Lagnam Spintex is involved in the manufacturing of cotton yarn. They began their operation in 2012 and since then they have restricted themselves into the manufacturing and export of yarn. Yarn manufacturing is a process of converting raw cotton fibres into yarn, suitable for use in other textile end-products. The company now wants to raise money so that they can increase their capacity by opening a new yarn manufacturing facility and attain economies of scale.
So should you invest in this company? We will take you through this story by asking questions that any reasonable investor ought to ask while investing in an SME IPO?
The company is already operating at its peak capacity and there is very little room for further improvement with the current manufacturing facility
Yes, the company is planning to open a new ring spinning manufacturing facility ( 25536 spindles capacity) for high quality Ring spun carded and combed yarn. The company's existing capacity only catered to the production of Rotor Yarn, a less sophisticated, cheaper version. The company has already purchased the leasehold right for the site where it wishes to set up its new project which is very close to its existing Manufacturing unit.
The major portion--they plan to raise through a bank loan, the company is financing the expansion through a loan of 94 crores i.e. 75 % of the project cost from State Bank of India & Punjab National Bank while they are raising around 24 crores i.e. 19 % of the project cost through IPO proceeds. Remaining 9 crores will be used through Internal accruals.
But investors must note that the promoter has pledged about 50% of the Pre-IPO equity share capital in favour of the consortium of State Bank of India & Punjab National Bank whilst securing this loan.
When you are in the business of yarn spinning, where margins are very thin and demand is erratic, taking on huge debt could deteriorate your company's financial health very quickly. So how much do they need to pay?
Terms of repayment: Quarterly Repayment starting Sep 2020
A loan of Rs 94 crore @ 10% rate of interest boils down to around paying 9.4 crores of interest every year. A company with profits of around 4 crores aspiring to pay 9.4 crore of interest seems suicidal. So why they are doing it??
The company has a workaround.. On this particular loan, they will be eligible for a 6 % interest subsidy for a period of 5 years under the Rajasthan Investment Promotion Scheme (RIPS 2014) which means the net cost of borrowing boils down to only 3.5 % - 4.15 % and not 10%.
"The State Government of Rajasthan introduced RIPS-2014 in order to promote investment made by enterprise(s) for establishment of new units and/or investment made by the enterprise(s) for expansion of existing units and/or investment made for revival of sick enterprise"
Well, we need to look into its current business operations to figure that out. They are currently manufacturing rotor yarn which are coarser compared to yarn manufactured through ring spinning. Rotor yarn has a low count* (High thickness) and they sell at a lower price compared to yarns manufactured through ring spinning. So the decision to open a Ring Spinning manufacturing facility, on the face of it seems like a good strategy as it could help Lagnam in improving its operating margin. Also there is more scope for automation when you manufacture ring spun yarn i.e. lower labour cost (Labour expense is one of the biggest expenses textile companies bear). This move will definitely aid the company's expansion if everything goes according to plan.
"This expansion will increase uses for our company's product i.e. yarn will significantly increase by further diversifying end use scope for our current offering i.e. increasing product variety in Denim, Terry Towel, Home textiles, Industrial Fabric and also adding Suiting & Shirting, Linen and Home furnishing fabrics to the end use purposes. The company will also be diversifying its product by being able to offer Double yarn on (Two for One twister) and Slub yarn which will be used in Fancy fabric"
*Count is a measure of thickness of yarn.
Proposed Capacity Utilization
Based on the annualized earnings the asking price of Rs 41 translates to PE of about 15 which seems reasonable. Maybe the company will travel the growth path with its new manufacturing facility and make boatloads of money. But what if it doesn't? What if something goes wrong?
We here at Finception, wish the company all the best in its future endeavour.
Review & Analysis by Pawan, IIM Ahmedabad
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