Raj Oil Mills

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.
Execution risks

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.