Innoventive Industries IPO Analysis

Innoventive Industries (IIL) is a multiproduct engineering company currently engaged in the manufacturing and sale of precision steel tubes, tubular components, auto components, machined components and other steel products. It caters to diversified industries such as auto, farm equipments, general engineering and oil & gas in both domestic and export market with over 475 customers world wide. Its major customers include Bajaj Auto, BHEL, Thermax, John Deere India, Sundram Industries, Gabriel India and Alstom Projects.

IIL is among the leading manufacturers of ERW/CEW tubes in India. It is approved tube supplier for domestic OEMs (Bajaj Auto is the largest customer with 21.7% contribution to company's revenue in FY 10) and caters to auto ancillary companies in and around Pune.



Currently the company has five manufacturing plants in Pune and one in Silvassa. The total manufacturing capacity of electric resistance welded tube (ERW tube) is 64,800 mt and of cold drawn electric welded tubes (CEW tubes) is 23,265 my in FY 2010. Besides ERW and CEW tubes, the company manufacturers tubular components, membrane strips and auto components. Through its subsidiaries the company manufacturers CR coils, machined components, forgings, laminates, stampings and steel wire. The raw materials are HR and CR coils that are sourced through Essar Steel Limited and Ispat Industries

Innoventive Industries was originally incorporated as Arihant Domestic Appliances and engaged in manufacture and assembly of mixer, grinder, emergency lights and other domestic appliances. Chandu Chavan, the current promoter, acquired majority stake in Arihant Domestic Appliances in 2002 and the company subsequently in 2006 acquired the precision tubes business of Phoenix Enterprises, a promoter (Chandu Chavan) group company. In 2007, the company forward integrated by investing in Seven Star Electrodes, a company manufacturing auto components. Further, in the same year, it ventured into a new line of business by acquiring 26% equity stakes in Sankalp Forgings a company manufacturing oil well drilling couplings and other ancillary activities. Investments in Arihant Steeland Metal Wires, a steel wire manufacturing concern, further provided avenues for new line of business. To achieve backward integration, it acquired 51% of the equity of Saicon Steels, a company involved in the conversion of hot rolled coils to cold rolled coils. In 2008 the equity stake in Sankalp Forgings was raised to 51% (from 26% earlier).

The company has five subsidiaries – Saicon, Sankalp, Arihant Auto Components, Arihant Steel and Metal Wires, and Seven Star Electrodes. Saicon, where Innoventive holds 51% stake, manufactures CR coils and lamination from steel coils. Sankalp, where Innoventive holds 51% stake, manufactures fully machined ready to assemble parts such as machined tubing, coupling, casing coupling etc used in oil rigs and oil wells. Arihant Steel and Metal Wires, a wholly-owned subsidiary, manufactures steel wires from steel scraps of the group's various plants. Arihant Auto Components Private Limited, a wholly-owned subsidiary, carries out machining of tubes, fabrication of tubes and tubular assemblies. Seven Star Electrodes, a wholly-owned subsidiary, manufactures and deals in auto parts and other ancillary products.

The company has embarked on augmenting its CEW plant capacity at Pimple Jagtap, Pune from 23,265 mt to 28,785 mt. It also proposes to expand the capacity of CEW plant further to 76,701 mt by 2012. It is also currently expanding its ERW capacity by 20200 mt through de-bottlenecking. Augmenting CEW plant capacity is inline with the strategy of the company to focus on products, which involves higher realisation and profits such as CEW tubes and value added products such as strips and machined components. Given lower competition than ERW pipes and widening of usage into newer areas the demand and profitability of CEW tubes will be higher than ERW tubes.

Of the total offer size of Rs 219.58 crore, the company intends to use about Rs 163.06 crore to fund its CEW tube capacity expansion; Rs 50 crore for repayment of term loan and balance for general corporate purpose. The offer is priced at Rs 117-120 for each share of Rs 10 face value. On February 2011, a pre-IPO placement of 26, 00,000 equity shares at a price of Rs 117 per equity shares aggregating to Rs 30.42 crore was made to Standard Chartered Private Equity (Mauritius) II Limited.

Strengths

Given the product basket comprising ERW, CEW tubes, membrane strips, automotive components, machined products and other steel products the company caters to diverse user industries such as auto, power, oil & gas, general engineering and farm equipments. The company has successfully reduced its high reliance on the auto sector and the share of the same to the top line now stands at 47.7% (as on FY 2010 end) compared to earlier 62.5% (as on FY 2008). This was done without compromising on margin. On the other hand, the share of oil & gas industry sales in total revenue has increased from 1.4% in FY 08 to 10.4% in FY 2010. Moreover, the shifts and increased volumes of high value products such as CEW tubes and membrane strips have improved the consolidated operating margin of the company from 10.8% in FY 2008 to 26.4% in FY 2010.

The company has invented the use of cold pilgering process to make CEW tubes from ERW tubes without draw bench. As per the study conducted by the Indian Institute of Technology, Mumbai, this process saves energy costs up to 80%, minimizes usage of chemicals and reduces wastage of steel by 7% without compromising on the quality of the product. So far, this product has been well accepted by 93 customers worldwide and is sold under ARIDOM brand through long-term arrangement with Salem Steel North America, LLC. The company has applied for process and product patent rights for this with 33 countries and expects approval by FY 2012. This process already provides pricing advantage to the company on CEW tubes, acquiring the patent rights over the same would enhance the company's business and, thus, profitability.

Membrane strips, made from steel coils and used in boilers and heat exchangers, are largely imported in India due to technical complexities. The company has developed in-house capacity to produce these membrane strips working as import substitute. This has been accepted well as the company is the largest domestic supplier of membrane panel strips to companies like BHEL, Thermax Limited, Alstom Projects India Limited, Cethar Vessels Limited. It provides savings for power generation equipment manufacturers such as Thermax and BHEL, while its high margin product for Innoventive.

Currently the company enjoys various government benefits under the mega project status. The plant at Pimple Jagtap has been granted mega project status by the government of Maharashtra. This entails several benefits to the plant such as electricity duty exemption for the period of seven years till November 2015, 100% exemption from payment of stamp duty and industrial promotion subsidy (IPS) equivalent to 75% of the eligible investment to be made from March 28, 2007. Also the company is availing interest free sales tax deferral loan from the government due to its presence in backward area. The repayment of sales tax deferral loan will start from FY 2014 onwards.

Weaknesses

Currently the CEW plant operates at a capacity utilisation of 44.6% (as on FY 2010). And this is largely on account of additional capacity coming on stream in FY 2010 on account of expansion of available capacity of CEW plant from 7,920 mt in FY 2008 to 19,759 mt. Since the stabilization of operation takes at least 2-3 years the aggressive augmentation of capacity of CEW plant even before attaining stabilization of current expanded unit and attaining full capacity utilization is a cause of concern.

The precision tubes business is highly working capital intensive in nature and involves delays due to time taken in approvals of OEMs.

As on February 28, 2011, it had a secured loan of Rs 385.60 crore and unsecured loan of Rs 58.81 crore on consolidated basis. The company has delayed meeting the debt and payment obligations and, consequently, its credit rating has been impacted. Credit rating of the company was recently downgraded by CARE, a leading credit rating agency: long-term bank facilities rating to CARE B from CARE BBB and short-term bank facilities rating to PR4 from PR2 due to temporary delays in meeting debt and payment obligations. In July 2010, CARE suspended the rating by citing lack of information from the company for continued monitoring. However ICRA, vide letter dated June 14, 2010, has assigned a rating of ‘LBB' for long-term fund based/non-fund based facilities and has assigned a rating of ‘A4' for short-term fund based/non-fund facilities. Any downgrading of this credit rating could impact the cost of funds and the company's ability to borrow.

The company faces high competition from players such as Tube Investments of India, Tata Steel, Bhushan Steel in ERW and CEW tubes in India. Also, the auto division faces stiff competition from OEMs and suppliers to OEMs, which is a fragmented market.

The company has expanded its CEW tubes capacity from 7,920 mt in FY 2008 to 23,265 mt in FY 2010 based on their invented pilgering process. It further plans to expand CEW capacity based on the cold pilgering process to 76,701 mt through IPO proceeds. The company has applied for patent right for this process. But in case it leads to infringement of third party rights, it would have to pay license fee and penalty fee or change the process. In such a scenario, it could alter the CEW tube production plan, which is the core of the IPO.

Valuation

Innoventive Industries recorded a 143% jump in net profit to Rs 34.34 crore in FY 2010 on a topline growth of 16% to Rs 421.48 crore. Profit was aided by 960 basis point hike in operating margin due to increased share of high margin products such as CEW tubes, membrane strips and auto components, mega project status benefits, lower labour and energy cost from the cold pilgering process, increased exports and operations of subsidiaries. However, the consolidated results of FY 2010 are not comparable with those of FY 2009 due to acquisition of Sankalp in December 2008. For the nine months ended December 2010, the top line and bottom line has already surpassed that of FY 2010 results.

On the offer price of Rs 117-Rs 120, the post-issue expanded equity stood at Rs 59.83 and Rs 59.36, respectively. Thus, the annualized EPS for the nine months ended December 2010 stood at Rs 8.2 and Rs 8.3 on post-issue equity of Rs 59.83 and Rs 59.36, respectively. At the upper price band P/E multiple works out to 14.5 times. Much larger player Tube Investments is trading at 12.5 times consolidated nine-month annualized EPS. A smaller player Gandhi Special Tubes trades at P/E of 6.2.