Sanghvi Forging and Engineering is entering the capital market on 4^th May 2011 to raise Rs. 36.9 crore via a public issue of equity shares of Rs.10 each, priced between Rs.80-85 per share. The issue, constituting about 34-36% of post issue paid-up capital of the company, closes on 6^th May for QIB bidders and on 9^th May for retail and HNI bidders.

Vadodara based Sanghvi Forging and Engineering provides forging components to the non-automotive sectors such as oil and gas, power, infra and defence, operating a 3,600 MTPA plant in Gujarat. However, its capacity utilization has been low at just 58% in FY10 and 63% in FY11.

The company is now embarking on a massive expansion plan to increase its open die forging capacity by 15,000 MTPA with investment of over Rs. 120 crore to be funded through a 60:40 mix of debt and equity, key items as under:

• Term loan at floating interest rates (currently 11.75% pa) worth Rs 72 crore
• IPO proceeds of Rs. 37 crore
• Pre-IPO placement worth Rs. 5.6 crore (aggregating to 8.38% pre-IPO shareholding) in Dec 2010 and April 2011 at Rs. 80 per share to a German company, who also happens to be one of its suppliers of machinery for new project

This expansion project seems too ambitious for this small company and the target date for commencement of commercial production as mentioned in the RHP as May 2012 seems a little difficult to meet. Even the company's banker, SBI, has alerted medium risk on the cost and time overrun, plant performance and product off-take in the new project's appraisal report.

For FY10, company, serving clients in India, China, Europe, Australia, Canada and Middle East, clocked annual sales of Rs. 28 crore with PAT of Rs. 2.5 crore. During 9mFY11, sales rose to Rs. 26 crore and PAT grew to Rs. 3 crore, resulting to 9mFY11 EPS of Rs. 3.86 on equity of Rs. 7.99 crore, as at 31-Dec-10.

Taking into account the pre-IPO placement, current equity now stands at Rs. 8.35 crore which will rise to Rs. 12.7-13 crore, based on the IPO price discovered. Company's networth is about Rs. 20 crore which will jump to Rs. 57 crore post-issue. Promoter holding will decline to around 56% from the current 86.28%.

The significant negative difference will be in debt levels, which will rise to Rs. 87 crore, due to project financing through high-interest bearing bank loans. The debt equity ratio will not only double to 1.54:1 from present 0.77:1, but the annual interest outgo on these loans will be as high as Rs. 8.5 crore, as against company's FY11 expected EBIT of Rs. 7.5 crore. Thus, servicing these loans will be difficult in FY12 itself as new capacities will go on stream only in FY13. Also, once production commences, company will resort to further borrowings to meet high working capital needs.

At the upper end of the price band at 85, share is being issued at PE multiple of around 17 times, which is very aggressive given the company's small size, likely execution risks and high debt servicing obligations. This is also not in-line with other larger and established peer such as Ahmednagar Forgings with 10 times the company's expanded capacity and sales of Rs. 850 crore and trading at PE of less than 5 times.

As much better players are available in the secondary market, investors can give this one a miss. Only solace for the issue looks to be that it does not look like a BRLM-company-operator nexus stock.