Part 1
Lets think its around October 2012. One of our friends has told us about a company named Avanti Feeds Ltd.
So we start looking. Lets assume we had screener then and rest all is through annual reports.
Just to look or give a first glance:
Ohk its seems like something is changing in the company it is the rise in margins in phenomenal. Now it could be a temporary change or a permanent one? But this arises some interest in the company. This seems to be going on for two years consecutively.
Before going further lets remind our mind something, What are the Bayes odds of Turnarounds? ( Meaning What happens to most turnarounds generally? )
Majority of them fail or not turnaround. But the payoff of a turnaround is huge.
Before forming any opinion and lets start digging? What is happening?
1. Business Model
While reading the annual report of 2012 of the company which is very detailed, we realise the company is in the business of producing feeds for shrimps (Majorly exporting).
The company sells feed mainly for shrimps and Prawns.
The industry seems to be going for a change. Let’s see.
Farmers are converting from Black Tiger shrimps to Vannamei shrimp cultivation.
Before going further lets see, How is the past of the industry? Then we will try to judge whether it is relevant? What are the changes being introduced by the company?
Then finally we’ll consider the risks and see if its worthwhile to invest.
As of now, We will not study 2011-2012, as they are showing some changes in fundamental model, lets first understand the past of the industry.
Business Consumer:
Majorly the shrimps culture are exported from India to developed countries like USA, Japan, etc. Shrimp feed accounts for 70% of the cost of the culture. Farmers are majorly buyers of the products of the company. The company is the largest producer of feed for shrimps.
Let us try to understand the model more.
P&L Statement:
If we will study the gross margins of the company since 2003, it is quite clear that they are very fluctuating, the company is unable to pass on the cost to farmers. Like in 2003 gross margins were around 30%, 2005 – 33%, while in 2008 it was 26%, 2009 was heavily hit time with falling sales and falling gross margins – 25%.
If we look it at the net margins (EBIT) even in good times of 2003, they are very less of around 5.7%. This shows the competitive intensity in the industry is very high and its more of less commoditised, however lets look @ Balance Sheet.
Balance Sheet:
The business has almost similar or slightly more money tied up in working capital, when compared to fixed capital.
Fixed Capital: Company is easily able to generate 2.5-3 turns on the fixed capital, depending on which year you see.
Working Capital: 4-5 months of money is tied up in inventory while 1-2 months in net receivables (Recievable- creditors), depending on which time horizon you see.
This is quite expected as the business is dealing with farmers and feeds, it requires inventory and such money will be tied up in future too. With farmers the business seems, to have almost no bargaining power as a whole.
ROCE: Obviously lower fluctuating margins, and too much money tied up in working capital make it a poor play.
However, these all may not be relevant once we consider the changed growth prospects.
2. Growth Prospects
Thai Union Frozen Foods Limited, one of the largest shrimp exporters of Thailand, formed a joint venture with the company in 2009. The investment was made to cater the shrimp feed market. In 2011-12, the joint venture was consolidated with the company. Thai Union holds roughly 15% equity stake in the company. Land was finalised in Gujarat in 2009, to set up hatchery with Thai Union, however it seems the project didn’t go as planned. Its in 2012 that another land near Chennai is finalised.
Some positive from joint venture is that Thai Union seems to acquire additional board seats.
The company had even made an investment into a hatchery with a hatchery owner. However, it took four years for the company to materialise that plan. It was in 2012, when hatchery started supplying quality seeds. Further, the company has made certain investments in windmills, which are unrelated to the business.
Before going further, or forming any opinion lets look @ the balance sheet?
Two Things are noteworthy
1) Significant Increase in fixed assets. It means there is some investment. Let’s have a deeper look.
A) It is quite clear, that the company has doubled its capacity.
B) Sales has increased by 125%, mainly due to shift in farmers from Black Tiger shrimps to Vannamei shrimp cultivation
C) Further the company is expecting:
However, Lets not go with the company and look deeper further to confirm or disconfirm.
2) Another point of Significance in the Balance Sheet is too much money tied up in Investments. Let us investigate:
Around 17 crore, is kept as liquid cash, this may be kept by the company as the company is expanding to meet its cash needs.
Roughly 28-32 crore is tied in investments made in power plants. However, this does not seem to be made for self use.
Leverage: The company seems to have taken leverage, to finance the project and as it is being executed it has already started paying it down in 2012.
3. Risk
A) Government interference in the sector
B) Climatic conditions and some disease getting hit in the industry to the company.
C) Export Consignments being rejected
D) Competition eroding the margins expected to accrue
4. Management
As of now no big negative evidence against the management, however no significantly good one too for the management. It is too early to comment regarding the same. The company seems to be the market leader in its field.
Now before going into over analysis, Let’s look into the valuation:
Valuation
The TTM P/E of the company is around 5. The last 6 year CAGR in sales is around 26% (Source: Valuepickr Discussion) while Profit CAGR is around 76%. The market cap of the company is around 115-150 crore.
We need to take care that working capital needs remain similar and the management executes.
Now it all matter, if you believe, the growth of the company to continue at above 10-15% rates for the future with profits flowing to the shareholders, then at this P/E the company is super cheap.
However, if you think the growth was one-off, uncertainty regarding management and some competition creeping in despite joint venture with Thai Union then it does not make a good investment.
We feel, the growth is probable, the risk are less, considering the price.
However, well first allocate some less %age (Most turnarounds fail to turnaround-Bayes odds) and as the company performs we may increase or decrease our allocation accordingly.
This is the price chart:
Observations:
1) We may be wrong and you may have different opinions. However, we would love to hear why you may have did differently or thought some other way.
2) We may be suffering from hindsight bias (Means because we know the outcome we may be speaking)
3) We may be using the wrong thinking models.
4) We would love you to visit valuepickr.com, to see how people were thinking at that time. Please read discussion only till mainly October,2012.
What Happened?
We will distribute this section into 2 segments and discuss it only till July 2016. Sometimes going year by year while other times clubbing some years together.
(PLEASE CLICK ON PAGE 2 MENTIONED TOWARDS THE LOWER END OF THE POST TO SEE WHAT HAPPENED)
Argha Investment Advisers 