The business model of SP Apparels, which is engaged in manufacturing and exporting of knitted garments for kids, is similar to that of its listed peer Kitex Garments. While the revenues of both companies are more or less similar, there is a huge difference in their margin profiles. In FY16, for instance, SP Apparel’s earnings before interest, taxes, depreciation and amortization (Ebitda) and net profit margins stood at 16.8 per cent and 6.5 per cent, respectively – less than half of Kitex Garments figures which stood at 34.1 per cent and 20.5 per cent.
The margins of the two companies are expected to expand going forward, as they reduce the debt on their books. So, although SP Apparels` own margins might improve on the back of lower debt and consequent savings in interest costs, they could take some time to catch up with that of Kitex Garments.
In this backdrop, SP Apparel’s initial public offering valuations are not cheap. Assuming a good 35 per cent growth in its net profit in FY17, the issue is priced at 14.5 to 14.9 times FY17 estimated earnings on a post-issue basis – in line with Kitex Garment’s current valuations of 15 times FY17 estimated earnings. The multiple, though, shrinks to 13.1 to 13.4 times if we assume a higher earnings growth of 50 per cent in FY17 for SP Apparels. However, the company’s earnings growth has been rather lumpy in the past three years and, hence, it is difficult to predict (high profit growth is also aided by a very low base). The higher margins have also led to superior return ratios for Kitex Garments, which posted return on equity of 35.5 per cent in FY16. This metric stood at 29.4 per cent for SP Apparels in FY16. With higher dependence on exports, SP Apparels` prospects are closely linked to growth in developed markets, particularly Europe.
Continued relationship with its five key clients – Tesco International, Primark Stores, Mothercare UK, ASDA Stores (owned by Walmart), and Dunnes Stores – is a key strength of the company.