IPO Analysis - Jubilant Foodworks

Conservative investors can avoid subscribing to the initial public offer of Jubilant Foodworks (JFL), the operator of the national pizza chain, Domino's Pizza. Though the business has managed strong growth rates so far, the asking price for the offer is stiff.

The issue is priced within a band of Rs 135-145, with annualised FY-10 per-share earnings at Rs 4.02, resulting in a price-earnings of 34 to 36 times on a post-issue basis. Globally comparable food retailers such as McDonalds, Papa John International's and Dominos Pizza ( the parent company) are available at PE multiples of 13 to 15.

High valuations apart, the issue is also primarily an exit route for strategic investors with just 20 per cent of funds raised actually accruing to the company. This creates uncertainty about funding for the company's future expansion plans, which are key to its growth prospects. Accumulated losses, high interest costs (should the company take recourse to further debt) and potential hikes in raw material costs are other factors that dim the prospects of this offer.

Business Strength

JFL runs the Dominos Pizza chain in India through an exclusive franchise agreement with Dominos International (DI). Recently renewed, this agreement will continue for another 15 years. JFL currently operates 286 outlets, across a geography of 59 cities. JFL plans to open about 15 more outlets by end-FY10, and is required to open at least 25 stores a year after that per its agreement.

DI holds sway in the operations of the business. tore openings and franchise agreements can be undertaken after obtaining certificates in prescribed formats. Major advertising and promotional campaigns require review by DI; suppliers need to be designated by DI or approved by it. JFL's subsidiary profitably operates five outlets in Sri Lanka, and JFL has the right to open Dominos outlets in Nepal and Bangladesh as per the franchise agreement. It has, however, no outlets in either country.

A good portion of new stores are slated for smaller towns and cities where demand is beginning to take off as income levels and spending habits pick up.

JFL has taken steps to expand the Dominos menu, adding variety as well as distinguishing items such as its choco-lava cake. Though pricing may not be given the ‘affordable' tag, it is below that of closest competitor, Pizza Hut. More importantly, Dominos commands sizeable brand recall and majority market share in the pizza home delivery segment.

Financials

Growth in terms of volume and sales has been healthy. From an annual 8.99 million pizzas sold in FY-07, volumes have jumped to 21.74 million in FY-09. Sales, therefore, recorded a 42 per cent three-year compounded annual growth, while net profits grew 49 per cent.

A centralised sourcing and distribution system in four centres across the country, combined with back-end facilities in smaller cities, has largely aided operating margins. Dedicated transport fleet and cold-chain systems allow efficient distribution; inventory turnover period is less than a week. Operating margin has been at 13 per cent in FY-07 to FY-09, it further improved to 16 per cent in the first half of FY-10 on account of controls in manufacturing costs.

Of the Rs 58 crore of the offer that goes to JFL, Rs 35 crore is marked for repayment of debt. With a pre-issue debt-equity ratio of 2.4 times (Sept '09), repayment will help bring this ratio down to 1.2 times, post-issue. Interest costs have hitherto been the biggest dampener on margins, cutting net profit margins to 4 per cent in FY-08 and further to 2 per cent in FY-09. In this backdrop, the company is unlikely to use capital raised to fund expansion of outlets. It has previously bankrolled expansion through a combination of internal accruals and debt.

Hurdles

Despite the positive picture presented by JFL, there are a good many risks. For one, with a good portion of the offer proceeds not flowing into the company, should debt be taken on in the future to fund expansion, it could reduce margins and constrain cash flows.

Two, JFL has an accumulated loss of Rs 62.3 crore as of September 2009, against average yearly profits of about Rs 6 crore, , precluding dividend payouts in initial years after listing.. Once losses are written off, the company would face increased taxes, squeezing net margins.

Three, going forward, inflationary pressures could lead to raw material cost increases. Margins, thus, could slip, else JFL may increase retail prices of its products, which could hurt sales.

Current assets, including cash, also do not cover dues to sundry creditors. Of the capital raised that accrues to JFL, almost 40 per cent goes towards issue expenses and general corporate purposes which may be varied and difficult to ascertain.

Dominos Pizza, while enjoying brand equity in the door-delivery segment, still faces tough competition from dine-in eateries, other national lower-priced fast-food chains such as McDonalds, KFC and so on, besides small, local eateries.

These factors, therefore, argue against paying premium valuations for this offer. It may thus be avoided, but price corrections post-listing bringing about more reasonable valuations may be used to enter what is an attractive business with no other listed competitor.

Offer details

The issue is open from January 16 to 18. On offer are 22,670,447 shares, of which 4,000,000 shares are a fresh issue. Kotak Mahindra is the lead manager.