SP Apparels (SPAL), a company engaged in the business of manufacturing and sale of knitted clothes for infants and children (through its garments division), caters solely to the exports markets. The company’s retail segment exclusively manufactures and sells ‘Crocodile’ branded menswear garments in India through Crocodile Products (CPPL).
Barring a miniscule increase in operating profits, SPAL’s performance in the quarter gone by was lacklustre. Nevertheless, despite the blip, the company’s strategy for the upcoming fiscals could result in better earnings visibility, and therefore, warrants investor attention.
From a year-on-year (YoY) perspective, SPAL’s garment segment, that contributes 85-90 percent to the company’s top-line, reported a flat set of quarterly numbers in terms of sales and margins due to Brexit-related uncertainties.
However, a significant YoY improvement was visible in SPAL’s retail segment. The division’s income growth was driven by an increase in sales from large format stores (LFS) and exclusive brand outlets (EBO) across the country. The segment’s profile turned EBITDA positive, too.
After a disappointing Q2, what is the road ahead for SPAL?
Volume growth
SPAL is expected to increase its garment sale volumes from nearly 23 million pieces as on September 30, 2017 (order book stood at Rs 230 crore) to approximately 50 million pieces by the end of FY18. From FY19, the growth outlook is pegged at 10-15 percent annually, attributable to steady demand growth.
Order executions
Commencement of shipments to 3 non-UK clients (that were added in FY17) in H2FY18 will bolster SPAL’s revenues. As of now, supplies to 2 of them are underway, whereas deliveries to the third client will begin in the next 2-3 months. Adding 2 new clients is on the company’s agenda in the next few months.
Risk mitigation
To reduce risks associated with geographic concentration in the UK, SPAL’s focus is progressively shifting towards clients outside the region. The contribution of non-UK importers to SPAL’s turnover is likely to be in the range of 8-10/20-25 percent by the end of FY18/FY19, respectively.
Sewing capacity
The average utilisation rate of SPAL’s existing 4050 sewing machines in Q2FY18 has been 78 percent. As the utilisation scales up in due course, 10-15 percent growth in revenue is achievable without any capex. Commercialisation of 350 new sewing machines by FY19 will boost SPAL’s growth prospects as well.
Franchise route
To facilitate asset-light expansion, SPAL’s network augmentation will be mainly undertaken through franchise stores. Most of the company-operated outlets will be gradually converted to the franchise-run format. By FY19 end, the company targets to build its presence in large format stores from 172 to 300.
Efficiency maximisation
SPAL’s backward integration plan, which includes setting up a spinning facility, is anticipated to conclude by Q2FY19, consequently resulting in a gross margin uptick. The mix of fashion products to basic variants that stands at 60:40 at the moment, will move in favour of the latter to derive better operating leverage.
Traction gain in subsidiary
SP Apparels UK’s (SPAL’s subsidiary) numbers in Q2 (2.5x YoY revenue increase, 5 percent EBITDA margin vs loss in Q1FY18) are indicative of the potential it has. An extension of SPAL’s current UK-centric product offerings from children wear to the women swear category could diversify consumer-oriented risks, too.
SPAL’s cash flows remain vulnerable to foreign exchange fluctuations (depreciation of the pound and euro). Change in duty drawback rates on garment exports (from 7.5 percent to 2 percent), coupled with a change in rebate of state levies (RoSL) rate, may impact SPAL’s EBITDA margin by 200-400 bps till FY19.
At 13.6x FY19 projected earnings, the stock can be considered for accumulation from a long-term horizon.
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