IPO Analysis: Indigo Paints

IPO Rating - Invest with limited exposure

About the issue

Pune-based Indigo Paints (Indigo), the fifth-largest company in the Indian decorative paint industry, is entering the primary capital market with its initial public offer (IPO) of equity shares of Rs 10 each. The price band has been fixed between Rs 1,488 and Rs 1,490. A discount of Rs 148 per equity share is being offered to the eligible employees, bidding in the employee reservation portion.  

The issue size is Rs 1,170 crore at the upper price band, including a fresh issue of Rs 300 crore and an offer for sale of Rs 870 crore (at the upper price band) by the exiting shareholders. The offer includes a reservation of up to 70,000 equity shares for subscription by the eligible employees of the company.

Out of this offer for sale,  at an upper price band of Rs 1,490, the company will issue up to 0.2 crore of equity shares, aggregating up to Rs 300 crore. The IPO proceeds will be used for the repayment of the outstanding debt of around Rs 48.1 crore. It would be used for financing the project cost towards the establishment of a new manufacturing facility (Telangana) estimated at Rs 184 crore and upgradation of the existing manufacturing facility. This new facility (Telangana), will have a total estimated installed capacity of 51,943 tonnes per annum. Meanwhile, its production is likely to commence in FY21.

The IPO will open for public subscription on January 20 and closes on January 22.

About the company

Indigo, which was incorporated as 'Indigo Paints Private Ltd' in Pune on March 28, 2000, is the fifth-largest decorative paints company in India. It has clocked the fastest organic revenue CAGR of 29 per cent in the past five years among the top-five decorative paints companies in India. What has helped the company to post such growth numbers is its differentiated production. The company consistently seeks to launch first-to-market products by identifying niche product opportunities and introducing products that address these requirements as they are easy to sell as consumers find them attractive.

It has been a pioneer of certain category creator products such as metallic emulsions, title coat emulsions, bright ceiling coat emulsions, and floor coat emulsions. The value-added portfolio comprises products such as dirt-proof and waterproof exterior laminate, exterior & interior acrylic laminate, and PU super gloss enamels. Differentiated products have not only helped the company to enhance its brand recognition across dealers but also resulted in superior gross margins. Aggregate gross margin in differentiated products is 8-10 percentage points higher than the rest of the portfolio. Moreover, it has resulted in creating cross-selling opportunities for the rest of the company’s portfolio. Revenues from differentiated products have consistently comprised around 27-28 per cent of the total revenues for Indigo in the past three years. As of September 2020, Indigo has a portfolio of seven differentiated products.

Floor coatings: Tier II, III & IV cities-centric products, due to more space outside the house, have better durability and good reputation. In the southern states of India, floor painting is also applied on staircases. In the industrial areas, all factory floors are currently being coated with floor coatings, and in top cities, large popular schools use floor coating on all floors as well as badminton & basketball courts. Indigo marketed this product more around durability and less about the look, which was a differentiator.

Ceiling paint: Higher sheen and brightness for making the room look bigger; dark colours were introduced as consumers in the rural markets like having colourful ceilings.

Tile coatings: A special paint for external roof tiles that provides gloss & sheen with excellent protection against algae and fungus.

PU enamels: Specialised metal-like finish being imparted on wooden surfaces, which gives a rich impression on furniture, doors & windows.

Polymer putty: Waterproof putty with better water-repelling qualities.

Acrylic pouch distemper: Attractively packed pouch with better performance than normal powder distemper with no other competitor in this space.

Metallic emulsion: Applied on wood, walls, and metals, it gives a zinc-like shine to the surface, which no other paint company has launched.

Differentiated products contribution to revenue

In order to create demand for its differentiated products, Indigo decided to tap into tier III & IV towns and rural areas, where brand penetration is easier and dealers have a greater ability to influence customer purchase decisions. Typically, when Indigo enters new states, it begins with doing business with dealers in tier 3/4 towns and rural areas and, subsequently, leverages this dealer network to engage with dealers in larger cities. The company has used this approach to expand into cities such as Kanpur, Kochi, Thiruvananthapuram, Patna & Ranchi. The strategy has prevented the company from directly taking on larger players head-on, and steadily building its own footprint in a profitable way. Also, riding on this strategy, Indigo has clocked organic revenue CAGR of around 29 per cent in the past five years, which is comfortably higher than the 5-12 per cent clocked by the top-four over the same period, in the domestic decorative paints segment. Such growth, however, has come on the back of a smaller base.

One of the biggest entry barriers to this industry is tinting machines, which act as a prerequisite for dealers that sell emulsion paints. Typically, dealers tend to install tinting machines of only recognised players due to space constraints. Indigo, with its small-town approach, has been able to partner with a large number of dealers in tier III & IV towns, which have few or no tinting machines at their premises thereby, making the acceptance of the company’s tinting machines at these locations relatively easier. Installation of a tinting machine tends to increase sales of a company from a particular dealer by 2.5 times. It has added 1,223 tinting machines every year on average for the past three years, taking the total count to 4,603 tinting machines (as of September 30, 2020). As a result, revenue from emulsion paint sales (45 per cent of FY20 sales) has posted a sales CAGR of 29.5 per cent over FY18-20. While the tinting machines-to-dealer ratio is at 0.38, Indigo fares better than some of its competitors. Hence, there is still significant room to cover with respect to other peers.

Financials

For the financial year ending March 2020, the company’s total revenue stood at Rs 624.8 crore compared to Rs 395.1 crore at the end of FY18, showing a CAGR of 25.8 per cent. However, for the first half of FY21, the company’s total income stood at Rs 259.4 crore. EBITDA in the same period, however, grew at a faster pace of a CAGR of 87.8 per cent.  The margins have moved steadily after posting 6.5 per cent for FY18, it increased to 18.5 per cent for the first half of FY20. The profit growth remained stronger and the company’s reported profit after tax grew at a CAGR of 92.5 per cent between FY18 and FY20. The net profit margins also increased from 3.6 per cent at the end of FY18 to 10.5 per cent for the first half of FY21.

The company also has a strong balance sheet, in terms of working capital and gross asset turnover, which is at par or better than peers’ and has resulted in an impressive average RoNW of 24 per cent in FY20. While RoNW for Indigo lags the market leader, it is similar or better than other peers.

Valuation and recommendation

At the higher price band of Rs 1,490 and on the expanded equity base considering the IPO, the offer is demanding a market cap to sales (FY20) of 11.25 times, which is lower than the market leader and even compared to Berger Paints that is available at the market cap to sales of 13.45 times. In terms of PE, the offer is made at around 129 times its H1FY21 annualised earnings based on a post-issue equity share capital of Rs around Rs 4.71 crore of the face value of Rs 10 each. Market leader of this industry is also available at PE of 115 times and even Berger Paints is available at 125 times.

The issue seems to be fairly priced purely from a valuation perspective. Nonetheless, looking at the past growth rate of the company (almost twice the industry average) and potential to maintain its growth rate further looking at the minuscule market share of 2 per cent, we advise aggressive investors to subscribe to the issue with limited exposure.