Innoventive Industries - IPO : Avoid

Massive spending on trebling capacity appears a high-risk strategy.

Investors can refrain from taking exposure to the IPO of engineered steel products maker Innoventive Industries. Though the company plans to expand capacities in a lucrative, high margin segment of steel products, the company's significant debt servicing obligations and execution risks associated with its ambitious expansion plans make this offer a risky exposure. At the price band of Rs 117-120, the offer is priced 14.2-14.6 times annualised FY-11 earnings, a premium to listed peers such as Tube Investments and Bhushan Steel.



The offer

Innoventive Industries makes precision steel tubes and other steel products that are used in the automotive, power, oil and gas and other engineering sectors. The company has the capacity to produce 71,000 tonnes of ERW (electric resistance welded) tubes, of which 28,000 are further processed into CEW (cold drawn electric resistance welded) tubes. Rs 161 crore of the issue proceeds of Rs 220 crore are to be spent on trebling CEW capacity, which are 30-50 per cent more lucrative than ERW pipes.

The company's consolidated sales grew at a compounded pace of 14 per cent to Rs 425 crore, while profits moved from Rs 8 crore to Rs 34 crore between FY08 and FY10 as the company aggressively added capacity and entered new product lines from primarily being a supplier for the auto sector. The company derived 50 per cent of its sales from the transportation segment, with Bajaj Auto contributing to 20 per cent of sales for the nine months ended December 2010. General engineering accounted for 24 per cent, while power, oil and gas accounted for another 24 per cent.

The company's sales for the nine months ended December 2010 stood at Rs 457 crore, 7.5 per cent higher than that of entire FY2009-10 due to an improved product mix and realisation. Net profits were Rs 37 crore during the first nine months, higher by 9 per cent compared with the entire previous fiscal. While the company enjoyed operating margins of 26 per cent during the nine-month period ended December 2010, net profit margins were at a much lower 8 per cent.

The latter is a result of the company servicing its high cost debt (debt as of February 2011 was Rs 444 crore) incurred in the process of setting up its current capacity. The company's EBIT covered its interest costs just twice over during the first nine months of the year.

While the Rs 220 crore raised by the company will also be crucial to reducing debt:equity levels, only Rs 50 crore of the amount raised would be utilised to repay debt. The post offer debt:equity ratio would be 0.96 times after considering the pre-IPO palcement to Standard Chartered Private Equity, profits accrued and the above repayment. However, the interest obligation (at rates of 15 per cent) may continue to weigh on net profit margins.



STRETCHED ON debt FRONT

The stretched balance-sheet has necessitated equity infusions (Rs 35 crore from a private equity firm in 2010) with ICRA (June 2010) providing a rating of LBB for the company's long-term funding facilities while the rating for short-term funding was A4 (both non-investment grade). Its working capital requirement too remains elevated with relatively high debtor days. At this juncture, massive spending on trebling capacities appears to be a high-risk strategy; especially given that the company has room to use existing capacities.



The ERW space is dominated by Tube Investments, Bhushan Power and Steel, Tata Steel and Bhushan Steel, among other producers. The top five account for 75 per cent of capacity and operate at 75-80 per cent utilisation levels. With heavy capacity additions under way by the other producers, Innoventive is likely to witness some competition from well-funded peers.

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