Valuations asked for are expensive, offering no upside even in the medium term

A2Z Maintenance Engineering Services Limited is tapping the capital markets with its IPO to raise Rs 675 crs in a price band of Rs 400-410, with a simultaneous offer for sale of 45,56,193 equity shares. The issue has opened on Wednesday the 8th of December and would close on Friday the 10th of December.

Business

The company is a diversified business group having varied and diverse businesses. It started with Facilities Management Services in 2002 when the company was incorporated. The company provides engineering maintenance, energy saving services, janitorial services, parking management, property lease management, and telecommunication tower maintenance, security services to public and private sector companies. The company provides specialised service to Indian Railways under the Clean Train Station scheme, the intensive rake cleaning scheme and the on-board housekeeping services scheme in 11 out of 16 railway zones. The company provides service in 27 states in India and the NCT of Delhi and Haryana and employs 14,670 employees. The revenue from this activity was Rs 50.1 crs in March 2009, Rs 91 crs in March 2010 and Rs 44.9 crs in the four months ended July 2010.

EPC business segment – The Company started its engineering, procurement and construction business segment in 2006. The company offers services to the power transmission and distribution sector with a focus primarily on the distribution sector. A2Z offers services for the installation of distribution line infrastructure with capacities of up to 33 KV and also participates in system strengthening projects and rural electrification projects. The company has also select projects in the construction of ‘EHV’ Extra high voltage sub-stations of 400 KV and EHV transmission lines of 765 KV. The company is executing projects for power utilities like Power Grid, NTPC and NHPC. The revenue from this segment was Rs 664.42 crs in March 2009, Rs 1122.78 crs in March 2010. In the four month period ended July 2010 the revenue was Rs 365.94 crs. The order book is Rs 1291.99 crs as on 31st July 2010.

Municipal solid waste segment – This business is referred to as collection and transportation of municipal solid waste and sale of compost. A2Z provides services of collection, transportation, processing, disposal and treatment of municipal solid waste. This business has 4 different stages. The first stage is the collection and transportation of waste to a disposal site. The second stage is the sorting and recycling of waste to segregate PET and plastic materials. The combustible waste is converted into RDF (refuse derived fuel) and sold as fuel. In the next stage all the compostable materials is converted into compost organic which is sold by fertiliser companies. The construction debris is used to make interlocking tiles and bricks which are sold to construction companies. The inert remnants are used for sanitary landfills. The first plant for processing municipal solid waste has been running in Kanpur.

Renewable Energy Generation – The Company is constructing 3 renewable energy co-generation plants of 15 MW each for sugar mills in Punjab on a BOOT basis. The company is setting up a 15 MW biomass based power plant at Kanpur, where the RDF (refuse derived fuel) would be used. A2Z is setting up 5 biomass plants of 15 MW each in the state of Rajasthan which would primarily use crop residue as fuel. It is also in the process of setting up 100 MW of aggregate power generating capacity that would use the rice husk generated from rice milling operations. The plants in Rajasthan are expected to be commissioned by October 2011 while the three plants are expected to be commissioned by March 2011.

The business has moved very fast from being a facility management company to an EPC contractor and now extending itself to solid municipal waste handler and moving on to energy and power generation. The company as the name suggests is A2Z but the businesses are more diversified than required. The last two businesses are new for the company and it has to consolidate itself and establish its presence in the segment. As regards the power generation business, its first plant is still more than a quarter away and it needs to establish itself in this segment. There are players in each of the segment that the company operates in, even though the scale and size may be different.

Objects of the Issue

Financials

The consolidated revenue of the company is Rs 723.88 crs for the year ended March 2009; Rs 1225.29 crs for the year ended March 2010 and Rs 418.10 crs for the 4 month period ended July 2010. It may be mentioned that the revenue mix for the year March 2009 comprised of Rs 664.42 crs from EPC and Rs 50.06 crs from FMS. Revenue mix for the year ended March 2010 comprised of EPC of Rs 1122.78 crs, FMS of Rs 90.98 crs and revenue from waste collection 4.62 crs. In the first four months of the period ending July 2010, the break up was Rs 365.94 crs from EPC, Rs 44.94 c5rs from FMS, Rs 3.61 crs from waste collection and Rs 1.07 crs from sale of Compost.

The net profit after tax and minority interest was Rs 59.05 crs for the year ended March 2009; Rs 97.87 crs for the year ended March 2010 and Rs 26.11 crs for the four month period ended July 2010.

The company has rewarded its shareholders very liberally and there have been two bonus issues in the recent past. The first bonus issue was in August 2007 when the company gave 11 shares for each share held. The second bonus was in the year March 2010 when the company gave 3 shares for every 2 shares held. This means that for every one share held prior to August 2007 is now 30 shares. If one were to compare this return with the benchmark indices the comparison is simply spectacular and unparalleled. A2Z gave its shareholders a return of 750% per annum each over the last four years. The BSESENSEX appreciated from 10,743 points at the end of July 2006 to 19,521 at the end of November 2010 and the NSENIFTY appreciated from 3,143 points to 5,862 points. The returns in the case of the BSESENSEX were 81.7% over the four year period which corresponds to 20.42% per annum. In the case of NIFTY the returns were 86.5% over the period and 21.62%. This return when extrapolated means the company outperformed the BSESENSEX by 36 times and the NIFTY by 35 times. This outperformance would be extremely difficult to match going forward.

Comparisons

The company has chosen to compare itself with ABB, KEC International, Jyoti Structures, Kalpataru Transmission and Larsen and Toubro. The business which is comparable with these players is the EPC part of the business and nothing else. The revenue figure is lowest for Jyoti structures who had a turnover of Rs 2136 crs for the period ended March 2010 against a revenue of Rs 1122 crs for A2Z. ABB is more of an equipment supplier while Larsen Toubro is into many activities which include manufacturing, EPC, designing, consultancy etc and it had a turnover of over Rs 46,500 crs which was almost 38 times the revenue of A2Z.

In the business of solid waste management there is nobody in the listed space though there are some who are doing this in subsidiaries of listed entities and also in unlisted entities. The new business of Renewable energy has a number of players like Orient Green Power, SuryaChakra and Gammon Infra already in operation. We also have players like Ind-Solar and Moser Baer in the solar space. Rice players are in plenty with Usher Agro, REI Agro, KRBL, and Lakshmi Overseas and so on.

Concerns

The company started out as a FMS player and changed track completely into EPC. This business is its core strength and is the dominant business currently for the company. It is a competitive business and has many players as well. In this segment one finds that A2Z has huge sundry debtors and the same is Rs 826.63 crs as on 31st March 2010. The same as of 31st July 2010 is Rs 651.40 crs. This shows that debtor days are extremely high and are a big cause for concern.

The second concern is that the company does not have any experience in the business of power generation or rice milling into which it is venturing. Bio mass projects are difficult and their viability is dependent on getting adequate agri residue from a command area close to the plant. The experience of some of the players in the listed space is not as satisfactory as one would have expected and the concern has been about getting adequate quantity of raw materials at a sustainable price.

The margins being earned in the EPC business seem to be higher than the competition and one is not sure whether they are sustainable. The higher margins maybe on account of the longer receivables that A2Z has.

It appears that A2Z has been entering into new businesses faster than one would have expected and one is tempted to make a reference to another listed company which had done something similar in terms of diversification. The company being compared is Shriram EPC which went public in January-February 2008. It had a number of segments and was entering a few new ones and all those businesses sounded extremely exciting at that time.

Valuations

A2Z is offering shares at Rs 400-410 which values the company at Rs 2967 crs at the lower end and Rs 3024 crs at the top end of the price band post the issue. The pre-IPO valuation of the company before the raising of the IPO proceeds is being valued at Rs 2292 crs at the lower end and at Rs 2349 crs at the upper band.

The net profit of the company for the year ended March 2009 was Rs 59.05 crs and was Rs 97.97 crs for the year ended March 2010. This would result in an EPS of Rs 10.30 on the pre-IPO equity for the year ended March 2009 and Rs 17.09 for the year ended March 2010. For the current year on the first four months annualised basis the EPS would be Rs 13.65.

Based on the above EPS the share is being offered on a historical basis of between 23.40 and 23.99 times and on current year earnings at between 29.30 and 30.03 times.

If one were to take it on forward numbers on a fully diluted basis the EPS for the year ended March 2010 based on dilution at Rs 400 would stand reduced to Rs 13.20 and for the current year annualised would be Rs 10.56. Based on this EPS the price band would be a staggering 30.30 times for the year ended March 2010 and an even more expensive 37.8 times for the year ending March 2011.

Conclusion

The issue looks expensive from all parameters and looking at the current market scenario may be given a miss.

SEBI Disclaimer: – I do not intend to subscribe to the above issue.