Valuation in Motion: CCL Products (India) Valuation: Freshly Brewed Value

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Everyone loves coffee and not just in India. Coffee is loved globally and even today, it is one of the most sought-average hot beverage by a long margin. So, it’s not far-fetched to say that CCL Products (India) is in a sweet spot, operating in such a niche industry.


The Company

CCL Products (India), a 24-year old firm, is a private label coffee exporter having a repertoire in over 90 countries. In fact, it’s the largest private label instant coffee exporter in the world. The company produces several different types of coffee based on customers requirements, which in turn means that they have a decent amount of pricing power. Of course, growth in private label exports isn’t as rich as domestic retailing, which the company has been trying to crack for a short while now. Recently, there has also been a change in the top management, with the wise-and-experienced Mr. Challa Rajendra Prasad (The Executive Chairman) giving up the role of MD & CEO to his son, Mr. Challa Srishant. The company has skinny dipped in to the domestic retailing market in India, going toe-to-toe against the big boys like Nescafe and Bru. But that is not sucess story we will weave around CCL Products (India). In fact, at this point, it is not a story at all. This will be one of a steadily growing business with good margins, being handled by a new, younger business manager.

The Industry

For more almost half a decade, Italy had claimed exclusive knowledge on how to perfectly roast coffee beans in order to extract the most aroma from them. In reality, it wasn’t until the twenty first century that this illusion was broken by several private label coffee makers.

Nielsen has a research article on Private Labels in general (All industries combined), which gives us good insights into the minds of its customers:

Of course, if you want to understand the Private Labelling industry for Coffee in specific, refer to the articles by CarliniCoffee and CoffeeTalk.

The Numbers

For calculating the Beta and Indexed Returns, I have done something a little different this time around. I tried calculating a 5-year CAGR for the NIFTY 50, but because of the recent market turmoil, the figure came out to be in the low 10%+, which I personally think is misrepresented, especially since India’s T-Bill itself is at 8%+ or so. That is to say, the recent market turmoil has distorted this value. So, I choose to ignore 2018 altogether and go for a 4-year period estimation of both NIFTY 50’s CAGR and CCL Products (India)’s Beta. You can look at the calculations below:

The Capital Conversions

This is the part where we convert expended financial numbers into Capital. For instance, Advertisement Expenditure (At least, a part of it), usually serve the company for several years put together. Expending it in a single year would be wrong.

Advertisement Expenditure

In their latest Concall, Mr. Challa Srishant mentions that they’re planning for a Rs. 20 Crore Advertisement budget.

I would assume that at least half of that should be Capitalized. Using this piece of information, I calculated the proportionate levels of Advertisement Expenditure for 5 previous years. Then, these expenses were Capitalized accordingly.

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If you have a keen eye, you may notice that I usually Capitalize Research & Development Expenditure as well. But look what their Annual Report has to say regarding R&D:

I find this a little odd, but in the absence of any relevant information, I will ignore this.

Debt

CCL Products (India) has a considerable amount of Debt on its books, the latest D/E Ratio being almost 0.50 (Which is on the lower side, I know, but not something you’d expect to see on the books of a company operating in a niche space–maybe it’s not so niche after all, huh?)

Anyway, there’s not much to worry. Most of their debt is either secured or short term in nature:

It might interest you to know that a big chunk of their Debt is in the form of an External Commercial Borrowing (ECB). ECBs already come with several sets of benefits, so it begs the question of why the company felt the need to secure the ECB loan. But let’s not nitpick here.

So I have converted the remaining part of the loan and ended up with a Market Value of Debt of Rs, 453 Crores (As opposed to the Book Value of Debt of Rs. 390 Crores).

The Assumptions

Now we’ve arrived at the most engaging part of the exercise.

As it is usually with me, I will attempt to justify every input I have entered here:

High Growth Period

20 years, because CCL Products (India) operates in a niche space with only a handful of competition in each geography they operate in. In fact, entering new geographies will only further reinforce their Competitive Advantage.

Sales Growth

As admitted by the management itself, the business is facing headwinds. Here is what they had to say about Growth guidance:

So, we can put things together like this:

In the past, however, the management guidance hasn’t been accurate. There has always been some negative difference between the Guided and the actual Growth. So, I have been a little conservative here and used a lower figure for the first 5 Years: a little above around 8% or so. Eventually, I have assumed, that CCL Products (India) will be able to realize their full potential, growing at the Self Sustainable Growth Rate of 16% or so.

I usually assume the Terminal Growth for all companies I value in the 4-5% range (i.e. Half of the long term Risk-free Rate). However, since CCL Products (India) also has the option of venturing into Retailing in several countries (Including India), I have given it a Terminal Growth rate of 6.50%, a tad above the normal.

Operating Margin

Once again, the management itself has admitted that the sudden spike in Margins in the past few years has been due to the a sharp decrease in Raw Material prices.


You don’t have to take the management at its word though. In fact, I highly suggest that you don’t. You can verify things for yourself easily. Here is a chart showing the price history of Raw Coffee (CCL Products’ Raw Material) over the last decade:

So, instead of continuing the High 22%+ Margins, I am starting from the long-term average of 18%+ instead. I have also assumed that the Margins will slowly increase from there (Due to decent pricing power) and then settle on the Industry Average of 14.82% (Based on Prof. Aswath Damodaran’s ‘Useful Data Sets’).

Tax Rate

CCL Products (India) enjoys some Tax Benefits due to it being an Exporter. I have simply assumed that these Tax Benefits will vanish over time, closing in on India’s Corporate Tax Rate of 30% and later settle of the Global Average Tax Rate of 25%

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Capital Turnover

I have no malice towards Mr. Challa Srishant, but it’s only true that as a new management takes over, the productivity (The ability to generate incremental returns on invested capital) will take a temporary hit. I have done the same here, starting with the long term average Capital Turnover and growing it slowly at first and then a little faster, before settling down to normal levels.

Cost of Capital

The Cost of Capital has been determined based on the Capital Asset Pricing Model. Not much to discuss here. The average Cost of Capital for firms in India is around 13.50%, so it looks like the market views CCL Products (India) as a safer bet than most listed stocks.

Reinvestment Rate and Return on Capital

These two aren’t inputs in the Valuation, but you can see how the story of CCL Products evolves over time here:

  • Low reinvestment initially, because of the lack of growth opportunities, but slowly picking up.
  • Return on Invested Capital stunted at first (Due to the new management taking over), but slowly picking up to manageable levels.
  • Terminal Return on Invested Capital still above the Cost of Capital, indicating the existence of a Moat.

With the assumptions done, let’s move on.

The Diagnostics

No sign of trouble. Let’s move on.

The Cash Flows

This is how CCL Products (India)’s Cash Flows will evolve, based on our assumptions:

I guess our earlier statement of “This will be one of a steadily growing business with good margins, being handled by a new, younger business manager” is well supported by the steadily growing Cash Flows, without any surprises.

The Value

We are here, at last. Here is how I value CCL Products (India):

The Value I have calculated, Rs. 316, indicates a 17% undervaluation in the stock. So, clearly I think there is some value to be had in CCL Product (India)’s Equity. This may very well be due to fact that it is trading at the same levels as it was in 2015, returning little to nothing over the 3-year period. This kind of behavior of a stock is positively termed as a ‘Time Correction’ by market experts. But if you know me, I am not willing to settle for euphemisms. I will take statistics over hearsay any time.

The Sensitivity of Value

The Sensitivity of Value tool shows you different values for a stock based on varying Terminal Growth Rates and Terminal Cost of Capital:

The Monte Carlo Simulation

However, the true test of a company’s stock is a simulation across a range of parameters that go into its Value. It’s essentially compatible with the real world. Just because I assumed a X% growth, doesn’t mean that the actual growth would be that much. It would usually be a range of values. Every change in an input parameter will change the Value of the stock. So, I will attempt to stress-test the Value of CCL Products (India)’s Equity using the following range of assumptions:

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1. Sales Growth: Simulated between 5% (Recent Average) and 11.80% (Medium-term Average)

2. Operating Margins: Simulated between 11% (Lowest ever) and 23% (Highest ever)

3. Capital Turnover: Simulated between 0.92 (Lowest ever) and 1.43 (Highest ever)

4. Cost of Capital: Simulated between 10.44% (CAPM Cost of Capital based on 5-year Average Beta and Indexed Returns) and 11.40% (CAPM Cost of Capital based on 4-year Average Beta and Indexed Returns)

While these change, the underlying story will stay intact (For instance, regardless of whether the Capital Turnover starts at 0.92 or 1.43, the improvement in Capital Tunrover will stay the same i.e. Slow at first and then a little faster later).

Here’s how the initial output looks like:

A better way to interpret the above Normal Graph (“Histogram”) would be this way:

So, with everything said and done, it looks to me like at the current market price of Rs. 268, there’s a Probability of Undervaluation of around 67% and change. Is that enough? Only you can answer that question for yourself. I personally buy a stock only if there’s a 90-95% Probability of Undervaluation (Yours truly is a student in the Buffet-Graham School of Investments). This would place my Expected Purchase Price at Rs. 200-220 levels.

The Model

But yes, you do not have to agree with me at all. If you do disagree with me, by all means, download the model and change the inputs as you see fit:

If your Value differs drastically from mine, feel free to let me know in the comments below. We can have a healthy discussion over our difference of opinion.

Recently, I was watching a series of videos titled “Principles of Success: An Ultra Mini-series Adventure“, based on Ray Dalio‘s famous book “Principles“. In one of the videos, he notes:

Going from seeing things through just my eyes to seeing things through the eyes of these thoughtful people was like going from seeing things in black and white to seeing them in color. The world lit up. That’s when I realized that the best way to go through the jungle of life is with insightful people who see things differently from me.

It would be an understatement to say that I too believe the same. Humans are social animals. It would be extremely value-additive for us to discuss our differences in a productive manner. So dear reader, all I ask is that we do the same.



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Dinesh Sairam
Dinesh: Investor | Risk Consultant | Finance Geek | Writer @Quora | Blogger | Poet | MBA from XIME
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