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Birla Cotsyn IPO: Our view - Views on News from Equitymaster

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Birla Cotsyn IPO: Our view

Jun 30, 2008

Issue Summary
Birla Cotsyn (India) Limited, a Yash Birla Group company, is issuing around 80 m shares as part of its initial public offering, which has begun today and will remain open for subscription till July 4, 2008. The company has priced its offering at Rs 15 to Rs 18 per share. The company expects to raise Rs 1.4 bn from the issue to fund its expansion plan. Here is a brief snapshot of the issue.

Objects of the issue
As a part of its expansion plan, Birla Cotsyn will be setting up an integrated textile unit at Khamgaon, Ghatanji and Malkapur (all in Maharashtra). The company also plans to start manufacturing its own branded garments (with installed capacity of 50,000 meters per day) in 2009 and has plans to put up 20 retail outlets across major cities in the country. The proposed expansion plan has been appraised by SBICAPs.

  Overall capex plan Estimated cost (Rs m)
1 Expansion of Integrated 2,892
  Textile Project  
2 Setting up of a garment 252
  manufacturing unit  
3 Establishing retail outlets 58
  Total 3,202

Company background
Promoted by the Yash Birla group, Birla Cotsyn is engaged in cotton ginning (a pre-spinning process), pressing and oil expelling and manufacture of synthetic yarn (18,304 spindle capacity). The company has capacities in the Buldhana and Yavatamal districts of Maharashtra.

Birla Cotsyn entered in a 50:50 joint venture with the PB Bhardwaj Group in 1HFY08. The latter has interests in textiles and steel. This venture is expected to enable both the partners combine their resources for manufacturing, marketing and distribution of the products.

Reasons to apply
‘Mega Project’ status: The Government of Maharashtra has offered the status of ‘Mega Project’ to the expansion plan of Birla Cotsyn. For this the company entered into an MOU (memorandum of understanding) with the Government of Maharashtra and has become eligible to receive the following incentives -
  • Electricity duty exemption for a period of seven years from the date of 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 fixed capital investment.

The benefits of this status are set to accrue to Birla Cotsyn over the next 5 to 7 years and aid its margins.

Forward integration benefits: In order to capitalise on the increased growth opportunity in the branded apparel industry and earn better realisation on the higher value products, Birla Cotsyn intends to integrate its manufacturing capacity and enter into retailing of branded products. This will make the company a completely integrated textile player and help it leverage its distribution channels through the JV with PB Bhardwaj Group in the marketing of the branded products. It will also help Birla Cotsyn in substantially improving its operating margins that have averaged at 10.7% over the last 5 years.

Reasons not to apply
Retailing fraught with risks: Birla Cotsyn intends to use the net proceeds of the issue to, among other things, set-up its retail outlets. However, the company has not yet signed up any lease/franchise agreement for the same. Thus, non-availability or delay in availability of retail space at desired locations and prices may adversely impact its project cost. Further, the Indian retail industry is currently fraught with risks relating to rental rates, pricing, advertising, quality and service differentiation. The competitors that are larger in size are better placed to take advantage of efficiencies created by size, and have better financial resources or greater access to capital at lower costs, besides their wider presence. Thus being a late entrant in to this sector with fetch considerable risks for Birla Cotsyn.

Intensifying competition: Birla Cotsyn faces increased competition from domestic players as well as those in low-cost producing nations that are in the expansion mode. Although India retains a niche market for small and medium sized orders or orders for short-run products, price competition is expected to intensify with the increase in supplies. The ready-made garment industry, particularly, is highly fragmented with a few organised players. The organised segment is relatively less competitive and buyers are less sensitive to prices, as purchase decisions are based on brand preferences. Price competition is also severe in the garments export business and particularly fierce from China, Pakistan and Bangladesh. In the domestic market itself there are several branded garment players having established retail presence and will offer stiff entry barriers to new entrants like Birla Cotsyn.

The brand tussle…
Player Brand No. of outlets Cities
Raymond The Raymond Shop 380 174
Koutons Retail Koutons & Charlie Outlaw 500 221
Pepe Pepe 58 27
Madura Garments Peter England 22 12
Arvind Brands Lee 71 71
Provogue India Provogue 75 27
Madura Garments Allen Solly 24 16
Levi Strauss Levi's 115 29
ITC Group Wills Lifestyle 55 30
Arvind Brands Wrangler 35 23
Gini & Jony Gini & Jony 29 15
Madura Garments Van Heusen 25 16
Raymond Be: 15 8
Madura Garments Louis Phillipe 22 15
Kewal Kiran Killer 35 25
Celebrity Fashions Indian Terrain 7 7
Source: Prospectus

Rise in input costs: Khamgaon, which is the proposed location for Birla Cotsyn’s integrated textile unit, is the centre of cotton production and there are about 35 ginning units in and around this place. Hence, good quality cotton is easily available. However, given the demand supply mismatch in cotton production and the same expected to intensify with increased capacities, the company may face supply shortages going forward. Also, the price of cotton has escalated nearly 38% in the last 12 months and poses considerable risk to the company’s total input cost (raw material is 60% of operating cost) and operating margins.

Leverage risks: Birla Cotsyn had a leverage (debt-equity) ratio of 0.6 times in FY07, which is reasonably high considering the size of operations (Raymond had 25 times Birla Cotsyn’s turnover and debt to equity of 0.7 times in FY07). Although, the debt to equity ratio post IPO will come down to 0.3 times, the rising interest cost will continue to weigh heavy on the company’s already thin margins.

Comparative valuations & comments

Standalone financials
(Rs m) FY03 FY04 FY05 FY06 FY07 1QFY08
Sales 22 33 34 38 535 184
Other income 1 1 1 2 12 2
Total income 23 34 35 40 547 186
Manufacturing cost 20 29 29 32 474 165
Administration & selling costs 1 1 2 2 23 8
Operating profit 2 4 4 5 50 13
OPM (%) 8.7% 11.5% 10.6% 13.4% 9.4% 7.1%
Finance expenses 1 1 2 1 4 1
Depreciation 1 1 1 2 7 3
Miscellaneous expenses - - - - - -
Profit before tax 0 1 1 2 39 9
Taxes 3 0 0 (1) 14 1
Net profit after tax (3) 1 1 3 26 8
NPM (%) -11.6% 3.7% 1.6% 7.3% 4.8% 4.3%
No. of shares (m) 0.4 0.4 13.6 13.6 13.6 93.6
EPS (Rs)* (7.0) 3.3 0.0 0.2 1.9 0.3
*Annualised EPS for FY08 on expected post issue number of shares of 93.6 m

As the above analysis suggests, we are not very enthused by the company’s business model of venturing into saturated segments with high entry barriers. The target customer segments of the company also do not seem to have the potential of being high yielding. The incremental capacity coming up across all the low cost apparel manufacturing countries and increased presence of established brands in the domestic, the US and UK apparel retailing market makes Birla Cotsyn’s foray into the same fraught with risks. Revenue concentration in a few customers without contractual agreements accentuates our concerns with regards to the company.

FY07 Sales (Rs m) EBIDTA margin (%) NPM (%) RONW (%) P*/E (x)
Birla Cotsyn 535 9.4% 4.8% 8.2% 53.1
Celebrity Fashions 3,269 5.9% -1.2% -2.7% -
Kouton Retail 4,024 17.7% 8.4% 36.1% 49.3
Celebrity Fashions incurred net losses in 1HFY07. P/E for Gokaldas and Celebrity calculated on trailing 12 months earnings.
* P/E has been calculated by considering prices as on 30th June 2008
* P/E for Birla Cotsyn has been calculated by considering the post issue fully diluted capital and at the upper end of the price band.

The valuation of the company post issue at the higher end of the band is 53.1 times 1QFY08 annualised earnings. We do not find the valuation very attractive as compared to its peers in the industry and the more established players in the sector. While our outlook remains positive on the prospects of the apparel and garment export sector with a long-term perspective, the high execution risks involved warrant caution. We would advise investors to invest in textile companies that have better visibility in their business model and lower operational risks. Our recommendation to investors is to AVOID the issue.

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