Adani Wilmar Limited (AWL) filed its Draft Red Herring Prospectus (DRHP) last week. The company is a joint venture between the Adani Group and Wilmar International Limited. Wilmar is a Singaporean food processing giant and one of Asia’s largest agribusiness groups. Unlike recent IPOs, the offer will consist of only fresh issue and no offer for sale by existing shareholders.

Adani Wilmar focuses on manufacturing of edible and non-edible oils, production of oleo-chemicals, and the trading of agro products. According to the Nielsen Retail Index, Adani Wilmar’s market share of branded edible oil was at 18.3 per cent, putting it at the top position in the edible oil category in India. The company’s ‘Fortune’ brand is the largest selling edible oil brand in India.

Meanwhile, the company has also focused on moving higher up the value-chain, and producing higher margin products. It has been using its widespread distribution network to offer a wide array of packaged foods since 2013, including packaged wheat flour, rice, pulses, sugar, soya chunks and ready-to-cook khichdi.

Despite the new offerings, edible oil contributes to 82 per cent of Adani Wilmar’s revenue. The company has grown its revenue at a compounded annual growth rate of 13 per cent.

However, on closer look we see that revenues increased at a rate of 2.9 per cent for financial year 2020 (FY20), while seeing a 25 per cent jump in FY21. However, the increase stemmed from a rise in oil prices world over, rather than an actual increase in volumes.

Similarly, edible oil prices were relatively flat in FY20, which resulted in a mere 2.9 per cent increase. Therefore, the business is exposed to the vagaries of commodity prices.

The company’s operating margins have remained around 4 to 5 per cent for the past three financial years. The low operating margins also indicate that the company possibly operates in a market without much pricing power. The edible oil business is an extremely competitive business, with a large number of organised and unorganised players. The barriers to entry are low, resulting in high competition in the sector.

The debt to equity ratio of the company has been decreasing as the company has generated enough cash flow from operations to cover capital expenditure and interest expenses. The company plans to use a part of the IPO money to fund its capital expenditure, while using the remaining for acquisitions and paying down debt.

The company has also outsourced production to 28 tolling units in addition to its original 22 owned plants, as a way to reduce capital expenditure and have an asset-light model. The company has a net fixed asset turnover ratio of around 10 which implies that the company can generate sales of Rs 10 with every Re 1 invested in fixed assets. A high net fixed asset turnover is great, but it can also attract competitors as a small investment can generate high sales.

AWL is reportedly being valued at Rs 36,000 to Rs 45,000 crore for the IPO, giving it an Enterprise Value to Operating Profit ratio of around 25 to 31. Other companies operating in the same industry have ratios which are much lower, despite having grown at a similar pace. For instance, Gujarat Ambuja Exports, which trades edible oils and agro-products, has a price to earnings ratio of 10, despite being at multi-year highs.

The business is highly competitive, due to which several participants have given negative returns in the past. For instance, Ruchi Soya, which operates in the same segments as Adani Wilmar, had entered insolvency proceedings in 2017. Investors should keep in mind that the failure rate in the industry is quite high.

Key Risks

Competitive Pressure: The company faces intense competition from both organised and unorganised players. Large competitors like ITC and Ruchi Soya pose a threat to the company’s operations. Ruchi Soya is among the largest producers of edible oils and a direct competitor of AWL. The low barriers to entry keep attracting a constant stream of competitors in the business. It is a low-margin commoditised business.

Raw Material Concerns: AWL’s revenues are dependent on the prices of edible oils in the markets. If costs increase but AWL is unable to increase prices, it can lead to a squeeze on margins. In the past, the edible oil and agro-products industries have faced cost pressure issues. AWL has secured its raw material sourcing through Wilmar which has a strong presence in south-east Asia.

Rise Of Modern Trade Channels: Modern Trade channels like supermarkets, malls, online grocers among others have been growing at a rapid pace. Several have removed the middlemen, and prefer to deal with manufacturers directly due to their scale. As these companies grow their online and offline presence, they will have greater negotiation powers which could lower margins for companies like Adani Wilmar.