Gokul Refoils and Solvents IPO

Investors can consider subscribing to the IPO from Gokul Refoils and Solvents in the price band of Rs 175-195, at the cut-off price. The asking price for the offer appears reasonable in relation to listed peers as well as the company’s own financials and growth prospects.

At Rs 195, Gokul Refoils would be valued at a price-earnings multiple of about eight times its estimated FY08 earnings and at about six times FY09 earnings, using conservative assumptions, on the diluted equity base. Solvent extraction and edible oil players of a similar or much larger size such as Agro-Tech Foods and Ruchi Soya trade at valuations of 11-15 times current earnings.

The company’s expansion projects are likely to scale up contributions from the current fiscal. However, the offer is suitable only for investors with a high risk appetite, as the edible oils business is characterised by thin margins and is exposed to commodity price fluctuations as well as policy changes.
Business overview

Gokul Refoils is a marketer of edible oils such as palmolein, soyabean oil and cottonseed oil, mainly in bulk form, to domestic retailers. It also exports de-oiled cake, a by-product of oil extraction and is present in the vanaspati business.

The company’s present capacities include 1,280 tonnes per day (tpd) of seed processing and solvent extraction capacity and 1,200 tpd of oil refining capacity. Partly financed by the offer proceeds, these will be stepped up to 2,780 tpd and 1,500 tpd, respectively.

In the three years to 2007-08, Gokul Refoils managed a 21 per cent annualised growth in sales with a higher 46 per cent growth in profit. Operating profit margins, though thin, have improved from 3.5 per cent to over 6 per cent in this period.

Trading activities, shifts in the product mix, and a gradual increase in retail sales (38 per cent of sales in 2007-08), relative to bulk sales, appear to have aided margin expansion. However, given that the margins managed by the peer group hover in the 2-3 per cent range, the sustainability of current OPMs remains to be seen.
Expansion plans

In this context, the recent capacity expansion, apart from building scale (crucial in this volume-driven business) may aid margins by improving utilisation. The soybean crushing plant is a backward integration move. The addition of refining capacity in proximity to the Western ports will provide the flexibility to source imported crude oil, to tide over any shortfalls in domestic availability of oilseed. Plans to set up a Singapore subsidiary may help sourcing and open up export avenues for de-oiled cake.
Branded foray risky

Expansion plans apart, Gokul Refoils plans to enhance its retail presence by establishing a larger distribution network and investing in brand-building efforts. Though the company claims a distribution presence in 19 States and has managed to ramp up proportion of retail sales from 18 to 37 per cent in two years, establishing a foothold in the branded edible oil market on a national scale may prove extremely challenging.

This business is highly competitive with strong regional brands as well as established commodity trading houses in the fray; Gokul may find it difficult to sustain the promotional spends required by foray over several years. The branded edible oil market is extremely price-sensitive and requires dynamic pricing to build as well as retain market shares. Changes in tariff values or duty structure by the government also have the potential to impact margins.

At this juncture, the sharp increase in global edible oil prices and the firm outlook for the same do pose risks to edible oil market and could result in slower growth rates.

However, as the category tends to be quite income elastic, substitution, rather than low offtake, would be the key risk for individual players. In this respect, Gokul’s flexibility to alter its product mix between various edible oils should help reduce substitution risks to some extent.