Healthcare Global Enterprises Ltd.- Data is God- Updates on stake sale in Strand Life

Click here for last year post on HCG

Today HCG has sold its stake in Strand life to Reliance Industries. HCG had 38.4% stake in Strand and it has sold it for Rs. 158 cr. Reliance is paying Rs. 550 cr for 80% stake in Strand. I always liked the work being done by Strand in Genomics, Genetics and diagnosis and I was thinking that HCG would sell their IVF business (Milann brand) and use the same for increasing their stake in Strand. But looks like the focus has changed after the arrival of a new majority shareholder in the form of CVC and they want to focus only on Cancer care. I have no problems with them selling strand but I also want them to exit this IVF business.

But they have done one good thing while selling stake in Strand- strand has hospital Labs and Clinical research business and HCG has bought the same from Strand as a part of the deal for 81 cr (setting off 7 cr against receivables so net outflow is 74 cr). In my last year article on HCG I have mentioned this clinical research business. I think due to inherent strength of HCG in cancer care and their huge database of cancer patients they can do great in clinical research in India. If someone wants to do research for cancer treatment/diagnosis in India then they need the genetic and cancer related data of Indian patients only and that’s where HCG can contribute big. Acquisition of Hospital labs will help HCG to grow its diagnostics business.

So after paying for Labs and clinical research businesses it has got 83 cr cash which is good as they are focusing on paying off debt and expansion also which requires funds. I like businesses when they take tough decisions and this stake sale is a tough decision by them. But I think they don’t have any other choice- Strand was a research heavy business and only recently they started focusing on growing their revenues. But they are still making losses and require regular capital inflows which I think is something that HCG cannot do right now as they are trying to generate capital for expanding their cancer care business and reducing debt. HCG needs to cut its debt but they can't take their eyes of the business expansion because India is still having massive unmet cancer care needs. So they need to be extremely careful in capital allocation.  Hence in these circumstances this looks like a wise decision and I like their single minded focus on growing their cancer care business in India.

In last 2 years, we have picked three healthcare stocks as our healthcare Trinity- Max healthcare (click here for article on Max Healthcare), Narayana Hrudayalaya (Click here for article on NH) and HCG. Max Healthcare has already been almost a 10 bagger for us (adjusted for demerger) while NH and HCG are a double right now but I always have a feeling that HCG may outperform all in the next 2-3 years as their expansions of last 2-3 years are going to bear fruits in the near future. So HCG at 240 is still looking good.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post.  Reach me at oscillationss@yahoo.in)

Growth in a Finite World

These days I get a lot of queries on whether the stock market is overheated and is going to have a crash. I think people are expecting a crash since Sep-2020 but we have been investing regularly and never stopped. This strong journey has taken many by surprise as market is not seemed to be in any sort of negative mood. Every fall witnesses strong buying afterwards. I see reports about the linking of USD, Bonds, Oil, Gold, Interest rates/yield curve, FED policy, inflation etc. with the stock market and all try to conclude the coming crash (sometimes jump) of the market. In this crowd of variables; one can conclude anything and these days they are forecasting a crash. Many times, I ask these people what drives the base interest rate and there is no confident answer except some murmurs about inflation rate but I see them shouting on the top of their voice about yield curve and coming market crash.

But Stocks, Dollar, Oil, Gold, Bonds etc. don’t derive majority of their valuations from their inter-relationships. Most of the time and most of their valuation is impacted by their individual demand supply dynamics not the demand supply dynamics of other counterparts. Like, most of the valuation of the Bonds is impacted by its own demand supply dynamics rather than money from stock market entering bond market. Most of the money circulating in Bond market is meant for Bond market only and same is true for the stock market. Overlapping part is very less and shifting takes place mainly for short time. Like for example, the prices of Onions are settled based on its own supply demand dynamics. I call this price as Base price which is based on its own supply demand dynamics. Now suppose there is a big shortage of Tomatoes so people will shift some demand from tomatoes to onions and this will raise the price of onions over and above the base price. But the individual base price of the onion will still comprise the majority of the total price and for the purpose of long term decision making (like fresh cropping) the price impact due to tomatoes is not relevant and should not be considered.

Like for Interest rates, I always say that above everything, money is first a commodity...a commodity for enabling trade and exchange. Unlike other commodities like Onions money is not capable of satisfying any needs/desires directly by direct consumption as its primary function is to enable exchange. So in case I don’t need any commodity or service in exchange of my money I would keep the spare money with me. But other people needing money for the exchange of goods/services they don’t have create the demand for this spare money available within the economy and this demand of money as debt creates a price for the money in the form of interest rates. In case there is no demand for money as debt then we would in fact be required to pay some charges for keeping the money safe in banks etc. (regardless of whether inflation rate is high or low). So Interest rate is not the "cost of money" as is always said but a “price” which is a function of demand supply dynamics of money. So just like an onion, every asset has its own very individual base price upon which further layer (or layers) of price comes due to overlapping part (temporary shifting of money from one asset class to another).

So most important factor for interest rate is demand supply dynamics of money itself. Inflation is not the primary motivation behind interest rate. Inflation does impact the interest rate but it is not responsible for the establishment of base interest rate. Inflation can impact the portion of interest rate over and above the base rate. In my view, base rate is a function of opportunity cost of the money but base rate just takes the clue for the "Price" from the opportunity cost. Opportunity cost is not the reason for the emergence of the price (int rate) because price emerges due to its own demand supply dynamics. So Gold or real estate can play that role (opportunity cost). Somehow I feel that the corporate earnings and stock market returns are more relevant opportunity cost for interest rates for a fairly stable and strong economy. But inflation is not the opportunity cost of the money. There may be a situation where inflation is high but there may not be much demand for money from businesses or individuals as they mayn’t want to take risks for new investments etc. Hence even with higher inflation the rate of interest will still be low. Just consider the current issue of short supply of semiconductors which has raised the prices of cars worldwide (second hand cars also). So is it possible to reduce the resultant inflation by rising rate of interest? No, not at all. In fact, I think the solution is quite the opposite- Governments need to give low interest loans to corporates to build new capacities for semiconductor manufacturing. So in real life, economics principles are very different. 

Once one analyst told me that market would fall as interest rate was rising (money would shift from stocks to bonds). But I asked him why Interest rate was rising at first. Interest rate rise is not some isolated individual act of God like heavy rain which can cause floods and loss of crop. But the rise is a reaction to a number of events. Interest rate may rise- Due to rising demand for loans by corporates as they are investing big or due to risk of loan defaults by most of the corporates due to economy shuffle or earlier mis-allocation of credit (like happened in India in Infrastructure few years back). Stocks will fall in the later situation while in the former more money will come both to stock as well as Bond market. This more money will either come from other assets class or new money will be created by banks.

So every commodity or asset class has its own demand supply dynamics. Similarly, stock market also has its own demand supply dynamics and it is the earnings growth/future earnings growth (GDP growth) potential that drives the demand (base) for equities. And the issue is- how growth happens? And the bigger issue is that current GDP calculations are not more than a crude proxy for the real growth. Growth is much more comprehensive and multi-dimensional and much bigger phenomenon than summation of total income produced in a given period (GDP).

Here I remember one interesting book “The Limits to Growth” which was published in 1972 by a group of thinkers called “The club of Rome”. The book was an attempt to forecast the outcome of massive scale consumption of earth’s resources by humanity and the capacity of Earth to withstand such consumption as our Earth is a “Finite sphere” with a limited supply of resources like minerals. The club worked out a model based on five basic variables affecting the resources of Mother Earth industrialization, population, food, use of resources, and pollution. They modeled data up to 1970, and then developed a range of scenarios out to 2100, depending on whether humanity could took serious action on environmental and resource issues. If that didn’t happen, the model predicted “overshoot and collapse” – in the economy, environment and population – before 2070.

Their main point was Earth being Finite has limited capacity to provide resources for the huge growing population. Hence our quest for unlimited growth by over-production and over-consumption of resources will eventually lead to a crash. But we never grow only by over-consumption and it is the emergence of new innovative technologies which bring more growth. As we can see much of our growth in the last century was mainly related to “Invention of New and Substitute technologies” like the invention of Aircrafts and transportation technology which made possible the exchange of goods/services across the globe, telephone and then Mobile phones, Computers and then softwares. Their model was not well accepted as Population, capital and pollution all grew exponentially in all their models, but technologies for expanding resources and controlling pollution were permitted to grow very marginally.

But I feel their model has one very valid hidden (implied) statement- that unless we create and discover newer, innovative, clean and efficient technologies we can’t afford to grow by consuming the finite resources of the earth as one day they will be obsolete. And good thing about technology is that they have INFINITE possibilities and potentials. Technology does not create linear growth opportunities but even a small innovation can bring massive growth and revolutionize the existence of entire humanity. Here, I remember one such small innovation-Elevator. It was a very small technological breakthrough but just imagine the world without it. Real estate sector’s massive growth has been possible only because of elevators so as of mining sector. Elevators have made it possible to construct massive vertical buildings resulting in the most efficient use of available land. Just imagine the cost of land and houses in the absence of elevators as we could have only made 3-4 storey buildings not 50 storey now.

So technology is transformative beyond imagination. Technological innovations can create new products/services classes, can result in more efficient use of existing resources, and can create new resources. Another massive but less talk about transformative impact is on the even distribution of income and resources. This distribution pattern of production and wealth is the biggest limitation of our current GDP calculation measures as they don’t (can’t) take into account the decline in the “value” of marginal production when it flows only to a few people (unequal distribution of income). Right now, we are at that stage of our evolution that only technology can create next leg of growth and save the humanity from pollution and destruction. I find it funny to see words like “sustainable growth” because unsustainable growth is not growth but short term exploitation of resources and we count this short term exploitation of resources as production (extracting coal is production but the resultant destruction of forests and water resources is not “deducted” from the value of production) is the biggest mistake ever committed by humanity (of course after Religion). I call this like having a “Profit & loss account without a Balance sheet”.

And right now, we are witnessing a period of major technical innovations which will result in the next long leg of growth and luckily it appears that this time the growth will also extend and save the humanity and this earth also. This growth is going to be led by clean technologies in the form of solar, wind and Hydrogen power. These are going to transform the current energy dynamics across the globe and will also solve the existential threat in the form of pollution. These clean technologies will result in the even distribution of resources (energy) because wind and solar are evenly distributed among nations as compared to oil which is concentrated only to a few countries which has made many countries poor as they are dependent upon costly imports for their energy needs. But this clean energy is more democratic and this will change the distribution of wealth also. Just imagine the scale of income generation in India if our energy needs are satisfied in house from wind/solar/hydrogen rather than costly imports. It also means that India can’t afford to lag behind in this race of clean technologies and we need to up the ante for developing these in house.

After clean technologies, there is a massive growth in communication technologies in the form of 4G/5G and space tech and these new age communication tech is going to create the next industrial revolution. 5G is going to reduce the latency to just 2 milliseconds which means that networks will almost be latency free and information will be exchanged between devices in real time. New age communication technologies will result in the growth of IOT, factory automation, autonomous vehicles, augmented reality, remote healthcare etc. New age communication technologies, automation and AI are also going to bring next revolution in agriculture which is hampered by the negative impacts of 3^rd agriculture revolution in the form of chemical fertilizers. Then we have genetic engineering revolution which is developing higher yielding and disease-resistant crops. Similarly Genomics and Genetic engineering is going to transform our healthcare.

So we are now at a very critical juncture in the journey of humanity and earth and our actions are going to be critical. Good thing is- Humanity is looking good for most of the part…people are surprisingly more aware and conscious about everything which is negative and inflicting damage. World has taken a good start in the form of huge growth in clean technologies and this is going to be the norm for the coming decade. So we are going to witness a period of growth which has the capability to bring comprehensive prosperity across the globe and it appears that market is aware of this high growth phase and this is why we are seeing continuous rise in the stock market and looks like it is not going to witness any major correction.

India in particular has done some major policy reforms which are going to result in high growth in manufacturing in India which was the major pain point for India. Agriculture as of now is not capable of transforming India into another leg of high growth as it is hampered by political, technological, economics (small size) and supply chain issues. But this Void is also an opportunity and recent start of policy reforms is a good step. India’s focus on policy support in the form of PLI schemes and Make in India for local manufacturing of electronics goods, medical devices and chemicals is going to result in high growth in GDP even at the same consumption levels because the money will be spent in india not on imports. This will also create demand for new investments and incremental job growth. The focus on growing Ethanol production is also going to create the same impact of high growth in GDP even at the same consumption levels also raising the income levels of farmers which is the long targeted objective of the Government but which has taken a quite a bit of time (of course due to politics).

So the time is to be optimistic about the growth potential and India is also in a very sweet spot. Clean energy technologies and new age communications technologies are going to lead the next leg of growth.

( Reach me at oscillationss@yahoo.in)

  

Heritage Foods Ltd: Worthy Portfolio Candidate

Stock Idea: Heritage Foods Ltd

CMP: 410

Heritage Foods is a Hyderabad based dairy company operating predominately in AP, Telangana, Karnataka, Tamil Nadu but off late expanding in Maharashtra, New Delhi, Haryana and Punjab.  Its topline is 2473 Cr and NP of 148 cr in Fy-2020-21. At CMP of 410 it is trading at 12 PE whereas Dodla dairy which was listed two days back is trading at a PE of 25. In the IPO analysis reports from brokers, they were surprisingly comparing the PE of Dodla to Parag milk who is trading at a PE ratio of 32 but whose business is very different from Dodla as Parag is predominately a Value added dairy player(70%-75%). They have not compared the valuation of Dodla with Heritage foods (12 PE) which is also a southern India player with almost similar business model (fresh Milk heavy). The size, margin and net profit profiles of Dodla and heritage are almost the same though i think Heritage has a better brand recall and higher share of Value added products (VAP) (30-33% vs 25% of Dodla). I am yet to do a detailed analysis of both Heritage and Dodla...this note is just a compilation of my preliminary study.

The margins in fresh milk business are low but the ROCE is high due to lower capital requirements if the firm can manage working capital issues. But for Value added products like Ice cream, Ghee, Curd, Milk shakes etc. margins are high but ROE is lower until the firm reaches a critical large scale of operations to drive the economies of scale because the shelf life of these products is much longer requiring investments in working capital and then capital investments in the form of plant and machinery is also high. But brand connection in the form of fresh milk drives the sale of VAP as customer who are using fresh milk brand are more likely to use the VAP of the same brands. The higher investments by Heritage in assets shows the under-utilization of VAP capacity and margin profile as of now of VAP must have been quite weak but the same will improve once the economies of scale kicks in. Working capital days in case of Heritage are 11 which is one of the best in the industry (Dodla also has similar levels). Heritage is the second biggest private sector dairy player after Hatsun and they have done well in building long standing relationships with farmers amid tough competition from milk co-operatives.

Last year due to covid, farm gate milk prices were low so dairy companies earned much higher profits which may not happen in the future although though milk prices are still low this year. But I am more interested in the growth of value added products which in the case of heritage is going good and they have very strong brand recall. Heritage belongs to Chandrababu Naidu (Former CM of AP) so this political link forced me to wait for the last 3-4 years. Current Jagan govt  tried hard to prove some foul play at Heritage growth but nothing came to materialize and Heritage is growing strength by strength even when Naidu is not in power. So this has made me to have a relook. They are paying good dividends and i have a feeling that they are the most liberal here and after Hatsun they have the best books. They have grown the share of VAP to some 33% last year. FY-21 there was low share of VAP due to covid as the sale of VAP products like Ice cream was hit hard. But this year the same will grow fast and Heritage is quite aggressive in the branding and distribution. So I feel that at 12 PE Heritage is trading cheap and rerating may be fast.

Heritage is also into cattle feed business with turnover of 120 cr and NP of 7 cr. Its topline has doubled in the last 4-5 years and it is a fantastic fit for them as they can use their milk procurement supply chain to sell these products to farmers. It is all about relationships in Indian Dairy. Here farmer is the producer and the relationship with the farmer in the form of milk sourcing tie up acts as a big entry barrier. It is very costly to run a dairy farm in India due to high land prices etc. That's why global giants couldn't do well in India as their global model of having large farm houses will not work in India. So the milk supply chain is a high entry barrier business.

Also, Heritage has almost paid the entire debt of some 260 cr last year (35 cr now). So this will save interest cost of around 20 cr which means its effective PE is just 10. With cash balance growing in the future we can expect more liberal dividends and some good acquisitions. keeping in view that it is yet to grow its VAP share to a meaningful levels, volatility in fresh milk margins, still some sort of political overhang please treat this one as risky business. Tier 3 Investment as of now.

(This study is a business analysis of Heritage Foods ltd.  Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post.  Reach me at oscillationss@yahoo.in)

UTI AMC: Significant Re-rating Candidate

Stock Idea: UTI AMC

Grade: TIER 2

(This business study of UTI AMC is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. The sample of Jan-21 edition was shared at this blog on 28th Jan, 2021.)

UTI AMC is a melodrama but the drama started with the debacle of US-64 fund of UTI in early 2000 forced Indian government to split UTI in 2003 into UTI Asset Management and Special Undertaking Unit Trust of India (SUUTI, having the junk/illiquid assets of UTI). First melody was tried with the likes of SBI, PNB, LIC and BOB acquiring 25% stake in the troubled (reputation) UTI AMC bringing in 500 cr.

Things were going fine but it still had the trauma of US-64 and then in 2009 these 4 decided to sell 26% stake to the US investment giant T Rowe Price who manages more than $1 trillion globally for $ 140 million (Rs. 650 cr). I think this was done to do some image makeover by bringing in global giant as largest investor as this would make people to have trust in UTI as global giant was picking a stake. This was a good move or we can say a perfect move. But these 4 could not leave the greed to manage one of the biggest AMC in India (holding some 10% (4^th biggest) share of Indian market at that time, now 6% share and 8^th biggest). They continued to interfere in the working of UTI along with government who wanted to dominate and control the board of UTI which was just the opposite of what had been promised to TR Price that UTI AMC would be a professional firm.

On the contrary except PNB, the rest three were having their own AMC businesses and they owned 18.5% stake each which clearly was a case of conflict of interests. After the initial stage, these 4 were not interested in running the UTI. In fact, LIC and SBI who were having relatively very small AMC business even tried to acquire the stake of others to control and merge UTI AMC with their own AMC business. It was without the head for two years and so could not introduce new schemes because SEBI rules do not allow a new fund offer without the approval from the head of a fund house. Even around 2018 TR Price took these four gentlemen to court. As the three gentlemen (except PNB) were running their own AMC businesses so they were not that much focused on growing UTI AMC as they were  having just 18.25% share in UTI so their only attempt was to merge it with their wholly owned AMC business.

The association of these three investors (LIC, SBI, BOB) having their own AMCs with UTI was a clear case of conflict of interests which was badly hurting the growth of UTI which was losing market share continuously (SBI now is the biggest AMC in India). So things were terrible for the growth perspective although the schemes of UTI AMC were doing well and they have done well in last 20 years. But then amid this tussle over controlling UTI; SEBI happened as a blessing. In 2018, SEBI in order to control the conflict of interests made a regulation that a sponsor of a mutual fund, its associates, group company and its AMC cannot hold 10 per cent or more stake in a rival AMC. They also can’t have a representation on the board of another mutual fund house. This regulation forced these three investors to sell their stake in the recent IPO and brought the same to 10%.

In the recent IPO, TR Price and PNB also sold 3% of their stake bring down their stake to 23% and 15%. So this is a significant event in the journey of UTI and in my view this is going to change the fate of this company.

In all research reports, I have seen issues related to high employee cost and high operating expenses eating out the profit margins so these reports conclude that UTI deserves lower valuation due to these issues impacting profitability and they declare it is working just like a PSU. But its historical ROE was around 16% and it is around this level in Dec-20 and Nippon is also having the similar ROE. HDFC is having high ROE of 31% but this is due to the fact that HDFC can distribute its funds from its vast banking channel at much lower costs and at a much bigger scale. Bank brand name also helps. Same has happened with SBI with highest market share although it is also a PSU. Also, low dividend payout and large cash in the books is one of the reasons for lower ROE for UTI and recently it has approved dividend policy for much higher dividends (50% of profits) so this will improve the ROE. Dividend payout ratio of UTI was around 20%-30% while the likes of Nippon and HDFC have much higher dividend payout ratios (80% and 50% respectively). Even due to growing net worth the ROE of HDFC has also fallen from 40% in 2018 to 36% in 2020.

Further, banks distributing schemes of AMCs related to their group are a clear conflict of interest as banks are forcing their group mutual funds on the customer rather than really giving honest advice and in this process they are earning huge commissions from the group AMCs. But I think SEBI is going to tighten the things more here in the near future. Direct schemes (Online sale without any intermediary) are gaining momentum as current investors are well informed and they don’t need to go to some selfish intermediaries for deciding their choice of fund as they can do the research on their own in this digital age. So things are going to change in the fund distribution very fast. Already direct channel has grown to 50% share from some 30% 2-3 years back. In today’s world, investors can find the information related to consistent fund performers like UTI against others and they can take independent decisions so due to this there is a possibility of smaller funds growing faster than the other big brands. Like, UTI is one of the best performer in the retirement solutions (pension funds) and its funds under this are growing faster. Its retirement benefit pension fund is the largest in its category.

I was looking for the performance evaluation of UTI AMC schemes and luckily I found the recent report from CITI which has very detailed data and I found the same in their report saving much of my time. UTI schemes have done much better. In last one year, UTI Equity schemes have outperformed the benchmark index in 63% of their schemes. The same figure is 10% and 30% for HDFC and Nippon. Axis is the leader with 78%. The equity schemes of HDFC are performing badly and it is losing market share (at 13.6% from 15.8% last year Dec-19). Its stock price is also doing badly with negative returns in last one year. Actually people do not realize that AMC is a knowledge based business and skills of managers matter the most rather than their costs. UTI has higher employee costs as it got large number of employees from the erstwhile UTI in 2003 split and management is working on it to reduce it. In next 5 years the retiring employees will reduce some 80-90 cr payout.

But if it has legacy issues then it has some high growth catalysts also. First, most of these problems were related to past and already happened in time and space and current board run management is working to resolve these issues. Second, UTI AMC has strong distribution strength in Tier 3 cities (B30) having the largest share. Future growth in the AMC/Mutual fund industry will be driven by these small cities. These cities have higher focus on equity schemes where charges are higher than debt funds so UTI can earn higher than other due to its strong presence in these cities. But for me the most important event is the coming possible restructuring in the ownership of UTI. I don’t think the likes of LIC/SBI/BOB have any scope left to acquire it or mismanage it. In fact, they have sold their stakes in UTI Trustee Company to TR Price in line with their stake sale in AMC business. A Mutual fund trust holds assets of the fund on behalf of investors and monitor performance and compliance with regulations.

So trustees have significant control over the working of an AMC due to regulatory powers. After the stake sale by these three; now TR Price holds 51% stake in Trustee Company which enables it to indirectly control the operations at AMC also. TR Price is a global giant and is waiting patiently for the things to turn good in India as India is the next high growth market. It has waited 11 years for the things to take shape in india which shows its commitments to India. So my feeling is that very soon something is going to happen in UTI AMC shareholding. It may be that these four may sell their stake (or part) making TR price the majority holder running the show. TR Price can channelize huge funds from its US business to India for investment through UTI.

UTI AMC has big business in PMS where it manages the funds of Employees Provident Fund Organization (EPFO), Postal Life Insurance (PLI), National Skill Development Fund (NSDF) etc. UTI manages the largest share of the funds of EPFO. SBI is the second AMC who manages the funds of EPFO. Earlier it was only SBI who was managing the funds of EPFO but it was performing very badly (not being able to beat the bank FD rates). I think the likes of EPFO may opt for an independent AMC like UTI rather than corporate owned AMC like HDFC AMC where there is a clear case of conflict of interest as they may be biased in their EPFO fund investment strategies.

Summary of Analysis levels Involved in the study of UTI AMC:

1. Level 1 (Lower relative valuation) – Low valuation (18 PE and 2.4 times book value) keeping in view the established brand, expertise, market share. Underlying performance metrics are not that weak as compared to other two listed players. It is more the result of market perception.

2. Level 2 ( Industry level growth and restructuring)- Mutual fund industry will grow fast in India as people are getting aware of the financial assets and planning for the same quite early.

3. Level 3 (Forecasting of management decisions which may result in massive future growth and value unlocking) – However, the most value will come from the actions of the management in shedding the Government control, PSU work culture and becoming more professional, TR Price acquiring majority shareholdings or some other private player coming by acquiring the share of other PSU investors. 

This one is a Tier 2 grade stock as of now but once it implements dividend policy distributing liberal dividends, management becoming more independent and professional in approach and any stake sale by 4 PSU shareholders this will be transformed into Tier 1 quite fast and aggressively. 

(This study is a business analysis of UTI AMC. Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. This business study of UTI AMC is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. For subscribing to the monthly Newsletter reach at oscillationss@yahoo.in).

 

Newsletter Club of this Blog

Dear all, Off late receiving many queries regarding lesser stock ideas/studies being posted at this Blog in the last 5-6 months. Actually as I have shared earlier, we have started a monthly newsletter of this Blog in Sep-2020 and most of the stock analysis reports and ideas are being shared with the Newsletter club. The main focus of the Newsletter is on the education and learning part related to equity research covering financial and fundamental analysis. In case anybody wants to join the club please send an email at oscillationss@yahoo.in giving brief introduction. I am sharing the names of some of the stock ideas shared with the Club since Sep-2020:

Apart from the above stocks, we are investing in many other promising stories. Also, we continue to buy many of our old stock picks whose studies have been shared at this blog like HCG, MCX, Godrej Agrovet, Zydus wellness, ABFRL etc. while many of the stocks advised in the last one year have performed well hence we are not adding them anymore like Tata power, Borosil Renewable, Laurus Labs, BEL,BEML etc. I am also receiving regular requests for sharing the performance of all the stocks shared at this blog in the last 4-5 years and the future course of action for these stocks. I have started the work on the same and will share the same very soon. 

Thanks very much for your support.

Tata Coffee Ltd: The Arabica has Matured with Intense Flavors

Grade: TIER 1

(This business study of Tata coffee Ltd is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. The sample of Jan-21 edition was shared at this blog on 28th Jan, 2021.)

Coffee: A global Drink

1) Coffee truly is a global drink and a global commodity. However there are disputes related to this being second most traded commodity after oil. Many argue that this is not the case as agro commodities like Wheat or rice are having much bigger trade value. But I think, Coffee may be a big trade commodity if we take into account only the international trades as other agro commodities like wheat or rice are mostly traded in the production country and international trade may be much lower than the total production. Even on standalone basis the value of international trade (exports) is significant at USD 30 billion.

Coffee generally is of two types-Arabica and Robusta. Arabica is of premium quality with half of caffeine levels as compared to Robusta. So it has much deeper, smoother and sweeter taste with notes of chocolate and hints of other fruits flavor. So Arabica has much higher and intense flavors. Robusta is much stronger in taste with almost twice the caffeine levels. So due to higher caffeine levels, it is much bitter and harsher in taste with notes of grains. Robusta is much easier to cultivate, has almost double the yield and less prone to insect attacks (due to high caffeine) so all these factors makes it to cost lower. But Arabica beans are sold at double the price. The instant powdered coffee we find in all the retail stores is all robusta coffee. In order to drive up the profits, producers are using more and more of robusta coffee whether it is instant coffee or a coffee retail chain.

Across the globe, Arabica accounts for some 75% production share while Robusta is 25% share. Brazil leads the globe with Arabica production (70% of its total coffee production) while Vietnam is the leader in Robusta (95% of its total coffee production). The global coffee production data is as follows:

2) Europe accounts for some 35% consumption with nil production. Europe and North/South America account for some 65% of total global coffee consumption. Europe and USA are fairly stable in coffee demand so now it is India and China which are the new coffee hot spots. India’s coffee consumption is concentrated to southern India but off late with the growth in coffee retail chains like CCD and Starbucks a strong coffee culture is happening in India which is going to enter their houses also. With the availability of premium coffee beans and electric roasters and coffee makers the home consumption is going to increase significantly in India.

As of now, India exports around 70% of its production of 3 lac-3.5 lac MT. Karnataka accounts for 85% of Indian production while the rest comes from Kerala. So with rising consumption in India, India has sufficient local production to cater to the demand. And now the trend is clearly towards coffee consumption in India and this will grow much faster than tea. In fact I feel we may see coffee plantations growing up in India even in the Himalayas where the black pepper plantations may bend towards coffee. So i think slowly more and more Indians are moving towards coffee. I like it when in movies and TV Shows they show actors holding a large coffee mug (though may be empty) because this is subtle marketing and it hits the cords more effectively...though i am not sure whether it is deliberate or not but if it is not then i think coffee marketing companies should think over this seriously.

3 Coffee beans (though Coffee beans are not really “beans” but seeds of the fruit of the coffee tree) are just like any other agriculture commodity with limited pricing power but when we move up the value chain the dynamics of this industry changes to one with premium pricing power with premium brands like that of Starbucks or Cafe Coffee Day (CCD). So the value proposition changes relevant to the type of producer like a plantation company is prone to boom and bust cycles of all commodities and Coffee is not an exception. Right now, coffee industry is witnessing bust cycle and prices are trending lower.

In last 10 years or so, the cost of inputs for coffee production has increased by some 250% however the prices have been increased only by 175% so there is a clear over supply of coffee beans in the global market. But coffee production is not that easy to start and stop. Unlike other commercial crops like Wheat/rice where crops are planted every year the plantations like Tea, Coffee etc. take much longer time to start producing and in the subsequent years it is not beneficial to stop production as massive investments have been made in the initial unproductive years.

It takes four to five years for a coffee tree to start producing coffee fruits, while the land on which it grows will produce fruit for about 25 years. Hence apart from routine inputs in the form of fertilizers maximum annual costs are in the form of labour only.

The likes of Starbucks and other retail chains brought a revolution in coffee drinking habits of the people and this spurred the demand for coffee across the globe especially in Europe and USA and more and more farmers started cultivating coffee as prices were at life time highs. This started in Mid 90’s and culminated around 2007-08 and since then global supply has outpaced demand by fair margin putting pressure on the prices.

In the last 4-5 years, Brazil and Vietnam are producing more and more coffee even when international coffee beans prices are lower. In fact, in dollar terms the cost of producing beans is higher than the prices but still the poor farmers of Brazil and Vietnam are being able to support even with these lower prices is only due to the fall in currencies of these countries to Dollar. Fall in currency has enabled these farmers to earn something more than their cost of production. However, Brazil is mainly responsible for this supply glut in the global markets.

As Brazil produces massive 35% of the global production (25% of global export market), so it is the main force behind the rise and fall of global coffee prices. No other country has this much power in controlling the coffee prices. Here, Brazilian currency Real has major impact because Real is falling as compared to USD every day and this is making Brazil coffee suppliers to sell more and more coffee even at lower prices in Dollar terms because they are getting more Real for every ton of coffee sold in international markets. The exchange rate of USD to Real was 1.68 Reals in 2011 but the same now is 5.3 reals!!! More than 3 times fall. The weak real is putting more pressure on the global coffee prices.

4) So even when coffee prices are ruling at 13 year ($1 per pound) low Brazil farmers were still able to extract something but the situation is grim across the world for coffee producers. Coffee producers across the globe are abandoning their coffee farms or turning to other crops like Cocoa in Colombia which is the supplier of world’s best quality coffees. So sooner or later coffee production is going to come down and this will raise the prices to more reasonable levels.

But I feel there is another crisis which may come with current situation. The countries where coffee farmers are abandoning their farms are some of the best quality coffee producers like Colombia, Guatemala, Kenya which means this will reduce the supply of premium quality Arabica coffee and this may result in very high prices for premium coffees and very low prices for Robusta coffees.

But still, even now people can create the demand for premium quality coffee as prices are low. Low quality coffee does not make people to consume more coffee but a cup of premium Arabica coffee can make people to consume 3 cups in place of 1 cup of coffee and this may create or raise the demand for premium coffee which is not within our reach mainly because of low quality instant coffee used by most people so far. They are no aware of the fine taste of a premium coffee.

Amid all this mayhem in global markets, India is facing shortfall in its coffee production due to pest attacks, climate issues. But this year is going to be good for Indian coffee production and production will be higher. Also, Global coffee beans prices has firmed up recently due to harvesting and supply chain issues faced by farmers across the globe due to covid restrictions. So I think we may be near the end of bust cycle of coffee and prices may start firming up from now on as supply is going to shrink especially for premium Arabica coffee the prices may go up much higher. So this year should be good for Indian Coffee plantation industry including Tata Coffee Ltd.

5) But things are different for instant coffee or retail coffee chain branded players like Nestle, Bru or Starbucks. As for these retailers, the low prices of coffee beans are good as the prices of their end product are driven by suppliers not by consumers as demand is stable at current price. This is because they are not selling a homogenous commodity but a branded product with distinct attributes, quality and taste so producers are price settlers.

Tata coffee Ltd: Indian Coffee story

Tata coffee is India’s largest coffee producer. Indian coffee production is mainly about small farmers holding small land holdings and instances of large corporate producers like Tata coffee are very few. Tata coffee deals in coffee in all combinations- it has plantation business producing raw coffee beans, it has instant coffee production capacities, It has retail presence in USA through Eight O’ clock coffee brand, sells instant coffee in India under “Tata coffee Grand” band, it supplies roasted coffee beans to all Starbucks chains in India, it has also developed Indian coffee blend for Starbucks chains across the globe.

 

Tata coffee owns around 8000 hectares (around 20000 acre) of Coffee plantations in southern India. If we take Rs. 4-5 lac price per acre then the valuation of these coffee plantations will be around 800-1000 cr. However, normally prices for Coffee estates are in the range of Rs. 10 lac to Rs. 20 lac per acre especially in tourism heavy areas like Coorg where Tata coffee owns around 11000 acres and this will make the valuations anywhere near 2000 cr to 3000 cr!!! And we are still left with 2400 hectares (6000 acres) of tea estates. Recently Tata Coffee was looking to acquire 12000 hectares of coffee plantations owned by troubled Café Coffee Day for Rs. 1200-1500 cr (while CCD is asking for some 2000 cr) which supports our calculation of minimum 1000 cr value for coffee plantations. Tata coffee has entered into partnership with group hospitality company Indian Hotels for managing its coffee heritage resorts for hospitality business. This also have the potential for a good business going forward and this will further establish the valuation of its coffee plantations.

Its recent expansion (invested some 400 cr for new Instant coffee plant) in Vietnam has started performing this year and mainly due to operation of its Vietnam plant  its PAT for the first half is Rs. 59 cr vs 47 cr even during covid crisis which is an indication towards things to come in the near future.

Merger with Tata Consumer to unlock big Value and Synergy for Both

Tata coffee has 50.08% holding in Eight O'Clock Coffee (ECL) which is a famous American retail coffee brand (Arabica roast and ground coffee) dates back to 1859. Before Vietnam plant, ECL was accounting for 60% of the total turnover- 1120 cr out of 1966 cr in 2019-20. ECL’s net profit in 2019-20 was 117 cr but due to its 50% share only 58 cr accrue to Tata coffee. But after Vietnam plant, NP will grow much faster as the same is 100% subsidiary of TCL. Its NP for the first half this year is 59 cr and I think the same may touch 150 cr this year.

CCL Products India Ltd. (Market value 3200 cr, PE 20) is another listed coffee player but it is more of a wholesale producing instant coffee and does not own plantations but still its valuation is same as of TCL. But I think both can’t be compared- Tata coffee also has large Instant coffee business but it has much higher brand strength in both B2B and B2C. In B2C it has a great brand in Eight O’clock coffee which is growing fast in USA now so it should be valued as an FMCG brand. In 2006, Tatas paid $ 220m (Rs. 1000 cr as per 2006 exchange rates and 1600 cr as per current exchange rates for ECL acquisition. Tata coffee contributed 50% of the amount ($110m). At that time, ECL was having revenues of $110m and the same right now is around $160m so as we can see not that much high growth by ECL. And this may be one of the reasons for the underperformance of Tata coffee because biggest revenue contributor was not growing that much. But ECL once was top coffee brand in USA and Tatas are now working on revamping the brand and supply chain and this should show the impact pretty soon.

I have not done its valuation exercise comprehensively but 50% stake should value around 1500 cr Rs. (at 20-25 PE). 1500 cr value for 50% stake in ECL is still at the lower end as it would make for just 2 times returns for Tata coffee in ECL in last 14 years. US is still and will be the biggest coffee market globally (70% consumption at home which augurs well for ECL) and that’s why ECL is critical to Tata group and they are restructuring its business in USA and this year the growth is good in ECL and looks like the strategy is working. Total Income of Eight O'Clock Coffee Company for the Six months ended September 30, 2020 was USD 87 .81 Million compared to USD 76.48 Million for the corresponding Six months of the previous year. Further, I think as demand for premium coffee will rise in India for home consumption there is a possibility that Tata may introduce ECL in Indian market. And I feel Tata should make the first move rather than waiting for other brands like Nestle. Recently, many brands have started offering premium coffee beans in India for home consumption like Blue Tokai which are witnessing high demand. Though Tata Coffee has also introduced their single estate coffee brand “Sonnet” but still I feel ECL is an established brand and have time tasted blends for USA market and these blends should do well in India markets with some tweaking for Indian tastes (though I think there is nothing like Indian taste in Indian coffee as of now). ECL can benefit from vast supply chain and distribution reach of Tata consumer which is way bigger than ECL in USA.

Balance 50% holding in ECL is with Tata consumer which is also the holding company of Tata coffee (57% holding) and that’s why I feel Tata coffee may be merged with Tata consumer and at that time there will be value unlocking for plantations of more than 25000 acre (coffee and Tea) which are not valued much in the current valuation but for merger they should get the valuation of around 1000 cr.

Tata consumer is already doing the distribution and marketing for “Tata coffee Grand” brand owned by Tata coffee Ltd. Tata group is on a great value accretive restructuring path simplifying ownership, supply chain and management structure and there is no reason for Tata consumer to leave Tata coffee alone when they have already restructured the FMCG brands of Tata chemicals.

Tata Starbucks- Emerging Giant of Indian retail coffee

Tata coffee is the exclusive supplier of coffee beans to Tata-Starbucks (50:50 JV) in India and has also started supplying the same for their global business and this is going to make a mark for Indian coffee blends in the global market just like Indian single malt whiskies by Amrut/Paul John/Rampur. Tata Coffee has revamped its plantations into 8000 micro grids to cater to the premium beans requirements of Starbucks. Growth of Starbucks in India means growth for Tata coffee. It is for the first time in the history of Starbucks that they are procuring coffee from the roasting facility owned by its partner. This shows the expertise of Tata coffee in producing premium quality coffee. This localization also saves the costs for Tata-Starbucks as they are not required to import costly coffee. Coffee drinking in India is moving beyond south Indian states and coffee retail brands are going to see big growth in the future and Starbucks should be the leader of the pack. Tata-Starbucks turnover last year was 540 cr and it is already profitable and Starbucks is very aggressive about Indian market growth.

Indian coffee market is still in its infancy just like China. Just like India, China was a country of tea drinkers. But Starbucks happened to china in 1999. Starbucks has succeeded in blending coffee culture into Chinese culture and it has done the same by relentless attention on details in creating Starbucks a place where Chinese people love to enjoy best coffee, sit, relax and enjoy with their friends. Starbucks has focused on integrating local customs and designs in its cafes. Starbucks were aware of the growing middle class in China and its powerful impact on demand and need for new recreational places. Coffee is a western drink but young Chinese considers coffee culture sophisticated and to influence. It is normal for people in China these days to have business meetings and even job interviews at Starbucks. So with great execution, Starbucks has been successful in creating its cafes as place to go after home and office. The same thing happened in Japan which was another tea drinking nation and now a big coffee nation with Starbucks having more than 1000 stores. Starbucks is having some 4400 stores in China, the largest outside USA and it is betting big on China as next big market after USA. Its China revenues are around 6000-7000 cr which are only going to grow bigger in the next 2-3 years as Starbucks is looking to double the store count.

So India is going to follow the footsteps of Japan and China in adopting the coffee culture and Tata coffee as a supplier of premium coffee beans will be one of the major beneficiary of this shift. Starbucks has worked out a great marketing strategy for Chinese market and developed and created products keeping in view the Chinese tastes. Chinese are much more serious about their culture and family value and social status. So Starbucks did some great marketing there- No aggressive Coffee promotions to avoid being treated as a threat to their tea-culture, blended Coffee culture with tea culture initially, engaging annual family programs etc. Starbucks is a giant success in creating great and innovative coffee products and it is doing this for decades. Starbucks had partnered with local partners for China market in order to address the complexity of massive china market. The same thing it has done for Indian market which is going to as massive as China and after a lot of search it partnered with India’s most trusted and iconic brand Tata. The selection of Tata itself shows the brand strength, trust and customer loyalty it has in Indian market. If you ask any Value investor- China was not a market where Starbucks could achieve any sort of success but with their superior executing skills they have made it their biggest outside USA and may one day even bigger than USA. So I have no doubts that they will do the same in Indian market also.

As of now, Tata-Starbucks operates 200 stores in India across 13 cities. Tata’s stake is owned by Tata consumer product ltd (TCPL) and as of now they have invested around 300 cr in the JV.

But if you ask me the creation of a coffee culture by Starbucks in India will have multi-dimensional impact on coffee demand in India not just for retail chains of Starbucks but also for home consumption and Tata coffee is going to be the major beneficiary here also as it is focusing on developing premium Coffee products for Indian markets. Recently it has launched premium single estate retail coffee brand “Sonnet” which is available online.

Tata Coffee being an integrated coffee player is going to be a major beneficiary of coffee industry growth in India as it can restructure its product offerings as per the requirements of the market like it can shift the export of its premium quality coffee beans to meet the higher demand of Starbucks outlets in the future. For any premium coffee retail brand like Starbucks the supply of uniform premium quality beans is the foremost requirement and Tata coffee can maintain this supply through premium coffee produced in its coffee plantations.

Troubled Cafe Coffee day- An opportunity for Tatas to acquire assets and Relative strength

Troubled Cafe Coffee Day enterprise is looking to sell various assets/businesses to pay off the debt. Promoter family is also selling their assets to reduce the debt at promoter level. Tatas are interested in their Coffee plantations spanning 12000 hectares and Coffee vending machine business. Talks were at advanced stage and are taking time due to issues related to valuations and some creditors asking for more. I think we will see something on this very soon... may be within a month or so. Tata coffee and Tata consumer will do anything to acquire these assets. The acquisition of coffee plantations will make Tata coffee a substantial player in Indian coffee beans market and it will be an integrated coffee player- all the way from plantations to retail sale and coffee chains.

Some analyst friends have questioned this asset heavy approach but I think owned plantations are a key to ensure and control the coffee bean quality and Tata coffee is eyeing premium-ness in its products now. India is going to witness a coffee culture at home and out of home and this will create massive demand for quality coffee beans and that’s why having its own plantations will ensure the supply without any worry of the beans prices. Now, Tata coffee wants to be established as a premium brand. Brand strength and loyalty in B2B is more strong and relationships like supplier of Starbucks are tough to create and are long lasting (Just check the valuation of recent IPO of Mrs Bectors).

Tata coffee was in restructuring mode for last 5-6 years and the stock has not performed at all during this period. It is still available at 2014 valuations. So it has gone nowhere. I think as of now, market has valued it as some sort of plantation company but the share of plantation business and its impact on NP has come down to great extent in the last 4-5 years and now it is more of coffee product company so its re-rating catalyst are just nearing now and it may get the re-rating quite fast just like the same has happened in many tata group stocks- Tata consumer, Tata Motors, Tata communications, Tata chemicals and Tata power (we hold all).

I think things are nicely shaped for Tata coffee to witness a high growth phase and at a valuation of 2000 cr I think market is not valuing its various businesses adequately.

Summary of Analysis levels Involved in the study of Tata coffee:

1. Level 1 (Lower relative valuation) - Current stock price is not reflecting the value of its coffee and tea plantations, value of its overseas subsidiary Eight O’clock Coffee.

2. Level 2 ( Industry level growth and restructuring)- Tata coffee is going to see massive growth in its premium coffee beans and instant coffee business due to growth of coffee demand in India both for home consumption and Coffee retail chains.

3. Level 3 (Forecasting of management decisions which may result in massive future growth and value unlocking) - (a) Merger of Tata coffee with Tata consumer products Ltd (b) Acquisition of Coffee plantation assets of CCD.

(This study is a business analysis of Tata Coffee Ltd. Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. This business study of Tata coffee Ltd is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. For subscribing to the monthly Newsletter reach at oscillationss@yahoo.in).

Redington India Ltd: Imperfection is not Incompleteness

 Stock Idea: Redington India.

(This business study of Redington India Ltd is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. The sample of Jan-21 edition was shared at this blog on 28th Jan, 2021)

Stock: Redington India Ltd		Financial Performance (Fig in Cr)
Description	(Amt)	Description	Up to Dec-20	FY-2019-20
CMP (On 28.01.2021)	135	Sales (Inc other income)	41500	51500
Market Value	5240	Net Profit	483	534
PE Ratio (Annualized)	7	Cash	3100	2368
Net worth (Sep-2020)	4500	Purchases-Stock in Trade	39200	48600
Dividend Yield	3.00%	Purchases/Sales	94%	94%
		Debt	827	2537

More than the perfection of the market (stock market), it is its imperfection which is more beneficial and attractive. I usually say this and someone questioned me why more value in negativity. But I told him that Imperfection is not incompleteness...negativity...deficit as is generally taken. It is not the absence of creativity and skill but closeness to these. Perfection lies with the Almighty. When we move into a garden...there is no perfect order...leaves are scattered all over...not perfect but it is not incompleteness or disorder or chaos because the garden looks beautiful...in fact this imperfection makes it look more beautiful. Perfection may not be that perfect from the perspective of enjoying or living. So the market is imperfect because it is its basic nature and it is beautiful, lively and creative only because it is imperfect. As they say-Best is the enemy of the Good and this is not more relevant elsewhere than in the stock market.

So perfect stocks are those picked imperfect and amid imperfection. Redington I feel is one of the best fit in this category- It has done perfect to improve its business, margins and balance sheet but as of now lying in a corner ignored and so at low valuation due to market imperfection but it is a great investment opportunity only because of this imperfection.

Redington India is a global IT products distribution giant just behind Ingram Micro. It is an investor owned, Board managed and professionally run company as promoters have exited by selling their entire stake. At present, Synnex group which is a global giant in IT product distribution is having 24.2% stake, Affirma capital 15.8% (an arm of Standard chartered PE), MF 11.5% and FIIs/FPIs having 3.3% stake in it. Its turnover is massive Rs. 51500 cr with 40% business coming from India but India is going to be their fastest market. Its top 5 vendors are-Apple, Dell, HP, Samsung and Lenovo. Distribution is a high volume low margin business which makes it one of the toughest business with high entry barriers as it is very tough to create large scale supply chain, managing inventory of countless products, offering credit/financing to promote growth, long term relationships with suppliers and vendors, logistics, market making, technical support. And amid all this complexity they have to keep an eye on working capital management so as to ensure a reasonable level of margins (ROE). In distribution business, working capital is the plant and machinery and so the success and viability of distribution depends upon how well they manage this as higher levels of inventory and debtors blocks huge amount of capital straining returns and growth. 

This year they have improved their working capital massively and generated large free cash flows as their working capital days have been improved to 14 days from 38 days last year. But this was due to significant collections due to covid and so this will stay around 30 days which is the normal practice in industry of giving credit period of 1 month. I remember this figure was in high 60-70 days some 3-4 years back so they have done massive improvements in their working capital. Working capital is like plant and machinery for a distributor. In 9 months this year they have improved EBITDA by 11% in spite of the Covid lockdowns across the globe and generated Free cash flows of staggering 2761 cr (this will cool down to some extent next year). Its ROE stands around 17% but I think this will see huge jump this year and very soon we will see this touching 25%.

But in spite of making massive improvements in working capital management in last 3-4 years it is still trading at low PE of 7-8 while Ingram Micro is trading at 25-30 PE during this period. Somehow, I feel market is not being able to value and understand its high entry barrier business because it requires huge resources and planning for building this gigantic supply chain in low margin distribution business.

Distribution business is very tough as they have to establish their relevancy in the present era of cost cutting where some product channels see them as not adding any value to the product chain. But it is not….distribution is a very complex function, needing huge resources for keeping inventory, giving credit to resellers, market knowledge, providing after sales servicing and training etc. Just imagine how big resources Producers would need to block in these activities if not for distributors like Redington. Distributors earn their bits by achieving efficiency in the supply chain and economy of scale. Distributors like Ingram Micro and Redington, in order to fight another war of relevancy, have entered into the distribution of Cloud computing business. Earlier some suppliers were doubtful but then they see the value addition and now most of the cloud computing suppliers are having distributors. Redington is distributing the cloud products of Microsoft in India.

Distribution is one of the most important functions in the entire value chain of a product from production to final consumption. And when we talk about value chain then it implies that distribution function adds “value” to the product. How? Distributors adds value in the form of creating market for the product, bulk procurement and redistribution, financing, inventory management and logistics, after sales services, knowledge of the local markets etc. Distribution is inherent in the entire value chain because the function like financing, storing large quantities, market creations etc. are very important in order for a product to get demanded and sold. People think that the likes of Flipkart, Amazon will eliminate the distributors but they are wrong because then they will become the distributors itself because somebody has to perform these distribution and marketing functions so if Amazon holds the inventory, provide credit, ensure delivery then they are playing the role of distributors. If they are not doing then it is sure that either the producers themselves or someone else is doing this function. Retailers keep small quantities of many products from different producers so they need the services of distributors to procure these small quantities whenever they need.

Producers want and need to focus on the designing, innovation, production and branding functions and these require a lot of capital. So blocking further capital in the distribution channel will be very risky for them as they can only afford to take that much risk hence they need the services of distributors in placing and managing the product and supply chain. So distribution needs large investments and lack of proper distribution strategy can make or break a product in the tough market conditions. Apart from the need for big investments, one can gauge the value addition by distribution function on its own from the fact that if retailers or consumers try to arrange for self-procurements of goods from producers then this will render them very costly…in fact unaffordable. So Distributors has independent value addition in the form of lowering the cost of product and that’s why new disruptions like ecommerce will in most optimistic case will only transform (not eliminate) the distribution function and may result in cost savings and better efficiency. In traditional product distribution, distributors with their immense value addition result in the creation/enabling of a transaction which without them could not have been possible (Like without distributors a new product can’t be sold to customers as who will create the awareness of the product by market making).

Take the case of Cloud computing where people were expecting the death of IT distributors. But as I have said distribution is inherent in the entire supply chain of a product from production to the final sale to the ultimate consumer. When internet came many expected the death of middlemen as they felt the producers would sell directly to consumers but the result was the emergence of much bigger Distributors/Retailers in the form of Amazon/Alibaba. Cloud computing has in fact widened the market of IT products as many small firms can now afford costly IT systems which earlier were too expensive for them. But reaching these millions of new firms who are prospective clients of cloud computing need the support from IT distributors like Ingram/Redington in the form of financing, technical support, market making, logistics etc. These distributors have long term relationships with these firms and they can impact or motivate them to look at Cloud computing as a low cost option for their IT system requirements because in the end Cloud providers are competing with many other similar vendors so they need the help of these “market gurus” and as they can rely upon the expertise of these distributors so they can focus on their core work which is offering new services/products under cloud.

Redington’s third party logistic business “proconnect” is growing very fast. Proconnect is having one of the biggest logistic capacities in India with 155 warehouses covering 6.7 m Sq feet. In 2015, it was getting some 70% revenue from Redington but now the same is just 13%. Total revenue is around 500 cr and the same is growing fast and this one is going to be a big contributor in the future growth and valuation of Redington.

Some Critical Events and Decisions to put Redington into High Growth

But apart from low valuation in high growth sector, there are some other very critical factors which can catapult this one into another high growth orbit and that is the coming growth of local electronics goods manufacturing in India. Indian Govt. is promoting the local manufacturing by offering Production linked Incentive (PLI) schemes. Indian Govt has launched a Rs. 50000 cr production-linked incentive (PLI) scheme to boost the electronics goods manufacturing in India. Global giants like Samsung, Nokia, Foxconn, Wistron etc. are already going to ramp up their Indian manufacturing to benefit from the PLI scheme. I think local manufacturing will increase the demand for its services big time and this is going to be a big catalyst event for it. Second, I feel as Redington has good cash reserves so time is ripe for it to do some good acquisition in technology space or logistics space and I think we may see something on this very soon. Third, the demand of Data centers/cloud will grow much faster with 5G and Redington is already a big force in it and it will see high growth in this vertical and I think it may even increase the services offered in relation to Data centers/Cloud.

Summary of Analysis levels Involved in the study of Redington India:

1. Level 1 (Lower relative valuation) – Low valuation (7 PE) keeping in view the scale, low debt, high entry barrier, significant improvements in working capital (Plant and machinery).

2. Level 2 ( Industry level growth and restructuring)- IT products demand is going to see high growth in India and across the globe and Redington  is nicely poised to participate in this growth. Another massive industry level event is local electronics goods manufacturing in India.

3. Level 3 (Forecasting of management decisions which may result in massive future growth and value unlocking) – They have already done the great work in last 3-4 years which is not rewarded by the market. However, its management still has the scope for another round of decision making to lead it to massive growth. The decision to be taken by management for doing some acquisition in technology or logistic space and then to capture market share in high growth cloud and increasing their service offerings are the key strategic actions to be taken by the management.

(This study is a business analysis of the company under consideration. Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).