IPO review - S H Kelkar: Sample the aroma

Strong growth prospects, improvement in cash flows are positives

Mumbai-based S H Kelkar & Company is the country’s largest domestic producer of fragrance with a market share of 20.5 per cent. This segment forms the bulk of its revenues while its other business of flavours contributes about five per cent of the revenues. The company has about 12 per cent share in the Rs 4,000-crore fragrance and flavours market in India.

While the company and its earnings have grown at a good pace in the past, the future prospects also appear bright. Factors such as experienced management, high entry barriers and strong co-relation with Indian consumption growth augur well for S H Kelkar’s prospects. IPO valuations are at a slight premium to global peers though, but justifiable. In this backdrop, investors with a long-term investment horizon can subscribe to the issue.

Produced at its four manufacturing units across Maharashtra, Gujarat and Netherlands, the fragrance and flavours ingredients are used in a host of products such as soaps, shower gels, detergents, shampoos, hair oils, deos, perfumes, air care, floor cleaners, biscuits, ice creams, cakes, beverages, syrups, among others.

Given that S H Kelkar supplies these to over 4,000 companies, including Godrej Consumer, Wipro Consumer, Marico, Vini Cosmetics, HUL, Britannia, Vicco Laboratories, Vadilal Industries, among others, it only shows the company's standing in the business.

The proposed IPO to raise about Rs 500 crore includes a fresh issue of shares worth Rs 210 crore which will flow into the company, while the rest is an offer for sale by private equity firm Blackstone and the promoters. Large part of the money coming into the company (Rs 158 crore) will be deployed to retire debt of the company and its subsidiaries. SH Kelkar currently has consolidated net debt of Rs 180 crore. The repayment will boost the company’s earnings as it will save about Rs 19 crore towards interest costs annually.

Interestingly, SH Kelkar has a well diversified revenue model—no single product or client contributes over five per cent to its revenues. This is a key positive as makes it less vulnerable to client/product specific setbacks. Strong research and development skills (developed 12 molecules in the past three years) enable the company to offer innovative products to its clients. Going forward as well, the company plans to focus on innovation and enhance its product offerings. It aims to increase market share by adopting steps such as expanding its client base to include multinational companies, invest more to grow in emerging markets such in Asia and Middle East and North Africa, among others. Inorganic growth forms an important part of SH Kelkar’s strategy to achieve geographic expansion, strengthen technology and broaden product offerings.

On the flipside, given that most of its clients are in the FMCG space where activity levels are quite robust, SH Kelkar will have to continue to keep pace with changing consumer behaviour. Demand slowdown in the FMCG sector could also limit the company’s ability to take price hikes.

Given that 45 per cent of SH Kelkar’s revenues come from exports, adverse currency movements too have a bearing on its profits. The pricing pressure, however, is partly offset by the fact that fragrance and flavour form a small part (lower single digit) of the client’s total cost of producing a product. Notably, there are quite a few entry barriers in the business of which the high customer acquisition time (given that some of the relationships between the suppliers and FMCG players are long standing and difficult to overcome) is the key. Established players also have a larger share of the flavour and fragrance market with the top five accounting for over 70 per cent of the business, with the top four being multinationals.

S H Kelkar’s financial performance has been robust with revenue and net profit compounded annual growth of 16 per cent and 22 per cent, respectively, over FY11-15. In FY15 though, the effects of overall slowdown was visible with topline growth slowing to just 10 per cent. The topline as well as profits were also impacted by raw material availability and pricing issues, which led to a decline in margins. However, the Q1'FY16 performance is pointing to some pick up in topline and rebound in margins.

With respect to IPO valuations, at the price band of Rs 173 to Rs 180 and after annualising FY16 net profit and assuming interest cost savings, the issue is priced at 27.3 to 28.3 times FY16 earnings on a fully diluted equity base. This is above the 20-26 times CY15 price/earnings ratio of global peers such as Givadaun, IFF and Symrise. However, the longer-term growth trajectory of the Indian company is much higher (sector expected to grow at double the developed market rates), so a bit of premium is due.