Gokaldas Exports is India's largest apparel exporter in terms of revenue. Its annual capacity of 26 million pieces gives it an advantage over other domestic companies, which are now starting to ramp-up capacity after quotas were dismantled on 1 Jan 2005. The company's wide product range (for men, women and children), design capabilities, focus on niche segments like outerwear (53% of FY06 revenues), and expertise in managing multiple orders make it a preferred vendor to many fashion brands and retailers around the world. Gokaldas offers integrated facilities; it manufactures the accessories it needs inhouse, and offers value-added services like laundry, embroidery and printing. The company relies on exports, which account for 98% of sales. The Hinduja Group in Bangalore controls the company, with the major shareholders having a 75% stake.
Controlling stake acquired at Rs 275 per share
The Blackstone Group has entered into an agreement to acquire a 50.1% stake in the company from the founder promoters, the Hinduja Group, for Rs 275 per share, at a 20% premium to the current price of Rs 229 per share.
Triggers open offer
As per SEBI regulations, this acquisition by Blackstone triggers an open offer to the minority shareholders for an additional 20% of the company's outstanding shares at Rs 275 per share. Subject to regulatory approvals, Blackstone will invest $165 million for this controlling stake and the 20% open offer.
Blackstone's background
The group is a leading global alternative asset manager and provider of financial advisory services. It plans to leverage on its global investments in retailing to drive the growth of the company.
Who will manage the business?
While Blackstone will hold a controlling stake with board representation, the Hinduja Group would continue to manage the business with minority stake of 20%; with Mr.Madanlal Hinduja as Chairman, Mr. Rajendra Hinduja as MD and Mr.Dinesh Hinduja as Executive Director.
Impact
Prima facie, we believe the open offer at a 20% premium from current levels provides a good upside. While the company is unlikely to witness any major operational impact; the fact that promoters have sold a significant stake does raise some concern.
Investment thesis
We maintain a Buy/Medium Risk on Gokaldas Exports with target price of Rs 285 based on P/E of 12x FY08E PE, a significant premium to sector valuations of 8.4x P/E. We think it offers the best exposure to the garment outsourcing theme. With Gokaldas' large capacity, good relationships with global brands and healthy order-book position; we believe the company is well positioned for growth. Its strategy to focus on outerwear (which offers margins of 10% compared with the garment industry average of 7-8%), enrich its wide product range and expand customer base should lead to a lower-risk business model. While external pressures are mounting with appreciating rupee and rising interest costs, building for which we still forecast healthy growth potential. With earnings CAGR of 14% over FY07-10E, superior ROCEs of 15% vs. sector average of 9% and stock trading at 8.4x FY08E PE, at par with sector - we expect valuations to appreciate.
Valuation
Our target price of Rs 285 is based on 12x FY08E P/E. Our target multiple places the stock at premium to our India textile universe valuations of 8.4x FY08E P/E. Our premium valuation is a function of Gokaldas' leadership in garment exports from India, largest garment capacities, rich product mix and preferred vendor status with a spectrum of global brands. In our opinion P/E captures the earnings growth potential and hence is our primary valuation tool. The stock is trading at 8.4x FY08E PE, on par with sector and below the historical P/E band (10-15x). With steady earnings growth visibility and the company's superior capital efficiency, we see upside potential to current valuations.
Risks
We rate Gokaldas Medium Risk. This is different from the Speculative Risk rating assigned by our quantitative risk rating system (which measures the stock's volatility over a 260-day period) to stocks that have less than one year's trading history. Key reasons for our Medium Risk rating
1) Secular growth prospects for Indian garment manufacturers now that quotas have been removed;
2) Strong medium-term growth trend given global macro changes in the apparel industry;
3) The company is a leading garment exporter in India, has large capacity and good relationships with global brands
4) We rate many of the company's regional peers in our coverage universe Low Risk. Main risks to our investment thesis and target price are: Client concentration – Gokaldas has high dependence on its top-10 customers (80% of revenues). With GAP accounting for 43% of revenues.
Appreciation of the Rupee vs. the USD could affect exports and thus earnings. A 5% appreciation of Rupee could lead to a 7-8% fall in earnings as exports accounted for 98% of FY05 revenues. Labor unrest in the company's 54,000strong workforce could adversely impact productivity. Fixed wage rates that are not linked to productivity could adversely impact cost Gokaldas' cost competitiveness going forward; and rapidly changing fashion trends could result in shorter delivery schedules and increases in freight costs. Closely held shareholding pattern, with promoters holding 75% stake could pose a risk. If any of these risk factors plays out, Gokaldas' share price is likely to have difficulty attaining our target price.
Controlling stake acquired at Rs 275 per share
The Blackstone Group has entered into an agreement to acquire a 50.1% stake in the company from the founder promoters, the Hinduja Group, for Rs 275 per share, at a 20% premium to the current price of Rs 229 per share.
Triggers open offer
As per SEBI regulations, this acquisition by Blackstone triggers an open offer to the minority shareholders for an additional 20% of the company's outstanding shares at Rs 275 per share. Subject to regulatory approvals, Blackstone will invest $165 million for this controlling stake and the 20% open offer.
Blackstone's background
The group is a leading global alternative asset manager and provider of financial advisory services. It plans to leverage on its global investments in retailing to drive the growth of the company.
Who will manage the business?
While Blackstone will hold a controlling stake with board representation, the Hinduja Group would continue to manage the business with minority stake of 20%; with Mr.Madanlal Hinduja as Chairman, Mr. Rajendra Hinduja as MD and Mr.Dinesh Hinduja as Executive Director.
Impact
Prima facie, we believe the open offer at a 20% premium from current levels provides a good upside. While the company is unlikely to witness any major operational impact; the fact that promoters have sold a significant stake does raise some concern.
Investment thesis
We maintain a Buy/Medium Risk on Gokaldas Exports with target price of Rs 285 based on P/E of 12x FY08E PE, a significant premium to sector valuations of 8.4x P/E. We think it offers the best exposure to the garment outsourcing theme. With Gokaldas' large capacity, good relationships with global brands and healthy order-book position; we believe the company is well positioned for growth. Its strategy to focus on outerwear (which offers margins of 10% compared with the garment industry average of 7-8%), enrich its wide product range and expand customer base should lead to a lower-risk business model. While external pressures are mounting with appreciating rupee and rising interest costs, building for which we still forecast healthy growth potential. With earnings CAGR of 14% over FY07-10E, superior ROCEs of 15% vs. sector average of 9% and stock trading at 8.4x FY08E PE, at par with sector - we expect valuations to appreciate.
Valuation
Our target price of Rs 285 is based on 12x FY08E P/E. Our target multiple places the stock at premium to our India textile universe valuations of 8.4x FY08E P/E. Our premium valuation is a function of Gokaldas' leadership in garment exports from India, largest garment capacities, rich product mix and preferred vendor status with a spectrum of global brands. In our opinion P/E captures the earnings growth potential and hence is our primary valuation tool. The stock is trading at 8.4x FY08E PE, on par with sector and below the historical P/E band (10-15x). With steady earnings growth visibility and the company's superior capital efficiency, we see upside potential to current valuations.
Risks
We rate Gokaldas Medium Risk. This is different from the Speculative Risk rating assigned by our quantitative risk rating system (which measures the stock's volatility over a 260-day period) to stocks that have less than one year's trading history. Key reasons for our Medium Risk rating
1) Secular growth prospects for Indian garment manufacturers now that quotas have been removed;
2) Strong medium-term growth trend given global macro changes in the apparel industry;
3) The company is a leading garment exporter in India, has large capacity and good relationships with global brands
4) We rate many of the company's regional peers in our coverage universe Low Risk. Main risks to our investment thesis and target price are: Client concentration – Gokaldas has high dependence on its top-10 customers (80% of revenues). With GAP accounting for 43% of revenues.
Appreciation of the Rupee vs. the USD could affect exports and thus earnings. A 5% appreciation of Rupee could lead to a 7-8% fall in earnings as exports accounted for 98% of FY05 revenues. Labor unrest in the company's 54,000strong workforce could adversely impact productivity. Fixed wage rates that are not linked to productivity could adversely impact cost Gokaldas' cost competitiveness going forward; and rapidly changing fashion trends could result in shorter delivery schedules and increases in freight costs. Closely held shareholding pattern, with promoters holding 75% stake could pose a risk. If any of these risk factors plays out, Gokaldas' share price is likely to have difficulty attaining our target price.
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