SH Kelkar IPO - Medium term looks uncertain: Fernando

By VS Fernando

For a company of SH Kelkar’s standing a price of Rs 180 for a 10 paid-up share may not look steep. However, for a company having an asset base of Rs 207 cr, an equity capital of Rs 145 cr is disproportionately high. Further, for the company’s stature its operating margin of 17% is very low. A P/E of 40x may hold in boom time but, when the largest shareholder Blackstone decides to offload after the lock-in, public investors would feel the pinch as Blackstone’s cost is less than Rs 35!

 

The IPO

Fresh Issue of Rs 210 cr (121.39 lakh to 116.67 lakh shares of Rs 10 each) and Offer for Sale of 131.41 lakh shares (Rs 227 cr to Rs 237 cr) with a price band of Rs 173-180 a share. Investors should apply for a minimum of 80 shares and multiples of 80 thereafter.

The IPO will constitute 17.15% to 17.42% of the post-issue paid up capital of the company (Rs 144.62 cr to Rs 145.09 cr). The promoters would hold between 56.53% and 56.71% of the enlarged capital. JM Financial and Kotak Mahindra Capital are acting as book running lead managers to the public offer.

Issue Object

The Company proposes to utilize funds from the fresh issue towards funding the following objects: Repayment/pre-payment in full or in part of certain loans availed by the issuer company (Rs 126 cr) and investment in K.V. Arochem Pvt Ltd (KVA), a wholly owned subsidiary of the issuer company for repayment of certain loans availed by KVA (Rs 32 cr). The balance, net of issue expenses to the extent payable by the company, is earmarked for general corporate purposes.

Lineage

The genesis of Mumbai-based S H Kelkar and Company Ltd (SKCL) dates back to over 90 years. Until mid 1955, V G Vaze, known as Damodar H Kelkar before he was adopted by his elder sister who was married into the Vaze family, was managing the fragrance business started by his elder brother, S H Kelkar, under the proprietary firm S.H. Kelkar & Co. In July 1955 SKCL was incorporated to take over the businesses of two firms namely S.H. Kelkar & Co and Saraswati Chemical Works. Presently, one of V G Vaze’s three sons, Ramesh Vaze (74), controls the Kelkar Group of companies which also manages the famous Kelkar College in the suburb of Mumbai. In running SKCL, managing director Ramesh Vaze is ably assisted by his son, Kedar Vaze (41) who is the whole-time director and chief executive officer of the company.

SKCL is reportedly one of the largest fragrance and flavour companies in India by revenue. It is said to be the biggest domestic fragrance producer with exports of fragrance products to over 52 countries. The company attributes its market leadership to its diverse and comprehensive product portfolio, superior and consistent quality of products, economies of scale, R&D and product innovation. The company is claimed to be a full service supplier with over 9,700 fragrance, ingredients & flavour products and a large library of product formulations created over 90 years. The company claims to enjoy a competitive advantage both in terms of products portfolio and understanding of customers’ requirements and brands, driven by consumer preferences. SKCL reportedly has over 4,100 customers, including leading national and multi-national FMCG companies, blenders of fragrances & flavours and fragrance & flavour producers.

Business

The Indian fragrance & flavour industry consists of more than 1,000 companies, ranging from multinationals, large Indian industrial houses to small-scale units and local manufacturers. The top five fragrance & flavours companies in India, Givaudan SA, Firmenich, SKCL, International Flavors and Fragrances Inc and Symrise SA contributed approximately 70% of the Indian fragrance & flavour in the year 2013. The four leading multinational companies have a significant presence in India and have established customer relationships with FMCG multinational corporations as well as Indian companies.

In fiscal 2015, SKCL claims to have manufactured over 8,000 fragrances, including fragrance ingredients & flavours for the personal and home care products, food and beverage industries, either in the form of compounds or individual ingredients. SKCL’s fragrance and flavour products are usually a blend of a number of ingredients and are created by its perfumers and flavourists to produce proprietary formulas.

Fragrances & flavours are considered to be one of the important factors for consumers in deciding repeat purchase of a product and this often influences their decisions, thereby making them one of the key components of FMCG and integral part of product attributes. SKCL’s fragrance products and ingredients are reportedly used as a raw material in personal wash, fabric care, skin and hair care, fine fragrances and household products. The company claims to have over 3,700 customers for its fragrance & fragrance-ingredients products. Its clientele includes well known names like Godrej Consumer Products, Marico, Wipro Consumer Care, Hindustan Unilever, VINI Cosmetics, J.K. Helen Curtis, etc. The company’s flavour products are used as a raw material by producers of baked goods, dairy products, beverages and pharmaceuticals. SKCL claims to have over 400 customers for its flavour products. Here, its customers include Britannia India, VICCO Laboratories, Vadilal Industries, Ravi Foods, etc.

The company has four manufacturing facilities, three of which are located in India and one in The Netherlands, with a total installed manufacturing capacity of over 19,819 tons annually. It produced approximately 7,170 tons of fragrance and 434 tons of flavour in fiscal 2015. For the year its operating revenue was Rs 837 cr of which fragrance contributed Rs 776 cr (93%).

Financials

A close look at SKCL’s financials reveals that the company’s standalone performance is relatively better than the consolidated operations of its subsidiaries. The company’s standalone margins have been higher than the consolidated operations. As compared to previous years, SKCL’s profitability suffered a major set-back in fiscal 2015. Its standalone operating margin fell from 20% to 14% and its consolidated margin fell from 18% to 14%.

The company’s consolidated top line has steadily grown from Rs 460 cr in FY11 to Rs 837 cr in FY15 though it bottom line witnessed a decline in FY15. From Rs 34 cr in FY11, the company’s consolidated net profit steadily climbed to Rs 79 cr in FY14 but, slipped to Rs 64 cr in FY15. The company’s capital base was quite attractive until FY14 at about Rs 13 cr which has shot up to over Rs 132 cr through a bumper 9:1 bonus issue in September 2014.

SKCL has been in the dividend list for the past couple of years. In fiscal 2014, on the pre-bonus small capital, it paid a dividend of 113% amounting to Rs 15 cr. For fiscal 2015, on the enlarged capital, it paid 11.3% which is equivalent to the pre-bonus rate.

 

 Valuation

Experienced promoters; Proven market leadership and brand name; Comprehensive product offering and diverse customer base; Strong research and development skills; Established sales and marketing network; Long standing relationships with suppliers; Scalable manufacturing facilities; etc., may perhaps justify SKCL’s offer price in the long run. It is worth noting here that the company’s three plants are relatively new and its current capacity utilization is only 36% which is projected to gradually increase to 70% in the next five years. Nevertheless, medium term looks uncertain for the scrip due to many factors.

The company is said to be a leader in its line of business, far ahead of its next best domestic competitor yet, its profit margin looks very ordinary. Further, SKCL’s bloated equity has considerably diluted its earnings per share. The 60-year-old company’s standalone EPS has crawled from Rs 1.59 in 2013 to Rs 4.13 in 2015. Its consolidated EPS moved from Rs 4.58 in 2013 to Rs 5.95 in 2014 but, slipped to Rs 4.84 in 2015. The company’s net profit of Rs 64 cr discounts the market cap on the higher band (Rs 2603 cr) more than 40 times which is very steep compared to the current P/E multiple of both Sensex and Nifty (less than 22x).  

Perhaps to underplay the ultra high discounting, SKCL’s merchant bankers have conveniently stated in the offer document that there are no listed companies with similar business in India. From the investors’ perspective, a comparable industry for SKCL is fine or specialty chemicals. In this segment, Camlin Fine, whose main product is food grade flavor, commands a P/E of more than 40. But, a comparable fragrance peer Camphor & Allied is discounted only 11 times. SKCL’s management wants to compare themselves with FMCG players. Of course, the top FMCGs to whom SKCL is supplying its material are currently quoting above 40 times their earnings.

Even though, FMCGs current discounting may justify SKCL’s pricing, the IPO does not leave much on the table for the investors. When market sentiment turns weak, a 40 P/E could easily fall below 30. If the current market mood continues, SKCL’s offer may bring some return in the short run. Nonetheless, after a year, when the lock-in period lapses, and when private equity firm Blackstone turns a seller, the scrip may come under severe pressure. Moreover, if the market mood too turns weak at that time, it could be a double blow for SKCL’s investors. In fact, for the scrip’s prospects a lot hinges on the private equity. Blackstone, who invested about Rs 154 cr in 2012 and got 4.45-odd cr shares at an average cost of Rs 34.64 a piece, would be realizing more than Rs 238 cr from the present offer. Post-offer, Blackstone would still be holding more than 3.13 cr shares with a negative cost. If needed, Blackstone can dump its holdings at any price after the lock-in period.