Bajaj Corp IPO Review

The Initial Public Offer (IPO) from Bajaj Corp may not be suitable for investors with a conservative risk profile. Though the company occupies a lucrative niche in the hair oil market, it relies heavily just on this one segment to drive growth and profitability. Bajaj Corp plans to diversify by foraying into new products, backed by heavy spending on advertising and promotion with money raised from this IPO.



However, the payoff from such a strategy is by no means certain, given that the FMCG sector is currently grappling with pricing pressures due to high inflation, consumer down-trading and, as a result, moderating growth rates.

Stiff competition

Competition in the hair oil segment is particularly high, with exceptional growth in the segment attracting a host of new players. This offer, however, is priced at a discount to listed FMCG companies operating in similar segments and thus may offer the possibility of short-term gains.

At the upper end of the price band (Rs 630-660), the stock would discount the company's trailing 12-month earnings by 23 times, compared to PEs of 30 and 34 times for Marico Industries and Emami respectively. At Rs 660, Bajaj Corp would trade at a PE of about 22 times its estimated FY11 earnings and about 17 times estimated FY12 earnings, on a fully diluted equity base. Bajaj Corp has managed a substantial scaling up of its operations since it obtained licence to the Bajaj group's established hair oil brands and commenced business in early 2008. The company's net sales over the past three years have grown at a compounded annual growth of 32.4 per cent to Rs 330 crore in 2009-10 while net profits expanded from insignificant levels to over Rs 83.9 crore in the latest fiscal.

The company's growth rates have been well above the average for the FMCG sector mainly on account of its strong presence in hair oils, a fast growing segment within FMCGs. Though the company owns a clutch of vintage brands in the hair oil business — Brahmi Amla Kesh Tel, Jasmine Hair oil and so on — it is Bajaj's light oil offering, Almond Drops, that has been a key driver of both growth and margins.

Light oils

Light hair oils (a category with annual sales estimated at Rs 696 crore) has been one of the most lucrative sub-segments within FMCGs over the past three years, with the category growing at a compounded annual growth of 28 per cent in value over the past three years.

Bajaj Corp with its premium Almond Drops brand has a 47.7 per cent volume share of this segment. A shift in urban consumer preference from the conventional sticky hair oils to light oils, aided by an expanding retail presence for these brands, has enabled substantial growth of this segment and premium pricing for players such as Bajaj.

In addition, the hair oil market is in itself among the faster growing categories within FMCGs, driven by rising rural penetration and a consumer shift from unbranded to branded oils. Bajaj Corp has positioned itself well to benefit from this growth momentum by switching from third party sourcing of these products to own manufacture; it has built up sizeable capacity in tax-free zones, to improve its margin profile.

The high contribution from the premium Almond Drops brand (92 per cent of 2009-10 sales) and the above measures have in fact been the key contributors to Bajaj Corps' high growth rates as well as 30 per cent-plus operating profit margin in 2009-10.

Sustaining both the growth rates and margins over the medium term, however presents a challenge. For one, with Bajaj Corp already occupying a near 50 per cent share of the light oils market, further market share gains are not likely to be easy. Competitors such as Marico, Cavinkare, Dabur and Emami too are looking to this segment, with a slew of new launches to drive growth.

Two, with high food inflation prompting consumers to down-trade in some categories, players in categories such as hair oil are beginning to take price cuts to drive volumes. This, combined with higher advertising outlays, may compress margins in this segment from exceptionally high levels.

New areas, products

Bajaj Corp plans to deal with the above issues by charting forays into (unspecified) new categories and products within the FMCG space. Of the Rs 297 crore proposed to be raised from this offer (at the upper end of the band), Rs 220 crore will be deployed towards advertising and promotional expenses on four new products over the next three years.

Of the balance, Rs 50 crore is proposed to be used in strategic acquisitions, if and when identified. Now, the above plan envisages a near threefold jump in Bajaj Corp's annual ad and promotional spends starting this fiscal (from Rs 27 crore in FY10 to Rs 60.6 crore in FY11).

Sustaining profit growth, despite this spike in cost, will require the company's sales to sustain 30 per cent-plus growth, continued benign trends in raw material costs and no change in the prevailing tax/excise duty rates over the next 2-3 years.

Given the considerable uncertainty in all these variables, the risks of investing in this offer seem to outweigh the payoffs. Investors can wait and watch the success on Bajaj Corp's new product launches before betting on this stock.