Yet another share sale of a chemicals company has hit the market, with the Laxmi Organic Industries (Laxmi Organic) IPO. The IPO opened today and on its first day, the issue is already fully subscribed, with retail investors leading the way. This happened within the first few hours of the book-building process opening. At the end of the first day of bidding, the IPO was subscribed 2.3 times the shares on offer.

Such an overpriced issue should ideally face some skepticism from investors. But listing gains in the secondary market seems to be the priority, with the grey market premium of the company’s shares already topping 80% of its upper band price.

The company makes acetyl intermediates and specialty intermediates. These products have varied usages in high-growth industries, including pharmaceuticals, agrochemicals, dyes & pigments, inks & coatings, paints, printing & packaging, flavours & fragrances, adhesives and other industrial applications. The company is the largest player in some product segments in India, and has presence in over 30 countries.

But is the exorbitant premium that Laxmi Organic is asking for justified?

Steeply priced issue

Laxmi Organic’s IPO is priced at a band of Rs 129-130. This prices it nearly 49 times its FY20 earnings per share on the upper band. Compared to its peers like Aarti Industries (44 times), Atul (32 times), Fine Organic (60 times), among others, Laxmi Organic seems steeply priced. Most of the exuberance in pricing the IPO seems to have been done based on the company’s future capacity that will come onstream over the next few years. Whether this capacity expansion, and a resultant increase in revenues and profits will play out, will have to be seen. On that hinges the entire long-term investment play into Laxmi Organics.

The issue size is up to Rs 600 crore, with an offer for sale by promoters worth up to Rs 300 crore, and a fresh issue of up to Rs 300 crore. The company has also raised Rs 200 crore in a pre-IPO placement. These proceeds, including the fresh issue, will go to fund capital expenditure of its subsidiary and to fund its working capital requirements. This amounts to around Rs 98 crore.

The company is expanding its specialty intermediates capacity by investing nearly Rs 92 crore, and around Rs 35 crore will be earmarked for funding Laxmi Organic’s own working capital needs. It will also use nearly Rs 13 crore to purchase plant and machinery and infrastructure development for the special intermediates business. Then there is a Rs 180 crore debt repayment or prepayment of all or part of the debt of its wholly-owned arm Viva Lifesciences.

High margin businesses help shore up profits

The Covid-19 pandemic hit all manufacturing companies across the board in India, and Laxmi Organic is no different. The company’s revenues in FY20 came a little lower than FY19 because of the lockdowns imposed across India in March 2020. Net profit also took a hit in FY20, but the company’s bottom line has been volatile. This could be because its raw material costs are very erratic (the company uses ethanol to make its products) and this affects the cost of production of acetyl and specialty intermediates.

In the first half of FY20, there was a flood that submerged the company’s facilities in Maharashtra, which led to a stoppage of activity for around a month. This also impacted the company’s revenue performance during the period.

The company is stepping into the fluorochemicals business, and had bought a promoter-controlled entity called Yellowstone Fine Chemicals (YFC) in the past. Part of the IPO proceeds are also going to fund setting up of a manufacturing plant under YFC and also fund its working capital needs.

This is expected to change the revenue composition of the company in the future. As of FY20, the acetyl intermediates made up a little over 60% of its revenues, the company expects to rake in more revenues from the higher margin specialty intermediates business, and the YFC acquisition will only add more into this mix.

This is how the two segments have contributed to Laxmi Organic’s revenues:

The management of the company stated that specialty intermediates will contribute nearly 50% of revenues in 3-4 years’ time. This means the company’s margins will increase in the near future. The YFC plant is expected to come on stream by the end of Q4FY22, this will also add a higher margin revenue stream for the company.

For the six-month ended September 30, 2020, Laxmi Organic’s earnings before interest, tax and depreciation (EBITDA) margin was at 10.6%, as the specialty intermediates contribution to revenues rose. This is despite a fall in production at the beginning of FY20. The company used its capacity to also meet the surge in demand for hand sanitisers. It isn’t clear whether this also contributed to the surge in margins. Laxmi Organic’s EBITDA margins from FY18-20 were in the range of 9.3-11.1%, with a dip in margins in FY20.

The company’s cash flows reflect the strength of its business in generating cash, despite the company’s profits being volatile.

When we peg Laxmi Organic against its peers, the company’s return on equity to shareholders is very underwhelming.

Considering this, the valuation of the company at 49 times its FY20 earnings per share seems really rich. Looking at the subscription numbers as of day 1 of subscription, the company’s IPO is already fully subscribed. This shows that investors seem to be willing to pay any price in the primary share market for a good business.

And this brings up the nature of the primary market and the frothy secondary market. It seems like issues can be priced at any level, and they will sail through the book-building process. For investors wanting to make a quick listing gain, this might seem like a good strategy to invest in IPOs.

But for those who are long-term investors, it is worth waiting and watching, while pondering over the over exuberance of India’s current IPO market climate.