Khadim India Primary Offer: Solely for the risk-takers

Barring intermittent corrections, mid- and small-cap stocks have had a dream run since the 2014 rally. These stocks continue to attract investors even as markets touch new highs everyday. Private equity investors and promoters of Khadim India (Khadim’s), a player in the organised footwear market in India, are looking to cash in on this wave through the IPO of the company. Khadim’s plans to raise ₹539-543 crore from this issue, at a price band of ₹745-750. Of this, only ₹50 crore is a fresh issue, which is being made to partly repay the company’s debt. The rest is an offer-for-sale by PE investor Fairwinds Trustees (Reliance Alternative Investment Fund – PE Scheme ) and promoter, Siddhartha Roy Burman.

The offer is priced stiffly, keeping in mind the sharp expansion in valuation of peers over the last three years or more. Based on fiscal 2017 earnings, Khadim’s demands a price-to-earnings ratio of about 43 times on a post-issue basis. The stock’s market cap at the price band works out to around ₹1,338-1,348 crore. Peers such as Bata India (market capitalisation of about ₹10,500 crore) and Relaxo Footwear (₹7,000 crore market cap) trade at 62 times and 56 times, respectively.

Khadim’s discounted valuation to bigger peers makes it attractive. The company’s asset-light business model and its premiumisation strategy also hold promise. However, investors must keep in mind that the mid- and small-cap space will be vulnerable to steep corrections, should the market begin to display bearish sentiments. Hence, only those with a high-risk appetite can consider subscribing to the issue.

Khadim’s runs its footwear business through two verticals — retail and distribution. Retail sales is through exclusive stores, which are either the company’s own stores or franchisee-run ones. These outlets typically cater to the middle and upper middle income group in the metros and bigger towns and cities. As of end-June 2017, the company has a network of about 853 retail stores, next only to Bata, which has over 1,200 stores. The distribution business is targeted at the middle and lower income groups who shop at multi-brand outlets. While retail sales bring in about 70 per cent of revenues, the distribution business contributes 27 per cent. The company has a small online presence too, which along with segments such as institutional sales and exports fetches the remaining 3 per cent.

Over the near-to-medium term, prospects for Khadim’s remain sanguine. First, the branded footwear market is expected to grow at a CAGR of 20 per cent to account for 50 per cent of the overall market by 2020, from the current 40 per cent. Secondly, the implementation of GST will shift demand from the unorganised to the organised market. Along with segments such as jewellery, watches and consumer electronics, footwear already enjoys the highest penetration in organised retail in India, at 26 per cent. This is expected to improve further to 29 per cent by fiscal 2020. Growth is expected to be driven by increased penetration of exclusive branded outlets in tier II and tier III towns, across the country.

Khadim’s is well-poised to cash in on the above trends. While it is looking to expand its retail presence in the west, central and northern regions, the company’s asset-light model will ensure that it does not get saddled with high debt or high operating expenses in the process. Khadim’s does not do in-house manufacturing of most products sold in its retail channel. Being fashion-oriented, retail is a lower-volume, higher-value business compared to distribution.

Hence, the company procures its retail stocks from outsourced vendors, who number 107 currently. The company also uses the franchisee route for expansion and keeps its own stores to the minimum. Of the 853 retail stores that are operational currently, about 685 are franchisee stores.

Thanks to this asset-light growth strategy, margins in the retail segment, especially the franchisee stores, are higher than in the distribution segment. The company’s depreciation and interest costs have come down over the last few years. The debt-to equity ratio has improved from 2.2 times in fiscal 2013 to 0.7 times as of June 30, 2017.

Besides, Khadim’s has also rid itself of non-core businesses. The company closed down Khadim’s Khazana which were large format stores offering apparel, grocery and beauty products in 2015. Four Khadim’s Sona Khazana stores engaged in the retail gold jewellery business were shut in 2016. In addition, Khadim’s also formulated and implemented a policy to identify slow-moving inventory and liquidate these in fiscal 2015. Due to this one-time exercise, the company made losses of about Rs 19 crore that year. However, profits have bounced back since then. Inventory days have come down from 90 days then to 67 days currently. After the clean-up exercise, same store sales growth in fiscals 2016 and 2017 have come in at an average of 6-7 per cent, which is a reasonably good number.

Overall, net sales have grown at a four-year CAGR of 10.1 per cent to Rs 621.2 crore for the year ended March 2017; net profit has grown at a four-year CAGR of 36.3 per cent to Rs 30.75 crore.

Barring 2014-15, operating margins have hovered at 9-10 per cent. Given the growing fashion consciousness and higher disposable incomes, the contribution of premium sub-brands in the retail business, at about 50 per cent currently, is expected to go up further. The company is also focusing on improving average selling prices in the distribution segment through the introduction of premium products here. Hence, margins can be expected to go up in future.

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