Coffee Day Enterprises Ltd IPO – Can it Brew Good Returns?

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Coffee Day Enterprises Ltd IPO – Can it Brew Good Returns?

Most of us have been avid customers of Café Coffee Day, a chain of retail coffee shops, at some point of time. Its parent company has now come out with an IPO and we present our view and the details below:

Issue Details

Issue Open Date 14th Oct, 2015
Issue Close Date 16th Oct, 2015
Issue Size (Rs. crores) 1,150
Issue Price (Rs.) 316 to 328
Type of Issue 100% Fresh Issue
Market Lot 45 shares
Objects of Issue Expansion of coffee business (Rs.150 crores), repayment of debt  (Rs. 632 crores) & general corporate purposes

Business Summary

Coffee Day Enterprises Ltd. (CDEL), popularly known for its coffee business actually has diversified business interests through its various subsidiaries:

  1. Coffee Business–

    This segment constitutes Café Coffee Day Retail (1,538 outlets), vending business for institutional clients & coffee exports business.

  2. Development of IT/ITES parks

  3. Logistics–

    The company has ~53% stake as on 30th June, 2015 in Sical Logistics, a listed company.

  4. Financial Services–

    Presence through Way2Wealth Securities

  5. Hospitality–

    Coffee Day Hotels & Resorts

  6. IT/ITES–

    ~16% holding in Mindtree, a listed IT company, as on 30th June, 2015

 

Key Strengths

  1. Strong Coffee Franchise – Leadership Position with complete backend integration

CDEL’s coffee business is vertically integrated from procuring to retailing, its management has nearly two decades experience in coffee plantation business, its retail business has the first mover advantage in India & has the largest coffee chain with 1,538 outlets (4X larger than cumulative footprint of next 4 competitors) and ~46% market share.

The retail coffee chain business has strong gross margins of ~65% & EBITDA margins of ~21%. There is potential for operating leverage as Same Store Sales Growth (SSG) and Average Sales per Store improves, pace of store addition moderates and depreciation costs reduce. Additionally, the vending coffee business is a high EBITDA margins business of ~30 to 35% and could be a strong growth driver too.

The operating profit margins in overall coffee business have improved from 11% in FY12 to 15% in FY15. An improved product mix, increased footfall and consumer spending in stores coupled with growth in high margin vending segment could further boost this coffee business’s profitability.

  1. Low Risk Technology Parks Business

The company is developing and maintaining two technology parks and related infrastructure for IT/ITES companies. It follows a built-to-suit model where it enters into contracts with potential tenants prior to commencement of any construction. This ensures limited inventory risk and predictable cash flows.

Key Risks

  1. Competition in Coffee Business

Currently, there are ~100 café and bakery chain brands with an estimated ~3,200 outlets across India. The huge market in India owing to its favorable demographics has led to the entry of several global coffee chains like Starbucks, Costa Coffee, Coffee Bean & Tea Leaf, etc. Though CCD is the largest coffee chain in India with ~1,538 outlets, there is immense competition in this space from both, organized as well as unorganized players.  A slowdown in consumer discretionary spends could also impact the growth of this business.

  1. Sectoral Risks in Non-Coffee Businesses

CDEL which is issuing the IPO, is a holding company while all its businesses (coffee, logistics, financial services, hospitality services, etc) are operated under its subsidiaries. The underlying value of the company is solely dependent on the performance of its subsidiaries. The value of investments in Mindtree&Sical Logistics is dependent on the performance of IT industry, logistics sector and equity markets.

GreenEdge Wealth Services’ View

Though the retail coffee business is a formidable brand & commands the undisputed leadership position, we are negative on the IPO and recommend our readers to AVOID subscribing to the issue as:

  • Expensive Valuations–

    At the upper end of price band of Rs. 328 per share, CDEL’s is valued at 2.7 times FY15 Market Cap/ Sales. Typically, the holding companies trade at a discount to their subsidiaries but at the given price band, CDEL is commanding steep valuations.

  • Several Negatives – 

    All the negatives have been highlighted below.

  1. Coffee is One of the Many Businesses

The company’s complex structure – 40 subsidiaries & 5 diverse, unrelated businesses, makes it a conglomerate. All businesses have a history of weak return ratios and losses.

  1. Poor Track Record of Retail Coffee Business

The retail coffee business has posted Same Store Sales Growth (SSG) of 6% and Average Sales per Store of 9% CAGR in the last 5 years. However, FY14 was the only year which recorded a real high SSG over FY12-FY15; The SSG in FY13 was inflated due to introduction of service tax on food and beverage outlets.

  1. Concerns on Profitability of Consolidated Operations

On a consolidated level, the company has been registering losses since FY12. Despite its coffee business having a strong retail franchise and posting operating margins of ~21% at store level, it’s still incurring losses. There is no guarantee that the company will not incur losses at consolidated level in future.

Also, the IPO proceeds will reduce debt by Rs. 632 crores from consolidated debt of Rs. 3,550 crores as on FY15. However, any further increase in debt in any of its businesses could adversely impact CDEL’s profitability.