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).

 

TTK Healthcare Ltd: At the Crossroads

 

TTK Healthcare Ltd.

Grade: TIER 3

Value trigger: Level 3. Management is going to take certain decisions which will put the company on a strong growth path.

Stock: TTK Healthcare Ltd
Description	(Amt)
CMP	562
Market Value	794 cr
PE Ratio (Annualized)	35
Net worth (Sep-2020)	275 cr
Dividend Yield	0.50%

TTK is a very confusing company- Not for analysis point of view but as a company because somehow they don’t seem to be certain about their path. And in all this confusion they have created a mess of products and divisions which are going nowhere. Their portfolio of pharmaceuticals, medical devices and protective devices looks good but I don’t understand what they are doing in deodorant and home care business (Good home Brand-Drain Cleaner, Room Freshener, Scrubbers, Air Freshener Block and Odour Remover) where there already is very stiff competition with established multinational and national brands. I mean they could never spend on marketing and branding like other biggies and there is nothing great about their products. They are just routine products. And then they are also in foods business selling ready to fry snacks!!! It is surprising why management plans these half-hearted useless expansions where they stand nowhere against the competition-neither in terms of product innovation nor in terms of marketing spending. Their investments in these verticals have not shown good results and they are incurring losses or lower profits in these two. On the surface, their consumer business earning PBT of around 18 cr on topline of 181 cr looks good but this figure in mar-2017 was 240 cr and 25 cr respectively. So they are not being able to compete. Same is the fate of food business where turnover has grown at very slow pace from 72 cr in Mar-17 to 88 cr in Mar-20. So why to spend time, energy, efforts and money on such adventures when they have other business verticals with very strong growth potential and where they have done well.

And where they have done well?

Pharma and animal healthcare business: They have done well here. Topline has grown from 190 cr in 2017 to 231 cr and PBT at 21 cr from 13 cr. But they need to expand their product line and they need some path breaking products. They have herbal products like male/female fertility. In animal welfare division they offer products like medicines, tonics and productivity boosters and if you ask me this one is a great high growth opportunity. I feel they should have gone for some acquisitions in pharma and animal welfare segments if they can’t expand these businesses organically. Still, not a bad performance but they need to focus on complex products.

Protective Devices and Sexual wellness division: They have done well in placing Skore in the sexual wellness industry in India. They launched Skore condom in 2012-13 and with some path breaking aggressive marketing and branding they achieved 3^rd position in no time by 2016. In 2012, it had to break its long standing partnership with Reckitt Benckiser for selling Kohinoor and Durex condoms in India because both couldn’t be able to reconcile their dispute. Due to this, TTK lost the rights to Kohinoor (launched in 1979) and Durex (launched in India in 1997). But TTK launched Skore condom with big heart in 2012 and within a period of 4 years, it put behind both Kohinoor and Durex with wide margins. It even outpaced the giant Kamasutra brand. It is now at 3rd place in India behind Manforce and Moods with 10% market share (Manforce has 32%, Moods with 12%). Aggressive marketing and advertising, is the main reason for this success. Its advertising & Sales Promotion expenditure is at 88 cr in 2020 vs 68 cr in 2017 and bulk of it is going towards Skore. Recently it has started spending more on the advertisement of Woodward’s Gripewater (WGW) and it would be interesting to see the impact as WGW has not witnessed much revenue growth in last 4-5 years. At present it is selling around 15 cr condoms.

Actually, although TTK lost the brands of Kohinoor and durex but it never lost its technical prowess in manufacturing high quality condoms. TTK was the first to establish condom plant in India in 1963 and it was to first to install electric testing facility and first to introduce subsidy free condoms in India in 1974. So with its decade old marketing and distribution strengths, Skore was always going to make it big and fast in Indian market.

Recently, Skore has forayed into sexual wellness products and has introduced innovative products like lubes, sprays like pheromone-activated body sprays and gels, Vibrating rings with rechargeable and remote controlled variants (three variants, Skore Shiver, Skore Vybes and Skore Buzzz). These products are selling fast at online portals and these are going to see high growth in India. In fact sexual wellness category is growing at 25% across the globe so one can judge the scope of growth in India where people are opening up on sexual wellness and experiments looking beyond the taboo. Most importantly, online platform are playing a vital role in the search, information, availability and delivery of sexual wellness products not only in urban but rural India also. Online sale of sexual wellness product is going to be the major differentiator in the future high growth of this industry in India. In india condom penetration is still way lower at 6% and a country with vast population the value of condom industry is just around 1200-1300 cr. But this low value points towards a vast untapped market and this is the reason Skore is playing the game aggressively for the market share.

TTK management may look confused when it is about their Eva Deo, Home care and Foods business but in sexual wellness industry their approach and strategy is just top notch. I really like the aggressiveness, strategy, product innovation, disruptive marketing and branding activities of TTK management in establishing and growing Skore brand.

TTK has capacity to manufacture 2 billion condoms a year at its three factories in southern India. Some people compare the performance of Skore with another listed condom player “Cupid Ltd” (female condoms) which is having high margins and profits. But they are not comparable. Cupid is catering to wholesale market supplying to export market and orders from welfare agencies like WHO/UNFPA. But Skore is focusing on branded consumer segment where a lot of investments is required initially in establishing a brand especially in premium segment. Indian sexual wellness industry is still in the initial phase with a long way to go and that’s why one can see brands like Manforce, Durex, Kamsutra spending big on innovative products and marketing. Most of these players are incurring losses as of now but accounting losses are different from business losses. In many cases, accounting losses are business investments from business point of view for accounting does not recognize or value strategy and brand establishment. So big marketing and advertising spend is responsible for the losses of Skore whereas the likes of Cupid does not spend much on these. Hence, over a period of time with growth in volumes and lower requirement of marketing the profits of Skore will see massive growth. TTK is also focusing on getting bulk orders for export markets from agencies like WHO.

Medical device Business: The next big opportunity

Indian medical device market is quite large valued at some 40000-45000 cr but sad point is that we import around 70-90% across various product categories.  Local manufacturing is very poor and it is mainly catering to low tech class 1 (class A) devices. Class 1 devices are those which are having low to moderate risk to the safety and health of the patient like stethoscopes, bandages, dental floss etc. The level of manufacturing complexity is very low so these are low value devices. Class 2 and 3 are relatively much more critical to the health and safety of the patient. Class 3 (Class C) is the most complex with highest risk to the life of the patient. These are the devices which support or sustain the life of the patient like the implantable pacemakers, prosthetic heart valve, ventilators, HIV diagnostic tests etc.

It is shocking that with vast healthcare requirement for a large populous country like India we are importing 70-90% of our total requirements. This shows the neglect by the regulators and government in formulating policies to promote the local manufacturing and also a great opportunity missed by Indian manufacturers due to their own neglect. In fact, this neglect and poor manufacturing prowess appears shameful if we see the highly advanced world class pharma industry in India where India is the global powerhouse in medicine manufacturing. Most of the medical devices which india import from the global giants like GE, Siemens, Phillips are actually coming from China who realized the importance of medical device manufacturing much earlier than India and focused on local manufacturing some 20-30 years back. The current value of industry is Rs. 40000 cr but this is going to grow much bigger in the future with high growth in healthcare industry and demand. For information, the value of chinese medical device industry is somewhere around 4 lac cr to 5 lac cr!!! That’s why I always say that India needs businessmen everywhere not politicians (to make policies for poor people) and bureaucrats.

One of the major drawbacks hurting Indian medical device industry was that Indian medical devices industry was largely unregulated which hurt the investments and export opportunities. Now, Indian government has released The Medical Device (Amendment) Rules, 2020 (“MDR Amendment”) to regulate this market and they have approved stimulus package for promoting the manufacturing in India. (Will cover more on this topic in the next edition on medical device sector).

TTK Chitra heart Valve: For decades, India relied on imports of expensive artificial valve replacements to meet domestic need, but many families whose children developed Rheumatic Heart Disease (RHD) were also among the poorest in India, and could not afford even the heavily discounted price tags of imported valves, which hovered around $1,200 each. And so our children died, or lived drastically shortened and unhealthy lives.

Then TTK Chitra Heart Valve came to their rescue, it was developed painstakingly over 12 years at the Sree Chitra Tirunal Institute for Medical Sciences and Technology in Trivandrum, India, the device is now licensed for manufacture and marketing to TTK Healthcare. TTK valve uses the highest quality materials, features genuine design and material, blood flow resistance reduction, and durability. But in spite of high quality product with 12 year product development cycle with extensive clinical trials, TTK Healthcare still sells each valve for just $315-$400 (Rs. 20000-25000), a price range it has maintained since 1995, even when inflation is high in India. Due to TTK Chitra heart valve, all the MNCs had to lower their prices in order to stay in the Indian market.

TTK Chitra heart valve is the only Class 3 medical device produced in India which is a proof and a testimony to the technical capability in India for manufacturing complex medical devices. In numerous studies conducted, TTK valve has performed equal to other heart valves manufactured by renowned global producers like St. Jude. One recent study conducted in 2020 has established the efficiency of TTK Chitra heart valve equivalent of an imported St Jude Mechanical heart valve at almost half the cost making the prospect of cardiac surgery available to a large number of deserving poor patients. India is home to estimated 20-25 lacs patients with Rheumatic Heart Disease (RHD) which is the leading cause of structural heart valve damage in the country so there is a huge undiscovered and unmet market for heart valve surgery in India.

The Indian Government has designed and working on a massive Medical Insurance Scheme to cover poor families and this is going to create big demand for cost effective products like heart valve and orthopedic implants made by TTK.

TTK healthcare is also into the manufacture of orthopedic implants under the brand "Altius" which is low priced option against costly imports. The products are very good with US FDA cleared designs. As we can see, TTK has done well in medical devices but somehow the hard work is not reflected in the topline numbers and I think it may have been related to these products being looked down upon by Indian people who can afford costly products (doctors/surgeons also don’t take chance and opt for products with very slight medical benefits though at high costs)  and then there are poor people with no capacity to even buy these cost effective products in the absence of no support from government which as I have shared above is going to change and TTK may see high growth for its medical devices.

TTK’s R&D expenditure was around 4 cr (.6% of turnover) which is not bad keeping in view the fact that its NP is meager 20 cr.

So what is going to be the catalyst event for TTK in medical devices business?

They are having around 210 cr cash and I feel time is good for them to deploy this into high growth business of medical device. There is no better time to enter this sector than now. So I think TTK management is going to do something big in this segment this year- may be they will acquire a mid-size company or they are going to make investments for expanding their medical devices business. And if they can do this then we will see high growth happening in this company finally.

Why I feel they can do something big in medical device? Actually if we look at their performance in establishing Skore as a national brand in just 4 years then there is no doubt that they have the capabilities to execute something big taking over the entire industry; establishing a product where marketing and branding is the key and they did it skillfully so i think they can do something big in medical devices keeping in view their vast experience in dealing with this industry for last 20-25 years. The only thing is that they also feel like doing something in this industry. But I feel they don’t have any other choice and so soon we will be hearing something on this.

TTK healthcare has not performed at all in last 10 years and I think it has not given any returns at all but still good thing about them is that they have kept their business out of debt and amid all this surficial non-performance has created a significant consumer brand in Skore which is going to see high growth in the future and even the performance by Skore may be sufficient for a big re-rating. But as most of the value is coming from the future strategic actions taken by the management so treat this as a risky stock (Tier 3).

Summary of Analysis levels Involved in the study of TTK Healthcare:

1. Level 1 (Lower relative valuation) – Not cheap but not high also…just adequate for the current scale.

2. Level 2 ( Industry level growth and restructuring)- Sexual wellness and Medical device industry will see high growth but scale is small for TTK in these and it is not a leader in these segments so no automatic growth for TTK similar to industry growth.

3. Level 3 (Forecasting of management decisions which may result in massive future growth and value unlocking) – So the whole value is coming from the strategy and decision making of the management. Their strategy in growing sexual wellness and acquiring or expanding medical device business are the key growth and valuation catalyst events.

(This article is taken from the Monthly Newsletter of this Blog)

(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).