IPO files: Is there any meat in TOMC?

After the rights issue of Al Shaheer (PSX: ASC) earlier in January, Pakistan’s first IPO of FY21 is also by another meat export business. At a time when forecasts of global economic recovery are bitterly divided between U-, and L-shaped recoveries, is the excitement in the meat segment warranted? Enter, The Organic Meat Company Limited (TOMC).

TOMC represents a classic entrepreneurial success story. In its tenth year since incorporation, the firm is already closing in on $20 million worth of exports annually. Sales have grown at a comfortable double digit CAGR over past 5 years, as the management explores new product lines and exporting destinations beyond the traditional Halal Middle East base, such as Far East, China, Russia, and even CIS countries. (For more, watch out for Faisal Hussain, CEO TOMC’s interview with BR Research to be published later this week).

The prodigy of fourth-generation livestock processing merchant family, TOMC's growth phase is far from over. The management plans on expanding its footprint in high margin global Offal trade – especially White Offal - by setting up 2 new units, one in Korangi and the other in EPZ Karachi to source local and imported raw material for value added re-exports.

Because White Offal is a highly perishable product, the new location will ensure that the plant is located closer to the value chain of slaughterhouses and abattoirs. A nuance that only sponsor-led management that has its skin in the game can appreciate.

And the tick marks on the checklist of Pakistan's mini unicorn don’t stop there. Healthy profit margins, impressive box-standard liquidity ratios, 100% ploughed back profits, and leverage maintained under a tight lid with nil LT debt! But if you are a careful reader, this should stop you in your tracks.

Why would a 100% exporter - betting on Pakistan's value adding future with healthy financial profile and zero LT debt – and eligible for SBP's Long Term Financing Facility (both conventional & Islamic) at max. 6 percent, dilute sponsor ownership by taking the company public? Short answer: the broken lending behavior of local banks, compounded by the skewed cash conversion cycle of the organized meat processing industry.

As a meat processor, TOMC purchases its raw material (livestock) on advance payment basis from suppliers in the informal segment, reflected as a hefty sum under Loans & Advances to suppliers (unsecured). That is in addition to payables incurred in the normal course of business. On the other hand, exports are made on credit (with 30% advance), with an average turnover cycle of 3-4 months. Fortunately, the inventory conversion is relatively quick – cattle is slaughtered and frozen to be shipped immediately.

Under normal course, banks would provide working capital financing against collateral over raw material/inventory. But because livestock is a risky business with purchases from suppliers in the informal segment, banks are only left with the option of providing financing against receivables/bill discounting. Except, exports shipped by airway bill are drawn on direct consignee rather than LC/bank contract basis, leaving behind little current assets to ‘bank’ on (although partially mitigated through access ‘by sea’ to some markets).

To be fair, these risks affect all players in the industry to varying degrees. And so far, TOMC has maintained its liquidity position very well. If it were any other meat subsidiary housed under a big conglomerate, corporate guarantee or share pledge of parent/sister concern would suffice to secure bank financing. But that also means any other entrepreneurial, cash-hungry firm seeking to expand its business must look for working capital elsewhere. Thus, it is logical that TOMC plans to utilize two-thirds of IPO proceeds towards working capital needs, while only Rs272 million out of Rs720million issue is earmarked for fixed assets expansion.

Which brings the story to the downside. As per the Prospectus, the company only has short-term contracts with its existing customers, with only one regular buyer over past 3 years, representing a puny 3.30% of sales.

So far, customer base is mostly concentrated in Middle East, a highly competitive market, where Pakistani meat exporters have been regularly priced out by rivals from Brazil, USA, and Australia due to an adverse exchange rate regime in a not-so-distant past. The sector is yet to obtain access to major export markets such as China (which is expected to be secured by next year). Already, Pakistani meat suppliers face technical barriers to western markets due to Foot & Mouth, and other disease outbreak risks.

Thus, the industry’s business model is exposed to unmitigated exogenous vulnerabilities, which is reflected in the poor performance on the bourse of the once promising Al Shaheer Corp., while the fate of non-listed ventures such as Fauji Meat has not been much different. From risk of unsecured credit advanced to suppliers in the unorganized sector, risk of disease outbreaks, order cancellation risk (by directly consigned buyers), to restriction on market access (tariff as well as technical); the meat export segment faces several low probability, high impact risks.

And that speaks volume about the broken value chains, missing regulatory support, lack of private debt market for firms operating in non-traditional segments, and, an unorganized, unbanked cash-based livestock economy, which is greater in size than the Large-Scale Manufacturing segment.

If fully subscribed, TOMC may boast one of the most solid financials within meat processing segment. Given a right mix of enabling environment and regulatory support, a brave new world is waiting ahead for growth firms such as TOMC.