Steep valuations, operational challenges and execution risk fail to lend credibility to Ess Dee Aluminium's initial public offering.
Operates in a niche market
Proposes to augment capacity by five times
Dependence on single supplier and few customers
Valued at 21-24 times forward earnings
Investors may consider giving the initial public offer (IPO) from Ess Dee Aluminium a miss, as challenges appear to outweigh the opportunities over the medium term. Steep valuations, operational challenges and project execution risks suggest a cautious stance on the pubic offer.
Player in a niche market
Ess Dee Aluminium makes aluminium foil-based packaging products, mainly for the pharmaceutical packaging industry. Fast moving consumer goods (FMCGs) are the largest consumers for the packaging industry. The pharmaceutical packaging segment remains largely untapped; several innovations are taking place in packaging, especially in the over-the-counter (OTC) segment. For Ess Dee, this presents a good opportunity.
The company has facilities in Daman, Goa, Thane and Baddi (Himachal Pradesh). As a good number of pharmaceutical units operate out of these places, proximity is likely to help the company generate more sales and keep logistics cost low.
Through the proceeds of the issue, Ess Dee proposes to fund its expansion plan. The company plans to augment its foil-rolling capacity from 3,600 million tonnes per annum (MTPA) to 18,000 MTPA. It is operates at a capacity utilisation rate of about 53 per cent at its Goa unit and about 65 per cent in Daman. While there is plenty of scope to improve the current utilisation rate, the additional capacities, when they are likely to fully go on stream in mid 2007-08, are likely to exert some pressure on supply.
Second, the size of the project appears reasonably large compared to the size of existing operations. The project involves an outlay of about Rs 115 crore. This is about 6.5 times its net worth as on March 31 and five times its current level of capacity. Hence, the ability of the management to see through expansion of this scale remains to be proved.
Operational blocks
The company imports 100 per cent of its requirement of aluminium sheets, which constitute the largest component of its raw material cost. The entire requirement is sourced from a single supplier in Bahrain. Hence, the sourcing and exchange rate risks are relatively high. Being a small player, the company may find it difficult to pass on the increase in cost to its customers.
For the proposed project, it intends to import second-hand machinery to the tune of 40 per cent of the total cost of plant and machinery. As they are not covered by warranties and generally score low on efficiency, the company may end up paying more on operating costs.
Sales concentration risk
The high dependence of Ess Dee on its subsidiary for selling its products is also a key risk. It sells about 57 per cent of its production to its Flex Art Foil (a 100 per cent subsidiary engaged in conversion of printers stock into printing designs), which sells printing designs to its customers. Ess Dee's five other customers account for about 28 per cent of sales volume.
Steep valuation
As Ess Dee operates in a niche area, there are no listed peers in this space that it can be compared with. However, for the purpose of relative valuation, we take Bilcare and Gujarat Foils as its peers. Though both cater to the needs of pharmaceutical packaging industry, Bilcare offers a host of solutions and Gujarat Foils supplies aluminium foils to the packaging industry as a whole.
Ess Dee has fixed a price band of Rs 200 to Rs 225 per share. This works out to a multiple of 21 times its likely 2006-07 earnings and 24 times on the higher end. This appears steep compared to its peers who command a multiple of about 15 times forward earnings. Further, the equity overhang post expansion is likely to dampen valuations.
Offer details
On offer are 69.6 lakh shares at a price to be decided through a 100 per cent book-built process. The offer opens on December 4 and closes on December 8. UTI Securities and Enam Financial Consultants are lead managers to the issue.