Concerns ahead

IPO REVIEW

Though the company's initiatives are progressive and the valuation reasonable, execution concerns mar future prospects.

Technocraft Industries (India) plans to raise between Rs 79 and 87 crore from its public issue of 83 lakh shares. Though the IPO is a step in the right direction""to finance upgradation, expansion and investment in cost saving measures""its past financial performance does not inspire confidence.

To its credit, Technocraft has a well-balanced presence in three segments: drum closures, steel pipes, tubes and scaffoldings, and cotton yarn. It is primarily focussed on exports with 86 per cent of its H1 FY07 sales coming from overseas.

The company exports to 60 countries and has subsidiaries in European countries, and Australia. Given that most of its plants are operating at over 90 per cent capacity, the ramp-up in capacities appears timely. In this backdrop, the company's initiatives appear positive.

The drum closure segment, producing various sheet metal components used as closing devices for steel barrels, contributes nearly 27 per cent of total sales revenues.

The company, which is the second largest producer of this product globally, plans to use Rs 19 crore by FY08 from the issue proceeds for improving manufacturing processes to improve quality and reduce the raw material component in costs.

Given the high volatility of key raw materials like steel, this remains a positive step forward. The company's future export strategy for the proposed upgradation is to focus on the Chinese market.

However, this could pose significant challenges as China would not only be a relatively new market but also a difficult one due to the high duty structure and presence of many small local producers. The exact implications on revenue growth are thus a tough call at this stage.

Technocraft remains highly bullish on its pipes (steel tubes and scaffoldings) division, which contributed 42 per cent of sales in FY06. The company plans to use 19 crore by FY08 from the issue to expand the capacity of this division and introduce new scaffolding products. The company is focusing on increasing the share of scaffoldings in segmental revenues to around two-third over time.

Given that realisations from this sub-segment are higher than from pipes, this could have positive implications on the bottom line in the near term.

Moreover, the company is also adding new value added tube products to its product portfolio which should stand it in good stead. Given the ongoing infrastructure boom in the domestic market, the company could cash in on the local opportunity too.

However, some concerns remain mainly centered around the key input material, hot rolled steel coils.

A glance at the past financials of the company reflects that the volatility in steel prices, has impacted margins considerably. So, obviously there are limitations in terms of the pricing power that it can command.

The company's significant presence in Europe could help it take advantage of the continental cutback in production of speciality tubes. But competition from the Middle East and Chinese producers is expected.

And given that these two countries are also among the fastest growth drivers for construction demand overseas, penetrating these markets given existing competition, would pose significant challenges.

The company's proposal for setting up a captive power plant of 15 MW with an investment of Rs 6 crore deriving from the issue caters to the cotton yarn division (100 per cent EOU) and seems positive as this will reduce the cost of power by Rs 1.2 to Rs 1.5 per unit.

Given that power costs are a significant element in the yarn segment, this would significantly reveal in the balance sheet from FY09 onwards.

Technocraft also proposes to invest over Rs 6 crore from the issue for financing the expansion of the yarn division for 25200 spindles to 61104 spindles to be completed by FY07.

The company is also in the process of widening its business ambit by foraying into stitching garments and brand building. The garment business will be through its subsidiary, Danube Fashions.

Technocraft believes a strong technological base and locational advantages to be the key drivers for overall growth. But though the company presents a de-risked business model, the uninspiring financial performance of the company casts a shadow on its future prospects.

The company has recorded an over 4 per cent decline in consolidated sales in FY06 y-o-y. And over the past two years, its sales have increased by just about 10.5 per cent CAGR, despite robust growth in inflammable material transport and strong global GDP growth. Net profit margin trends also cut a sorry figure collapsing from nearly 9.3 per cent in FY04 to 8.4 per cent in FY06. 
 

FINANCIALS Technocraft Industries (Consolidated)
(Rs crore)	FY04	FY05	FY06
Sales	296.70	378.90	362.90
Net Profit	27.70	30.90	30.50
Net Profit margins	9.30	8.20	8.40
Operating profit	45.80	59.70	56.89
Operating profit margins	15.40	15.75	15.67

Moreover, the fall in sales realisations from the yarn segment, between March04 and March06 is also significant.

Also, the fall in sales revenues from the pipes division, a key focus area for the company, from Rs 133 crore in FY05 to Rs 117 crore in FY06 also stands out. This being said, the first half of FY07 has shown an increase in profitability.

Analysts are clearly divided over their preliminary valuations. The price band of Rs 95 to Rs 105 however appears quite reasonable.

Taking the post-diluted annualised EPS we get a P/E of 6.8 to 7.5 (lower and higher end of the price band) for FY07. If the EPS grows at 15 per cent in FY08, the P/E multiple works to 5.9 and 6.5 times FY08 earnings. So, valuations are quite reasonable. A chief difficulty in comparative valuations, however, remains the absence of another large organised player with a similar product portfolio mix domestically.

Moreover, some analysts also express their doubts over prospects given the nature of its business. Overall, small size and scalability problems could pose significant challenges.

Overall, investors would be best advised to wait and watch, and see how the company performs over the next few quarters.

Issue Opens: 18 January, 2007
Issue Closes: 23 January, 2007