SEL Manufacturing — IPO: Avoid

Investors can avoid the initial public offer of SEL Manufacturing, a producer of yarn, fabrics and knitted garments. At the upper end of the price band, the offer is valued at five-six times its FY-07 consolidated per-share earnings, on an expanded equity base. The valuation is in line with several mid- and small-cap textile stocks, which have undergone a severe de-rating over the past year. Larger players such as Nahar Spinning are available at comparable valuations. Given the uncertainty over the near-term prospects of textile stocks, investors may be better off sticking to the leaders in the space.
Background

SEL has a consolidated revenue base of about Rs 200 crore and derives its income from the export and domestic markets equally. About 40 per cent of its consolidated revenues are accounted for by the garment business. The company exports its garments mainly to Russia and the UAE. These are much smaller markets than the US or the UK, and imports by these countries are likely to be subject to fluctuation.

The company has over the past three years consolidated its outfits under its fold; it recently acquired a garmenting unit. Its previous financial performance is therefore not strictly comparable.

SEL is raising Rs 37 crore from the equity market, which will help fund only 20 per cent of its Rs 185-crore project. The rest will be funded mainly through loans under the technology upgradation fund scheme, which entitles it to an interest subsidy of 5 per cent. A substantial portion of the proceeds will be used to expand its spinning capacities by about 50 per cent. The project will add 1.5 million pieces to its garment capacity (now at six million). A part of the project has been implemented and commenced production. The rest of the capacities are expected to go on stream by August.
Prospects

While SEL has had a presence across segments, it has, so far, not capitalised on the advantages of integration and has, instead, outsourced most of its yarn and fabric requirements. Once the new capacities are installed, it will be able to captively source most of its requirements, which will lead to time and cost savings. SEL’s plans to discontinue its trading activities and polyester business also augurs well for profitability.

That the company’s capacities are set to go on stream shortly is also a positive. However, given the poor macro environment for textile exports, the ability to significantly ramp up utilisation levels will be a challenge. Its existing capacity utilisation of yarn and fabric do not also appear to be at optimum levels. With fresh supply coming in, realisations in the domestic market are likely to remain low. Its plan to further expand its spinning capacities in addition to the current project is also, therefore, a cause for concern, especially as it intends to fund the next phase of its expansion through additional debt.

With cotton prices showing signs of firming up and mounting interest costs, we expect profitability to come under further strain.

Offer details: About 41 lakh shares are on offer at the price band of Rs 80-90. The offer closes on July 31. The lead manager is UTI Bank.