The ₹500-crore IPO of Gandhar Refinery, a leading manufacturer of white oils in the country, which will close on November 24, includes ₹302 crore of fresh issue and ₹198 crore of offer for sale.

The company manufactures a wide range of oils from automotive lubricants to specialty oils used in healthcare, cosmetics and other applications. Gandhar operates three plants of which two are located in India (one each in Silvassa and Taloja) and one in Sharjah. The company exports to over 100 countries and accounts for over 53 per cent of the overall revenue. Gandhar’s clientele includes large multinationals such as Procter & Gamble, Unilever and their Indian counterparts such as Marico, Dabur, Patanjali, Emami, Bajaj Consumer and Amrutanjan to name a few.

Though these are the positive factors to consider, we believe that the raw material price volatility and dependence on imports for the same pose risk to the company’s profitability in the short to medium term, given that the company’s operating margin is already low at 7-8 per cent.

The issue is priced at 6.7 times its FY23 earnings of ₹25.1, at the upper end of its price band at ₹169 a piece, respectively. While the valuation appears cheap and the company has a good clientele, fluctuations in crude oil and currency can pressurise the profit margin. Investors with a long-term perspective can wait for a cool-off in energy prices before taking exposure to the stock, although the issue has witnessed strong demand and was already subscribed around 14 times at close on November 22.

Following are the three reasons why we would recommend retail investors caution before investing.

The company’s business can be divided into three key segments — the largest one being Personal care, Health care and performing oils, which accounts for almost 55 per cent of the revenue. Products in this segment include white oils, waxes and jellies such as petroleum jelly, which are used in OTC products, ointments and cosmetic skin care products. Also, the company claims it has significant leadership in the white oil market with a 26.5 per cent share in the India and 9.6 per cent share in the global market.

The second largest segment is of automotive and industrial lubricants sold under Divyol brand name, which accounts for a fourth of the revenues. The third segment is the performing oil segment which includes transformer oil and rubber processing oil. This accounts for under 10 per cent of the consolidated revenues.

For all the three segments, the underlying raw material is crude-derived base oil. About 80 per cent of the company’s raw material is crude-based. Further, over the last three years, the company’s dependency on imported base oil has increased significantly, from 57 per cent in FY21 to 72.5 per cent in FY23 of the total raw material consumed. Rising crude oil prices fuelled by geopolitical tensions, coupled with rupee depreciation can hit profit margins for the company. Also, thelegroom to pass on the cost increases to its clients appears limite. Hence, moderation in the energy prices will be critical for the company.

Further, the automotive lubricant business can also witness some demand moderation over the medium term, with a pick-up in demand for electric vehicles. While this impact may not be immediate, this can lead to moderation in the segment growth in the medium term.

Also, the company’s business model is raw material-intensive with very limited value addition, given that the company operates in the B2B spaces with hardly any scope for branding. About 92-94 per cent of the revenue is from enterprise customers (B2B). As a result, the margin profile of the company is also modest. In FY21, when the input prices were at historic lows, the company’s gross margin was 19.5 per cent and operating profit margin during this period was 6.2 per cent.

In FY23, the company reported revenue growth of 20 per cent to ₹4,079 crore. Operating profit margin for the year stood at 7.8 per cent, translating into operating profit of ₹316 crore. In the first quarter of FY24, the company’s revenue stood at ₹1,070 crore, with operating profit margin of 7.9 per cent, largely flat when compared to FY23. Also, the company’s receivables and inventory remained higher in the June 2023 quarter translating into negative operational cash flow of ₹130 crore, versus positive cash flow of ₹166 crore in FY23. As a result, short-term borrowings as at June 2023 stood at ₹320 crore versus ₹147.2 crore as at March 2023. Increase in crude prices can further impact the working capital cycle for the company. Hence, we recommend long term investors to wait, although the IPO is attractively priced.

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