Scotts Garments IPO: Another Bombay Rayon in the making? VS Fernando, Financial Analyst & Columnist

The clout that Bombay Rayon's new owner, Best Seller of Europe, exercises over Scotts Garments makes one feel that the Bangalore-based company may go in the same way of Bombay Rayon! The IPOThe present IPO is a fresh issue of 105.07 equity shares of face value of Rs 10 made through 100 percent book building process with a price band of Rs 130 to 132 per share aggregating to Rs 137 cr to Rs 139 cr. Keynote Corporate Services and Canara Bank Merchant Banking Division are appointed as book running lead manager (BRLM) and co-book running lead manager (C-BRLM) respectively. Keynote Capitals is acting as a syndicate member. Though the offer document does not specify the amount underwritten, the BRLM would be responsible for bringing in the amount devolved in case the syndicate member does not fulfill his obligation. Issue ObjectiveThe main object of the IPO is to part finance the company's trouser manufacturing facility at Doddaballapur in Karnataka and knitting & fabric processing unit at Kagal in Kolhapur district of Maharashtra. Both these projects are estimated to cost Rs 320 cr including working capital margin of Rs 11 cr. Canara Bank has sanctioned a term loan of Rs 150 cr for the projects. OFFER AT A GLANCE Name Scotts Garments Ltd Public Offer Fresh issue of 105.07 lakh shares Offer Price Between Rs 130 and Rs 132 Offer Amount Between Rs 137 cr and Rs 139 cr IPO% on Total Equity 26.95% Post-IPO Free Float 47.8% Application Quantity 100 & Multiples of 100 Bid/Offer Opens April 25, 2013 Bid/Offer Closes April 29, 2013 Listing NSE and BSE IPO Grading CARE Grade 3 out of  5 Lead Manager Keynote and Canara Bank Registrars Link Intime India Rating & Rationale CARE has assigned a grade of ‘3/5' to the IPO indicating that the fundamentals of the company were average. While the grading has taken into account the promoters' experience and the capability of the executive team, the company's long-standing operational record, its association with reputed clients and the relatively stable margins, the rating is constrained by the business concentration risk with nearly three-fourths of the revenue derived from just one group and significant share of the revenue directed to Europe which is faced with economic downturn. _PAGEBREAK_ BackgroundThe multi-located, Bangalore headquartered, Scotts Garments Ltd (SGL) is a Government-recognized export house having manufacturing facility for woven and knitted garments that includes shirts (cotton/denim), tops, skirts, trouser (cotton/denim), shorts, cargos, T-shirts (basic and embroidered), sweats and jerserys supported by in-house facilities of embroidery, printing, dyeing and washing. The company reportedly had capacities to make 152 lakh pieces of knitted garments and 102 lakh pieces of woven garments annually spread across 24 units located in Karnataka and Tamilnadu. Originally registered as a partnership firm in 1992 by Naseer Ahmed, Refath Jehan Begum and Saifulla Sayed, Scotts Garments commenced business in 1994. Saifulla Sayed withdrew from the partnership in 2002 subsequent to which a limited liability company was incorporated to continue the business of the partnership firm. The promoters floated Scotts Clothing Private Ltd (SCPL) in 2004 for setting up a manufacturing facility for knitted garments at Tirupur in Tamilnadu which was merged with SGL in 2007. The amalgamation of SCPL led to increased production facilities, improved turnover and overall reduction in the operating cost apart from tax benefits. SGL acquired the closely-held Mumbai-registered Arora Fashions Ltd (AFL) in 2008 for a consideration of Rs 54.11 cr. The amalgamation of AFL enhanced the number of manufacturing units of SGL at Tirupur. ManagementThe management team of SGL indeed comprises of highly qualified and experienced professionals in garmenting. The promoter-MD, Naseer Ahmed, has two decades of experience in the textile industry. He is also the vice-chairman of Bombay Rayon Fashions Ltd (BRF), a listed company which was recently acquired by the Best Seller Group from the Agarwals. Naseer Ahmed is a former minister of state for small-scale industries in Karnataka. He is presently a Member of the Legislative Council and has secured a ticket from Congress for the forthcoming Assembly election. The senior executive team of SGL is drawn from textile giants like Arvind, Gokaldas, Raymond, etc.  A noteworthy aspect of SGL is that the company has more than 12000 employees yet, has never faced any labour trouble in last two decades. Unlike some unscrupulous management, SGL has not opted for contract labour but has hired on permanent basis.   Financial TrackSGL primarily focuses on export of manufactured readymade garments and derives more than 90 percent of its revenue from overseas. The company's financial risk profile is characterized by stable growth and margin. Its revenue has grown steadily from Rs 331 cr in fiscal 2008 to over Rs 500 cr in 2012. The company's EBITDA, which was at Rs 52 cr in 2008, increased to Rs 78 cr in 2012. However, the operating profit has remained almost stagnant for the past three years, growing only Rs 6 cr.  From Rs 22.25 cr in 2008, the company's bottom line grew to Rs 35 cr in 2011. Nevertheless, it fell to less than Rs 25 cr in 2012 (excluding the abnormal income - capital gain on sale of investments of Rs 59.49 cr).    The net worth of SGL amounted to Rs 228 cr at the end of Fiscal 2012 which gave a book value of Rs 85 per share on an equity capital of Rs 26.74 cr. In December 2012, the company made a pre-issue placement aggregating to Rs 20 cr at a price of Rs 115 per share. Post-IPO, the company's capital would increase to around Rs 39 cr and its reserves will shoot up to over Rs 345 cr. Prospects The company's Doddaballapur garmenting project has partially started operations and is expected to be in full flow by the second half of this year. The knitting-cum-processing project at Kolhapur is scheduled to start commercial operations by June 2014 though it is at a preliminary stage at present. With assured market from the Best Seller group, SGL is expected to be in the big league on completion of its current expansion. Valuation SGL presents an EPS of more than Rs 31 for fiscal 2012 discounting the IPO price even at the higher band just 4.2 times which looks very cheap compared to peers like Bombay Rayon, Kewal Kiran and Zodiac. Nonetheless, if the abnormal capital gain is excluded, the EPS amounts to less than Rs 9 which discounts the offer price more than 15 times. SGL has been paying a dividend of 10 percent which if continued would give a yield of only 0.8 percent. Here it is worth noting that the cost of holding of the promoters, who would control 52.18 percent or 203 lakh shares, is just Rs 1.45, and Best Seller's group companies, B.R. Machine Tools and BRF hold 30 lakh and 20 lakh shares respectively at a cost of Rs 30 and Rs 70 respectively. Though SGL's stature may justify the current offer price, any delay in completion of the Rs 320 cr expansion and any change in the strategy of Best Seller group towards SGL, may dent the prospects of public shareholders. HOW SGL COMPARES WITH PEERS CO_NAME M-CAP PE P/BV P/FV P/R OPM YIELD PRICE (Rs Cr) (x) (%) (Rs) Bombay Rayon Fashion 3,290 18.1 1.1 24.4 1.1 27.3 0.0 244.40 Kewal Kiran Clothing 883 17.9 3.9 71.6 3.0 23.7 2.4 716.15 Zodiac Clothing 369 29.1 2.2 19.0 1.2 5.4 1.6 190.25 Kitex Garments 292 9.3 2.4 61.4 0.9 19.0 1.3 61.40 Pearl Global Ind 274 421.3 0.9 12.6 0.5 3.8 0.0 126.40 Gokaldas Exports 108 - 0.5 6.3 0.1 - 0.0 31.50 Sudar Industries 38 1.4 0.3 1.7 0.1 18.3 0.0 16.70 Scott -Hi Band 515 15.3 1.6 13.2 0.9 15.6 0.8 132.00           -Lo Band 507 15.1 1.6 13.0 0.9 15.6 0.8 130.00 Lead Manager TrackIn five years between December 2007 and 2012, Keynote Corporate handled 13 IPOs of which two viz. Thangamayil Jewellery and Gravita India have given decent returns. Four IPOs have inflicted more than 90 percent loss and two are quoting at a discount of more than 80 percent. Performance of Keynote-associated IPOs CO_NAME IPO DATE IPO PRICE CURRENT PRICE GAIN % Porwal Auto 17/Dec/07 75.00 4.60 -93.9 Sita Shree Food 11/Mar/08 30.00 5.30 -82.3 Lotus Eye Care 12/Jun/08 38.00 7.00 -81.6 20 Microns 08/Sep/08 27.50 30.90 12.4 Edserv Soft 05/Feb/09 60.00 4.88 -91.9 Globus Spirits 31/Aug/09 100.00 100.30 0.3 Thangamayil Jewell 27/Jan/10 75.00 190.00 153.3 Emmbi Polyarns 01/Feb/10 45.00 11.61 -74.2 Prakash Steelage 05/Aug/10 110.00 95.00 -13.6 Bedmutha Ind 28/Sep/10 102.00 9.93 -90.3 Gravita India 01/Nov/10 25.00 39.30 57.2 Servalakshmi Paper 27/Apr/11 29.00 2.56 -91.2 Veto Switchgears 03/Dec/12 50.00 50.50 1.0 Concerns Whereas SGL has already proved to be employee-friendly, its concern towards investing public is yet to be tested. Of late, SGL is increasingly coming under the clutches of European retailer, Best Seller, which is certainly a cause for concern. Whereas Best Seller sources its woven garment requirement from Bombay Rayon Fashions (BRF), it uses the European name-sounding company, Scotts Garments, as a supplier for knitted garments. SGL's business concentration is too risky as Best Seller group entities account nearly 75 percent of its turnover. In the past, when BRF did not have the capacity to supply woven garments to Best Seller, BRF sold the woven fabrics to SGL who in-turn made the garments. With BRF itself expanding its garmenting capacity, how long this arrangement will go on is to be seen. Interestingly, while Best Seller has secured more than the controlling interest in BRF, it has not directly staked in SGL. What's intriguing is the undisclosed arrangement between the Best Seller group and SGL's Indian promoters.  While Naseer Ahmed does not believe in forward integration into garment-retailing, SGL has made an investment of Rs 20 cr in Bombay Rayon Clothing Ltd (BRC) and has also floated a subsidiary called Inmark Retail (P) Ltd investing Rs 6.75 cr besides providing trade credit worth Rs 9.79 cr.  When the promoter himself does not find retailing business lucrative, why should SGL invest in retail firms? Also, while SGL has booked a capital gain of more than Rs 59 cr in fiscal 2012 on sale of BRF's shares, SGL's investment in BRF has shot up from Rs 6.6 cr in 2011 to 23.43 cr in 2012!  When SGL itself requires huge funds to finance its expansion, why should it invest in Best Seller associates like BRF and BRC? It seems that Best Seller, which directly cannot have a majority control in retailing in India, uses SGL and BRF to prop up its interests. Cross investments between SGL and Bombay Rayon entities and also Pedigree Construction, which was once a subsidiary of SGL, now becoming a major shareholder of SGL raise serious corporate governance issues. Another noteworthy aspect is that Best Seller's listed Indian entity, BRF, skipped the dividend no sooner it came under Best Seller's kitty!

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