Sunday, June 29, 2008
The initial public offer of Birla Cotsyn India may not be suitable for conservative investors. The execution of the project could result in a significant ramp up in revenues and earnings.
While integrated textile mills are the way forward, the lack of a relevant earnings track record and uncertainty regarding the likely offtake for the newly installed capacities, peg up risks.
The scale of the project would impose a significant strain on the balance-sheet in the near term, with the equity base alone expanding seven-fold following the issue.
Investors can wait for further clarity on the execution front and the demand situation before considering investment.
At the upper end of the price band of Rs 15-18, the stock trades at 7 times its annualised FY-08 earnings, not factoring in the expansion in equity base. With textile stocks out of favour, stocks of several larger integrated players are now available at lower valuations in the market.
Birla Cotysn is raising Rs 144 crore through this IPO to partly fund an ambitious expansion project to set up an integrated textile facility from spinning to apparel.
Initially engaged in cotton ginning, the company took over a synthetic spinning facility from a group company in 2006.
This helped revenues and profits jump manifold. As of December 31, 2007, the company had a revenue base of Rs 60 crore and profits of about Rs 2.5 crore. Given the change in business, the financial track record upto August 2006 is largely irrelevant.
This project, conferred “mega project” status by the Maharashtra Government, will be executed in three phases.
The first phase involves setting up of a 36,000-spindle cotton yarn facility and modernisation of the existing synthetic yarn facility. Full capacities will go on stream by December 2008. The second phase involves setting up an open-end spinning facility and will be fully operational shortly.
The third phase involves setting up of a fabric processing facility capable of processing 50,000 metres of fabric a day. This is expected to go on stream by July 2009. Besides this, the company also plans to foray into apparel manufacturing and retail.
Starting from scratch
The expansion is on an ambitious scale and could well change the nature of the business, if it successfully makes the transition from a cotton ginner to a fully integrated textile player.
The company’s existing facilities operate on a significantly smaller scale and the company is being built virtually from scratch at this point.
Fully integrated facilities with capabilities to market a wide variety of yarn — from polyester and blended yarn to pure cotton yarn — could stand the company in good stead over the long term. Successful execution of the project can result in a manifold jump in revenues and profits.
However, in a fragmented industry with low differentiation and uncertain demand conditions in the export market, significant offtake is not guaranteed.
The project could also pose considerable strain on the company’s financials. High interest and depreciation costs in the near term could curtail the company’s ability to service a substantially higher equity base.
A sustained rise in cotton prices (prices have risen nearly 40 per cent in the last four months) will not augur well for margins in the yarn segment either.
The offer opens on June 30 and closes on July 4. The lead manager is Allbank Finance.
Increasing spends on oil exploration and production activities, driven by the surge in global crude oil prices, have put Aban Offshore, the country’s largest offshore oil rig service provider, in a sweet spot. Investors looking to play the high oil price scenario can consider investments in the stock at current market price. Aban’s large and relatively young fleet with an optimal mix of short- and medium-term rig contracts lend it strong revenue visibility over the medium term.
Besides, the current market valuation also makes a compelling case for fresh investments in the stock. At the current price of Rs 2992, Aban trades at about nine times its likely FY-09 per share earnings on a consolidated basis.
Investors, nevertheless, may need to temper their expectations on the returns front given the volatility in the broader market.
Strong demand environment
The surging oil prices combined with the tight supply of rigs worldwide, are likely to keep the demand and, hence, rentals for oil rigs upbeat over the next year. Aban Offshore, with a fleet size of over 20 assets, appears well-placed to reap the benefits of this strengthening demand trends in the offshore industry. Besides, with a pool of assets that is the largest among the Indian offshore service providers and even compares favourably against some of its global peers, Aban appears the best investment bet in the sector. While there are concerns that rising charter prices for oil rigs may begin to taper as new capacities hit the market this year, Aban may remain relatively shielded from any such moderation in rig rentals. This is because it has a healthy mix of medium- and short-term contracts for its rigs.
While the short-term contracts may suffer from the softening trends in rentals the company’s medium-term contracts that have been sealed at attractive rates would continue to rake in sufficient cash flows over the next few years. That the earnings visibility that Aban enjoys is mainly attributable to the medium-term horizon of its contracts only reiterates this.
Addition of rigs
The company proposes to further add to its existing rig capacity; four jack-up oil rigs are scheduled to be delivered to Aban over the next year or two. Besides that, Aban recently added semi- submersible rig “Bulford Dolphin” for a consideration of $211 million. Renamed ‘Aban Pearl’, this rig is currently under repair and is expected to be ready for use in a couple of months.
With the demand for deep offshore drilling expected to remain high, this rig is likely to get contracted at competitive rates. Aban’s other two drill ships — Aban Abraham and Deep Venture (50 per cent stake) — which have been deployed at attractive rates also lends credence to the firm rental trends in deep-sea offshore drilling.
The company had in 2006-07 acquired the Norway-based Sinvest ASA at about $2.2 billion. While that had vaulted Aban into the league of the top ten offshore rig players in the global arena, thanks to Sinvest’s global clientele and large pool of assets, the acquisition also burdened the company with a lot of debt.
Aban proposes to retire a significant chunk of this debt by listing its Singapore subsidiary. The refinancing of its debt structure by listing the subsidiary would help prop up Aban’s earnings. However, the same has been put on the backburner, considering the waning appetite for primary market offers globally.
Till such time, the debt burden would continue to eclipse the company’s earnings growth over the next two-three years. This, however, is no cause for immediate concern since Aban’s assets (both the current ones and the new assets that are likely to become operational in the current fiscal) may generate sufficient cash flows to service its debt.
On a standalone basis, the company’s overall performance for the year ended March 2008 continued to be on a strong footing. Aban reported a 31 per cent increase in revenues and 58 per cent growth in profit. Operating profit margins expanded by two percentage points to over 52 per cent.
However, on a quarterly basis, Aban’s profits dipped by about 29 per cent due to higher costs and interest expenses. The consolidated numbers of the company, however, are still awaited.
In terms of risk, any delay in either the delivery schedule of rigs or in deploying them, significant drop in rig rentals and lower-than-expected utilisation rates for the rigs pose a downside risk to Aban’s business.
The current valuations of Mundra Port and Special Economic Zone (Mundra) provides a good opportunity for investors to take exposure to an infrastructure segment that holds huge potential for development.
Mundra, with the unique advantage of a special economic zone in its vicinity, has not only clocked healthy cargo volumes in FY-2008 but also made good progress in its effort to offer port-related services that could fast track earnings growth.
The stock has fallen 60 per cent in 2008 to Rs 495 now trades at 19 times its expected per share earnings for FY-10. The valuation is attractive, given the huge business potential in the port sector and the absence of a ports business in the listed space. Invest with at least a three-year perspective and consider adding the stock in small lots, to take advantage of any gyration in the price as a result of broad market volatility.
Stability in revenue flows
Long term contracts with users have helped Mundra gain some assurance in the cargo volumes handled by the port. Over 50 per cent of Mundra Port’s projected volume for coal is expected to flow from agreements with Adani Power and Tata Power — two 4,000 MW imported coal-based power plants to be set up in the region. More coal volume can be expected from the power plants that are expected to come up in the western region. Coal, which accounts for about 14 per cent of the current cargo mix, can therefore be expected to contribute a higher proportion.
Mundra has also entered into contracts with IOC and HPCL for providing single-point mooring facility for crude oil transport. More recently, it has also inked an agreement with Maruti Suzuki for setting up a dedicated car export terminal with an initial capacity of 2,50,000 cars with further capacity increase in the offing.
These contracts not only provide stability to revenues over the long term but also aid in better planning of surplus capacity that can be handled by the port for other customers.
Mundra, a non-major port, is blessed with a deep natural draft and large waterfront for future development.
The inability of major ports in the region to handle high traffic has also benefited Mundra, given its locational advantage. However, with ports such as JNPT and Mumbai Port Trust expanding their container terminals, Mundra could face the risk of pricing pressure.
This potential threat appears to have prompted Mundra to offer port-related value-added services as a service differentiator in relation to other ports in the region. A part of the IPO proceeds has already been invested in subsidiaries (which are now wholly-owned) to develop container road business and inland container depots. The rail-linked container depot business has acquired land in 14 locations for this purpose and also secured notification for one depot. The logistics subsidiary (Adani Logistics) has two rakes in operation with the management planning to take the number to 20 by FY-2009.
We believe these services could provide strong support to Mundra’s core port operations, thus enabling the company to offer integrated services under one head.
While the current business is likely to provide sufficient volume for existing players, the real challenge could be when other private ports with equally well-planned integrated services also come into operation.
Upfront income from SEZ
In line with a change in its accounting policy, Mundra has started recognising non-refundable upfront premium against lease/sub-lease of land in the year of agreement as against the earlier policy of accounting over the lease period.
In the current year, it recognised Rs 52 crore of such income from 155 acres of land. As a result, income from the SEZ segment has seen a jump. This also means that over the next two-three years when the company would continue to enter into fresh agreements for lease, income by way of such premium would add to the revenues.
The over-6,700 acres of notified SEZ area is likely to provide robust lease income given the logistics advantage and tax concessions that port based industries would enjoy by setting up units in the region.
This would, in turn, feed traffic for the port. However, the lease income would come from industries and not residential/commercial projects. Hence the realisations could be lower than other typical real-estate projects.
For the year ended FY 2008, Mundra’s sales grew 41 per cent to Rs 817 crore. Net profit however grew by only 14 per cent. The muted growth in profits was a result of increase in the deferred tax component (the deferred tax holiday reversal period was reduced from 15 years to 10 years as the company availed benefit under Sec 80IAB).
Operating profit margins, however, surged by 11 percentage points to 65 per cent. A better product mix from crude and container volume aided the margin improvement. Crude oil volumes, for instance, grew 97 per cent in FY 2008 on a Y-o-Y basis.