The Hindu Business Line : JHS Svendgaard Laboratories : Invest at cut-off

JHS is set to gain from contract manufacturing orders from retailers, who are increasing the shelf space allocated to their own brands or private labels.

MR NIKHIL NANDA, MD.

Investors with an appetite for risk and a long-term perspective can consider the initial public offer of JHS Svendgaard Laboratories (JHS), a contract manufacturer of oral-care products such as toothbrushes, toothpaste, whitening products and mouthwash.

The price band of Rs 49-58 values the offer at 6-8 times the 2005-06 per-share earnings (pre-issue). JHS has no comparable peers in the listed space.

The company is investing Rs 50 crore in a project that will expand its capacities several fold.

The new facilities will be operational by December, but the benefits of the expansion will most likely be realised only the next fiscal.

Business prospects

The company is in the early stages of an emerging opportunity. Buoyant trends in the oral-care segment augur well for contract manufacturers, with FMCG players launching new products. For JHS the opportunities are in catering to the rapidly expanding retailers.

Players such as Reliance and Pantaloon are seeking to increase the shelf-space allocated to their own brands or private labels. Private labels are products offered at a cost lower than the branded ones, but offer retailers better margins.

Contract manufacturers such as JHS gain by undertaking orders from retailers, as they have better scope for adding value through in-house designs and processes. Margins from retailers are estimated at 30-40 per cent more than that derived from FMCG players. At present, the majority of sales is derived from FMCG companies.

An aggressive push in the retailer segment could, however, enhance profitability; operating margins now stand at about 19 per cent. It will also offset any cutbacks in outsourcing by traditional FMCG marketers.

JHS recently broadened its portfolio from mainly toothbrushes, which is typically low-margin, to include toothpaste, whitening agents and niche products such as denture effervescent tablets, some of which fall in the pharmaceutical domain. The oral-care market in India is still underdeveloped and some of these niche or premium products may be sold mostly in the export market.

Exports have been a strong driver of revenues. JHS started exporting toothbrushes in 2002-03. It already derives about 50 per cent of its Rs 35-crore revenue from exports. International retailers appear serious in their plans to increase sourcing from India, and JHS will have to take advantage of this trend.

Challenges

While the business outlook is bright, JHS, which has been in operation for about a decade, appears to have gained ground only in recent years. JHS' limited track-record heightens the risk of the ambitious scale of its expansion project. Products such as floss and mouth rinse that are in demand in the West are yet to take off in a big way in India, where dental hygiene awareness is poor, even in urban markets.

Also, while retailers in international markets have successfully sold private labels across categories, in India, they are yet to make a mark in segments dominated by brands.

JHS hopes to carve a market for itself by being the only one-stop-shop manufacturer of oral-care products. The bulk of its production will be in Himachal Pradesh, where several FMCG players have set up facilities. Most of its production will not attract excise duty and its profits will be almost tax free. JHS will be able to position itself as a cost efficient producer to domestic and export customers alike.

Risks

As the only listed player of its kind, JHS may enjoy fancy on the back of the uptrend in FMCG. Given the incipient stage of its business, however, JHS' ambitions may take longer than expected to fructify.

With the equity base post-offer set to more than double, markets will stress on strong performance. The per-share earnings may fail to keep pace with profit growth.

JHS does not exclusively manufacture products for any single player. It is, however, dependent on a few players, who could wield considerable buying power. Minor changes in the contract agreements could have an adverse impact on performance. As a small-cap stock, it remains vulnerable to market risks. Conservative investors may avoid the issue and look for entry points in the secondary market at a later stage.

Offer details: On offer are 67 lakh shares, of which the promoter will subscribe to five lakh shares. About Rs 40 crore will be raised at the higher end of the price band. The Rs 50-crore project is to be funded by a mix of debt and equity. The offer opens on September 26 and closes on October 4. The lead managers are UTI Bank, Centrum Capital and Bajaj Capital.

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