Verdict: Pass now, monitor post FY19 results

Update: 19Mar19: IPO price band revised to 120-128 from 121-128 earlier & issue closing extended to 20th March. Our view remains unchanged. 

IPO Snapshot:

MSTC is entering the primary market on Wednesday 13^th March 2019, with an offer for sale (OFS) of up to 1.77 crore equity shares of Rs. 10 each by the Government of India (GoI), in the price band of Rs. 121 to Rs. 128 per share, with discount of Rs. 5.50 per share for retail investors. Representing 25.10% of the post issue paid-up share capital, total issue size is Rs. 223 crore at the upper end of the price band. 75% of the issue is reserved for allocation to institutional investors, while only 10% is for retail. Issue closes on Friday 15^th March and listing is likely on 26^th March.

Company Overview:

A Mini Ratna company under the Ministry of Steel, MSTC (formerly Metal Scrap Trading Corporation) has the following 3 business segments:

1. Trading of bulk industrial raw material used in steel, oil and gas, power sectors – accounting for ~80% of company topline, catering mainly to government bodies, with top 3 clients accounting for 60% of revenues.
2. E-commerce services like e-auction, e-procurement etc. mainly to govt. and related entities – accounting for ~8% of company topline.
3. Mahindra MSTC Recycling Pvt. Ltd. - Recycling e-waste through 50:50 JV with a subsidiary of M&M for auto-shredding and processing of end of life vehicles (ELVs) and white goods for production of iron and non-iron shredded scrap.

Objects of Issue and Shareholding Pattern:

The 100% OFS will marginally support GoI’s Rs. 80,000 crore FY19 divestment target, wherein 89.85% government holding will decline to 64.85% post-listing. Close to 650 individuals hold 10.15% stake in the company and their shareholding remains unchanged.

Financial Performance:

Volatility in earnings and poor working capital management best describe company’s financial performance.

Revenue from operations has been dwindling, especially for the trading segment, which contributes ~80% to topline. E-commerce business, however, which is barely 8% of topline, has shown consistent double-digit growth.

To exclude the impact of provisions created on doubtful debts and provisions written-back (as no longer required), it is prudent to compare adjusted profit before tax (APBT) as a % to revenue, which has been on an uptrend since FY16, as e-commerce business has shown healthy 22% CAGR between FY16-18:   

Adjusting for 1:1 bonus given in Jan 2019, on current equity of Rs. 70.40 crore, FY18 reported PAT and EPS stood at negative Rs. 6 crore and negative Rs.0.92 respectively. For H1FY19, reported PAT and EPS stood at negative Rs.16 crore and negative Rs.2.26 respectively. On net worth of Rs. 328 crore (30-9-18), BVPS is Rs. 47.

Many traits of PSUs

Company shares many traits which are common across listed PSUs in India:

• Cash surplus balance sheet: Total debt of Rs. 302 crore as of 30-9-18 (mainly short term) against cash and equivalents of Rs. 554 crore, leading to net cash of Rs. 252 crore or cash per share of Rs. 36. 
• High Dividend yield of 6%: Even when bottomline dropped to red in FY18, dividend payout increased to Rs. 7.40 per share, from FY17’s Rs. 7.10 per share, yielding high dividend % to share price. 
• Poor collection cycle: Outstanding debtors at Rs. 3,188 crore (30-9-18) represent 13 months of sales and have historically remained at elevated levels, creating huge working capital stress on the balance sheet. Even as of 31-3-18 and 31-3-17, outstanding debtors’ days are extremely high at 19 months and 23 months respectively, which is seen across many companies catering to the government bodies.

Potential Business Risks

1. While management may say that past bad deeds have been wiped off in H1FY19 and FY18, given high provisions for doubtful debts of Rs. 129 crore in H1FY19, combined with outstanding debtors (Rs. 3,188 crore as of 30-9-18), further skeletons in the closet can not be ruled out completely. What is concerning is that govt. entities from whom receivables have become doubtful or been written off, adversely impacting company’s profitability.
2. Client concentration risk is high, as top 3 trading customers make up for an average 70% of trading revenues or nearly 60% of overall company revenues.
3. Outstanding litigations worth over Rs. 225 crore with Standard Chartered Bank, some steel customers, potential cancellation of export-import licence, challenge to Ministry of Steel orders being awarded to company on nomination basis (without inviting competitive bidding) etc. in addition to contingent liabilities of Rs. 300 crore may throw negative surprises going forward.

Valuation:

At Rs. 128, company’s market cap and EV will be Rs. 900 crore and Rs. 650 crore respectively. Due to fluctuating historical financial performance on account of impact on topline in FY17 and provision for receivables in FY18 and H1FY19, it is difficult to estimate margins going forward, which can range from -7.7% (FY16) to -1.1% (H1FY19) to even as high as 6% (if 11% PBT achieved and no exceptional items) in the future. In the best case (6% PAT, PE multiple works out to only 4x). However, what is important to gauge at this stage is collections cycle improving and no further shocks in form of higher provisions for doubtful debts. In this backdrop, even retail discount of Rs. 5.50 per share (4.3%), dividend yield (5.8%) and cash per share of Rs. 36 should not be viewed in isolation, however attractive they may be.

Conclusion:

Since company is engaged mainly in trading business, scope for margin expansion or phenomenal growth is very restricted, although e-commerce services holds promise. Fate of recycling business is still uncertain, as both JV partners need to make investments to scale up the business.

Fluctuating reported profitability and poor collection cycle weigh adversely on the financials, besides few business risks highlighted above.

Best is to wait for financial results for few more quarters before taking a call on the stock. In the meantime, one can always focus on the action-packed secondary markets.

Hence skip this IPO for now, as PSU tag is not seen too exciting as well. 

Grey Market Premium of MSTC:

Grey Market Premium (GMP) of MSTC is an unofficial figure, against guidelines of SEBI. We strongly recommend investors against following the grey market premium. To know more about grey market premium and how it operates, read our article on ‘grey market premium’ in the Pathshala column.

Disclosure: No interest.