Kavita Fabrics IPO Review by Naman Securities (Avoid)

Review By Naman Securities and Finance Pvt. Ltd on Feb 21, 2013

The BSE SME IPO of Kavita Fabrics Ltd is open from 20th-22nd February 2013. The company plans to raise Rs 5 crs for the purpose of meeting long term working capital requirements. It is engaged in the manufacturing of semi-finished sarees and dress materials. The issue price is fixed at Rs 40 per share and the minimum order quantity is 3000 shares. I recommend avoiding the IPO.

Vague objects of issue

Of the Rs 5 crs that the company plans to raise, it intends to spend Rs 1.2 crs or 24% of the total issue proceeds towards general corporate expenditure, a nebulous term which hides more than it reveals about the intended use of those funds. This amount is at the upper end of SEBI's norms of 25% of the total funds allowed towards 'general corporate purposes', which to me is a clear concern area.  A further of Rs 0.4 crs is toward issue expenses; hence a total of Rs 1.6 crs or 31% of the issue proceeds is not intended to generate returns for the investors. The remaining Rs 3.4 crs is for meeting long term working capital requirements. However, in my opinion, the management has been aggressive is estimating the same.
The increase in inventory days is justified to an extent as the company is likely to triple its capacity in FY13, there may be trial production runs till the entire capacity is commissioned. However, the assumption of increase in receivable days essentially implies that the company is tweaking its business model, for instance it is going to focus on higher export sales.The decrease in creditor days can imply that the company is losing its bargaining power amongst its raw material suppliers - which are many in number, unorganised and lie in the bottom of the value chain! However, these are just my presumptions on what could have led the management to assume a deteriorating working capital trend, the reasons for which are mentioned in the prospectus. Nevertheless, the objects of this issue do not lead me to believe that issue funds are channelized for purposes that can generate a healthy RoE.

History of related party transactions

There have been numerous related party transactions in the past as the company outsources some of its processes to its group companies, M/s. Kavita Fabrics, M/s. Swayam Textiles and M/s. Shiv Enterprises and derives some if its sales to another group company, M/s. Aayush Creation. Kavita Fabrics has taken over the business of M/s. Aayush Creation, M/s. Kavita Fabrics and M/s Swayam Textiles have been dissolved, and M/s. Shiv Enterprises continues to carry out its sole business of job-work to Kavita Fabrics. That fact that M/s. Shiv Enterprises reported a net profit margin of nearly 20% in FY12 as compared to a 2% for Kavita Fabrics in the same year raises doubts on whether the transactions take place on an arms length basis.

Conclusion / Investment Strategy

Valuations expensive; Avoid the IPO

The company is likely to report an EPS of Rs 1.2 in FY13, based on weighted average number of shares post the IPO. At the issue price of Rs 40, the PE multiple translates to 32x. Having tracked textiles in the past, I understand that, over a complete cycle, spinners trade at PE multiples of 4-5x, fabric manufactures, like Kavita Fabrics, trade in the range of 7-8x and garment manufacturers trade at 14-15x on a one year forward basis. Further, given its small size, RoE of 2-4%, concerns on the objects of the issue and related party transactions, the issue is extremely expensive and avoidable.

Reviewer recommends Avoid to the issue.

Review By Naman Securities and Finance Pvt. Ltd on Feb 21, 2013

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