Mahindra Logistics IPO review: Asset-light logistics

Mahindra Logistics will be looking to follow the footsteps of VRL Logistics when it hits the primary markets through maiden offer next week. The Mahindra & Mahindra (M&M) group company will launch its IPO on 31 October in India’s 32^nd mainboard IPO this year. Priced in the range of INR425 – 429 per share, the IPO will raise INR829.36 crore at the upper price band. The IPO values the company at nearly INR3,000 crore. After the disappointing listings of Indian Energy Exchange and General Insurance Corporation (GIC), investors will be rightly cautious about prospects of new IPOs and it remains to be seen if Mahindra Logistics can turnaround the sentiment. As we delve deeper in Mahindra Logistics IPO review, we will get to see if the business has fundamentals to support valuations.

Mahindra Logistics IPO Review: No funds for the company, Kedaara to part exit

2017 is the year of private equity exits through IPOs and Mahindra Finance will be 10^th company this year to launch an offer with no proceeds going back to the company. All the 19,332,346 shares will be sold by existing shareholders. M&M, which currently owns 51,478,330 shares or 72.36% equity stake in the logistics arm, plans to sell 9,666,173 shares. Another major chunk of 9,271,180 shares will be offered by Normandy – a subsidiary of private equity (PE) firm Kedaara Capital. Kedaara AIF also plans to sell 394,993 shares. The PE firm invested INR200 crore in Mahindra Logistics in 2014 through the two firms and holds nearly 23% equity stake.

Mahindra Logistics IPO Review: In-house operations

Mahindra Logistics was incorporated in 2007 and M&M transferred its logistics business in the next year. However, these operations are much older and used to operate earlier in-house for exclusive use by the M&M group. Subsequently, Mahindra Logistics has grown considerably through adding new clients. Its exposure to M&M’s automotive business played a crucial role in winning new business from other automotive clients such as Volkswagen, BMW and Ashok Leyland. Nevertheless, M&M is still the biggest customer for Mahindra Logistics and accounted for over 55% of the latter’s top line in FY2017. A positive here is that this figure is down from 70% in FY2015.

The company operates in two business segments – Supply Chain Management (SCM) and People Transport Solutions (PTS). The core SCM business has a large network of over 1,000 business partners providing vehicles, warehouses and the other assets and services and counts Volkswagen India, Vodafone India, Thermax, and JSW Steel among biggest clients. The PTS business offers technology-enabled people transportation solutions and services to over 100 domestic and multinational companies operating in the IT, ITeS, business process outsourcing, financial services, consulting and manufacturing industries.

As we mentioned earlier in this article, Mahindra Logistics largely follows an asset light approach for its operations. This means the company does not own the assets required to operate the business. All major assets such as vehicles and warehouses are owned or provided by a large network of business partners. This helps in keeping capital expenditure low, better managing demand fluctuations while also minimizing the adverse effects resulting from cyclical movements. It also helps in mitigating the effects of operational risks relating to direct fuel costs, maintenance costs and depreciation risks emanating from changes in laws and regulations.

Mahindra Logistics IPO Review: Robust financial performance

Apart from keeping costs low, this asset-light model greatly helps operations by bringing in high scalability. This is visible in Mahindra Logistics’ revenues which grew from FY1535.5 crore in FY2013 to INR2,676.3 crore in FY2017. It is important to understand that logistics is largely a need-based function in most organizations and thus, one has little control over creating or growing market. In this sense, logistics is very different from consumption markets where a new product category can create fresh demand and a new market altogether. More often then not, the only way to grow business is by winning it from competitors. As such, Mahindra Logistics’ revenue growth is commendable.

Profits have also grown in line with revenues, although the growth hasn’t been as consistent. In terms of margins, the company’s margins have remained in the range of 1.6% to 2.1% in the last five years. These are not very high margins but let’s not forget that Mahindra Logistics operates an asset-light model and needs to pay the asset providers for their services. Another point to consider is the company’s cost structure and the one-time expenses it pays to its vendors for asset and service usage spread over a broader timeframe. A more accurate picture is provided by adjusted profits which exclude the impact of onetime charges in a business transformation exercise. Adjusted profits have expanded at an average rate of 22.3% to INR60 crore in FY2017. Margins are also better after adjusting for these costs.

FY2013, FY2014 figures based on Indian GAAP, subsequent years based on Ind AS

Mahindra Logistics IPO Review: Should you invest?

In Mahindra Logistics’ operations in the last few years, the trend of fast growth in SCM business has been prominent. This has outpaced the PTS business which has been growing moderately has remained resilient.  Non-M&M part has contributed immensely in the company’s growth. Average growth rate in SCM business outside M&M group has 65% in the last four years.

Another highlight for the company has been the introduction of GST. Over the next 5 – 10 years, we are going to see the logistics market shifting from smaller, unorganized players to large organized 3PL (third party logistics) players and this bodes very well for Mahindra Logistics. With removal of state boundaries and check posts, clients are going to increasingly opt for service providers with pan-India presence who can offer scalable and flexible solutions. We have already seen Mahindra Logistics’ executive capabilities and M&M’s continued support to the logistics arm is an added positive.

So finally, it comes down to valuations. Its Earnings Per Share (EPS) of INR6.62 in the latest year ended 31 March 2017 means the offer is in the Price by Earnings (P/E) range of 64.20 – 64.80. Considering adjusted profits, this range comes down to 48.35 – 48.8 which is still quite high. As always, we are discounting the first quarter earnings as there may be seasonality and other factors at play.  Among other parameters, Return on Net Worth (RONW) of 13.11% is good, thanks to a strong balance sheet. Although there are several listed logistics players, none of them operate an asset-light model like Mahindra Logistics. Nevertheless, solid logistics plays including VRL Logistics are available at reasonable valuations.

All in all, Mahindra Logistics IPO review reveals that the company has distinct advantage over its peers by not blocking funds in assets and operates in an industry with bright outlook. However, the pricing is high enough to deprive IPO investors of gains in case markets tumble from here.