Improving outlook and margins, Subscribe August 03, 2016 Gaurav Jogani gauravjogani@plindia.com +91 22 66322238 Rating Price Band IPO Grading Subscribe Rs258 Rs268 (Grade 5/5 indicates strong fundamentals and grade 1/5 indicates poor fundamentals) NA IPO Fact Sheet Opening Date Aug 2, 2016 Closing Date Aug 4, 2016 BRLMs Motilal Oswal, Centrum Issue Size Rs2.38 to 2.39bn Fresh Issue Rs2.15bn Offer for Sale 9,00,000 equity shares S.P. Apparels (SPAL) is one of the leading Indian manufacturers and exporters of knitted garments for Infants and Children, with ~86% of revenues (including duty drawback and export incentives) from exports. SPAL is expanding its Yarn capacity to source 100% requirement internally and is also putting up a knitting facility to reduce third party dependence for manufacturing and expand margins, going ahead. Sales growth of 12 16%, debt repayment of Rs630m and improvement in cash flows will help improvement in return ratios and expansion in earning multiples. At the upper end of the IPO price band of Rs268, the stock is at 13xFY16 earnings. With improving sales and margin outlook, long term prospects look encouraging with scope of decent returns over the coming 2 3 years. Capacity expansion for the next phase of growth: SPAL s dependence on third party for yarns used for knitting is expected to reduce significantly, going forward. They are spending Rs750m for expansion and modernisation of manufacturing facility at Valapady and Salem in Tamil Nadu. With increased capacity and better integrated operations, we believe SPAL will be able to accelerate its production as it will be more aggressive in sourcing orders from new clients in the absence of production capacity constraints. Margin expansion on backward integration and operating leverage benefits: Addition of spindles and the blowroom capacity will help SPAL to source 100% of its yarn requirement internally, while earlier it use to source 80% from outside. Also, addition of knitting capacity will help it to reduce dependence on thirdparty manufacturers for knitting and would help it to increase efficiency of manufacturing process and thereby, help it to increase margins. Globally, Kids wear segment producers enjoy average EBITDA margins of ~23 24% and at 16% EBITDA margins; SPAL has enough space to increase margins. IPO Note Objects of the Issue Expansion and modernisation Debt Repayment New stores for Crocodile products Issue Details Pre issue equity (m shares) Post issue equity (m shares)* Post issue Market Cap (Rs bn)* Rs 750mn Rs 630mn Rs 278mn 17.14 mn 25.16 mn 6.7bn Financial deleveraging will help to reduce cost of debt: SPAL s total debt at the end of FY16 stood at Rs2.59bn with an average cost of debt of ~12%. With the IPO proceeds, SPAL will repay debt of Rs630m, which will majorly consist of high cost debt, thereby, helping it to bring down the average cost of debt to ~8%. Key financials (Y/e March) FY13 FY14 FY15 FY16 Revenues (Rs m) 4,285 4,509 4,726 5,328 Growth (%) 7.0 5.2 4.8 12.8 EBITDA (Rs m) 550 639 689 853 PAT (Rs m) 24 67 100 347 EPS (Rs) 1.4 4.0 6.0 20.2 Growth (%) (75.6) 182 50.7 238.5 Share Holding (%) Pre IssuePost Issue* Promoters 87.5 59.6 Public & Others 12.5 40.4 *Equity issuance calculated on higher band price Profitability & Valuation FY13 FY14 FY15 FY16 EBITDA margin (%) 12.8 14.2 14.6 16.0 RoE (%) 2.9 7.1 9.7 26.2 RoCE (%) 11.1 12.9 14.7 18.0 PE (x) 190.5 67.5 44.8 13.2 P / BV (x) 5.6 4.8 4.4 3.5 Source: Company Data; PL Research Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
Exhibit 1: Issue Details Launch Date 2nd of August Issue Period Opening date: 2nd August; Closing date: 4 th August 2016 Exchange Issuer Offer Type Net offer Listing on both NSE and BSE S.P. Apparels ( SPAL ) Price Band Rs258 268 Issue Split (No. of shares) Use of proceeds Current Shareholding Initial Public Offering / Reg S Fresh issue of Rs2,150m + Offer for sale upto 0.9m shares QIB Portion: At least 50% of the issue Non Institutional portion: Upto 15% of the issue Retail Portion: Upto 35% of the issue Rs630m Repayment of Debt Rs701.6m Expansion and Modernisation of Manufacturing facility at Valapady, Salem in Tamil Nadu Rs278.54m Opening of 70 new stores for the sale of 'Crocodile' brand products Rs49.12XX addition of balancing machineries for existing dyeing unit at SIPCOT, Perundurai General Corporate Purpose Pre Offer Post Offer Promoter Holding 87.49% 59.60% NYLIM India Fund II 10.50% 3.60% Euro Asia 2.01% 1.40% Others 35.50% Offer Structure @ Upper price band @ Lower price band (No of shares in m) Fresh issue 8.33 8.02 Offer for sale 0.9 0.9 Net offer for Public 9.23 8.92 Syndicate Member Motilal Oswal Investment Advisor Pvt. Ltd, Centrum Capital ltd August 03, 2016 2
SP Apparel: Operating leverage to Play SPAL is one of the leading manufacturers and exporters of knitted garments for infants and children in India. Its USP is the Fashion segment in the Infant and Children clothing segment. SPAL commenced its business in 1989 and at present operates 21 manufacturing facilities, of which, seven are owned, consisting of 4874 sewing machines, eight cutting machines, 79 embroidery machines, 17 printing machines, 16,896 spindles and 22 dyeing machines. SPAL has 9,147 full time employees in the garmenting division. SPAL has a license agreement for the exclusive manufacture, distribution and marketing of menswear products under the trademark Crocodile in India. Under the brand name Crocodile, SPAL operates 40 exclusive brand outlets (37 company owned operated stores and three franchisees) and accounts for 6.4% of total revenues in FY16. SPAL s major clients include TESCO, ASDA, Primark etc. all of which are from the European region. Global Childrenswear Market Children wear market is divided into two categories: Infant and Toddler wear that caters to the age group of 0 3 years and Kids wear for age group of 4 14 years. Global infant and children wear market is marked by its resilience to pressures on economic conditions and disposable incomes. Market size: Global Children wear market was US$228bn in 2014, out of which, around 20% contribution came from Infant and Toddler apparels (0 3 years) and 80% from other children s apparels (4 14 years). The market has grown at a CAGR of 4.8% between 2009 and 2014. Key markets: United States is the largest market for children s wear with a market size of US$58.3bn, followed by China. European countries like Germany, U.K. and France are the leading countries in per child apparel spending. Growth of children wear market in developing countries like China, India, Russia, Brazil etc. has been higher with CAGR in the range of 8 12%, between 2009 and 2014. August 03, 2016 3
Exhibit 2: European countries leads per child spend on apparel Key sourcing destination: India is among the key sourcing destinations of children s wear. China remains the leading exporter of children s wear, with a global share of 36.1%, followed by Bangladesh at 6.5% and India at 4.2% Vietnam, Italy, Hong Kong, Turkey, Indonesia are among the other key sourcing destinations of children s wear. Knits children s wear exports from China and India have increased at a CAGR of 6% and 7%, respectively, between 2009 and 2014. However, Bangladesh and Vietnam have managed to demonstrate CAGR of 10% and 9% in the same period. Outlook: With the Improving global economic outlook, the growth rate is expected to increase to a CAGR of 5.6% between 2014 and 2019 to reach a value of US$300 billion in 2019. Exhibit 3: SPAL customers are from the economy segment August 03, 2016 4
Exhibit 4: 5 major customers contribute 95% of export revenues Client Name Revenue contribution in FY16 (%) Tesco International Sourcing ltd. 31 ASDA Stores ltd. 22 Primark Stores ltd. 13 Mothercare U.K ltd. 7 Dunnes Stores (Bangor) ltd. 3 Total 76 Future Plans: Margin to improve as operating leverage kicks in. Capacity expansion for next phase of growth: SPAL at present owns 4874 sewing machines, eight cutting machines, 79 embroidery machines, 17 printing machines, 16,896 spindles and 22 dyeing machines. Out of the total IPO proceeds of Rs2.15bn, SPAL is looking to utilize Rs750m for expansion and modernisation of its manufacturing facility at Valapady and Salem in Tamil Nadu which includes 1) increasing the blowroom capacity from present 3,200kg per day of cotton to 15,015kg per day of cotton 2) increase in the spinning capacity from 16,896 spindles to 22,272 spindles 3) setting up a knitting unit at Valapady and 4) addition of balancing machines for existing dyeing unit at SIPCOT. The capacity addition work is expected to be completed by the end of Q3FY17 and is expected to help SAPL to significantly reduce its dependence on third party for knitting and yarn requirements. Increase in volumes to bring operating leverage: SPAL at present is dealing with only 5 6 major customers in the U.K for its exports business due to high capacity utilisation and working capital constraints. However, with increased capacity and better integrated operations, SPAL will be able to deal with more number of customers as it will have better efficiency in operations and would also be able to meet the stringent requirements of its customers as its control on the manufacturing process will increase considerably, up from the 39m pieces production in FY16. Margin expansion due to improved backward integration: Addition of Spindles and the blowroom capacity is expected to help SPAL to source 100% of its Yarn requirement internally, while earlier it used to source closer to 80% from outside. Addition of knitting capacity will help the company to reduce dependence on thirdparty manufacturers for knitting and would help it to increase efficiency of manufacturing process and thereby, help it to increase margins. SPAL s consolidated EBITDA margins stood at 16%, while globally Kids wear segment producers enjoy average EBITDA margins of ~23 24%. We believe that with the increase operating leverage kicking in and improved efficiencies, SPAL s EBITDA margin is set to improve, going ahead. August 03, 2016 5
Financial deleveraging will help to reduce average cost of debt: SPAL s total debt at the end of FY16 stood at Rs2.59bn with an average cost of debt of ~12%. With the IPO proceeds SPAL plans to repay debt of Rs630m which will majorly consist of high cost debt, thereby, helping it to bring down the average cost of debt to ~8%. Better negotiating term with suppliers of raw material: With the reduced dependence on suppliers for its raw material requirements, SPAL will stand to improve its working capital cycle and secure better credit terms and services as its overall financial standing is set to improve with reduction of debt. August 03, 2016 6
Key risks Absence of long term supply agreements: SPAL executes sales orders based on the purchase orders received from customers. The purchase order usually involves designing, quantity, delivery schedule and price. Accordingly, SPAL manufactures the demanded requirements of customers. The prime responsibility of SPAL is to manufacture products as per the quality requirements and deliver such products on a timely basis. Generally, the orders are placed at the start of each season. However, there are no binding agreements with existing customers to provide future orders. SPAL does not enter into long term sales contracts with the customers, exposing the same to the risks of bleak revenue visibility. Furthermore, 80% of total revenues are earned from customers outside India and are denominated in foreign currency. Although the company follows prudent hedging policies, cancellation of any such order would cause significant losses to the company. 95% of export revenues contributed by five major clients: Significant proportion of SPAL s revenues has historically been derived from a limited number of customers. Over the last five financial years, top five customers contribute more than 80% of the total exports revenues. Furthermore, SPAL s customers are predominantly based in the UK, which is currently facing an adverse scenario relating to Brexit. Labour intensive business: For FY16, SPAL had 9147 full time employees at its garments division and 36 full time employees at its retail division. The recent textile policy has indicated an increase in minimum wages to employees. However, with majority of the strikes and lockouts experienced in the textile space, the labour intensiveness of the business leads us to maintain a cautious stance. The key to margins are higher utilization levels and higher production. Any impact on the same would drastically change the profitability scenario of the company. Loss making retail business: SPAL owned subsidiary Crocodile Products Pvt. Ltd (CPPL) has formed a JV with Crocodile International Pte. Ltd (CIPL) for retailing mens wear under the Crocodile brand. SPAL operates 40 exclusive brand outlets (37 company owned operated stores and three franchises) and generates 6.4% of total revenues. CPPL generated revenues of Rs120m, Rs241m and Rs190m, while it generated PAT of Rs(8.36)m, Rs76.24m and Rs(8.46)m in FY14, FY15 and FY16, respectively, while SPAL is looking to open 70 more stores in FY17 out of issue proceeds. We believe that initially these additional stores may be a drag on profitability till they reach a certain scale and size. August 03, 2016 7
Financials Exhibit 5: Income Statement (Rs m) FY13 FY14 FY15 FY16 REVENUE Revenue from operations (gross) 4,285 4,509 4,726 5,328 Less: Excise duty Revenue from operations (net) 4,285 4,509 4,726 5,328 Growth % 7.0 5.2 4.8 12.8 Expenses Cost of materials consumed 1,708 1,830 2,028 2,323 Changes in inventories of finished goods, work in progress and stock intrade (8) 238 35 (281) Gross Profit 2,585 2,440 2,663 3,286 Growth % 3.4 (5.6) 9.2 23.4 Gross margin % 60.3 54.1 56.4 61.7 Staff cost 786 761 1,000 1,211 % of sales 18.4 16.9 21.2 22.7 Other expenses 1,249 1,040 974 1,222 % of sales 29.1 23.1 20.6 22.9 Total expenses 3,735 3,870 4,037 4,475 EBITDA 550 639 689 853 Growth % (8.7) 16.2 7.9 23.8 EBITDA margin % 12.8 14.2 14.6 16.0 Depreciation 169 176 200 201 EBIT 381 462 489 652 Finance costs 343 356 312 253 Other income 4 12 67 49 PBT 41 119 244 449 Tax expense / (benefit): (a) Current tax expense 12 29 71 67 (b) (Less): MAT credit (10) (25) (69) (15) (c) Wealth Tax 0 (d) Deferred Tax 20 51 146 55 Net Tax expenses 21 54 147 107 Tax rate % 50.9 45.6 60.4 23.9 Minority Interest (3) (2) (4) (6) Adj. Profit 24 67 100 347 August 03, 2016 8
Exhibit 6: Balance Sheet (Rs m) FY13 FY14 FY15 FY16 Shareholders funds (a) Share capital 368 440 440 371 (b) Reserves and surplus 437 503 593 956 Total 805 944 1,033 1,327 Minority Interest (48) (50) (53) (59) Non current liabilities (a) Long term borrowings 1,001 920 728 679 (b) Deferred tax liabilities (net) 122 172 317 372 (c) Long term provisions 15 41 Total 1,123 1,093 1,060 1,091 Current liabilities (a) Short term borrowings 1,626 1,728 1,566 1,627 (b) Trade payables 1,105 1,075 1,215 1,168 (c) Other current liabilities 668 422 287 355 (d) Short term provisions 26 41 89 104 Total 3,425 3,266 3,157 3,253 TOTAL (A) 5,305 5,253 5,197 5,612 ASSETS Non current assets (a) Fixed assets (i) Tangible assets 2,908 2,769 2,680 2,701 (ii) Intangible assets 26 20 15 10 (iii) Capital work in progress 36 Total 2,933 2,789 2,695 2,746 (b) Goodwill on Consolidation 59 59 59 59 (b) Non current investments 1 5 4 (c) Long term loans and advances 112 158 232 290 Total 3,104 3,006 2,991 3,099 Current assets a) Current investments 9 7 3 2 b) Inventories 1,257 1,253 1,073 1,275 c) Trade receivables 509 542 743 816 d) Cash and bank balances 61 144 68 111 e) Short term loans and advances 363 293 315 307 f) Other current assets 2 8 4 3 Total 2,201 2,247 2,206 2,513 TOTAL (B) 5,305 5,253 5,197 5,612 August 03, 2016 9
Exhibit 7: Cash Flow (Rs m) FY13 FY14 FY15 FY16 Net cash flow from / (used in) operating activities 787 581 836 481 Net cash flow from / (used in) investing activities (82) (140) (58) (281) Net cash flow from / (used in) financing activities (685) (437) (772) (192) Net increase / (decrease) in Cash and cash equivalents 20 4 5 9 Cash and cash equivalents at the beginning of the year 12 32 36 41 Cash and cash equivalents at the end of the year 32 36 41 50 August 03, 2016 10
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