Avon Weighing Systems: Have you seen an IPO at face value so far??

Trust me guys, Iam not dreaming. Come June 9Th, Avon Weighing systems which assembles and sells weighing instruments in India is hitting the capital markets with its IPO priced at Rs.10 per share. The company, incorporated in 1999, is the authorised dealer of industrial electronic and digital weighing scale products of "A&D" and "Tanita" (Japan) in India. The company assembles these products after importing spare parts from these companies abroad, customising them to individual customer requirements. The company is also the authorised dealer of Excell Precision Co. Ltd., Taiwan and Ningbo Benui Electric Co. Ltd., China. A&D company is the world's third largest manufacturer of weighing machines.

The company is now venturing into manufacturing of weighing systems to address the competitive scenario and tap into the emerging opportunities in the 1000 crore market. The manufacturing would be done with the technical support of Tanita. The weighing balances distributed by the company are used in industries where precision weighing is critical eg: Gems, jewellery, pharmaceuticals, retail, healthcare, posts & couriers, oil, airports, iron and steel etc.The funds raised through the IPO will part-finance the company’s Rs 17.30 crore expenditure plan for 1. A manufacturing facility at Baddi (Himachal Pradesh) 2. Four showrooms for display and sale of its weighing systems 3. Purchase of additional office premises in Mumbai. The project is proposed to be funded through promoters’ contribution of Rs 4.36 crore, internal accruals of Rs 0.50 crore and a term loan of Rs 2.60 crore in addition to the IPO funding of Rs 9.83 crore. The fact that promoters are also making a contribution to the funding plans alone gives a lot of assurance to the issue. It also shows the confidence the promoters have in the sustainability of the business going forward, considering the fact that the company is a small scale industry (SSI) unit.

The size of the electronic weighing systems industry in India is around Rs.1000 crore and is growing at 25-30% p.a.
The biggest positive from this IPO is that it’s coming out with an IPO at a price of Rs.10 sans any premium. Retail investors can bid for a minimum of 500 shares and in multiples of 500 thereof upto a maximum of 10000 equity shares. The company plans to list its shares on the Bombay Stock Exchange (BSE). The IPO has been rated "Grade 2" by CARE indicating "below average fundamentals". Though this appears a negative from the IPO standpoint, there have been cases in the past where even a company with a moderate business profile can command superior valuations if the pricing is right and it is here where this IPO is right up your alley. Lets examine the pros and cons of this issue:

Strengths:

1. Good track record of the promoters in trading operations, excellent long
standing relationships with A&D and Tanita Corp., growing usage of digital
and electronic weighing machines compared to mechanical weighing
machines used earlier. Even a small transformation or conversion of retail
and trade establishments from mechanical to electronic weighing machines
presents a huge opportunity. Also the preference for precision and accuracy
in weights and measures will convert a significant population into potential
customers.

2. Backward integration into manufacturing will strengthen the weak margins
and lend better pricing power. The company is commencing its
manufacturing operations by November 2008 and this should ensure a
robust growth in topline going forward as well as reflect an improvement in
the PAT margins to 7-8% from the present 4%.

3. The manufacturing plant to be set up at Baddi, Himachal Pradesh is exempt
from taxes and duties. The fiscal incentives will definitely shore up the
margins of the company going forward.


4. Usage of properly serviced second hand dies for manufacturing will result in
saving on capital expenditure going forward.

5. Innovative products, better technology through internally developed
software, industry specific solutions and customised service have made the
company a preferred supplier to a number of its customers.

6. Avon has witnessed impressive growth in its topline and bottomline at a
CAGR of 43.5% and 64% respectively over the last five years. The company
has had a decent track record of paying dividends in the range of 12.5-
13.5% every year. Assuming the trend would continue, one can safely
conclude that this stock would have an excellent dividend yield given the fact
that the issue is priced at par value.

7. Legislations are being passed now by various state governments by banning the usage of
mechanical balances. Karnataka for example has already passed one such legislation.

8. Long standing relationships with companies like Novartis, Lupin, Sudarshan Chemicals lends
earnings visibility.

9. Any rupee appreciation against currencies like YEN and YUAN should result
in handsome gains for the company due to its import policy of spare parts
and raw materials.

Weakness :

1. No prior experience of promoters in the manufacture of electronic weighing
machines. The company has only been trading and distributing weighing
machines so far.

2. Excessive dependence on A&D and Tanita for business continuity. Inherent
business risk lies in highly concentrated business profile and
termination/discontinuation of dealership agreements. Also for the
manufacturing activities to commence, technical support from Tanita is
required for which no formal agreement has been entered into. The
agreement will be entered subject to inspection of the Baddi plant by
Tanita authorities. In case the agreement does not materialize, the company
plans to install an assembly plant at the proposed site.

3. Inadequate geographical reach

4. Limited investment ability of promoters

5. Significant competition from players like Essae- teraoka, Avery India, Sansui,
Phoenix, Atco, Contech and the presence of the unorganised market have
hampered the possibility of a wider geographical reach for the company.
Avery India is the only listed player that has been in existence in the
industry for more than two decades but has witnessed moderate sales growth
compared to Avon. But Avery has its own manufacturing facility in place.

6. The company has reported negative cash flows in the last three years due to
working capital constraints. The company faces a strained working capital
situation due to delay in receivables from government agencies. Government
agencies typically take 90-120 days to settle their dues. The interest burden
is expected to go up in the near to medium term.

Notes on financials:

1. With the commencement of manufacturing operations by Nov.2008, the growth momentum
is expected to continue with overall improvement in margins

2. The company has reported better earnings growth when compared to Avery India. The
margins are lower than Avery India as the former is already into manufacturing activities
that can lead to better economies of scale compared to trading activity alone.

3. At the fixed IPO price of Rs10, Avon commands a better market cap to sales ratio as well as
PEG (Price earning growth) when compared with Avery India, indicating scope for sizeable
listing gains.

4. The Enterprise value per share is also at a significant premium to the issue price


All in all, Avon India can be described as a SSI with a moderate business profile and decent financial strength with ability to deliver stable returns going forward.


Valuation:

The IPO price of Rs.10 discounts FY 08 fully diluted EPS of 1.12 by 8.92x, which is lower than the PE of Avery India, the only comparable listed peer.

The IPO is being recommended to investors for the following reasons:

·The scope for downside is very limited. The pricing of the IPO at par value discounts all the negatives associated with the company

·The company is financially sound with average fundamentals. The impressive dividend yield at the IPO price will alone attract investors to this counter.

· The weighing machines industry is growing at 25-30%p.a and players in the industry should command better valuations going forward.

· Avery India had an open offer from its promoters last year at a price of Rs.80 which indicates the sort of valuations companies in this industry should likely command.

·The market cap to sales ratio is significantly lower compared to Avery India. So valuations for Avon with better earnings growth should definitely catch up over the medium term.

·Assuming that the market conditions will stabilize by the time listing of this issue happens, investors can be reasonably sure that the scrip will get listed with a decent 30-40% premium above issue price.

It is indeed commendable that sanity has prevailed in pricing this issue. The merchant bankers have definitely left something on the table for investors. The proof of the pudding is in the eating. This “weighing balance” definitely tilts in your favour.