Investors can stay away from the initial public offering of PG Electroplast — a company that manufacturers and assembles electronic products (colour televisions, DVD players, compact fluorescent lamps and water purifiers) on a contract basis for original equipment makers (OEMs). Though the consumer electronics industry has a strong growth prospect with improving consumer aspiration levels, PG Electroplast may not be best placed to capitalise on the opportunities in this market.

The company derives 77 per cent of its income form sale of colour televisions. While colour televisions have the largest share in the television market currently, the traditional television market is shrinking, giving way to LCD/LED televisions. The company's high dependence on a small client base also pegs up risk. In 2010-11, 38 per cent of the total sales followed supplies to a single company (top five customers contributed more than 90 per cent of sales). The company's top clients are companies in the same promoter group.

At the offer price band of Rs 190-210, the stock of PG Electroplast would be valued between 17 and 19 times its FY11 earnings on a fully diluted equity base. MIRC Electronics, a competitor, trades at a price-earnings multiple of 11 times only. Do note that MIRC Electronics has its own brand ‘ONIDA' and unlike PG Electroplast, it is not dependent on contract orders to the same extent. The recent correction has also levelled valuations of listed branded OEMs such as Voltas, Blue Star and Whirlpool of India (PE range of 12-17 times on FY11 earnings).

Sales-mix

PG Electroplast drives its earnings mainly (over 70 per cent) from manufacturing and selling colour televisions (CTVs) and plastic injection moulding for front and rear cabinets of DVD players and CTVs. With the CTVs market contracting over the last three years, there are doubts about the scalability of the company's business. The increasing reach of panel televisions' (LCD/LED and plasma televisions) may see cathode-ray tube televisions being phased out over a five-year period say industry observers. The DVD players market is choc-a-block with Chinese brands and doesn't offer much scope either. Stiff competition doesn't allow domestic OEMs or their contractors with any pricing power.

Compact fluorescent bulbs and water purifiers offer good scope, but last year the company had used less than 45 per cent of its CFL capacity, and there have been hardly any sales in the water purifier segment. The company has to identify customers for itself in these categories.

Small client base

PG Electroplast has reported a compounded growth of 70 per cent in sales annually over the last five years (FY 11 reported sales was Rs 436.2 crore and net profit Rs 17.9 crore). However, in the last three years, growth was driven by orders from group companies — Bigesto Technologies and PG International. The two companies were servicing an order for CTVs from ELCOT- Electronic Corporation of Tamil Nadu following a successful bid to a Government tender. Whether similar orders will pour-in in the coming years is doubtful. Not only has the ruling Government in Tamil Nadu changed, there is no guarantee that PG Electroplast will continue to win such bids.

The company has been in the contract manufacturing business since 2003, but hasn't entered into long-term contracts with any big brand for selling its CTVs or air-conditioner assemblies. This is a major drawback as contract manufacturing market is highly competitive. The key objective of this offer is to expand the capacity of plastic injection moulding lines at Greater Noida and Ahmednagar. These two units will then be making more cabinets for CTVs, DVDs, washing machines and assemblies for air-conditioners. With uncertainties about the existing capacity being fully utilised, additions to capacity may take time to pay off.

Fragile margins

Contract manufacturers generally have a lower profit margin, compared to OEMs in the already competitive consumer electronics market. Whirlpool of India and Voltas for instance report a profit margin of around 8-10 per cent at the operating profit level, compared to 5-6 per cent for PG Electroplast. Contract manufacturers further run the risk of a dent to margins during times of volatile commodity prices as they do not have much say on pricing. Interest expenses have also risen sharply for the company over the last year with the total outstanding debt at Rs 68.5 crore (outstanding debt in FY10 was Rs 30 crore). The interest coverage ratio was around five times. Post-issue, the company intends to use around Rs 24 crore for prepayment of a term loan and Rs 15 crore for long-term working capital requirements. Net profit margin was around 4 per cent in FY11. Offer closes on September 12; price band: Rs 190-210

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