Sanghavi Forging and Engineering Ltd. - IPO Note "Avoid"- Ajcon Global Services

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Investment view

Gujarat based SFEL is engaged in manufacturing and exporting of forging products for the non-automotive sector. It has an installed capacity of 3,600 MTPA for manufacturing of forged flanges and precision machined components (with single piece forging up to 4 MT) in the area of open and closed die forgings catering to various user industries like Oil and Gas, Power, Ship Building and Aerospace.  The key factor in its forging business is the vendor/consultant approval, given the critical end use of the product. The company, in the last few years, has been successful in obtaining various such approvals in both the domestic and international markets. The company has diversified client base with top 10 clients accounting for 38% of revenues in FY10 and has good client relationship worldwide resulting in repeat business from its clients. The company has made Pre-IPO placement of 0.69mn equity shares of Rs. 10/- each fully paid up at premium of Rs.70/- aggregating to Rs.55.9mn to Dango & Dienenthal Maschinenbau GMBH KG, Germany.

At the upper band of the issue price, SFEL is valued at 27x its 9MFY11 annualized earnings of Rs. 3.1/share (post issue).However, we believe the company faces concerns like a)  modest scale of operations, b) high working capital intensity, c) project risk marked by project size of around six times of its networth as on December 31, 2010 and more than four times of its existing capacity, d) exposure to raw material price fluctuation risk and foreign exchange fluctuation risk, e) expensive valuations as compared to peers in the non automotive forging space, f)post issue market capitalization of Rs.1.08bn as compared to issue size of Rs.369mn, inspite of higher PE multiple.

With due consideration to the above factors, we believe that premium valuations are not justified and recommend investors to “AVOID” the issue.