BackThe time is right for Prataap Snacks investors to cash in the chips
Following the Avadh Snacks acquisition, Prataap Snacks shares is now priced for such perfection that there seems no room for any error
Premium
The phrase “cheap as chips" clearly doesn’t apply to manufacturers of potato chips in India. Prataap Snacks Ltd, which sells potato chips and other snacks, was valued at 58 times trailing earnings early this week. That was before it announced the acquisition of a majority stake in Avadh Snacks Pvt. Ltd for a sum of ₹ 148 crore.
Valuations have soared since, with investors concluding that Avadh is an excellent buy. On Thursday, Prataap Snacks’ valuation rose by ₹ 479 crore, or by about 2.5 times the enterprise valuation of Avadh Snacks. While there are synergies to be accounted for, Prataap Snacks is now priced for such perfection that there seems no room for any error.
The Avadh acquisition has added about 19% to Prataap Snacks’ market capitalization. The regional snack manufacturer will either need to grow at a scorching pace, or synergies between the two companies will need to be very high, for earnings accretion to be anywhere close justifying the jump in valuations.
Here’s why. Since Prataap Snacks will use up all the cash on its books to fund the acquisition, it will forgo non-operating income, which accounted for over a fifth of its pre-tax profit in the past two quarters. Non-operating income at Prataap Snacks has averaged ₹ 3.5 crore in recent quarters. Based on financial year 2017-18 numbers shared by Prataap’s management, Avadh’s operating profit stood at roughly ₹ 11 crore, or ₹ 2.8 crore on a quarterly basis.
As such, Avadh Snacks would need to contribute much more simply to make up for the shortfall in non-operating income. Then it would also have to contribute meaningfully to profit, to justify the jump in valuations.
Not that it can’t; based on the numbers shared by Prataap Snacks’ management, it has already demonstrated high growth in the preceding two years. And as a combine, synergies in distribution can result in higher growth. The company points out that their product portfolios are complementary, which will also aid growth. And importantly, the acquisition finally provides Prataap Snacks with a decent entry into the lucrative Gujarat market, which is dominated by regional companies.
In this backdrop, it’s understandable that investors are excited. But with the acquisition, Prataap Snacks’ enterprise valuation has soared to well over 30 times Ebitda (earnings before interest, taxes, depreciation and amortisation). One can argue that it has put the cash on its books to good use, and that the consumer staples sector trades at such high valuations in any case. But that’s hardly any comfort since valuations of all consumer goods companies are bizarre currently, and are hardly reliable as a benchmark.
Prataap’s return ratios are way lower than other consumer goods companies, and current valuations assume that they will catch up once it gains scale. There are one too many assumptions for comfort on the valuations front. In the most recent quarter, Prataap Snacks reported a decline in operating profits because of raw material cost pressures—as such, the assumption of uninterrupted growth is being challenged already. Besides, its relatively smaller size should warrant some caution from investors, although the flip side is that a low base can result in higher growth rates. From the looks of it, investors are clearly eyeing the prospect of higher returns more than pricing in the risks associated.
For prudent investors, it may be as good a time as any to cash in the chips while the euphoria lasts.
Milestone Alert!Livemint tops charts as the fastest growing news website in the world 🌏 Click here to know more.
