The Hindu Business Line : Kernix Microsystems: Avoid

WE recommend investors to avoid the initial public offering of Kernix Microsystems. The offer is to be priced between Rs 225 and Rs 250. At this price band, the offer is available at 18-19 times the annualised FY-06 per share earnings (based on five months ended August 2005). We believe the valuations are rich, considering the single customer for the company's products, complete dependence on railways' spending budget for revenue generation, low current capacity utilisation and the lack of concrete orders on hand for offtake of products.

Kernix Microsystems makes railway safety equipment, primarily anti-collision devices (ACD), contributing 99 per cent of the turnover. It plans to expand its ACD making capacity and diversify by expanding the product offerings and foraying into the export market. All these products will cater to the Railways. It plans to finance all the projects with pure equity.

Our recommendation is based on the following concerns:

Kernix has a tie-up with the Konkan Railway through which it markets its products for use by the Indian Railways. Hence, it depends entirely on the Railways for revenue generation. Though the latter has allocated funds for improving safety systems, the implementation may take time due to political reasons. For instance, the skybus project, cited as one of the demand drivers for the company's products, is still not on rails.

Kernix has an exclusive manufacturing and marketing rights for ACDs with the Konkan Railways. However, the Indian Railways is not under any obligation to source from Konkan Railways. It is free to choose a different technology offered by an international player. Since the project has a long gestation period, it is possible that an international player such as Siemens will enter the market with a different technology in the next two-three years.

As of March 2005, only 35 per cent of the capacity for making ACDs has been utilised. The expected utilisation rate is 65 per cent in 2006, which assumes an order growth rate of 80 per cent. Lack of orders on hand raises doubts on the achievement of such growth and may delay the utilisation of upcoming capacities expected to go onstream in FY-08. This could delay earnings accretion, making the offer expensive from a near-term perspective.

Only 18 per cent of the money raised will be used to finance the expansion of existing product range. Much of the funds would go towards working capital, setting up overseas offices and product diversification.

We view this negatively as the company has not tested the overseas market yet. It is yet to identify potential customers and find out the acceptability of its products in the overseas markets.

As the proposed projects are expected to take-off in three-four years, the offer appears stiffly priced under the current market conditions. Investors can revisit the stock in the secondary market.

Offer details: The offer intends to raise Rs 99 crore to fund capacity expansion, forays into overseas markets, diversification of product range and working capital requirement.

The present issue would dilute the company's equity by 60 per cent, if it is fully subscribed at the lower end of the price band. The offer opens on November 28 and closes on December 3. BOB Capital Markets and Allianz Securities are the lead managers to the offer.

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