Pradip Overseas IPO Analysis

Investors may refrain from subscribing to the Initial Public Offer of Pradip Overseas Ltd (POL), manufacturer of home textiles. Absence of long-term customer contracts, reliance on agencies for export orders and narrow product offering are reasons that dim the prospects of this offer.

The offer may be considered only if priced at a sizeable discount to larger listed players such as Welspun India and Alok Industries (which trade at about 6 times).

The company does not possess any unique aspect that sets it apart from its textile peers. This recommendation does not factor in gains from listing.

Revenue break-up

POL supplies to domestic and international markets, to retailers and distribution agents. The revenue contribution from exports has come down from 52 per cent in FY-07 to 47 per cent in FY-09, and further down to 45 per cent for the nine-month period ended December 09.

Exports, however, are almost entirely indirect, coming through procuring agents of foreign buyers.

Such a lack of direct relationship with the end user may render POL unable to take immediate advantage of any move on part of the end user to consolidate suppliers, or step up sourcing from a single player. POL also does not have long-term contracts with clients, and depends on trade fairs to sell a chunk of exports.

Increasing exposure to the US — from 58 per cent of total exports in 2006-07 to 67 per cent in 2008-09 — spells significant risk.

Risks also stem from POL's concentration on bed linen alone — sheets, pillow cases, quilts, comforters and curtains.

Peer companies in the listed space which make home textiles are far more diversified, supplying bath linen, besides fabric and garments, to spread risk and reduce dependence on a particular segment.

Issue objects

Part of the funds raised will go towards expanding manufacturing capacity by 33 million meters in a new plant in POL's proposed textile Special Economic Zone (SEZ) near Ahmedabad.

The facility is expected to be functional in the first quarter of FY-11, but execution could be dependent on the development of the SEZ itself.There will be benefits stemming from the 110-hectare SEZ. Infrastructure development within the proposed SEZ is yet to take off, and finding occupiers for the zone can be undertaken once all required approvals are in place, and may take a good while yet.

We are not, therefore, factoring revenue flows from the leases in the near term. Issue proceeds will also partly fund working capital.

Financials

POL's sales have more than tripled from FY-07 to FY-09, while net profits have just about doubled.

Part of this growth can be attributed to a lower base effect since the company was a result of restructuring exercise by the original company in 2007.

While this growth may appear healthy, both operating and net margins have been sliding primarily on account of raw material and interest costs.

From a 12.4 per cent operating profit margin in FY-07, FY-09 saw margins dip to 10 per cent, slightly improving to 10.3 per cent for the nine-month period ended December 09.

Cotton, which forms bulk of the raw material, is on a price upswing and margins may thus be further pressurised.

The company does not have long-term supply contracts for procuring raw material. It has a set of weavers from which it procures material, which reduces its own capital expenditure when compared with bigger textile players who have integrated manufacturing processes. But this move could also mean that it has lesser control over costs of raw material.

Interest costs have ballooned from FY-07, moving from 2.4 per cent of sales in FY-07 to close to 4.8 per cent in FY-09, resulting in net margins declining to 3.5 per cent for FY-09, from the 5.5 per cent two years earlier.

Net margins did improve to 4.2 per cent in the nine months ending December 09 as interest costs reduced to about 4 per cent of sales, but that could be on account of banks lowering interest rates.

Proportion of debt under the technology upgradation scheme of the Government, which typically come with low interest and long-term payment period, is minimal. If its SEZ is to take off, it will call for higher capital investment, even as revenues from the SEZ take time to flow in.

Issue details

The offer is open from March 11 to March 15. On offer are 1.06 crore shares. The pricing has not been announced while we went to press. Anand Rathi is the lead manager of the issue.

via BL