Fashionably expensive

IPO REVIEW

Investors need to factor in project risks and high valuation while investing in House of Pearl Fashions' IPO.

The languishing performance of textile stocks on the bourses has not discouraged new textile players like House of Pearl Fashions to raise money in the primary market for expansion.

However the risks of investing in the company's initial public offer (IPO) outnumber the long-term benefits. Though the company is well established in the apparels exports business, its expansion plans have a high gestation period. It is also entering the domestic retail market with most of stores contributing fully only after a couple of years.

Analysts opine that there are better and bigger listed garment players available at attractive valuations as the IPO is priced at rich valuations even at the lower end of the price band.

Ambitious plans
House of Pearl Fashions plans to raise between Rs 250-285.6 crore by offering about 4.76 million shares in the price band of Rs 525-600.

The promoters are offering 1.23 million shares for sale to the public too, which takes the aggregate issue size to Rs 314-359 crore. There is also a greenshoe option of 0.6 million shares.

The company is raising capital to double its manufacturing capacity from the current 20 million pieces per annum through its 63 per cent subsidiary Pearl Global (which is listed on the stock exchanges) and Norp Knit in Bangladesh.

It also plans to establish a design centre, repay loans to subsidiaries, venture into the domestic branded apparel retail business with 10 pilot stores initially and acquire existing international brands in the US or the UK for retail presence outside India.

Approximately 75 per cent of the total project cost of Rs 360 crore will be funded through issue proceeds while the rest through debt and internal accruals.

Well established
House of Pearl Fashions sells garments, mainly casualwear, to customers in the US and Europe. It has long standing relationships with retailers like JC Penny, ASDA Walmart and GAP, who account for a significant part of its revenues.

Other major customers include Esprit, S Oliver, VF Corp, Next, Bonton and Gordmans.

The company has ten manufacturing facilities across various geographies with six located in North India, one in South India, two in Bangladesh and one in Indonesia employing about 11,000 people.

Besides this, the company sources garments from about 150 factories operated by third party manufacturers in China, Bangladesh and India. It has marketing and distribution businesses in the US, the UK, Canada and Spain.

While the domestic business is done through its 63 per cent listed Indian subsidiary, Pearl Global, international operations are carried out by subsidiaries in Bangladesh, Mauritius, Hong Kong and the US. The company has also developed its own brands 'DCC' and 'Kool Hearts' in the US.

Unique business model but...
The company's business model is unique and de-risked in the sense that of its total sales, only 25 per cent is manufactured by the company itself. The rest is sold by sourcing from various countries and the company is involved only in marketing, distribution and branding of these products.

Thus this strategy insulates it from any adverse event in a particular region. Also, it markets are well diversified as about 50 per cent of the revenue comes from the UK and the rest from various countries like Spain, the US, Canada and rest of Europe.

Says Deepak Seth, chairman, House of Pearl Fashions, "We sell to the most expensive markets in the world and source it from the cheapest markets of the world which holds well for the margins."

Moreover, the company's business is highly scalable as selling products by sourcing from others requires minimal capital investment and limited manpower. Further, it also enjoys certain import duty exemptions from the EU and Canada due to plant locations in Bangladesh.

As a result, the company claims to enjoy a higher overall return on capital employed of over 20 per cent with a higher contribution of over 25 per cent from marketing, distribution and branding activities and a lower about 13 per cent from manufacturing activities.

The company has its own design team from different countries to cater to the tastes and requirements of the respective market.

For its retail operations, the company has recently brought Tom Tar Singh on board who has over 37 years of experience in retail business with ladies fashion chain in UK called 'New Look'. However the company's bright business prospects and ambitious plans come with certain risks which investors need to consider.

... a risky investment
The company's future plans involve a high gestation period as most of its projects like new facilities at Tamil Nadu and Gurgaon, design and technology centre and retail stores in India will come up only after one-two years.

Further, the company will be a new player in the Indian retail sector which has established and large players like Pantaloon and Shoppers Stop having their own private labels and financially strong players like Bharati-Walmart and Reliance who are planning to expand in a big way.

Also, the company is yet to decide about the possible target companies for acquisitions though it will declare the final deal by the end of 2007.

Further, there is no past comparable data of consolidated financial performance as the company recently completed a corporate restructuring in May 2006 by integrating its international and domestic operations in phases.

In H1 FY07, the company had a turnover of about Rs 435 crore while operating and net margins were in the range of 8 per cent and 5.2 per cent respectively. This is much lower than the biggest listed garment player, Gokaldas Exports, whose operating profit and net profit margins were in the range of 11 per cent and 7 per cent respectively for the same period.

Moreover, the issue is aggressively priced at 23-26 times and 18-20 times at the respective price band for FY07 (annualised half yearly earnings) and FY08 estimated earnings. Gokaldas Exports' valuation stand at 14.3 times and 11 times its estimated FY07 and FY08 EPS respectively.

Says Neha Bubna, analyst, UTI Securities, "Although the company's business model is different and unique, valuations look expensive."