Jindal Cotex IPO - Avoid

Investors can avoid subscribing to the initial public offer of Jindal Cotex. Though the proposed projects have the potential to improve the company’s product mix, expand profit margins and reduce its exposure to the commodity cycle, the execution risks associated with the projects and the lack of experience in the proposed businesses make investing in the stock risky at this stage.

The offer price discounts the company’s 2008-09 earnings by about 20-21 times at the two ends of the price band, considering the pre-offer equity base.

As the equity base is set to double post-offer, payoffs from the proposed projects will hold the key to valuations. Though the company does not have strict comparables for its new projects, textile industry peers currently trade at four to nine times earnings.
Business overview

The Jindal Cotex group currently produces polyester, polyester viscose, polyester cotton and acrylic with a capacity of about 24,000 spindles of manmade fibres. On a small base, sales (mainly knitted cloth, acrylic yarn and acrylic tops) grew by 27 per cent annualised over the three years to 2008-09, while profits grew 76 per cent.

The company managed a 86-89 per cent utilisation on existing capacities, reasonable for the sector. The company’s reliance mainly on domestic markets rather than exports (13 per cent of sales) could be an advantage at a time when global consumer spending is under stress, even as domestic retailers are reporting improving footfalls and sales.

The company’s operating profit margins have hovered in the 8-9 per cent band in recent years, dipping to 7.3 per cent for 2008-09, probably on account of higher input costs linked to oil prices. The polyester market is a highly commoditised one with very little pricing power due to heavy fragmentation.
Offer details

The offer proceeds (Rs 93 crore at higher end of price band) will be used mainly to part-fund setting up of a new cotton yarn, dyeing and garments facility and an investment of Rs 81 crore into subsidiaries — Jindal Medicot and Jindal Specialty Textiles.

First, the company plans to, in two phases, set up production facilities for yarn dyeing, garment production (3000 t-shirts a day) and yarn production (50,000 spindles, post expansion); these projects may be of a sufficient scale to be viable; but may not offer much scope for margin improvement.

On the other hand, the foray into medical textiles and specialty textiles may help expand Jindal Cotex’s margins sharply (potentially in the 10-15 per cent range, against 8-9 per cent for the existing business). But the projects are in a nascent stage, with orders for nearly three-fourths of the plant and machinery yet to be placed. The dates of commissioning range from March 2010 to October 2010.

Both the forays into medical textiles and specialty textiles appear to hold good potential. Jindal Medicot plans to produce medical textile products which include crepe bandage, stretch bandage, and absorbent cotton wool. Comber Noir, from the company’s spinning arm, is a major raw material.

Demand for these products is consistent and currently met mainly by local suppliers, with estimates putting the market size at Rs 1,800 crore. The margins are likely to be better than those of the existing polyester unit.

The project to be set up in Himachal Pradesh, which had been delayed on account of land acquisition, is expected to commence production in March 2010.

Jindal Speciality Textiles, the other subsidiary, is to produce 60 million square meters of a variety of coated fibres including materials for banners (currently largely imported), boats, trucks, tents etc. This segment, again, is a fragmented one with SRF having a national presence and several small regional players.

However, the potential for import substitution and the higher margins make it reasonably attractive. This plant is expected to begin commercial production in October 2010, a seven-month delay from the intended start date.

While the company is entering potentially lucrative businesses, there are risks relating to the execution of the projects. In addition, value-added products such as coated fibres, T-shirts and medical textiles are far less commoditised than the company’s existing portfolio and may require materially different pricing, marketing and distribution strategies.

The company proposes to borrow close to Rs 250 crore to finance the new projects in addition to the Rs 93 crore in equity from the IPO.

With higher levels of gearing, execution needs to be immaculate and sales even more impressive. Given the execution risks and the relatively low margin of safety in the offer price, it may be prudent to wait and watch how this story pans out before looking at equity participation.

via BL