Avanti Feeds: Is the story over?

This post is not BUY/SELL/HOLD advice but a statement of my personal views and opinion. I am invested in AF and my views are biased. Please consult a SEBI registered adviser.

Recency bias is powerful. I purchased Avanti Feeds back in July 2018, after what I thought was a significant correction in price of a mid cap stock that had been the darling of the bull run.

I was always interested in the shrimp business and had been tracking it for some time. I had missed out and my buying decision had to do with the fear of missing out again.

Time and the sobriety that comes with reflection proved some of my initial theories wrong-

  • Non-Cyclicity: I believed firmly that it was more of an FMCG business than a cyclical business. In this view I was alone. My thought was shrimp had become a food staple globally and with limited quality suppliers, and together with its non-seasonality – it could not be cyclical
  • Temporary not structural slowdown: An unusually long winter in the US and reversion to mean in soy prices seemed factors that would ease with time and the market was overreacting

As the price has since languished, I have had a lot of chance to question my assumptions. I am sharing some of my notes on the business and revised beliefs.

The significance of Farm Gate Prices

Cyclicity is introduced by Farm Gate prices: Farm Gate prices are the key incentive in this business. Shrimp farming in India is still discretionary and farmers weigh the risk / reward of seeding a shrimp harvest based on the prices they would get by selling the harvest to wholesalers or packagers. So what factors impact farm gate prices and make them cyclical?

  • Demand/supply – Like any raw material prices are determined by end user demand and available supply. Shrimp is cultivated everywhere from Ecuador to Saudi Arabia to Vietnam and consumed everywhere from China to EU to the USA.
  • Discretionary factors – Flooding, disease, import duties, raw material prices etc

In 2017 for instance, due to muted demand in the US and spike in raw material prices, the farm gate prices fell so low that farmers could not break even on their operating costs. The operating costs consist of the following –

  • Buying larvae – Shrimp larvae must be purchased
  • Feeds – Shrimp need a healthy and customized diet of protein and carbohydrates composed of soy meal, wheat and fish-meal. The prices fluctuate as soy meal is a volatile commodity and its price is not allowed to be hedged by feed suppliers, who must then pass on any increase in price. Shrimp also require different types of feed as per their stage of growth.
  • Electricity and antibiotics – Pumps and medicine to keep shrimp ponds oxygenated and healthy. Also refrigeration costs if applicable
  • Opportunity cost – growing some substitute crop

However farm gate prices have been slowly recovering and they look somewhat like this: Indian prices – 8 $, Indonesian – 12 $, Argentine/Equador – 6 $

Competition

In terms of quality and price, Argentinian and Equadorian shrimp are particularly competitive due to higher perceived quality and lower prices but there are caps on the metric tons of shrimp they can produce. Thailand used to be a major player but their shrimp culture has been suffering due to disease and their leadership has since been ceded to India and Vietnam.

China is not a major net exporter as it is a larger consumer of shrimp. Saudi Arabia and Mexico are the new players on the scene to watch out for. However in terms of scale – only Indonesia, Thailand and Vietnam offer real threats to Indian dominance in exports that is amplified due to limited local consumption (unlike South East Asia, where shrimp is a staple diet).

Where does Avanti Feeds fit into the Shrimp story?

Although there have been a lot many IPOs, Avanti Feeds remains a proxy to Indian shrimp story, which in turn depends on Farm Gate prices. Shrimp feed is highly customized and critical to the success of shrimp produce.

Shrimp feed therefore has qualities of a specialized commodity that must be customized to stage of shrimp growth and geographical needs.

Avanti has close to 48% market share in this space. Avanti is also established in other parts of the shrimp culture value chain – from hatcheries to processing.

It has been directionally focused on Shrimp processing and exports in the past few years in tie ups with large MNCs (Red Lobster/Thai Union) and with a focus to capture the quality trace-ability requirements of the EU and US such as SIMP better than its competitors.

Capture.PNG
Souce: Tijori Finance

However there are as many threats to AF as there are opportunities.

Medium term threats

  • MNCs like Cargill, CP, Godrej Agrovet etc. stall or erode Avanti’s market leadership in feed
  • Farm gate prices fail to become viable in 2020

Long term threats

  • Indian market fails to keep up with SE Asian growth in exports
  • Disease destroys Indian shrimp culture like EMS did to Thailand
  • US market stops expanding
  • US duties on shrimp are increased
  • EU ban on Indian shrimp
  • Chinese market captured by Vietnam

What could go right? (triggers for price)

  • Farm gate prices increase steadily through FY2020, leading to pricing power for feeds
  • Record monsoon cools of Soy prices like in 2017 (unlikely due to minimum support prices)
  • Packaging: Avanti Feeds captures 50% or more of Thai Union/Red Lobster packaging from India
  • Increased quality and scrutiny by importers puts other unorganized and smaller feed players plus processors out of business
  • Dollar, EUR furthers strengthens against INR
  • Ample cash with Avanti Feeds is deployed to increase capacities or extend credit to farmers hence protecting market share

Strengths and Advantages

  • ROIC highest in industry
  • Leadership in most Indian states on east coast (west coast needs improvement)
  • Excess cash to invest in capacities, fence out competition and cut prices if required
  • Latent pricing power in its customized feeds business, relationships with farmers, distributors and also in its wide geographical plus vertical integration
  • Management is nimble and a focused capital allocater – for instance they won’t pay dividends if they see a better use of the cash. They have deployed it strategically in the past and the same can be expect going forward

Conclusion

As long as farm gate prices are on the upswing and shrimp culture in India does not contract, Avanti will remain the ideal play on Indian aquaculture.

My Presentation on Edelweiss Financial Services – Bangalore Investor Group

I had the privilege to present on Edelweiss Financial Services today at the Bangalore Investor Group (BIG), a community that traces its origins to the ValuePickr forum.

The presentation includes valuations based on conservative and fair value scenarios (Slide 17). All disclaimers on Slide 2 apply.

Valuation on slide 27 is uploaded here:

Google spreadsheet

Valuation methodologies may vary and if you find an error in my numbers, please point it out or comment on the sheet.

Disclaimer: This is a hobby effort and not investment advice.

Data Science can’t crack the Stock Market

Data science is eating jobs, so why can’t algos (e.g. RenTech) “consistently” beat returns the same way as programs can beat high ELO rated players at chess?

The markets are more poker than chess, like life itself – where luck plays a defining role. Algos can break down factor-based investing and even use retail sentiment indicators (such as ICICI Direct’s RIBI) to make bets.

A data scientist will break LUCK as “stacked probabilities” in strategies backed by back-testing. This lies at the heart of algorithmic trading.

Let’s take the Put Call Ratio or PCR. PCR over 1 is seen as a bearish indicator but also as a contrarian indicator. Can an algorithm bake in “contrarianism”?

What happens to valuation defying momentum returns in the grip of panic like the crash in FAANG stocks?

What about Trump’s ever changing stance on trade wars?

Business is war. War by nature is asymmetric and unpredictable. In 1942, Germany’s surrender was thought to be around the corner due to its failure to secure Russian oil fields. Germany ground on till 1945, partly due to innovations in equipment and in using synthetic fuel (Fischer-Tropsch process).

Companies similarly are an ever-changing, non-ergodic process, with new inventions, new information and predicting their moves can be like predicting the weather on mars.

So you can take the emotion out of the markets but can you ever take the market out of emotions?

Nevertheless, those who sell shovels for this new gold rush to extract Alpha out of Data will get incredibly rich in the process.

Short note on Q3 Results of Housing Finance Companies. Will they stage a comeback in 2019?

Q3 results suggest a bottom is in place for Housing Finance cos. Are they set for a comeback?

With 2021 DHFL bonds at 24% YTM, market is pricing a default. It was not a lack of business that crashed the stock price of the leading mortgage provider (450+ to 120) but issues with governance & worries about raising funding and viability as a going concern.

Q3 results of its close private sector competitor – Indiabulls housing also show slowdown in disbursement, once again, not from a lack of demand for mortgage loans – but concerns over ALM.

Sentiment may be bad but the true measure of housing loan demand is from a government financing company that does not have to worry about its failure to raise funds. Q3 results of LIC Housing Finance show a spectacular increase in mortgage AUM and a maintained yoy financial margin of 19%.

Possible Bottom

Further the sell-down of mortgage portfolios to public banks and securitization have helped private players de-risk and raise funds for the post-RERA leg of growth via affordable housing. With the Cobrapost sting, all bad news is in public. Good news is being ignored. Further, there is no palpable distress on the liability side (CP market) as seen in earnings presentations. These signs indicate a possible bottom.

The real estate cycle is said to be of 11-13 years. The property bubble peaked in 2012 but the bottom may be closer than we imagine. Think of affordable housing like small cap and leading indicators that will rally way before home inventories in the main cities start getting back-filled in 2024. We are already in 2019.

At less than 2 forward price to book, the market seems to think mortgage disbursement will keep slowing into the future and loan yields will not rise as fast as bond yields. For the investor these misunderstandings and cyclically depressed valuations may spell opportunity.

Q3 Results by Avenue Supermarts. End of the uptrend?

Poor Avenue Supermarts (DMart) Q3 numbers.

In two months, stock was up from 1150 to 1650 in anticipation of good results and other news related euphoria like the new e-commerce policy that restricts foreign e-tailers. But now with just 2% PAT growth valuations seem unreasonable. I previously wrote how the stock was overpriced at IPO.

Even the salvaging 33% growth in topline is not sustainable. Discount stores can’t keep mushrooming at historical rates and same-store sales cannot grow indefinitely by giving deep discounts and squeezing suppliers.

So if not for growth or earnings, what are shareholders paying a forward PE of 78 for? Peter Lynch said he judges retailers by same-store growth and inventory turns.

Share holders should keep an eye out for trouble in DMart – especially piling of inventories and rising working capital that may signal that growing sales by discounting is not working well enough to catch up with valuations.

On Charts:

Stock has broken below 20-day SMA, center line of the Bollinger Band, which suggests the short term uptrend since November may be coming to an end. It will break under RSI center line on Monday, 14-January, beginning a down trend.

Long term opportunities in the Bandhan Bank and Gruh Finance merger

Bandhan Bank merging with Gruh in a share swap deal, is a marriage of east and west. Bandhan Bank is a microlending powerhouse based out of Bengal, while Gruh is a Gujarat based home lending NBFC with HDFC bank pedigree.

The marriage has caused market participants severe indigestion, primarily over valuation concerns. It is a marriage of convenience (Bandhan’s management seeks to dilute its ownership to be in compliance and HDFC seeks to raise capital) but there are more than tactical concerns. So what are the potential long-term benefits that are being ignored?

First, Bandhan, whose motto is “aapka bhala, sabki bhalai” (i.e. for your good and everyone else’s) is a very aggressive and profit-centric bank with a deceiving “not-for-profit” facade.

Bandhan has maintained industry beating NIMs of 10%+. In its recent quarterly results the treasury operations have also scaled and generated 63 times (!) YoY profit growth, in part due to treasury riding positive yield curve movements in AFS and HTM portfolio. This is clearly not a management that let’s an opportunity pass and Gruh’s acquisition will not necessarily prove to be EPS negative (Gruh has lower NIIs but higher ROE than Bandhan)

Second, Bandhan Bank has grown its CASA deposits within just 3 years to an astounding 41%, which is similar to a veteran bank like HDFC! This growing deposit base will help in the future to fund Gruh’s liabilities for long-tenor home lending. No more borrowing for Gruh at premium from debt markets and bank facilities. Gruh’s industry beating home loan underwriting standards will now have the benefit of the Bandhan’s low cost funding. The merged entity will enjoy peerless expertise in both unsecured (primarily Microfinance lending of Bandhan) and secured (collateralized home-lending) loans.

Third, geographical and cross-market synergies have immense potential. East India has a huge and untapped home lending market that could be accessed quickly using Gruh’s underwriting processes. Bandhan is deeply entrenched in this geography, while it has more than a toehold in the West of India (94 branches) and it could use Gruh’s branch network to cross-sell its micro-banking products.

The rural and semi-urban portfolio of the merged entity would be 71%. Bandhan Bank would then cross-sell deposits, microloans and home loans to a bottom of the pyramid clientele.

Additionally, Gruh has a significant wholesale book with its developer/builder lending portfolio. This is an area where a primarily retail lending bank like Bandhan can struggle to build capabilities as has been demonstrated by the recent IL&FS provisioning and write off (gross NPAs have surged YoY in the recent Q3 results). Bandhan will now have capabilities of a full-fledged bank across retail and wholesale portfolios.

Valuation Risks remain and have been noted and priced in by the market. At current market capitalization, Bandhan and Gruh finance have a combined market cap of about 70k crores, which is much more than the expected pro-forma AUM of the merged entity (50k crore). For comparison, Ujjivan and Equitas both currently trade at par or discount to its AUM.

But is it a fair comparison? Ujjivan and Equitas are small finance banks and Bandhan is a full-fledged bank without the restrictions placed on SFBs, which lends to lower costs of lending. Besides, based on past history and its presence in under-penetrated markets, the growth and profitability expectations from Bandhan should be much higher. The market is a voting machine in the short term but a weighing machine in the long term. So let us wait and watch.

Do Indian NBFCs really need new ALM regulations?

The recent crisis in the commercial paper market had put the regulatory spot light on NBFC’s borrow-short, lend-long strategy.

NBFCs effectively leveraged from the low interest CP markets to fund home lending with much longer tenors.

Due to the risk in this popular strategy, the Reserve Bank of India is creating new frameworks and reporting standards to monitor asset-liability mismatches in NBFCs. But can this case of over-regulation be avoided?

Why not simply tailor and extend the NSFR reporting requirement under BASEL III to NBFCs?

The Net Stable Funding Ratio requirement is defined as Available Stable Funding / Required Stable Funding > 1, i.e. the available stable funding sources at the NBFC should always be sufficient to cover said requirement. The stability of different funding sources (such as commercial paper) can then be weighted by the regulator to ensure an ideal mix.

NSFR therefore can be a simple metric to monitor stability of liquidity available to NBFCs. Good financial regulation is meant to be light yet effective. You can read more about the NSFR here:  https://www.bis.org/fsi/fsisummaries/nsfr.htm

NSFR implementation will also save NBFCs the costs of finally transitioning to a deposit taking Small Bank, under the RBI’s Small Bank License, which is the usual end goal for many NBFCs.

Just food for thought.