Should you subscribe to Kaynes Technology’s IPO?

Kaynes Technology’s (Kaynes) IPO, which opened for subscription on November 10, runs through November 14. The issue size of around ₹850 crore consists of a new issue of ₹530 crore, the remainder being offered for sale by the promoter and another investor. The Company intends to use the proceeds from the new offering for investment/capacity expansion, debt repayments and to fund working capital needs. The promoter participation, which is currently 80 percent, will be reduced to 64 percent after the issue.

Kaynes is engaged in integrated electronics manufacturing. Although the growth prospects are interesting, Kaynes is very expensively valued at the upper end of the IPO price range of ₹559 to ₹587/share. Based on post-issuance ownership, the valuation is 82x FY22 PE and about 87x June Q-FY23 annualized earnings. Such a valuation gives more than adequate consideration to the growth prospects and leaves no margin of safety for investors. Therefore, long-term investors may miss the IPO.

business

As an integrated player in electronics manufacturing, Kaynes has capabilities across a wide range of Electronic Systems Design and Manufacturing (ESDM) services. It has experience in providing concept design, process engineering, integrated manufacturing and lifecycle support to major players in various industries (see infographics). It operates from eight production sites in the country. Some of the products Kaynes supplies are cluster PCB assemblies, automotive lighting electronics, streetlight controls, motor control panels, energy meters, wired and wireless headsets, etc. Relative to the industry, the company has a fairly diversified customer base with top 10 customers growing to 51 contribute percent of sales. Around 20 percent of the company’s turnover comes from exports.

perspectives

While ESDM players originally started out as contract manufacturers a few decades ago, many of them now work with Original Equipment Manufacturers (OEMs) as early as the product design and prototyping/testing stages, adding value throughout the product lifecycle. The global ESDM industry was worth US$804 billion in 2020, with India’s share at a tiny 1.8 percent. China leads the field with a 45 percent share, followed by the United States with 16 percent. According to a report by Frost and Sullivan, the market size is estimated at US$1,002 billion in 2025, with India’s contribution possibly as high as 8.1 percent, implying a CAGR of 41 percent for the industry. While this may be overly optimistic, the growth can still be good. Enabling factors are government efforts and incentives to encourage manufacturing in India, domestic cost competitiveness (Indian wages are 46 percent cheaper than China according to one report), import substitution, China+1 strategy of global companies, etc.

risks

Besides Kaynes, some of the major players in the industry in India are publicly traded players – Dixon Technologies, Amber Industries, SGS Syrma; and unlisted players such as Bharat FIH, SFO Technologies, Avalon Technologies and Sanmina-SCI Technology. Bharat FIH and Sanmina-SCI are Indian units of impressive international players.

At the same time, this is also an industry with very high competition (domestic and established international players) and low margins. The global slowdown is also a near-term risk that can impact sales and squeeze margins. Lower-margin industries and companies tend to have higher earnings volatility. Higher interest rates can also impact working capital costs and profitability. Therefore, in addition to these risks, growth prospects must also be taken into account. Dependence on imports for key commodities until India is able to build domestic capacity for them is another risk. For example, imported raw materials accounted for 64.46 percent of Kaynes’ total raw material purchases in FY22.

Finance and Valuation

In FY22 Kaynes reported operating revenue of £7.06bn and net profit of £41.6bn (net profit margin of 5.8 per cent). In fiscal 2020-22, revenue and profit grew at a CAGR of 38 and 111 percent, respectively. Profitability improved through a combination of operational leverage and lower interest costs. Compared to its competitors, Kaynes has better profitability. According to its presentation, while the company reported EBITDA margins of 13.3 percent in FY22, the same ranges from 2.7 percent to 11 percent for some of its key competitors.

For the June quarter of 2023, Kaynes reported operating income of £1.99bn (28 per cent of FY22 revenue) and net profit of £10bn (24 per cent of FY22 profits). At the end of the quarter the company had a stronger order book of ₹2,266 crore (3x FY22 sales).

In the absence of global shocks, the company may continue to grow well, but its valuation at 82 times FY22 earnings makes the offer unappealing. Competitor SGS Syrma, which recently floated its IPO in August, is trading at 67 times FY22 earnings. While competitors also trade expensively, they don’t seem to adequately consider business risks.



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