Investment Thesis – Part 1 – Introspeck

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Part 1 covers the industry map and company fundamentals.

Industry

Coffee happens to be one of the most traded agricultural commodities in the world. Global trade in coffee is prevalent since its one of the most addictive substances consumed, and while its consumed mostly in the developed world, its grown in temperate developing countries like Brazil, Vietnam, Cambodia, Mexico and Indonesia, thereby facilitating global trade. Following is a primer on various coffee types and instant coffee processes –

Type of Beans Arabica – Superior quality, mostly grows in LatAm Robusta – lower grade, mostly grown in Asia
Types of Coffees Ground and Roast, Instant Coffee (powdered or granules) and One Serve Capsules (made from both the above beans)
Instant Coffee Processes Spray Dried – Concentrated coffee is blown as a mist with hot air blowing from the opposite side to remove water. The resultant coffee particles are sold. Cheaper process but retains more flavour. Freeze Dried – Coffee Concentrate is frozen at high temperature after removing all water (without heat). This frozen concentrate is broken into slabs. Coffee retains more  flavour but the process is expensive too.

The global market for instant coffee is around 400,000 MT, of which Nestle commands around 35% market share, while Kraft Foods has a share of 15% (both totalling 50%). The remaining 50% i.e. 200,000 MT is the market spread across many players. Although this information is dated (2016), with the coffee markets growing at 2% every year, the numbers are still good enough to get the industry map in one’s head.

A lot of this non Nestle non Kraft market is private label – meaning sellers only package and brand coffee in a region while their manufacturing is outsourced. CCL Products Ltd., headquartered in Hyderabad, claims to be the world’s largest private label coffee manufacturer with an annual capacity of 35,000 MT spread in India and Vietnam. Of this capacity, 20,000 MT is spray dried capacity and 15,000 MT is freeze dried. A rough estimate based on industry numbers and company’s capacity works out to CCL’s market share being 10-12%.

Company Fundamentals

CCL Products is the second business started by Challa Rajendra Prasad, who built and sold Asian Coffee Ltd. to Tata Coffee back in 1990s.  Coffee processing requires only 2 raw materials – green coffee beans and water. The company imports almost 85% of its green coffee bean from African and SE Asian countries and greatly benefits from the 0% import duty by GoI on green coffee beans. Despite these low entry barriers with respect to capital or manufacturing, CCL Products is the only large non plantation owning independent instant coffee producer in India. Even the second biggest processor Tata Coffee, with its own plantations, has capacities of 13,400 MT pa vs. CCL’s 35,000 MT pa.

While nearly 95% of instant coffee is exported, the company also transfers the entire raw material risk to the customer, by purchasing the green coffee on the day when a sale order is executed, with the pricing dependent on prevailing green coffee bean price + company’s fixed processing margin. It helps here that coffee orders have long lead times with almost 70% of the next year’s orders being received in the current year. This helps the company to protect its margins despite the fluctuations in robusta coffee beans (the company does not deal in Arabica) and it does not need to have low return high risk plantations on its books –

Particulars 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sales 437 364 502 651 717 881 932 976 1,138 1,081 1,139
increase by   -17% 38% 30% 10% 23% 6% 5% 17% -5% 5%
Volume increase   29% 12% 3% 6% 42% 14%        
                       
EBITDA per kg 70 57 69 93 103 87 92        
                       
EBIT   47 45 67 93 114 144 176 199 205 214 239
increase by   -4% 47% 38% 23% 27% 22% 13% 3% 4% 12%
                       
EBIT Margin 10.8% 12.5% 13.3% 14.2% 15.9% 16.4% 18.9% 20.4% 18.0% 19.8% 21.0%
PAT Margins 6.5% 7.3% 7.2% 7.3% 9.0% 10.7% 13.1% 13.8% 13.0% 14.3% 14.6%
Asset Turns 0.9 0.7 0.9 1.0 1.0 1.2 1.2 1.2 1.0 0.8 0.8
Total Assets / NW 2.4 2.3 2.4 2.4 2.1 1.8 1.6 1.3 1.5 1.7 1.6
RoNW 14% 12% 15% 17% 18% 22% 24% 21% 20% 18% 18%
Source: screener.in

As can be seen from above –

  1. Despite the fluctuations is revenues, the margins have been on an increasing trend. This is on account of better utilizations and other value added initiatives (discussed in Part 2).
  2. Volume details, which are available only till 2016, show a steady EBITDA per kg trend.
  3. Revenue and profit growth in last 5 years has been declining as the company has now reached a scale where growing volumes by 4,000MT – 5,000 MT in order to bring back previous growth rates may not be possible.

These are very good fundamentals, when one considers the fact that there has been significant global overcapacity in the instant coffee manufacturing to the tune of almost 50% capacity lying idle.

The company attributes the following for its revenues and profitability –

Customer Relationships – CCL claims to have client relationships with coffee brand owners which goes back 20 -25 years, and the ease of supply, the consistency in quality and the competitive price given by CCL have strengthened these relationships over time. The company has also adopted the strategy of selling spray dried coffee at very low margins in order to attract a customer. Once the customer (coffee brand owner) is successful in his / her geography and starts introducing value added products like freeze dried coffee, CCL makes better margins too. It further helps that the company has a spectrum of coffees on offer.

Further, in many cases, a lot of CCLs customers are themselves manufacturers who add the coffee bought from CCL to their own produce to make a unique blend.

Proprietary Blends – CCL claims it can offer almost 200 blends that it has developed internally, the IP of which is not even shared with its customer. For initial 10-15 years, CCL only had 4-5 blends and its through increased R&D, have they been able to scale this up. This helps introduce some stickiness with the customer for whom consistency in flavour of instant coffee is important. I am quite vexed by this point – there is only one ingredient (coffee beans) and only one process (spray drying / freezing), so I am at a loss to understand how can so many blends be even created in the first place?

As per the company, once a particular blend is established in the market, it is very difficult for that supplier to change its blend. The supplier will reject coffee from CCL even if there is 5% change in the blend.

Cost competitiveness

The company can harness scale in manufacturing on account of the large capacities it has created over the years, and with Vietnam capacity on stream, its RM sourcing has been low cost too, with Vietnam plant located in Daklak province, the robusta capital of the world.

Part 2 covers company’s expansion forays, risks and open questions.



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Umang Shah
Through his writing, Umang shares his perspectives on how he thinks of investing, decision making, books and life in general.
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