IPO review: Why SP Apparels is not exciting

Although earnings will get a fillip from lower interest costs, the company lags peers on profitability

The business model of SP Apparels, which is engaged in manufacturing and exporting of knitted garments for kids, is similar to that of listed peer Kitex Garments. While the revenues of both companies are more or less similar, there is a huge difference in their margin profiles. In FY16, for instance, SP Apparels’ earnings before interest, taxes, depreciation and amortisation (Ebitda) and net profit margins stood at 16.8 per cent and 6.5 per cent, respectively – less than half of Kitex Garments’ figures which stood at 34.1 per cent and 20.5 per cent.

The margins of the two companies are expected to expand going forward, as they reduce the debt on their books. So, although SP Apparels’ own margins might improve on the back of lower debt and consequent savings in interest costs, they could take some time to catch up with that of Kitex Garments.

In this backdrop, SP’s Apparels’ initial public offering valuations are not cheap. Assuming a good 35 per cent growth in its net profit in FY17, the issue is priced at 14.5 to 14.9 times FY17 estimated earnings on a post-issue basis - in line with Kitex Garments’ current valuations of 15 times FY17 estimated earnings. The multiple, though, shrinks to 13.1 to 13.4 times if we assume a higher earnings growth of 50 per cent in FY17 for SP Apparels. However, the company’s earnings growth has been rather lumpy in the past three years and, hence, it is difficult to predict (high profit growth is also aided by a very low base). The higher margins have also led to superior return ratios for Kitex Garments, which posted return on equity of 35.5 per cent in FY16. This metric stood at 29.4 per cent for SP Apparels in FY16. With higher dependence on exports, SP Apparels’ prospects are closely linked to growth in developed markets, particularly Europe.

Continued relationship with its five key clients - Tesco International, Primark Stores, Mothercare UK, ASDA Stores (owned by Walmart), and Dunnes Stores - is a key strength of the company. While the dependence on these firms is significant, the firm is looking to add at least one more client in the next one or two years. Given that a large part of its revenues are denominated in GBP and the USD, SP Apparels’ financials are exposed to the risk of volatility in these currencies.

Of the issue proceeds of Rs 215 crore, Rs 63 crore will be used for part-prepayment of debt, while Rs 70 crore will be used to expand and modernise its plant in Salem, Tamil Nadu. The company has earmarked another Rs 28 crore for opening new stores under the Crocodile brand for its menswear products.

There is a pending litigation over ownership of this brand, which constituted six per cent of the company’s revenues in FY16. The firm does not hold any copyright for the Crocodile brand; hence, this can be a downside risk going forward. Although the company, along with its peers, stands to gain from the new textile policy, the benefits of the same will accrue gradually and depend on the actual measures being passed in the policy.

While the management is focusing in the right direction to drive profitable growth, the company has a lot of catching up to do with peers, and the valuations are not cheap. Investors can, thus, skip this issue.