Birla Cotsyn IPO Analysis

Birla Cotsyn (india) is a constituent of the Yash Birla group (YBG) and was originally incorporated in 1941 by R. D. Birla under the name and style of M/s Jamod Ginning Company Private Limited. On conversion to public limited company the name of the company has been modified to Birla Cotsyn (India) (BCIL) with effect from May 2006. On 9th December 2006 Yash Birla Group signed a joint venture agreement with P.B. Bhardwaj group (PBG) to combine their resources and expertise and carry on the business of manufacturing, marketing and distribution of the products in India as well as other places. As per the JV the total promoter’s equity of BCIL would be taken up in the ratio of 50:50 between the PBG and YBG.

The company has been engaged in cotton ginning, pressing and oil expelling and after the acquisition of assets of Khamgaon Syntex, a wholly owned subsidiary of Zenith, one of the group companies of YBG with a spindle capacity of 18,304 spindles with effect from August 2006, has entered into the manufacturing of synthetic yarn.

The company is coming with an IPO to part finance the expansion of an integrated textile project at Khamgaon and Malkapur at an estimated cost of Rs 289.19 crore, setting up a garment manufacturing plant at Rs 25.21 crore and establishing retail outlets at cost of Rs 5.80 crore.

The company plans to implement the integrated textile project in three phases. During Phase I the spindle capacity of 18,304 spindles of Khamgaon Syntex is envisaged to be enhanced to 19,040 spindles along with the modernization and upgradation of facilities with part replacement of existing machinery and setting up of a 36,000 cotton spindle yarn manufacturing unit at Malkapur. During Phase II the company plans to manufacture open end rotor based cotton yarn with an installed capacity of 1,728 rotors at Khamgaon and weaving of grey fabric with 114 looms at Malkapur. During phase III the company plans to set up a dyeing and processing unit for manufacturing of finished clothes with an installed capacity of 50,000 meters per day. The expansion plan under phase I is estimated a cost of Rs 131.34 crore and subsequent phase II and phase III together has been estimated at Rs 157.85 crore.

In addition the company plans to forward integrate and set up facilities for garment and apparel manufacturing and also to establish retail outlets all over the country for marketing of the products at an estimated cost of Rs 31.01 crore.

The government of Maharashtra has decided to offer the status of ‘Mega project’ to the proposed project. Accordingly the company shall receive benefits of electricity duty exemption for a period of seven years from the date of the commencement of the project, 100% exemption from payment of stamp duty, industrial promotion subsidy equivalent to 100% of the eligible investments made and 75% reimbursement of expenditure incurred on account of employer’s contribution towards ESI and EPF for a period of 5 years but limited to 25% of the fixed capital investment.

Strengths

1. The company is into complete forward integration, i.e. right from ginning and pressing upto manufacture of fabrics, readymade garments and also to opening of retail outlets of its own which is expected to give considerable savings on margins.
2. Khamgaon is the centre of cotton production and there are about 35 ginning units in and around this place. Hence good quality raw materials like cotton are easily available.

Weaknesses

1. The textile industry is highly competitive and fragmented. With abolition of quota system from January 1, 2005 many companies have ramped up their capacities increasing competition among players in the textile industry.
2. The company is having negative operating cash flows for the nine months ended December 2007.
3. Financial and stock market track record of Yash Birla group companies is not encouraging.

Valuations

At the price band of Rs 15 - Rs 18, the annualised EPS for the nine months ended December 2007 on post-issue equity works out to Rs 0.3- Rs 0.4 and PE works out to 49.1-50.3. TTM PE of Textiles-spinning/Cotton/Blending Yarn sector is 10.9. However once the company’s plans for forward integration in garment and apparel manufacturing and setting up of retail outlets are implemented successfully, it may get higher P/E than 10.

Birla Cotsyn India

The initial public offer of Birla Cotsyn India may not be suitable for conservative investors. The execution of the project could result in a significant ramp up in revenues and earnings.

While integrated textile mills are the way forward, the lack of a relevant earnings track record and uncertainty regarding the likely offtake for the newly installed capacities, peg up risks.

The scale of the project would impose a significant strain on the balance-sheet in the near term, with the equity base alone expanding seven-fold following the issue.

Investors can wait for further clarity on the execution front and the demand situation before considering investment.

At the upper end of the price band of Rs 15-18, the stock trades at 7 times its annualised FY-08 earnings, not factoring in the expansion in equity base. With textile stocks out of favour, stocks of several larger integrated players are now available at lower valuations in the market.
Offer background

Birla Cotysn is raising Rs 144 crore through this IPO to partly fund an ambitious expansion project to set up an integrated textile facility from spinning to apparel.

Initially engaged in cotton ginning, the company took over a synthetic spinning facility from a group company in 2006.

This helped revenues and profits jump manifold. As of December 31, 2007, the company had a revenue base of Rs 60 crore and profits of about Rs 2.5 crore. Given the change in business, the financial track record upto August 2006 is largely irrelevant.

This project, conferred “mega project” status by the Maharashtra Government, will be executed in three phases.

The first phase involves setting up of a 36,000-spindle cotton yarn facility and modernisation of the existing synthetic yarn facility. Full capacities will go on stream by December 2008. The second phase involves setting up an open-end spinning facility and will be fully operational shortly.

The third phase involves setting up of a fabric processing facility capable of processing 50,000 metres of fabric a day. This is expected to go on stream by July 2009. Besides this, the company also plans to foray into apparel manufacturing and retail.
Starting from scratch

The expansion is on an ambitious scale and could well change the nature of the business, if it successfully makes the transition from a cotton ginner to a fully integrated textile player.

The company’s existing facilities operate on a significantly smaller scale and the company is being built virtually from scratch at this point.

Fully integrated facilities with capabilities to market a wide variety of yarn — from polyester and blended yarn to pure cotton yarn — could stand the company in good stead over the long term. Successful execution of the project can result in a manifold jump in revenues and profits.

However, in a fragmented industry with low differentiation and uncertain demand conditions in the export market, significant offtake is not guaranteed.

The project could also pose considerable strain on the company’s financials. High interest and depreciation costs in the near term could curtail the company’s ability to service a substantially higher equity base.

A sustained rise in cotton prices (prices have risen nearly 40 per cent in the last four months) will not augur well for margins in the yarn segment either.

The offer opens on June 30 and closes on July 4. The lead manager is Allbank Finance.