C Mahendra Exp

C. Mahendra Exports has entered the capital market on 31^st December 2010 with a public issue of 1.50 crore equity shares of Rs.10 each, in the price band of Rs. 95 to Rs.110 per share, aiming to raise Rs. 143-165 crore. The issue, comprising of 25% of the company's post issue paid-up capital, closes on 6^th January 2011.

It appears that the company is undertaking the IPO in a hurried manner, so as to avoid presenting financials for H1FY11. Since SEBI guidelines require updating IPO prospectus with audited statements, not more than 6 months old from issue opening date, the company is presenting financials upto 30^th June 2010 and opening the issue on 31^st December 2010. Besides the wide price band of 16%, showing lack of confidence on part of promoters / merchant bankers, the IPO will be open for 5 days, against the prevalent trend of maximum of 3 days.

C. Mahendra Exports is an integrated diamond and diamond jewellery player, with 2 diamond cutting and polishing facilities in Surat, Gujarat and a diamond jewellery manufacturing facility at MIDC, Mumbai. It has 9 marketing offices (across India, Hong Kong, US, UAE and Belgium) and 10 retail outlets in India branded as 'Ciemme'. To expand operations, company is undertaking the IPO, proceeds of which will be utilised as under:

1.       Investment in subsidiary to increase procurement of rough diamonds - Rs. 80 crore

2.       Establish a diamond processing unit in Surat, to be operational by September 2011 - Rs. 36 crore

3.       Establish diamond jewellery manufacturing facility in Mumbai, to be operational by October 2011 - Rs. 24 crore

4.       Establish 15 retail outlets upto FY 13, in India- Rs. 30 crore

5.       Brand ("Ciemme") development expenses - Rs. 20 crore

To meet the expanded capacity, the company will need additional working capital, funding of which is not accounted above. The business is very working capital intensive, as can be seen from the latest financials - debtors outstanding for 9.6 months while inventory outstanding for 4.7 months, as of 30-06-10. Besides poor working capital (On standalone basis, debtors of Rs. 132 crore outstanding for over 12 months, although some of it may be receivable from group companies) only reflects added working capital funding needs.

A large part of internal cash flows will go towards the above 5 objects itself, as planned expenditure above (excluding general corporate and issue expenses) aggregates to Rs. 190 crore, while the issue will mop-up a maximum of Rs. 165 crore, considering upper price band of Rs. 110. Thus, additional working capital will, to a great extent, be funded through debt. This will put added pressure on the balance sheet, which is already quite leveraged, with present debt-equity ratio of 2.5:1, as debt outstanding (30-06-10) is Rs. 1,050 crore on net-worth of Rs. 422 crore. Even post-issue, debt-equity ratio will be high at 1.7:1, when networth expands to Rs. 587 crore, while debt remains unchanged.

Coming on to its financials, for FY10, the company reported sales of Rs. 1,853 crore and earned PAT of only Rs. 6.1 crore, largely due to huge forex losses of Rs. 50.3 crore. Q1FY11 sales was Rs. 736 crore and net profit rose to Rs. 40 crore, thanks to decrease in raw material cost. Raw material cost as a percentage of sales declined to 79% in Q1FY11 from 88% in FY10. However, it remains to be seen if this trend can be sustained,as it is difficult to rely on one quarter results. Most of company's rough diamond procurement is through secondary market purchases. Primary sourcing of diamonds, from DTC and ALROSA, accounts for about 20% only.

Another point which will dent future bottomline is the expiry of income tax benefits, which the company is presently enjoying for its key Surat unit. Present tax rate for Q1FY11 was a mere 6.5%, similar to industry trends, which will increase sharply from FY12, as the company's tax holiday expires.  

Currently, contribution of diamond jewellery business, which earns higher margins for gems and jewellery companies, is very low at 3.4% in FY10 and only 2.3% in Q1FY11. The growth of this vertical will also be at a slow pace, since ramp up of retail outlets is not very aggressive. Company is adding 15 new stores in next 27 months, from current 10 stores. Thus, visibility of improved margins is not very high in the immediate future.

As on 30-06-10, BVPS was Rs. 96. Post-issue, company's equity will rise to Rs. 60 crore and promoter holding will drop to about 75%. Company is seeking an enterprise value of Rs. 1,660 crore, considering upper band price of Rs. 110, which is quite high for its scale of operations and financial strength.   With mounting debt levels, poor working capital management, uncontrolled forex losses and fluctuating bottomline, the issue appears weak on pure fundamentals.

We advise against the issue, as fundamentally-stronger companies in this sector, like Gitanjali Gems and Shree Ganesh (to name a few), are available at much attractive valuations, in the secondary market. Better to avoid this issue, to begin a Happy New Year 2011!