an arms-length transaction as well as timely conversion of debtors to cash — does pose a risk. Currently, about 18 per cent of Vascon's total debtors are due from related parties.
This said, Vascon's revenue decline during the realty downturn of FY-09 (at 15 per cent) was lesser than its real-estate peers, primarily because of growth in EPC revenue. However, its current EPC order backlog may not offer sufficient hedge, given the dependence on own projects.
Vascon's projects also appear long-term in nature. For instance, only one-fifth of the EPC projects (external and own projects together) of Rs 3,227 crore are slated for completion over 2010/11. Similarly, of the 55 million square ft. of real-estate projects planned/being developed, less than 10 per cent are due for completion over the next three years ending FY-13. Earnings growth in the near term may, therefore, not keep pace with the valuations sought now.
Further, unlike the Mumbai commercial market, where prices have seen a quick revival, Tier-II cities such as Pune, where the company's commercial projects are concentrated, have not seen any clear demand pick-up as yet. Over the long term though, residential projects, a chunk of it in Pune, dominate the portfolio.
Vascon's revenue expanded at a robust 54 per cent compounded annually over three years leading to FY-09, while earnings grew by 35 per cent over this period.
This growth, however, predominantly came from pure construction contracts. Going forward, revenues could be lumpy, given the higher dependence on real estate.
The offer is open from January 27-29.
Investors with a medium-term horizon can consider buying the stock of Indraprastha Gas Limited (IGL), the sole supplier of compressed natural gas (CNG) and piped natural gas (PNG) in the national capital territory of Delhi. IGL's growth prospects stem primarily from its monopoly status in Delhi where demand has been growing at a healthy clip, thanks to statutory backing and clear cost and environment advantages of gas over alternative fuels.
The company's CNG network of 187 stations services more than 3 lakh vehicles, while its piped gas network covers around 1,60,000 households and 315 commercial customers.
CNG (almost 88 per cent of sales) is the major contributor to revenues. At the current market price of Rs 203, the stock discounts the trailing 12 month earnings by 14 times.
IGL, a joint venture between GAIL and BPCL (22.5 per cent each), with a 5 per cent stake held by the Delhi Government, is in a sweet spot with rising petrol, diesel and LPG prices driving consumer conversion to gas-based substitutes.
The company now sources the bulk of its gas from GAIL at an administered price of less than $2 per mmbtu, much cheaper than other sources.
However, the agreements with Reliance Industries for KG-gas, and GAIL and BPCL for regassified-LNG to meet incremental gas requirements, are likely to push up costs over the medium term.
While this would lead to pressure on margins, there are a few mitigating factors.
The company's monopoly position results in relative inelasticity in consumer demand. Also, clear economies in using CNG in place of traditional fuels (about 62 per cent cheaper than petrol and 31 per cent cheaper than diesel) may allow leeway in hiking prices.
Healthy financial metrics
IGL has consistently posted healthy financial results, with sales and profits growing at an annual rate of 17.3 per cent and 16.8 per cent during 2005-2009. In 2009, sales grew 20.8 per cent year-on-year to Rs 853 crore while profits declined marginally (1.1 per cent) to Rs 172 crore.
Decline in profits was mainly due to overdrawal charges for gas drawn above allotted limits to meet increased consumer demand.
In response, the company has been able to pass on costs by increasing CNG prices by around 11 per cent in June 2009. In the October-December 2009 quarter, sales and profits grew strongly by around 30 per cent and 54 per cent respectively.
IGL has consistently maintained operating margins in excess of 30 per cent, and net margins above 20 per cent.
While margins may moderate if the blended input costs rise, they will remain at sufficiently healthy levels. Return on equity in excess of 25 per cent and zero debt also buttress the financials.
Low penetration rates, growing vehicular population and regulations that mandate that Delhi's public transport and light commercial vehicles run on CNG, bode well for IGL. The Commonwealth Games to be held in Delhi in October 2010 is expected to boost CNG sales significantly.
Increasing conversion of private vehicles to CNG and introduction of CNG models by auto makers are expected to provide a further fillip to demand. Piped natural gas too is likely to find increasing favour with households and commercial customers due to its cost and operational benefits. IGL plans to ramp up aggressively to meet this demand.
IGL which has expanded its footprint to Noida and Greater Noida, also plans to enter other cities in the national capital region (NCR). With the government planning to roll out city gas networks across the country, IGL as a first mover in this business could benefit.
In the initial two rounds comprising 13 cities, IGL bid for setting up CGD networks in Sonepat, Meerut and Ghaziabad.
While IGL has been trying to make inroads into other towns and cities, it has had to face regulatory hurdles due to guidelines laid down by Petroleum and Natural Gas Regulatory Board (PNGRB). In a series of run-ins with the regulator, IGL's bids for the Sonepat and Meerut CGD network were rejected on grounds of inadequate net worth. The company has gone on appeal against this order.
IGL had also gone to Court over the PNGRB inviting bids for city gas networks in Ghaziabad and Noida, where it claims exclusive rights.
The latest ruling by the Delhi High Court that PNGRB is not authorised to issue licenses for city gas networks strengthens IGL's case and bolsters its prospects in the NCR.
The CGD space is also witnessing increased competition with the entry of major players, including Reliance Industries and GAIL.
The Delhi CGD market, post December 2011, will also be open to competition and the marketing exclusivity given to IGL will end. However, network exclusivity for IGL in Delhi for 25 years and its ready infrastructure pose a high entry barrier to other players.
PNGRB has proposed caps based on return on capital on transmission and network tariffs for CGD entities. However, marketing margin, not being subject to such restrictions, allows IGL leeway in final pricing.
Indian benchmark indices tumbled over 4% during the week for the first time this year on aggressive selling by foreign insitutional investors (FIIs) and due to China`s monetary tightening and US banks regulations. China`s central bank had declared a 50 basis points hike in banks` reserve requirement ratio (RRR) on Monday and President Barack Obama proposed new limits on the size and trading practices of big US banks on Thursday.
Another factor which weighed on the sentiment was soaring food prices continued to fall for the third consecutive week. Food inflation eased to 16.81% for the week ended Jan. 9, 2010 as against 17.28% in the previous week. Index for primary articles increased marginally to 13.93% as against 13.82% for the week ago.
The 30 share index, Sensex lost 694.62 points, or 3.96%, to 16,859.68 for the week ended Jan. 22, 2010. On the other hand, the broad based NSE Nifty plunged 216.2 points, or 4.12%, to 5,036 in the same period.
Mid-cap stocks dropped 266.75 points, or 3.78%, to 6,783.66 in the week. While small-cap shares lost 309.29 points, or 3.45%, to 8,661.17 during the week.
All the BSE sectoral indices settled in the red. The BSE Realty Index was down 8%, as DLF fell 8.5% and Unitech lost 10.4% followed by Capital Goods, which fell 6.51%, Oil & Gas lost 6.06%, HC declined 5.99%, and Power went down 4.53% among major losers in the sectoral indices over the week.
Leaders in 30-share index were Maruti Suzuki India (1.64%), Bharti Airtel (1.31%), Hero Honda Motors (1.18%), Hindustan Unilever (0.59%), and Bharat Heavy Electricals (0.04%) over the week.
On the other hand Larsen & Toubro (10.83%), Jaiprakash Associates (10.64%), D L F (8.45%), Grasim Industries (8.34%), and Tata Power Company (8.27%) were the major losers in the Sensex over the week.