After a dry spell in the first half of the year, the IPO market has heated up again. With Indiamart Intermesh giving a listing gain of 20 per cent and Affle India being oversubscribed 86 times, it seems that the appetite for new listings has increased. In the midst of all these, comes the IPO of Sterling and Wilson.
Sterling and Wilson, part of the Shapoorji Pallongi group, operates in the renewable energy space. With several countries pushing for renewable energy owing to severe climate changes, this company has positioned itself to capitalise on this growing enthusiasm.
Involved in the engineering, procurement and construction (EPC) of utility-scale solar power projects, the company provides operations and maintenance services for third-party solar projects. Headquartered in Mumbai, it is able to facilitate engineering and design functions. It then sources locally, in the country of operation, the supplies and third-party subcontractors it may need to complete the construction of the project. The company leases most of the equipment needed for construction, while the investment in the land for the solar project is made by the client.
The company records its revenue based on percentage of completion, which means its revenue and expenses are recorded as incurred during the course of the project. Under this method of accounting, profits from a project will only be evident once the project is complete.
- The company's area of operations is in India, which proves to be a cost advantage, as the talent pool it can acquire here will be cheaper than its competitors abroad.
- It is under the umbrella of the Shapoorji Pallonji Group, which gives it the reputation to bid for high-profile projects across the world, as the group is a conglomerate with significant business interests in and outside India.
- It follows an asset-light model and leases most of its equipment. It is a pure-play solutions provider (consultant) and hence, can keep costs to a minimum.
- Strong order book, which stood at Rs 3, 832 crore as of FY19.
- Highly concentrated revenues, with top five customers contributing 54 per cent to total revenues, although this has been on a declining trend.
- The company sources most of its components from very few suppliers, for example they source their solar photovoltaic cells from a single supplier. High dependence on a few suppliers and changing regulations, such as anti dumping duties imposed by India on imports of such solar cells, can hamper the company's ability to source quality supplies in case the supplier fails to keep up with demand.
- The company has to assume liability for its work and hence, is exposed to liquidated damages (penalties arising from delays in the completion of a contract) which were to the tune of Rs 46 crore as on the date of the prospectus. Furthermore, the company is also held accountable to the performance guarantees it gives on its contracts.
- Based on the information available in the prospectus, the company seems to have low bargaining power with its customers as the contract for EPC seems to benefit their customers in a large way with guarantees for performance, liquidated damages and termination of the contract on a short notice.
Risks and concerns
- Solar energy is still at a nascent stage. There is a possibility of other types of renewable energy, such as hydro or wind, proving to be more efficient. The company, however, specialises in solar energy and the number of contracts can diminish significantly if other types of renewable energy gain popularity.
- The company will have to keep up with rapidly changing technology and if it fails to do so, it may not be able to sustain competition in the space.
- Solar energy depends highly on weather conditions, which is not in anyone's control. Bad weather conditions can affect the completion of the project and increase the costs for the company.
- There is always the risk of injuries at construction sites in the utility sector. Recurring mishaps can affect the reputation of the company.
- The company's revenues are exposed to significant foreign exchange risk, as most of the company's contracts are denominated in foreign currency.
Total IPO size: Rs 3125 crore
Fresh Issue: Nil
Purpose of Issue: A portion of the proceeds towards repayment of company's debt
Offer for Sale: Rs 3125 crore
Price band: Rs 775-780
Subscription dates: August 6-8, 2019
ROE (FY19): 124 per cent
Revenue (FY19): Rs 8240 crore
Post-IPO, promoter holding: 75 per cent
Post IPO valuation: Rs 12428-12508 crore
Total debt : Rs 2228 crore FY19
Equity (Post IPO): Rs 838 crore
Company / Business
1. Are the company's earnings before tax more than Rs 50 cr in the last twelve months?
Yes. The company's earnings before tax in FY19 was Rs 759 crore.
2. Will the company be able to scale up its business?
Yes. The company provides engineering, procurement and engineering services for solar power projects across several countries. With most of the countries pushing for renewable energy, along with the company's asset-light model, it is in a position to scale up its business significantly over the years.
3. Does the company have a recognisable brand/s truly valued by its customers?
Yes. With a presence across 26 countries and the company claiming to be the largest service provider in several countries across Africa, the Middle East and the Asia Pacific, it does seem to have a recognisable brand. In addition to this, it is allowed to use the Shapoorji Pallonji conglomerate's brand name, which further assists the company in leveraging several large contracts across the world. For example, it has recently won an EPC contract from the Abu Dhabi government for the world's largest single-location solar plant.
4. Does the company have high repeat customer usage?
Yes. The company claims that of their total commissioned solar capacity, more than 80 per cent of the Indian business and 69 per cent of the business abroad come from customers for whom the company has already executed at least one project.
5. Does the company have a credible moat?
No. There are several solar EPC solutions providers around the world who have been in the business longer than this company. Having said that, Sterling and Wilson does enjoy the cost advantage of being situated in India and as of now, according to the prospectus, is a market leader in the country, along with in other countries of Africa and the Middle East.
6. Is the company sufficiently robust to major regulatory or geopolitical risks?
No. The company is present across 26 countries in every continent and hence, exposed to the highly regulated utilities sector wherever its operations are. However, the company is quick to realise this and does mitigate its risk to a large extent by conducting business through different measures appropriate to that specific country. For example, in the US, it conducts business through a co-development model, wherein it buys an equity stake in a company that is eligible to win solar EPC contracts. On the other hand, in a place like Australia, it acquired a local entity to conduct its business.
7. Is the company's business immune to easy replication by new players?
No. There are no significant barriers to entry in this business, besides having the right kind of experience in the sector and the right team needed for the design and engineering of the projects.
8. Are the company's products able to withstand being easily substituted or outdated?
No. The company specialises in solar EPC. Solar energy as a technology is still at a nascent stage and other sources of renewable energy, such as hydroelectric power, wind power, etc, are also being tested. Other forms of renewable energy may prove to be cheaper and more efficient in the future.
9. Are the customers of the company devoid of significant bargaining power?
No. The company's revenues are significantly concentrated with its top five customers contributing more than 50 per cent to the revenue. Hence, they are in a position to leverage their importance over the company during negotiations. Furthermore, the price of the contract is fixed and is not open to negotiations in the case of any escalation costs during the course of the contract. The contracts also include guarantees for performance, liquidated damages and termination of the contract on a short notice.
10. Are the suppliers of the company devoid of significant bargaining power?
No. The company claims to have limited suppliers and is highly dependent on them, as finding suppliers with quality products in this space is still limited given the fact that solar energy is still at a developing stage.
11. Is the level of competition the company faces relatively low?
No. The company faces competition from players all around the world who have been in the business longer. Furthermore, after the demerger of this division from Sterling and Wilson in 2018, the company's history comes down to a mere two years and thus, making it ineligible to win certain contracts.
12. Does any of the company's founders hold at least a five per cent stake in the company? Or do promoters hold more than 25 per cent stake in the company?
Yes. The promoters, prior to the IPO, hold the entire shareholding and post the IPO, will have a 75 per cent stake in the company.
13. Do the top three managers have more than 15 years of combined leadership at the company?
No. The top three managers of the company currently have a combined experience of 13 years. In addition to this, three of their executive directors resigned in FY19.
14. Is the management trustworthy? Is it transparent in its disclosures, which are consistent with Sebi guidelines?
Yes. There are no instances of any non-compliances.
15. Is the company free of litigation in court or without the need the regulator that casts doubts on the intention of the management?
No. There is a criminal proceeding against the promoters. In addition, there is a pending arbitration case against the company by one of its clients abroad. The claim stands at US$ 3,159,038.
16. Is the company's accounting policy stable?
Yes. The auditors have not qualified the report, although they have emphasised a couple of matters, such as certain amounts recoverable only on account of successful arbitrations.
17. Is the company free of promoter pledging of its shares?
No. Around 36 per cent of the promoters shares will be pledged post IPO.
18. Did the company generate the current and three-year average return on equity of more than 15 per cent and return on capital of more than 18 per cent?
Yes. The company's return on equity in FY19 was 124 per cent and three-year average was *58 per cent. Return on capital employed in FY19 stood at 49 per cent and the three-year average was *79 per cent.
19. Was the company's operating cash flow-positive during the previous year and at least three out of the last four years?
No. The company's cash flow from operations was negative in FY19 and FY17, while it was positive in FY16 and FY18.
20. Did the company increase its revenue by 10 per cent CAGR in the last three years?
Yes. The company has achieved a revenue CAGR of 44 per cent in the last three years*.
21. Is the company's net debt-to-equity ratio less than one or is its interest-coverage ratio more than two?
No. The company's net debt-to-equity ratio is two times.
22. Is the company free from reliance on huge working capital for day-to-day affairs?
Yes. The company usually receives payments in advance at the beginning of the contract and during the course of the contract that covers most of its expenses. However, its working capital is significantly bloated because of large loans and advances given to related parties to the tune of Rs 1935 crore which came on the books post the demerger. Around 42 per cent of the current assets consist of related party transactions in the form of advances and receivables.
23. Can the company run its business without relying on external funding in the next three years?
No. With the massive increase in short-term borrowings and significant negative cash from operations in FY19, it seems highly unlikely.
24. Have the company's short-term borrowings remained stable or declined (not increased by greater than 15 per cent)?
No. There has been a drastic increase in short-term borrowings in FY19 to Rs 2228 crore from Rs 184cr in FY18 due to assuming liabilities in the demerger process.
25. Is the company free from meaningful contingent liabilities?
Yes. There are negligent contingent liabilities reported by the company. However, there are significant litigations against promoters. In addition to this, they have non-fund-based secured borrowings (do not involve inflow of funds but can if the company fails to honour commitment towards its creditors for example bank guarantees) explain what this means to the tune of Rs 3232 cr and unsecured non-fund-based borrowings to the tune of Rs 577 crore.
26. Does the stock offer operating earnings yield of more than eight per cent on its enterprise value?
No. The stock offers an operating yield of 5.91 per cent on its enterprise value calculated on its upper price band.
27. Is the stock's price to earnings less than its peers' median level?
There are no such listed companies that can be direct competitors. However, on the upper price band, the company's PE is around 20 times.
28. Is the stock's price-to-book value less than its peers' average level?
There are no such listed companies that can be direct competitors. However, on the upper price band, the company's PB is around 15 times.
Book running lead managers - ICICI Securities, Axis capital Credit Suisse, Deutsche India, IIFL securities
*All Calculations done on the basis of restated financials of FY18 and FY19 for the demerged company and carved out financials for FY16-FY17
#The lower the score you find here, the riskier the stock
Disclosure: Author may be an applicant in this Initial Public Offering.