With marquee clientele in its kitty and a higher share of margin-accretive original design manufacturing (ODM) contracts in its revenue, the company has all the right ingredients for a profitable journey.
Discretionary spending and demand for air conditioners (ACs) are trends that are unlikely to reverse in a country like India owing to a young population and rising income/affluence levels. Consequently, demand for ACs has been growing at a faster pace than other white goods. Despite this, the penetration remains low, thereby implying that there is considerable scope for growth. Improved availability of power and pan-India electrification are likely to provide added impetus.
In the backdrop of such favourable macro factors, the initial public offer (IPO) of Amber Enterprises assumes importance. The company is a solution provider for ACs as an OEM (original equipment manufacturer) and ODM (original design manufacturer). With marquee clientele in its kitty and a higher share of margin-accretive ODM in its revenue, the company has all the right ingredients for a profitable journey. While the issue pricing leaves little on the table in the short-term, the value proposition looks interesting for investors with a long-term outlook.
Why look at Amber?
Market leadership, marquee sticky customer base
Leading AC brands have been gradually outsourcing a greater percentage of their manufacturing activities to third parties (such as Amber) to focus more on innovation, brand-building and distribution activities.
Presently, out of ten renowned room AC companies (with a cumulative market share of 75-80 percent) in India, Amber supplies components/ACs to eight. In FY17, 19.1 percent of the country’s room AC market was handled by Amber.
Since Amber deals in non-commoditised products, typically, the contracts with customers are typically for a long duration and the degree of customer stickiness is high.
Higher chunk of ODM revenues
Original design manufacturing (ODM) activities, that are more margin-accretive in comparison to original equipment manufacturing (OEM) processes, constitute nearly 70-75 percent of Amber’s annual turnover, which improves the overall margin profile.
ODM yields better margins owing to the strategic consultations, in-depth research, end-to-end product development, quality control checks, flexibility to tweak manufacturing procedures, technological support, and higher capital deployment involved therein. Amber possesses the expertise to undertake all these on behalf of room AC brands.
OEM is a transactional arrangement between the brand (room AC company) and the contract manufacturer (like Amber), wherein the latter follows the instructions by the former from start to finish on all matters.
Given the importance of asset-light expansion, market share gain and shorter lead times, room AC brands have been prioritising ODM-based outsourcing instead of signing OEM-related ones. Amber, by virtue of strengthening its capabilities, is rightly positioned to cater to the diverse requirements of brands.
Backward integration, high entry barriers
Amber is a one-stop solution provider in the AC industry. Over the years, in addition to managing assembly of room ACs, Amber expanded its product portfolio to manufacture almost every single component (barring compressors) across categories such as window, split, and inverter for indoor and outdoor use.
Given the technicalities involved in manufacturing specialised output, there is not much competition for Amber. For new entrants, creating a niche is difficult because room AC brands don’t switch manufacturing partners easily, and even if they do, seeking such approvals is time-consuming.
Amber’s 11 manufacturing facilities are situated in a cluster format in northern India (other than one unit at Pune) in the vicinity of its customers’ premises. Locational synergy not only ensures economies of scale but also facilitates a better understanding of the market.
Currently, Amber’s plants are operating at a utilization level of 45 percent. The company targets increasing this to 50 percent or more. No significant capex has been lined up for the next few months.
Fluctuations in raw material prices or currency are passed on by Amber to the respective room AC brand. Employee costs are estimated to remain stable as no major hiring plans are on the anvil. IPO proceeds (fresh issue) will be almost entirely utilised for making Amber debt-free.
The room AC market in India is considerably under-penetrated, thereby indicating that the growth potential on this front is immense.
Higher disposable incomes, financing schemes, increasing urbanisation, government’s push towards electrification and housing, a decline in replacement cycle, and availability of energy-efficient variants have led to a spurt in demand for ACs in recent years.
Being a tropical nation, India’s temperature is warm for most part of the year. This necessitates the purchase of products such as ACs. Downsides associated with seasonality have been fading, evident from the fact that demand is not entirely subdued during the off-season to the extent it used to be previously.
China, India’s biggest competitor in ACs, has been losing its competitive advantage on account of high labour costs, greater domestic consumption, and import substitution policies adopted by the Indian government.
Is the IPO worth subscribing?
As far as fundamentals are concerned, Amber reported strong year on year sales growth in FY17, followed by a robust performance in H1FY18. The company’s margins have been decent vis-à-vis other consumer durable companies, as indicated by the exhibits below:-
From a valuation standpoint, the stock leaves minimal scope for an upside in the near future. Nonetheless, given the moats, investors with a long-term investment horizon ought to look at this issue.
Moneycontrol Research Page.