Backward Integration towards processing can improve margins
Vigneshwara Exports (VEL), is engaged in the home textile business of made ups for approximately 18 years. The company claims to be the largest exporter of bed linen to Europe. The company has been buying yarn, gets it converted into processed fabric from weavers / processors, and then makes bedlinen from that with its own cutting and sewing facilities. Now it company proposes a backward integration, whereby it will set up an integrated and modern weaving and processing plant.
The total cost of expansion is around Rs 200 crore, to be funded by debt of Rs 130.75 crore, IPO proceeds in the range of Rs 58 to 67 crore (depending on the issue price), while the balance will be from internal accruals. The plans includes setting up a weaving capacity of 15480 meters per day at a cost of Rs 32 crore, processing capacity of 1,20,000 meters per day at a cost of Rs 90 crore, 5MW gas based power plant with a cost of Rs 12 crore etc.
Strengths
The anti subsidy duty levied by European Union (EU) for many other domestic players were ranging upto 12%, but for VEL it is only 4.4% upto 18th January 2009. Hence, VEL has a competitive edge over other domestic players, in respect of exports to EU.
The abolition of the quota regime has opened new growth avenues for export-oriented companies like VEL.
Due to outsourcing of processing activities, the company is incurring huge wastage / shrinkage. Once it has its own processing facilities, with modernized machines, the company is hopeful that it would considerably reduce the loss due to wastage / shrinkage.
Presently the company outsourcers the weaving and dyeing where the shrinkage is around 18%. But once the company starts in-house production this could come down significantly due to modernized machines.
Derives major portion of the revenues from EU, with Germany being the single largest market. However, the company has started diversifying into other market, with US operations having been started from April 2006.
Weakness
The cash flows from operating activities for the nine months ended December 2005 were negative Rs 3.58 crore as against a positive Rs 3.13 crore in the previous year.
Even after the proposed backward integration, the company would meet only 12% of its fabric requirements in-house.
There has been run up in the performance of the company, just before IPO. For instance, its operating margins have been coming down from 5.0% in FY 2001 to 3.5% in FY 2004, but since then increased to 5% in FY05, which further zoomed to 10.6% for the nine months ended December 2005.
Valuation
On a net profit of Rs 3.70 crore in FY 2005, the company's EPS on post- issue equity works out to Rs 3.5. At an offer price band of Rs 121 to Rs 140, the company seeks a discounting of 35 to 40 times the FY 2005 earnings, which are on a very high side. However, the company's annualised EPS for the nine months ended December 2005 are discounted by mere 12 to 13 times. Welspun India, with dominant position in terry towels (of home textiles segment) currently trades at a PE of around 17 times (its FY 2006 earnings).
The company derived 39% of FY 2005 revenues and 26% of revenues for the nine months ended December 2005 from trading activities, which predominantly were in gems and jewellery. The company has since exited this business, but it was a blessing in disguise as the margins from this segment were in low single digits. Nevertheless, the company's sales turnover may fall consequent to phase out of trading business, unless it scales up textile business significantly. The expansion is likely to be completed in October 2006, from which period, its margins can scale up further and hence the financials can get brighter from the second half of the current fiscal.