What does an IPO priced at 202 times earnings say about our markets?
Prataap Snacks Ltd’s initial public offering (IPO), like others in the recent past, has been a breeze. It sold the maximum permissible 30% of its issue to anchor investors; and now, the remainder of its issue has been fully subscribed on the second day of bidding.
It’s almost as if investors are oblivious to the fact that the issue is priced at 202 times earnings for the year till March 2017. This shouldn’t be surprising—while valuations of Indian markets seem all right from a top-down perspective, things have been out of whack for quite some time now for many sectors and individual stocks. The Prataap Snacks issue, then, just underlines the bubble in various pockets of the Indian market.
Supporters of the snack foods firm’s issue point out that earnings were unusually depressed in the previous fiscal year and that valuations are more reasonable when juxtaposed against fiscal year 2016 (FY16) earnings. While it’s true valuations are much lower using FY16 earnings, they are nowhere near reasonable at more than 60 times.
Another argument put forth is that Prataap Snacks is reasonably valued compared to peers on the market cap-sales multiple. Relying on a price-sales multiple for a manufacturing firm is a sure sign we’re well in bubble territory—especially so when the company has been growing sales at the cost of profit margins. While revenues have grown at an annual average rate of 27% in the past four years, operating profits have expanded at a rate of only around 10%.
As it happens, private equity investors and some promoters are taking advantage of the absurd demand for IPOs. Over 58% of the company’s issuance is in the form of an offer for sale by a promoter group and investment arms of Sequoia Capital. “A large chunk of IPO activity these days is limited to offers for sale by existing investors, and private equity investors are having a field day selling into this market,” says investment adviser Sandip Sabharwal.
Sequoia, which invested about Rs265 crore in acquiring a large stake in Prataap Snacks, is selling only 13.6% of its shares in the IPO, but will end up recovering as much as 63% of its investment. Put differently, these investment firms bought the company’s shares at a little more than Rs200 per share between 2011 and 2014, but are now selling at as much as Rs938 per share in the IPO.
“We find valuations of several mid-cap stocks in our coverage universe very high. In fact, it would not be wrong to say that some are in the ‘bubble’ phase with the market extrapolating strong growth and high returns in perpetuity,” analysts at Kotak Institutional Equities had written in a 10 April note.
Broad indices such as the National Stock Exchange’s Nifty don’t reflect this because of high representation of low price-to-earnings stocks, which pull down overall valuations.
“Overall market valuations look palatable but hide super-rich valuations of ‘growth’ stocks and expensive valuations of companies with mediocre business models”, Kotak’s analysts added in the note.