Should you subscribe to Rossari Biotech IPO?

The initial public offering (IPO) of Rossari Biotech, a speciality chemicals manufacturing company, can be given a miss. Pricey valuation, intense competition in the segments the company operates in, low pricing power and high customer concentration are dampeners. Given the market volatility and the small size of the business (turnover of ₹600 crore in FY20), it would be advisable for retail investors to wait and watch before betting on the stock.

That said, a robust revenue growth (on a small base), strong return ratios (31.8 per cent at the end of FY20) and general market exuberance in recent weeks (on the back of liquidity) could drive investor interest in the near term. However, investors with a long-term horizon and lower risk appetite can play it safe and take a call after a few quarters when the uncertainty over the pandemic eases and there is more clarity over the sustainability of the company’s earnings in the recently entered segments.

At the price band of ₹423-425, the company is valued at about 34 times (post-issue) the FY20 earnings. The valuation appears pricey compared with its listed peers which are relatively larger in size (in terms of sales and market capitalisation). Galaxy Surfactants and Aarti Industries (peers in certain segments) are trading at about 31 times their FY20 earnings. Both companies enjoy a higher market share and operating margins compared with Rossari Biotech.

The promoters are looking to divest 21 per cent stake in the company through the IPO. The offer also comprises a fresh issue worth ₹50 crore.

Riding the bandwagon

Rossari Biotech’s revenues flow from two main segments — Textile Speciality Chemicals (TSC) and Home Personal Care & Performance Chemicals (HPPC) — comprising about 44 per cent and 47 per cent, respectively, of the company’s revenue in FY20. The firm has also forayed into the Animal Health and Nutrition (AHN) segment which contributes 9 per cent to revenues.

The company is a known brand in the TSC segment, and yet only enjoys a market share of sub-5 per cent levels. This is because the TSC segment is highly fragmented (with over 800 manufacturers and blenders). Also, the textile industry has been witnessing a demand slowdown (both in India and globally); the pandemic has worsened the blow.

To counter the limited growth potential in this space, the company had sought to diversify its product mix and forayed into the HPPC segment in 2013 .

Following this, its top-line grew by 42 per cent CAGR over FY18 to FY20, driven almost entirely by the HPPC segment — revenues from this segment quintupled over FY18 to FY20.

Sustainability is key

The company currently has one plant in Silvassa (Gujarat), with a capacity of 1.2-lakh million tonnes per annum (mtpa), operating at almost 90 per cent capacity.

Confident of further growth and export potential in all three segments, the company has set up a new plant in Dahej (Gujarat) with 1.325 lakh mpta capacity. The Dahej plant’s construction is almost through — about 25 per cent of the plant’s capacity was commissioned on July 1, 2020, and the plant is expected to be entirely operational by the end of FY21.

However, both HPPC and AHN segments face severe competition, both globally and from domestic unorganised players. Hence, there could be challenges in garnering new clients.

Within the HPPC segment, while FMCG (fast-moving consumer goods) exposure could be a growth driver, the company’s presence in the space is limited. The firm currently does contract manufacturing for reputed brands such as Amazon and Hindustan Unilever in the soaps and detergents space, and also manufactures sanitizess.

Most of its other products cater to industries such as water treatment, paints, inks and coatings, ceramics and tiles, and pulp and paper.

The company is also planning to launch new products such as speciality formulations for breweries as well as dairies, and certain products in the personal care and cosmetics segments. But these products are still in the R&D stage.

Lack of pricing power

The fragmentation in the speciality chemicals space not only limgrowth potential, but also hampers the pricing power of players.

While foraying into newer segments has helped improve the EBITDA margins for Rossari Biotech — from 14.3 per cent in FY18 to 17.5 per cent in FY20 — further improvements in margins could be limited due to the company’s lack of pricing power.

Also, based on our interaction with the management, we realise that much of the up-tick in the operating margins came from contract manufacturing based orders — a segment which the company is not too keen to grow, given its expertise in ingredient manufacturing.

That apart, the company also has high customer concentration. It manufactures about 2,030 different products for about 210 customers; its top five clients contributed about 44 per cent to the total revenues in FY20.

While most of the contracts being term-based (five/seven/10-year terms) offer some comfort, renewals could pose pricing risks, with the industry having fewer barriers for new entrants.

That said, the company’s strong return ratios — return on capital employed at 24.8 per cent and return on net worth at 31.8 per cent as of at the end of FY20 — are positives. The company’s debt-equity ratio also remains at a healthy 0.23 times (despite a debt of about ₹60 crore taken for the Dahej plant).

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