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Apply/ Subscribe or not? What to do with C Mahendra Exports- IPO Avoid says MLR Securities
We recommend investors to AVOID the issue considering the working capital intensive
nature of the business moreover going forward the company’s ability to scale up the retail
segment with ability to maintain reasonable growth and margins would be critical
Company Background
CMEL is in the business of manufacturing Cutting and Polishing Diamonds ranging from 0.01 carat to 1
carat. It exports diamonds primarily to Hong Kong, the United States (US), the United Arab Emirates
(UAE), Belgium, and Israel. The company has two manufacturing facilities at Surat (Gujarat). CMEL is
the flagship entity of the CMEL group, which also has a diamond jewellery manufacturing and retailing
division under the brand name of Ciemme.
Objects of the Issue
To set up a diamond processing unit at Gujarat Hira House, Surat – Rs 36 Cr
To set up a jewellery manufacturing unit atMumbai – Rs 24 Cr
To set up retail outlets – Rs 30 Cr
Finance brand development expenses – Rs 20 Cr
Investment in capital of C.Mahendra BVBA – Rs 80 Cr
Valuations
The market cap of the company is coming to around Rs 570-660 Cr on price band of Rs 95-110.Though
the valuation on the basis of annualized earnings of FY11 is slightly at a discount to its peers but the
concerns over its fundamentals still remain. We recommend investors to Avoid the issue.
Volatility in the prices of rawmaterial
Rough diamond procurement cost constituted 93.00%, 94.04% and 94.10% of the total cost of production in FY09, FY10 and period ended
June 30, 2010, respectively. Global shortage in supply of rough diamonds from primary source suppliers and the resultant demand supply gap
could lead to increase in the prices of rough diamonds. Any increase in cost of rough diamonds could significantly increase the company’s cost
of production. If the company is not in a position to pass on the increase in prices of raw materials to customers will dent the margins going
forward.
Highly Fragmented Industry
The diamond industry is very fragmented, with low value addition and is characterized by high competition. Players typically have low margins
and the working capital intensity is high arising from the long conversion cycle involved as well as delays in realization of export
proceeds, which is more pronounced during demand slowdown in the key export markets.
Around 22% of the supply of rough diamonds comes from DTC
The company is under extended three year contract with DTC ending on 31
st March 2011. Failure to renew the contract will severely impact its
production levels since it contributes around 22% of the raw material of the company. The top five suppliers contribute around 74% of the raw
materials requirement of the company while the top 10 suppliers contribute around 88% of the total raw material requirement.
Lack of Significant Experience in Jewellary Business
Currently jewellery segment contributes only around 3% of the revenues of the company. The company wish to expand its retail stores from 9
to 28 by FY13. The company is likely to face competition from significant large players like Tanishq and Gitanjali Gems. Given the high
working capital intensive nature of the operations, ensuring quick asset turnover would be critical for maintaining growth and profitability.
Since the CM group have limited operational history in diamond jewellery business; the ability to rapidly scale up the diamond jewellery
business would be critical for revenue growth as well as profitability of the group.
Exchange rate fluctuations
A substantial portion of our company‘s expenditure and earnings are incurred in foreign currency. The company faces substantial risk from
exchange rate fluctuation and has seen a significant fall in the profitability in FY10 as a result of the exchange rate fluctuation. The company
hedges its foreign currency exposure by entering into forward contracts as well as currency swap to a certain extent of its exposures.
Financials
CMEL’s revenue grew at a four year CAGR of 15.3% to 1,853 Cr in FY10. But its net profit fluctuated due to volatile foreign exchange. The
company’s net profit fell to Rs 6 Cr in FY10 from Rs 66 Cr in FY09 owing to foreign exchange loss. The company however posted good numbers
in 1QFY11 with sales of Rs 736 Cr and Net Profit of Rs 40 Cr translating an EPS of Rs 6.7 post issue.
Interest coverage ratio of the company does not seem attractive at 1.1 and therefore the ability to meet interest expenses may be
questionable. The debt portion of the company is also significant and stood at Rs. 1,029 Cr for the fiscal year ended 2010.
The debt equity ratio of the company improved from 3.5x in FY 06 to 2.60x in FY 10. The company’s adverse capital structure is attributed to
its modest accretion to reserve and high working capital borrowings . The company’s debt requirements are primarily working capital based.
The CPD business has a high working capital requirement as the raw material (the cost of rough diamond can be up to 85% of the product
cost) and work-in-progress inventory tend to be high because of the production process. Also the company is not able to earn any credit
period on rough purchases from DTC with the payment generally required to be made in advance. This increases CMEL’s working capital
requirement further.
Moreover, the margins and profitability indicators, too, which have been showing an increasing trend till FY 08 has seen a decline and stood
at 0.3% in FY 10.
Promoters
CMEL was promoted as a partnership firm by Mr. Mahendra Shah, Mr. Champak Mehta and Mr. Pravin Shah in 1974, who have significant
experience in the gems and jewellery industry. Its Board of Directors has six Directors, of whom three are Independent directors. Currently, the
promoters and promoter group hold 100% of the paid-up capital of CMEL.
CMEL has two direct subsidiaries namely C Mahendra International Limited (CMIL) and CM BVBA and has 9 step subsidiaries most of them
operational outside India. The Jewellery business is carried out through its subsidiary Ciemme Jewels Limited and owns 10 retail showrooms
at present, primarily located in Mumbai. The subsidiaries aboard are involved in sourcing, trading and marketing of rough and CPDs.
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