‘You learn more about the business after you own it’. Couple of years ago during euphoria of KRBL being called as FMCG company valued at 30 times earnings, I bought the stock. Since then, I have learned a lot about the business so here are some of my findings. Btw, I made a very basic mistake for not keeping enough margin of safety and now am stuck at a high price. Irrespective of that, it doesn’t change my conclusion that this is a great business and could be a great investment at current prices as of 4/17/2020. I hope this posts gives you some insights into their business model. I have written a long post couple of years ago here so I wouldn’t repeat myself too much.
KRBL is the world’s biggest Basmati rice producer. Basmati Rice is the highest quality rice in the world and only 2 countries can produce it due to geographic patent received to India and Pakistan. It is recognized as highest quality rice globally due to its long grain, aroma and unique taste. KRBL commands 35% domestic and 33% of international market share due to its quality, aroma, strong distribution network, and ability to provide rice in the highest quantities.
Rice is a commodity business so the fluctuation in the yearly produce, raw material prices affect operating margins of the business. KRBL however, has made its name over the last 3 decades by providing highest quality rice, large distribution network and a strong brand presence. Sales growth is 12% over last decade and net profits have grown at 17%. Operating margins are above industry peers by large margin and have increased over time due to vertical integration of the business and value added products such as rice bran oil. Their tax rate was previously below 30% due to credits in energy business but has come down to normal levels of 30%.
From customer perspective, KRBL stands as a top quality rice – think of Apple iPhone. It has a strong distribution network domestically and presence in 84 countries around the world. Personally it doesn’t matter to me what brand of Basmati rice I buy but people have become quality conscious over the years. Moreover, countries like Iran and Saudi Arabia eat Basmati rice as a staple food. Thus, they have a strong demand year on year.
KRBL’s business model is not as easy as it looks from outside. The business requires strong acumen of commodity prices to procure and store the paddy, large distribution network, high working capital and strong balance sheet to sustain during tough times. KRBL hits home runs in all of the above. They start procuring paddy every year from October to March where they take short term debt. This debt is reduced close to zero by the following September every year at the back of strong demand.
At first, KRBL’s cash flow statement does not look attractive. The business has generated around 2,654 cr of net profits over last 10 years but only 932 cr have come out of the business. This makes the operating cash flow look very less or just 35% of net profits. However, one needs to deep dive to understand that management has been pouring almost 65% of their cash flow back into the business and generating ROIC north of 25%. Charlie Munger praises such kind of businesses which earn high returns on incremental capital.
Inventory has increased 2.6 times from 1208cr in FY2011 to 3129cr in FY2019 whereas Net Debt has increased 1.58 times from 888cr in FY2011 to 1402cr in FY2019. Net debt has not increased at the same rate as inventory. In fact it has remained quite stable since FY2014 with downward trend. Net D/E was as high as 2.01 in FY2008, which has been brought down to 0.51 recently. These debt levels are not worrisome as it becomes almost zero by month of September when sales are converted to cash to pay off short term debt.
Working Capital has increased from 329cr in FY2011 to 1851cr in FY2019. KRBL has invested almost 1522cr to its WC during this period while increasing Net Debt levels from ~900cr to 1400cr. So we can say that around 500cr of 1522cr investment in WC has been funded by external debt where as 1,000cr has been funded by internal accruals. If KRBL had not shared dividends (330 Cr total) over the years, it could have almost fully funded its WC requirement. Investors should be fine as long as this working capital is funded by internal accrual and not external debt.
The point is, working capital is growing because the underlying business is growing. While it may seem like a low FCF business for now but once the KRBL grows to the size of procuring 5,000-6,000 cr of inventory, think about the financial muscle a company would need to pull in order to compete with KRBL. If the company decides not to grow further, then it can easily fund its working capital needs, be debt free business for march balance sheet and throw lot of cash back to owners since it doesn’t need a lot of capex.
Fixed asset turnover ratio has been stable over last 10 years which is a good thing that company has been able to utilize the capacity of its plant efficiently. Current utilization of plants is about 50% with more room to grow for next few years. This will only add to the scale advantages of the business.
KRBL’s business model is quite sustainable given that Basmati rice will always be in demand. KRBL buys commodity and sell’s brand; think of see’s candies. KRBL generates strong ROCE of 13-14% overall and dgri business generates higher ROIC as shown below.
Renewable Energy Business –
KRBL ventured into renewable energy business in 2015 on the back drop of tax incentives and electricity demand in the country. The spent about 700 crore in 5 years and the business is consistently generating 125 crores annually. However, management has clarified not to increase investments in renewable energy sector since the tax credits are not applicable anymore.
KRBL is a family owned business and has a long history of expertise and experience which is very essential in this business. Promoter’s own 62% of the company and management compensation has been less than 1% of net profits which is a good thing .KRBL does not have any control over price of paddy but management has shown excellent track record of buying raw materials at lowest prices and selling them at higher margins. Look at year 2015 and 2019 inventory levels. Also keep in mind that management has to foresight next two years sales while procuring their inventory and margins increase in 2 years later for low cost paddy.
Recently, KRBL has been involved in few corporate governance issues. Following is a summary and my understanding of the story.
June 2018 – Gautam Khaitan who use to be an independent director of KRBL from 2007 to 2013, was accused for money laundering in Augustawestland scam. Enforcement director arrested the suspect. KRBL was further accused for laundering proceeds from the scam. KRBL management denied these claims here
At the same time, Mohnish Pabrai had bought the stock at INR 550-560 and the block deal was being sold by Abdullah Ali Balsharaf who has been KRBL investor and distributor since 2003. ED accused this deal illegal by claiming that funds related with Augusta Westland case were used and stopped the transaction. Fast forward 8 months, Delhi high court gave a verdict in KRBL’s favor saying ED can not stop such transactions and allowed selling party to sue the ED for the same. Source: here Furthermore, Investor Ali Balsharaf sued ED in a separate case for stopping the transaction. source – here
Feb 2019 – Income tax department accused KRBL of not showing additional income of INR 2,220 CR in return of cash paid to the famers for procuring paddy. They levied a penalty of income tax worth INR 1,200 CR. KRBL denied the case and one year later the case favored into KRBL’s court with barely 100 crore of tax liability which management thinks will go away in span of a year. See here
July 2019 – The ED didn’t stop here, they accused KRBL with a connection in 2008 embraer deal case on property worth 15 crore. ED couldn’t provide proof of their claims and property has been returned back to KRBL for regular operations.
Overall, I believe KRBL’s management has shown integrity through out their operations. None of these claims in past 2 years were able to materialize while management has picked up shares worth 38 crore at low prices which shows the conviction for the company.
KRBL has a strong brand which commands pricing power and sustained margins that are higher than rest of the industry. They have a strong balance sheet strength and expert management makes efficient utilization of funds. Its hard to compete in such a high working capital business which is why rest of the competitors are struggling under debt, KRBL has been able to fund most of their operations through internal cash accrual as stated earlier. KRBL also enjoys economies of scale due to its size.
KRBL’s moat widens as they grow their size. This is because the demand for branded Basmati has been growing consistently and will keep growing on the back of export as well as domestic demand but no other player has or it will be very difficult to have the financial muscle to procure more than 3000 cr of inventory and command higher operating margins. The key to this achievement is management’s experience and business acumen.
There is no moat for switching costs, one can certainly buy cheaper Basmati rice however, it gets difficult to survive through the cyclical nature of the business. Small companies can take on more debt when the demand comes but get in trouble when demand drops. KRBL due to its brand and strong balance sheet is able to grab market share, provide for higher demand and can sustain themselves through tough times.
Here’s a latest video by management speaking about Covid-19 impact. As we know that Iran has been heavily impacted, their provision for rice procurement has reduced. Management mentioned that FY 2020 wont be impacted but next year I expect revenues to be down by 30% at least. Management stated that they currently have 2900 crore of inventory and only 400 crore debt so they do not have liquidity problems. They should be fine even with just 60-70% of sales next year. I expect profits to be reduced by 30-35% in FY 21
KRBL has large dependency on middle east countries such as Iran and Saudi Arabia with almost 50% of export revenue. If these countries get into economic crisis/war then there will be risk for KRBL’s business. While management has been prudent in their capital allocation, high working capital is a risk for the business. In case they take on more debt than necessary and the demand drops, it can affect their business. KRBL”s margins are also dependent on paddy prices which is dependent on monsoon every year.
KRBL has annual operating expenses of 300 crore with current inventory levels of 3,000 crore which can be sold in a year. With just 400 crore debt, they will have enough cash to run the lights even if the demand decreases by 30-40%.
KRBL’s rice miling utilization is currently at 60% of its capacity and management has mentioned to stick with Basmati business moving forward. Their annual depreciation range at 50 crore today and annual maintenance capex for last 3 years have been less than 50 crore which I expect to grow to 100 crore in next 10 years. As stated earlier, it is important to note that additional working capital that is being put back into the business is essentially a part of owner’s earnings. This WC is to grow the business. Thus, my owner’s earnings are 5 year’s avg cash from operations minus annual maintenance capex plus depreciation plus additional working capital reinvested into the business.
Lets look at KRBL ‘s valuation from different approaches.
Approach 1 – DCF calculation for owner’s earnings is 5 year avg CFO (210 cr) + incremental WC in the form of inventory (240cr) – maintenance capex (50cr) + depreciation(50 cr) = 450 cr. Also, I am assuming 30% profit reduction in FY 2021, then back to normal sales and 10% growth from there on first 5 years and 8% for last 3 years at 10% discount rate. I get value of Mkt cap of 6700 crore or 295 rs per share. Currently the business is providing 25-30% margin of safety for price around 220 rs a share.
Approach 2 – Use owner’s earnings mentioned above and value the company per Mohnish pabrai’s valuation process described in dhandho investor with similar assumptions as DCF except selling the business at 12 times 10th year’s owner’s earnings. It gives a price of 286 rs a share.
Approach 3 – Currently KRBL has 400 crore of debt and 2900 crore of inventory per latest management interview dated April 16th They decide to cut down the debt and not grow anymore. In couple of years, it should allow KRBL to fund its working capital entirely by its reserves which would generate almost 500 crore of net profits and 450 crore of free cash flows. If you discount this back at 10% like a bond KRBL is still worth around 4000 crore or 186 rs a share. Remember this is assuming KRBL will not grow anymore. This scenario gives us good margin of safety to buy the business at current valuation.
Overall, I think KRBL has very sustainable moat on the back of growing demand for Branded basmati domestically and internationally and current valuations provide enough margin of safety.
Final Thoughts –
I would be very comfortable to own this business at current valuations for a long time assuming management doesn’t change and they keep using their cash accrual to fund the business rather than relying on debt. One of the questions on my checklist is if I will be able to put 25% of my net worth into this business, my answer is yes at the price between 150 – 200 rs a share, I will be willing to bet on this business for a long time.
Few Helpful references