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Heranba Industries IPO: Information Analysis

Heranba Industries, a Gujarat-based agrochemical company, is raising Rs 625 crore through an IPO. Should you bid for its shares? Here is our analysis.

Heranba Industries IPO: Information Analysis

Heranba Industries IPO: Information Analysis

A Gujarat-based agrochemical company, Heranba Industries could be the answer to the growing malice of environmental degradation caused by conventional pesticides. Heranba manufactures and sells a range of insecticides, herbicides, fungicides and public-health products based on synthetic pyrethroids.

Pyrethroids are chemical compounds used to control pests and insects in farms, homes, offices, etc. Check the ingredients of your mosquito repellent and in all certainty, it will be a derivative of pyrethroid. Unlike widely-used organophosphate pesticides, pyrethroid-based pesticides cause less harm to the environment and cause less human toxicity.

Across its three manufacturing plants with a combined capacity of 14,024 Mtpa, Heranba has integrated operations with a presence in intermediaries, technicals and formulations. Technicals are concentrated solutions that are mixed with other ingredients to make formulations - the final product. The company sells both technicals (68 per cent of FY20 revenue) and formulations (25 per cent) directly to B2B players in India and outside, as well as to farmers through more than 9,400 distributors in India. The company exports its products to more than 60 countries, with China being its largest export market with a contribution of 28 per cent to the total exports in FY20. Overall, exports accounted for around 50 per cent of the company's FY20 revenue.

The pyrethroid industry is recently witnessing a resurgent demand, owing to requirements for less-harmful yet cost-effective substitutes for conventional pesticides. The shutdown of chemical plants in China, coupled with a large pyrethroid consumer base owing to environmental concerns, can result in an increase in the export volume. Moreover, the industry in India is expected to grow at a yearly growth of 8.5 per cent during 2020-25 and expected to reach a production volume of 25,398 tons by 2025.

Heranba Industries is right now focussing on entering the regulated markets of the US and Europe. It got two products registered in Europe in 2020 and is awaiting approval for one in the US. With a number of technicals going off patent in the near future, generic producers like Heranba can benefit from this. To develop more products, the company has recently started an R&D facility. It intends to use its IPO proceeds to fund its working-capital needs and grow its business further.

Strengths

  • Heranba has an integrated set of operations with a presence across agrochemical intermediaries, technicals and formulations at its three manufacturing facilities in and around the industrial belt of Vapi, Gujarat. Integrated operations enable the company to cut its reliance on third-party suppliers and can improve its margin as the industry grows.
  • The company has a strong registered product portfolio both in the domestic and international markets. It holds registrations for 18 technicals for manufacturing and sale in India, 103 technicals and formulations for manufacturing and sale in the export markets and 169 formulations registered for manufacturing and sale in India. Additionally, the company's international partners hold several registrations in more than 40 countries.
  • Its sales network is supported by more than 9,400 dealers/distributors in 16 states.

Risks/weaknesses

  • The company stands as a co-borrower for a term loan of Rs 35 crore issued to one of the promoter-group companies. The promoter and the director of the company have provided personal guarantees to secure this loan. An inadequate serving of this loan can affect the functioning of Heranba Industries.
  • The company is prone to regulatory scrutiny since its products and facilities can be hazardous to nature. In recent years, two of its facilities saw closure for a few days, owing to the violation of certain rules and untoward incidents.
  • In the past, several members of the promoter group have been issued warnings by the SEBI for the execution of certain trades in the stock market. Members of the promoter group were also disqualified as directors of the company as they failed to file annual returns and financial statements. However, their directorship was reinstated later on filing all pending annual returns and financial statements.
  • Around 50 per cent of Heranbas revenue comes from exports. Although the company exports to more than 60 countries, it doesn't hedge its currency risk.
  • The company is facing several litigation cases. These cases are related to a wide range of issues, such as failure to comply with relevant sections of the companies act, alleged violations of the environment laws, violations of the insecticides act and the evasion of income tax. Besides, the company has filed 526 cheque-bouncing cases against various parties.

IPO Questions

The 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 during the last twelve months (Oct 2019-Sep 2020) was Rs. 150.1 crore.

2. Will the company be able to scale up its business?
Yes. The company has filed for the registration of various technicals and formulations both in India and export markets. A number of technicals are expected to go off patent in near future. To seize this opportunity, the company has entered the regulated markets of the US (seeking product registration) and Europe (received two product registrations). Further, moderate facility utilisation, the growing use of pyrethroids as an effective alternative to conventional pesticides, integrated operations with a presence in both technicals and formulations and decent debt on the balance sheet should help the company scale up its business.

3. Does the company have recognisable brand/s, truly valued by its customers?
No. The company sells its products to B2B players and various distributors, who then sell these products to farmers. Although in the domestic formulations business (12.7 per cent of FY20 revenue), the company has a range of brands, these don't really provide meaningful pricing power because of the commoditised nature of the product. Moreover, in international formulations, the company sells its products under the brand name of its foreign partner.

4. Does the company have high repeat customer usage?
No, the company's top ten customers in FY20 constituted around 20 per cent of its sales. It means that the company relies on a large number of small customers for its sales. Being a B2B commoditised product supplier and yet selling to a large number of customers depicts that the company doesn't really have high repeat customer usage.

5. Does the company have a credible moat?
No. The company is a generic agrochemical producer with limited research capabilities. It started its R&D facility only in October 2020 to focus on entering the regulated markets of Europe and the US. The company doesn't have any patents or research collaboration with any global innovators. Moreover, as compared to other domestic agrochemical companies, Heranba is a minnow. Hence, it doesn't really enjoy economies of scale.

6. Is the company sufficiently robust to major regulatory or geopolitical risks?
No. Due to the critical and essential nature of agrochemicals, the company is prone to regulatory scrutiny. For example, a recent government committee report recommended stopping the use of certain pesticides that were banned in international markets. As a result, the company will cease to sell some of its products.
Moreover, before launching a product in a market, the company has to get it registered with the regulator, which is a tedious process and takes around six months to four years, varying on the types of the markets (regulated and semi-regulated).

7. Is the business of the company immune from easy replication by new players?
No. The company does not have any sustainable competitive advantage, such as patents, technical collaboration with global innovators, a majority global market share in a specific compound, etc. The deficiency of such business qualities renders the company prone to easy business replication by new players.

8. Is the company's product able to withstand being easily substituted or outdated?
Yes. There is a secular demand for agrochemicals for their use in crop production. Additionally, India's per capita consumption of pesticides remains low at 0.6 Kg/Ha as compared to that in developed countries. The company's products are expected to find an increasing application in crop production in the coming years, as they are safer for the environment and have low toxicity to humans compared to existing alternatives. Although regulatory changes can impact certain agrochemical compounds, overall this industry is relatively immune to disruptive changes. Together, these factors will enable the company's products to withstand being easily outdated or substituted.

9. Are the customers of the company devoid of significant bargaining power?
No. The company sells its products (technicals and formulations) to big B2B players and distributors, which then sell to farmers. Additionally, the global pyrethroids market is dominated by big MNCs and the company is a small player with a low market share. Together, these factors provide significant bargaining power to its customers.

10. Are the suppliers of the company devoid of significant bargaining power?
No. The company's products are heavily dependent on raw materials as they form roughly 66-70 per cent of the revenue. Heranba sources its raw materials mainly from domestic chemical companies and some of them are imported mainly from China. The company procures raw materials on a need basis and hasn't entered into any long-term contract with its suppliers. Since the company's overall scale of operations isn't huge, it's quite unlikely that the company is able to enter into very lucrative supply contracts.

11. Is the level of competition the company faces relatively low?
No. The global pyrethroids market is $3.2 Bn strong. The top four players account for the majority of this sector. When it comes to the Indian pyrethroids sector, Heranba is the biggest player with a market share of 19.5 per cent, closely followed by other companies. The fragmented nature of the agrochemical industry in India, along with the presence of both a large number of organised players and spurious pesticide manufacturers, has led to intense competition.

Management

12. Do any of the founders of the company still hold at least a 5 per cent stake in the company? Or do promoters totally hold more than 25 per cent stake in the company?
Yes, the founding promoters will continue to hold around 75 per cent of the company on a post-issue basis.

13. Do the top three managers have more than 15 years of combined leadership at the company?
Yes, the chairman and the managing director have more than five decades of combined leadership at the company.

14. Is the management trustworthy? Is it transparent in its disclosures, which are consistent with Sebi guidelines?
No. Members of the promoter group were disqualified as directors in the past, as they did not file annual returns for a continuous period of three years. Also, the management has given a guarantee for a related party loan and has also been very lax in compliance requirements.

15. Is the company free of litigation in court or with the regulator that casts doubts on the intention of the management?
No. The number of litigation cases against the company is on the high side. The cases are with regard to a wide range of issues, such as failure to comply with relevant sections of the companies act, alleged violations of the environment laws, violations of insecticides act and the evasion of income tax. Apart from this, the company has filed 526 cheque-bouncing cases against various parties.

16. Is the company's accounting policy stable?
Yes. As per the auditor's report, the accounting policy has been stable for the company.

17. Is the company free of promoter pledging of its shares?
Yes. None of the equity shares of the promoters are pledged.

Financials

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 three-year average RoE and RoCE was 36.3 per cent and 45.1 per cent, respectively. Its current RoE and RoCE are 33.7 per cent and 46.9 per cent, respectively.

19. Was the company's operating cash flow positive during the previous three years?
Yes. The operating cash flow for the FY18, FY19 and FY20 were 69.27, 136.82, and 94.1 crore, respectively.

20. Did the company increase its revenue by 10 per cent CAGR in the last three years?
Yes, the company's revenue has grown by 16.6 per cent CAGR in the last three years.

21. Is the company's net debt-to-equity ratio less than 1 or is its interest-coverage ratio more than 2?
Yes. The company's net debt-to-equity ratio is just 0.03.

22. Is the company free from reliance on huge working capital for day-to-day affairs?
Yes. As per the balance sheet in FY20, its net working capital was around 18 per cent of the total sales which is in line with its peers.

23. Can the company run its business without relying on external funding in the next three years?
Yes. The company carries only short-term debt and IPO proceeds will be used to cater to working-capital needs. Moreover, as of March 2020, one of the facilities was running at a moderate utilisation of just 58.6 per cent. The company would be able to scale up operations at least in the medium term without any need to set up a new plant. Hence, it will reduce its dependence on any external funding needs.

24. Have the company's short-term borrowings remained stable or declined (not increased by greater than 15 per cent)?
Yes. Its short-term borrowings have declined in the last three years.

25. Is the company free from meaningful contingent liabilities?
Yes. As of September 2020, the quantum of contingent liabilities stood at Rs. 53.21 crore, which was moderate at 14 per cent of the total net worth.

The stock/valuations

26. Does the stock offer an operating-earnings yield of more than 8 per cent on its enterprise value?
Yes. The company had an operating-earning yield of 8 per cent as of September 2020 operating earnings.

27. Is the stock's price-to-earnings less than its peers' median level?
Yes. Its TTM P/E at around 22 is lower than its peers' median level.

28. Is the stock's price-to-book value less than its peers' average level?
Yes. Its implied P/B (at the upper end of the price band) of 5.6 is lower than the average of 7.4.

Disclaimer: The authors may be an applicant in this Initial Public Offering.