HVA Foods Limited IPO

HVA Foods Limited announced its Initial Public Offering of 19.928 million Ordinary Voting shares at the rate of Rs 16.00 to be listed on the Diri Savi Board of the Colombo Stock Exchange. The issue opens for subscription on January 12, 2011, closing on February 1, 2011 or the date on which the issue is oversubscribed which is likely on January 12, 2011. The IPO is expected to raise Rs 319 million.

Issue and listing details

Number of shares: 19,928,598

Type of shares: Ordinary Voting Shares

Issue price: Rs 16.00

Minimum subscription: 100 shares

Basis of allotment: Employees 5 percent. Retail Investors 30 percent. Non Retailers 65 percent

Purpose of issue

The company plans to raise Rs 318,857,568 through public offering. Of the total funds so raised it plans to utilize Rs 45 million to acquire 100 percent ownership of HVA Holdings (Pvt.) Ltd. to obtain international brand rights for ‘Heladiv’, Rs 94.75 million for retiring term loans so as to reduce gearing; Rs 102 million for upgradation of pilot plant to commercial plant and expansion of existing operations and the balance proceeds to be used to meet the increased working capital needs of the Company.

Sources of funds (Rs in millions):

Funds raised through IPO 318.86

Utilization of funds (Rs. in millions):

Acquisition of HVA Holdings (Pvt.) Ltd. - *45.00

Settlement of term loans - 94.75

Expansion and Technology Upgradation - 102.00

Incremental Working Capital Requirements - 77.11

Total - 318.86

* Deferred Payment for acquiring 100 percent ownership of HAV Holdings (Pvt.) Ltd. for the assignment of international brand rights of ‘Heladiv’ to HVA Foods Ltd.

Post IPO shareholding

Shareholders name, Number of shares percent holding

HVA Lanka Exports Pvt. Ltd. 46,500,000 (69.9999 percent)

A R H Fernando 62 (.0001 percent)

Public 19,928,598 (30.00 percent)

Total 66,428,660 (100.00 percent)

Company and group profile

HVA Foods Ltd. a BOI approved company was incorporated in 1997 to export value added branded tea, tea extracts based products, tea concentrate based products and franchise operations. It is a wholly owned subsidiary of HVA Lanka Exports (Pvt.) Ltd. which is engaged in export of bulk tea. In 1996 HVA Foods build its own tea brand ‘Heladiv’ which is registered in 42 countries. The international brand of ‘Heladiv’ is owned by subsidiary HVA Holdings (Pvt.) Ltd. Group is pioneer in developing Ready-To-Drink Iced tea in the island.

Nearly 80 products are sold under the brand name which includes variety of flavours and presentations of tea. Franchise operations have already commenced in China with 10 outlets. As per the latest assessment by PWC, Sri Lanka, value of ‘Heladiv’ brand is in the range of US $ 1.08 million - 1.24 million.

Overview of industry and outlook for HVA

Tea industry is one of the major exports contributor sources of forex earnings in Sri Lanka.

The country is the fourth largest tea producer in the world adding 289.7 million kgs in 2009 and is world’s second largest tea exporter.

The value added tea business which comprise tea packets, bags, instant tea, and other blended teas has huge growth potential. Presently, the shift is from bulk tea to value added branded packages due to change in consumer preferences therefore the major tea importing countries are placing increased demand for the same.

Sri Lanka is strategically positioned to take advantage of the burgeoning value added tea market. Of the total tea exported from Sri Lanka value added tea constitute 42 percent. Sri Lanka Tea Board expects to increase the share of value added tea to 65 percent in next five years by assisting the local firms to market their brands.

The value added tea segment in Sri Lanka is fragmented with nearly 150 exporters. HVA has an edge over its competitors in the industry due to innovation and diversification into tea extract based products and tea concentrate. In 2009, export volume of value added tea market declined by 9.4 percent whereas the company’s volume increased by 18 percent. The Company owns the brand unlike other exporters who packs for third party brands.

‘Heladiv’ is recognized as one of the top five tea brands of Sri Lanka. It is registered with 42 countries with over 250 retail chains in CIS, Far Eastern and European markets. CIS countries account for 70 percent of export revenues and have grown at a CAGR of 29 percent during 2005-09 and is projected to achieve a moderate rise of 7 percent in next five years. In the Fast Eastern countries Japan is the largest consumer, however with the emerging Chinese markets the overall prices are expected to fall by 37 percent in 2010.

The Middle East region imports bulk tea while the company’s presence is growing in Europe and USA. During the current year HVA also made entry into Maldives and Malaysia.

HVA IPO offer, review and performance analysis

Half yearly position from April-September 2010 of FY 2010/11 has recorded a 13 percent growth in Revenue and 63.38 percent in Net Profit.

The growth is lower than anticipated as the sales to CIS region is decreased in the hot months of June-July. The net profit for the six months ended September 2010 is Rs 27.07 million as against Rs 16.57 million recorded during the corresponding period of FY2009/10 and Net profit margins are at seven percent and 10 percent respectively.

The revenue of the company has recorded a compound annual growth rate (CAGR) of 10 percent during the five year period from FY2005/06 to FY2009/10. During 2009 the overall tea industry was adversely affected due to bad weather conditions, HVA was able to sustain positive growth backed with price escalation. From 2007-09 export prices of HVA have shown a growth rate of nine percent. We expect the group’s revenue to record a 53 percent growth in FY2010/11 and 31 percent in FY2011/12 with export, local sales and contract packaging contributing 25 percent, 50 percent and 18 percent respectively.

With the upgradation of ‘Heladiv Innovation Centre’ commercial production of 5000-7000 litres of tea concentrate per month will be produced which in the FY 2011/12 will amount to marketable value of approximately Rs 100 million. HVA has also ventured into tea cosmetics and pharmaceutical markets which includes skin care, oral care, body care, facial care, food grade dye and tea tablets which will generate additional business in Japan, Singapore, Russia and Central America.

HVA has made way into Chinese niche market by setting up ten franchise outlets in past year. As per the MOU the number of such shops will be increased to 100 within three years. Also, ten tea franchise shops under sub brand ‘Infini-T’ targeted in the FY2011/12 will add to growth in revenues.

GP margins are below the industry average due to high cost of sales however the operating margins at average 13 percent is in line with industry average of 16 percent. GP margins are assumed to be maintained in the range of 22-23 percent in the years FY2010/11 and FY2011/12. Substantial brand building expenses led to high financing costs and volatile Net profit growth during the historic period.

However, the last two financial years have recorded a significant growth as against the loss of Rs 16.46 million reported for FY2007/08, with FY2008/09 net profit being Rs 14.82 million and FY2009/10 recording a 266 percent growth to Rs 54.27 million with a Net Profit margin of 11 percent improving from 4 percent NP margin in FY2008/09 as the finance costs decreased by 49 percent.

Valuation

We expect HVA to report net earnings of Rs 79 million in FY2010/11 recording a 46.21 percent growth and Rs 118.68 million in FY2011/12 with 50 percent growth. The valuation range for HAV on PE multiples ranging from 9x to 12x on FY2011/12 values gives the share a valuation of Rs 16.11 to Rs 21.48.

The IPO price is attractive on the basis of offering PE of 10.12x (FY2010/11) and 8.93x FY2011/12 respectively, compared to the Beverages, Food and Tobacco sector which currently trades at a PE of 22.4, the stock has strong potential for growth and value appreciation in the secondary market. ACUITY Stockbrokers (Pvt) Ltd Analysis