Varroc IPO opens, high valuations promise a roller-coaster ride
The Varroc Engineering IPO, which opens for retail subscription today, has a price band of ₹ 965-967 per share, implying an expensive price-to-earnings ratio of 29 times its FY18 earnings
A buoyant stock market is a good time for firms to tap retail investors. However, retail investors need to be wary of getting locked in at high valuations.
Take the case of auto component maker Varroc Engineering Ltd. Its initial public offering (IPO), which opened for retail subscription today, has a price band of ₹ 965-967 per share, which implies an expensive price-to-earnings ratio of 29 times its FY18 earnings.
Optimists, however, justify the valuations, given Varroc’s position among India’s top auto component groups, with a 4% share of global automobile lighting systems and top PV (passenger vehicle) makers as customers. The company also has a 6% share of the premium PV lighting market, which is growing fast.
However, big markets could often spark off big concerns. Varroc’s blue-chip customers, such as Jaguar Land Rover, Volkswagen and BMW, are growing in low single digits. The geographic concentration is also worrisome. The US and Europe, which account for about 22% and 41% of the company’s consolidated revenue, respectively, are likely to witness relatively low growth rates for PVs. The transition from diesel to electric vehicles and the geopolitical tensions caused by oil prices and Brexit are also likely to weigh on growth rates.
So, one wonders whether Varroc’s robust double-digit revenue growth, witnessed in the last 4-5 years, will be able to sustain in the years to come.
That’s not all. Its Ebitda (earnings before interest, tax, depreciation and amortization) margins have been erratic. This, at a time, when domestic peers, such as Motherson Sumi Systems Ltd, have clocked decent margin growth. Besides, there are concerns that the rise in input costs may further put pressure on component manufacturers.
A report by Investec Securities Research points out that Varroc’s Ebit margins are lower than its global peers. It says lower backward integration and sourcing issues in some regions (the firm has 36 plants globally) led to margin pressure.
At present, even the return ratios, including return on capital employed, are several notches lower than peers. It remains to be seen whether Varroc’s forecasts, or those by some brokerage firms, that its increasing presence in the premium LED lighting segment will lift realizations and margins, become a reality.
On home ground, too, there is not much reason for euphoria. Accounting for about one-third of its revenue, the business caters to two- and three-wheelers where margins are thinner than in PVs and commercial vehicles. Of course, the rural growth story in India could help make a favourable case for growth in the region.
Given the challenges of a not-so-vibrant global PV market and Varroc’s erratic margins, the valuation of 29 times looks intimidating. Investors may be jumping on the wagon at significantly high levels, which may take them on a roller-coaster ride, before the stock prices can be aligned with the company’s earnings. If anything, a depreciating rupee could help Varroc’s cause, given that more than two-thirds of its revenue comes from the developed markets.
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