Investment Thesis – Part 2 – Introspeck

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Part 1 covered the Industry Map and the fundamentals of the company wherein we established the market dynamics and above average fundamentals of CCL. Here we will look at the expansion forays, risks and open questions.

Expansion Forays

Along with above, CCL Products has taken several expansion measures over the years to move up the coffee value chain –

  1. Expansion in Vietnam – CCL commenced coffee processing operations in Vietnam in April 2013. The reasons for choosing Vietnam were – a. low cost coffee bean sourcing, b. proximity to end markets of China, Korea and Japan, c. reduced or zero duty structures with these countries on account of MFN (most favoured nations) treaties with Vietnam, and d. Tax breaks. With healthy orders and revenue pick up, Vietnam revenues have seen a decent mark up and its operations today are more profitable than India’s on account of tax breaks –
(in INR Crores) 2014 2015 2016 2017 2018 2019 2020
Revenues 102 196 244 264 297 261 267
increase   92% 25% 8% 13% -12% 2%
% of Total 14% 22% 26% 27% 26% 24% 23%
               
PAT -5   22   44   45   56   66   58
PAT Margins -4% 11% 18% 17% 19% 25% 22%

Vietnam has not only had impressive growth but is also more profitable with 22% PAT margins vs. India margins of 15%.

2. Value added initiatives – Agglomeration and Small Packs – Agglomeration is the process in which instant coffee powder is converted into granules to have resemblance to ground coffee. The company has been adding agglomeration capacities in India, Vietnam and Switzerland in order to achieve higher realizations, and only forward integrating to some extent. Although the Switzerland facility was in losses till 2017, it is now breaking even, while the other granulation facilities have good utilizations.

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In its quest to further add value, CCL also started selling instant coffee in small pack form (as low as 1kg) due to which the brand owner can directly buy from CCL without going through a reseller, while it also improves realization on a weight basis by more than 5%. The response has been very good for CCL with almost 15% of the portfolio now sold as small packs.

3. Retail Domestic Foray – Having failed once in 1990s, CCL initiated presence into domestic market in 2014 for sale of retail coffee – both B2B to hotels, canteen stores and supermarkets, and also through the brands ‘Continental’ and ‘Malgudi’ through retail channels. Unlike B2B, this is a different ball game altogether for CCL since this industry is effectively a duopoly with Nescafe (Pure coffee) by Nestle and Bru (Coffee + Chicory) by HUL, with Tata Coffee also ramping up its presence. However, the EBITDA margins here are double than the B2B business.

Despite the capital base available to it, the company has been slow in scaling up Continental Coffee, starting with Andhra Pradesh (20% of India’s coffee market), then covering 5 southern states (75%-80% of market) and now starting to sell in other locations. India is dominantly tea drinking and coffee has been rapidly growing (12-13%) on account of lifestyle changes and import of western ideas. The company also finds itself in a sweet spot as it can reduce the pricing of tea and coffee on a per cup basis (INR 5 vs. INR 10), and has an advantage in selling freeze dried coffee which attracts a 300% import duty. Below are the financials of the domestic operations –

(in INR Crores) 2017 2018 2019 2020
Revenues 3 24 49 77
increase   755% 108% 57%
% of Total 0% 3% 6% 8%
         
PAT -4 -6 -6 -3
PAT Margins -134% -25% -12% -5%

Despite its current losses, the domestic foray makes a lot of sense as per me, since it already has 1. A low manufacturing base. 2. Learnings from its previous foray. 3. Slowing growth in legacy B2B business and 4. Possibly one of the only companies apart from Tata Coffee that can break the duopoly.

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4. Foray in USA – CCL still has a small presence in United States, the largest instant coffee market globally (80,000 MT) which is currently dominated by Brazilian and Mexican producers. Its surprising that CCL cites poor hygiene standards as one of the reasons why it cannot compete on price with Brazilian and Mexican producers who engage in rampant adulteration (despite harvesting the more expensive Arabica variety). As the quality standards improve, CCL is confident of making inroads in US market too, which already accounts for 20% (less than 5,000 MT annualised) of its exports as per Q1 FY21.

Risks

So far, the narrative has been phenomenal and the numbers too have been holding up, simply because of so much of what has been going on comes from the management. With the second largest competitor Olam International being an agri conglomerate and Tata Coffee having integrated operations, I have been unable to compare CCL margins with any other company. Further, on analysing the data put out by Coffee Board of India, there are some differences in company’s claims –

Particulars 2012 2013 2014 2015 2016 2017 2018 2019
Export of Coffee                
Volume                
Instant GBE MT 83,383 89,258  85,096  95,266  91,795 103,432 115,764 112,045
Total Coffee GBE 324,841 302,657 301,476 275,390 310,204 345,948 391,796 353,576
Inst. As a % of total 26% 29% 28% 35% 30% 30% 30% 32%
Value (in INR lakhs)                
Instant GBE MT       164,979 161,917 176,543 188,461 198,094
Total       490,610 505,970 547,747 615,924 581,460
Realization – lakh/ton                
Instant GBE MT       1.7 1.8 1.7 1.6 1.8
Total Coffee GBE       1.8 1.6 1.6 1.6 1.6
Exports by CCL                
Volume 26,122    34,905  35,030    36,871  43,346  40,467
Instant Coffee Eq. (2.6) 10,047  –    13,425  13,473   –    14,181  16,671  15,564
Value 38,764    54,628  56,148    64,946  73,634  78,740
                 
Real – lakh/ton   1.5   1.6 1.6   1.8 1.7 1.9
                 
CCLs Vol. Market Share 31%   41% 37%   36% 37% 36%
CCLs Value Market Share       34%   37% 39% 40%
  1. The above table highlights total instant coffee exports out of India compared with the overall coffee exports. It can be observed that out of total instant coffee exports, CCLs instant coffee volume and value shares are around 1/3rd of the total market. So who are the remaining coffee exporters?
  2. This is surprising considering CCL is the only large processor I found in whole of India. So who else is exporting instant coffee out of India?
  3. Further, while CCL sells value added coffee, its realisations are not very different than the overall coffee realizations (1.9L / MT vs. 1.6L / MT in 2019)
  4. While its current capacity in India is 25,000 MT, its exporting 15,500 MT, with significant head room for growth (matches with company’s utilization)
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CCL has been vocal about this data in past and stopped giving internal volume numbers citing – “Lastly we would also like to touch upon one point which we have been receiving enquiries on over the last few weeks that is regarding the Coffee Board of India data pertaining to direct exports which comes on their website. We would like to clarify that this data does not include third party sales. This data is based on fixed green coffee conversion ratio and this information is not conclusive to draw assumptions upon the volumes of the company. As everyone is well aware we manufacture more than 200 blends of coffee including certified coffee. Therefore relying solely on the Coffee Board data is only likely to create more confusion. Thank you.”

With CCL dismissive about Coffee Board data, we, as investors, are in a lurch. Despite such a long thesis, I have been really struggling to identify the company specific risks and have yet not understood the competitive advantage in detail. I do not understand the role of relationships and blends and the great returns the company has been able to earn on account of the same. Its been a great wealth compounder over many years, and yet I am unable to grasp the softer nuances of the coffee processing business, so I’ll leave with open questions, and not have a valuation.

Open Questions:

  1. With the company only working with Robusta beans as raw material, how can it have 200 different blends?
  2. Despite significant overcapacity, how has the company been able to scale its capacities so rapidly?
  3. What would be the contribution of the top 5 customers to company’s revenues?
  4. Is there a significant churn in CCLs customers?

phew! if you have any queries or can add to our collective understanding, feel free to write to me (co ordinates in About Page). Hope this was helpful!

Happy Investing!



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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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