The Hindu Business Line : Kamdhenu Ispat: Avoid

Given the stiff valuations, the challenges involved in the franchisee model adopted by the company, and the threat from larger players, Kamdhenu may not provide an attractive entry point through this IPO.

Stiffly priced

Kamdhenu is offering 1.28-crore shares at Rs 25 per share. The price-to-earning works out to about eight times its likely FY-07 earnings on an expanded equity base.

This appears to be at the higher end of the spectrum compared to the larger players in the primary steel-making space, which trade at a multiple of 4-4.5 times. (We have compared Kamdhenu with integrated players, as there are no listed entities in the secondary segment making long steel products)

Franchisee model: A risky bet

Kamdhenu makes steel bars that are widely used in construction. It has worked out two types of arrangements for carrying on the business. Under the first model, the company allows the franchisee unit to manufacture steel bars under the brand name `Kamdhenu' and market the same using the company's network. In return, the company gets a royalty on sales/production, normally on a per-tonne basis.

Under the second model, Kamdhenu plans to establish its own stockyards at various strategic locations and source products from the nearby franchisees. However, a few issues need to be looked at.

One, six out of the ten stockyards are to be set up in locations where franchisees have their units. While this may save transportation and holding costs, it may result in overlapping, as there is nothing in the offer document that indicates the territory allocation between the company and the franchisees. Two, any disruption/discontinuance of production by any franchisee is likely to have a direct impact on its revenues. Three, though the income from royalty has more than doubled over the past two years, its contribution to the total income is very low at about 2.4 per cent.

This may be attributed to the robust growth in volumes on the back of buoyant demand rather than business strategy per se. But sustaining such a growth could be difficult, particularly on the back of capacity constraints.

Cost disadvantage

Kamdhenu makes about 35 per cent of its primary raw material in-house, while the rest is procured from the domestic market. This places it at a disadvantage compared to players which have captive sources for raw materials. The company may, thus find it difficult to fully pass on any increase in cost to customers. Further, a part of its requirements for scrap (substitute for sponge iron) is met through imports. Higher duties and volatilities in price are likely to put pressure on its cost structure.

Other issues

The proposed arrangement aims at increasing the company's presence in the market. But it is not clear where the volume growth is going to come from. The company is working at almost full capacity and has not outlined any expansion plan.

There are concerns on the working capital management front too. Kamdhenu plans to make purchases from creditors (franchisees) on cash basis but intends to extend normal credit to debtors. With such a practice, risk of the company facing a cash crunch remains high.

Offer details: The offer opens on April 3 and closes on April 8. Chartered Capital and Investment is the lead manager to the issue.

The proceeds of the issue will be deployed to meet the working-capital requirements, and set up the corporate office and stockyards.

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