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Stock Recommendation | SHANKARA BUILDING PRODUCTS LTD – SELL – Target Price : 620
Publish date: DECEMBER 4, 2018
NEGATIVE SURPRISE: Change in company’s business strategy
Shankara building products in its conference call has updated on the business strategy of achieving higher revenue growth in retail segment but at much lower margins which came as a negative surprise. It is transitioning into a low price retailer with focus on plumbing and sanitaryware as key growth drivers in the retail segment. Company expects healthy growth in the retail segment and expects debt to reduce from the current levels with working capital improvement.
In the near term, this change in the business strategy is likely to result in significant earnings reduction and we believe that positive impact of these changes is likely to be reflected after 2-3 quarters. Though we revise our revenue estimates upwards slightly, we revise our EBITDA estimates downwards by 18.7%/26.1% for FY19/20 and PAT estimates downwards by 38%/41% for FY19/20 respectively to reflect the change in the business strategy. We also reduce our valuation multiples for the retail segment owing to decline in margins, earnings growth as well as lower return ratios as against our earlier expectation. We thus downgrade the stock to SELL from BUY earlier.
Shift in the business strategy towards a ‘low price retailer’
Shankara Building products has changed its strategy to become a ‘low price retailer’ and expects to achieve 20-25% growth in the retail segment revenues. Company has reduced the EBITDA margin guidance in the retail segment from 10.7% achieved in FY18 to 6-8% going forward due to increased competition and higher cash discounts. Overall margin guidance has been reduced to 4-4.5% as against 6-7% earlier. From a rapid pace of expanding the number of stores and upgradation of stores in FY17/18, company is now focusing on consolidation and would work upon improving the store level economics and hence reduced the new store addition target to 10-12 stores from 15-20 additions in a year.
The channel and processing segment margin weakness may sustain in the coming quarters but company is trying to put in additional investments on backward integration at its processing facilities. The focus will also be on improving the working capital cycle and collections in this segment.
Though we had expected some reduction in retail segment margins at the cost of high growth, but reduction in margins to 6-8% in retail segment is beyond expectations. This is leading to a sharp downward revision in the earnings of the company going forward.
Focus on working capital improvement and debt reduction
During Q2FY19, borrowings for the company had witnessed an increase which resulted in higher interest expense for the quarter. Increase in borrowings was partly attributed to higher working capital requirements as creditors were paid off during the quarter. Debtor days has also come down to 47 days at the end of Q2FY19 as compared to 61 days in March, 2018.
Working capital cycle of the company had moved up to 55 days in FY18 and 66 days in H1FY19 as compared to 44 days in FY17. With the change in the business strategy, company expects to reduce receivables by lowering credit sales and giving higher cash discounts. It intends to reduce the receivable cycle to 25 days and net working capital cycle to 50-55 days by FY19-end. This is also likely to reduce the borrowings to Rs 4 bn by FY19 end as compared to Rs 5.2 bn as on Sep, 18.
Management is optimistic on the long term growth momentum with near term focus on balance sheet strength and improving store dynamics. Instead of focusing on increasing the number of stores, products and acquiring new business which it had done last year, company would in near term focus on consolidation in terms of stores and products(with focus on plumbing and sanitary ware as key growth drivers). More clarity on the results of these efforts will emerge by March 2019 and hence we believe that till any near term positive triggers, stock would continue to remain under pressure.
We incorporate higher growth in the retail segment revenues led by improved revenues per store despite lower than expected store addition. Though we revise our revenue estimates upwards slightly, we revise our EBITDA estimates downwards by 18.7%/26.1% for FY19/20 to reflect lower margins in retail segment and continued pressure on channel and enterprise segment margins. Correspondingly, our PAT estimates are revised downwards by 38%/41% for FY19/20 respectively to reflect the change in the business strategy.
At current price of Rs 624, stock is trading at 22.9x P/E and 10.2x EV/EBITDA on FY20 estimates. We had earlier ascribed higher valuations to the retail segment owing to higher growth led by incremental store addition, margin improvement and RoE improvement. However, the change in the business strategy is likely to impact margins, earnings and return ratios negatively. We thus reduce our valuation multiples for the company and now value retail segment at 12x EV/EBITDA and channel and enterprise segment at 4x EV/EBITDA and arrive at a revised price target of Rs 620 (Rs 1552 earlier). We downgrade the stock to SELL from BUY earlier.
Shankara Building Products is one of India’s leading organized retailers of home improvement and building products in India, based on the number of stores operating under brand “Shankara Buildpro”. Company has three segments – Retail, Enterprise and Channel and also has processing capabilities of 323200 tonnes per annum in products like Steel tubes, galvanized strips, cold rolled strips, bright rods, scaffolding.
BUY - We expect the stock to deliver more than 12% returns over the next 12 months ACCUMULATE - We expect the stock to deliver 5% - 12% returns over the next 12 months REDUCE - We expect the stock to deliver 0% - 5% returns over the next 12 months SELL - We expect the stock to deliver negative returns over the next 12 months NR - Not Rated. Kotak Securities is not assigning any rating or price target to the stock. The report has been prepared for information purposes only. SUBSCRIBE - We advise investor to subscribe to the IPO. RS - Rating Suspended. Kotak Securities has suspended the investment rating and price target for this stock, either because there is not a Sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA - Not Available or Not Applicable. The information is not available for display or is not applicable NM - Not Meaningful. The information is not meaningful and is therefore excluded. NOTE - Our target prices are with a 12-month perspective. Returns stated in the rating scale are our internal benchmark. Kotak Securities Limited established in 1994, is a subsidiary of Kotak Mahindra Bank Limited. Kotak Securities is one of India's largest brokerage and distribution house.
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