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.

Is the IL&FS debt default truly a Lehman moment for Indian markets? What investors must know

There is panic in equity investor circles with regards to what’s cooking in the opaque and mysterious debt markets.

In part, the panic is justified because a crash in financials stocks is seen as a leading indicator of an imminent and broader stock market crash.

Debt investors are known to be more conservative than equity market participants and a debt market freeze is often indicative of a shock across stock markets and the economy.

Stocks of Indian public banks and NBFCs have corrected sharply, partly due to fear and in part also from changing fundamentals from rising cost of borrowings. Bond yields have gone up and are expected to keep going up given the end of central bank quantitative easing, and the uptick in costs of funding globally. Money is getting expensive.

Fears of an Economic Crisis

Closer home, there is a much larger and looming fear than a stock market crash. A fear that the stress which was previously on the asset side of the balance sheet (non-performing loans) of financials has now spread to the liability side of the balance sheet (funding and liquidity for NBFCs).

Crippling of NBFCs will be akin to choking off the oxygen supply of the wider economy.

Regulatory actions and restructuring of the bad loans from profligate and irresponsible lending have turned public banks into lenders of last resort.

This critical credit vacuum has been filled by private banks and NBFCs. Small businesses must get affordable cost of capital to generate earnings and for effective job creation. Without availability and affordability of funding, infrastructure projects will also be IRR negative. Simply put, without money as raw material, the GDP cannot chug along at 8% growth.

If credit growth is the oxygen of the economy, then debt borrowings are the legs that NBFCs stand on in lieu of CASA funding available to banks.

NBFCs therefore are critical to not just credit growth but to the growing Indian economy as a whole.

IL&FS as a systemically important NBFC

Infrastructure Leasing & Financial Services (IL&FS) is a complicated holding company structure controlled partly by the Government of India. As the name suggests – it was created to fund the booming infrastructure sector. Not so long ago, IL&FS AA rated bonds were hot property for debt and mutual funds that are amongst the biggest and strongest cartel of bond buyers in the illiquid Indian debt markets.

Infrastructure projects have long payback periods and often are financially unviable. As a result IL&FS began to default on its bond payments.

Investors choose debt funds precisely because they are perceived as lower risk when compared to equity based funds but a default on IL&FS interest payments would lead to massive redemptions and NAV losses. Debt and mutual funds would have proactively sold the bonds and there would be a freeze on buying further bonds in the illiquid Indian debt market.

Not being able to meet their funding needs, NBFCs would collapse. MSMEs would not get money, home lending would stop. Credit growth would fail.

The government has therefore bailed out IL&FS as a systemically important financial institution. It has changed the composition of the IL&FS board and offered funding through the Life Insurance Corporation.

Has the Risk Contagion been stopped?

Now coming to the key question for investors – has the timely government intervention stemmed the possibility of a wider risk contagion through the markets?

The 2008 risk contagion started in the debt markets, spreading through securitization structures (such as Collateralized Debt Obligations) and leading eventually to huge trading book losses for banks.

This crisis is different or was. It is a crisis of trust and not a crisis of complexity and interconnectedness. I illustrate this below –

US Markets in 2008:

Risk path = Sub-prime Debt -> Securitization -> Debt Instruments in Trading Book

Indian Markets in 2018:

Risk path = Doubtful Infrastructure Debt -> Debt fund buyers -> Funding and liabilities for NBFCs

As you can see, fortunately, complex securitization structures are absent from the Indian debt markets. Additionally, Indian banks do not have large volumes of trading book exposures to debt products.

In other words, the 2018 Indian risk map is linear. A risk contagion event would start with credit defaults and would play out as shown below –

Credit risk -> Counterparty risk -> Market risk -> Liquidity risk

For the most part, debt markets in India serve simple functions of providing liability funding to the issuer and low-risk interest payments to the borrower. For banks it serves treasury functions rather than trading functions.

By funding IL&FS the government mitigates credit risk and by backing IL&FS through its timely intervention, the government infuses key element of TRUST to stabilize counterparty risk

Market Risk is mostly caused by noise rather than fundamentals and will stabilize as soon as a steadiness in expected cash flows are perceived.

Conclusion

If I had to put my money on the probability of a localized financial crisis – I would wager a grand total of 100 rupees, just to be a good sport, because I do not believe anything akin to 2008 Lehman Crisis in scale or spread will occur in the foreseeable future.

The optimist in me believes that the Indian debt markets will recover soon and it will be business as usual for NBFCs. In a few years, it is possible that 2018 would be seen as a great buying opportunity for NBFCs, similar to what was seen during December 2016 after the demonetization of currency notes.

Arman Financial Services: thoughts on quarterly results and future direction

This post is not BUY/SELL/HOLD advice but a statement of my personal views and opinion on the latest results. I own stocks of Arman Financial Services and my views are biased.

Arman Financial Services is a Gujarat based NBFC with a presence in two-wheeler financing, microfinance & SME lending. By the name Arman Financial Services Limited “AFSL” (NSE: ARMANFIN) caters to two-wheeler finance and SME lending. By the name Namra Financial – a subsidiary of AFSL – the group caters to Micro-finance lending across Gujarat, Maharashtra, M.P, U.P and Uttarakhand.

What is my interest in the company?

  • I own 0.06% of its non-class A, public shares. No really. It is my moonshot
  • As some one who tracks the microlending sector closely, I have written about the Microfinance Sector and have been a believer that it will emerge stronger after demonetization

Investment Thesis

Continue reading “Arman Financial Services: thoughts on quarterly results and future direction”

Aditya Birla Fashion and Retail – Good Brands don’t equal Good Business?

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion.

  • NSE: ABFRL is one of India’s largest fashion retail companies with Madura (premium) and Pantaloon (value) house of brands.
  • ABFRL’s brands include household names that capture the entire gamut of discount and premium customers, including in-house and foreign brands such as Van Heusen, Peter England, Global Desi and Forever 21.
  • ABFRL has the ownership / perpetual license of its brands unlike competitors like Future Fashion and Retail and Shoppers Stop. Intangible Assets.
  • These intangible assets however are not translating into improved ROCE (Return on Capital Employed) and this is not a source of competitive sustainable advantage
  • We can blame the industry structure and the value conscious Indian buyer who prefers substitutes to brands when it comes to discretionary spending such as apparel. The discount disruption by online players like Myntra and Amazon has spoiled the buyer and changed industry structure.
  • We can also blame the huge debt on its books and asset-heavy (rent is 600 crore) model of its brick and mortar retail format, which leaves little in terms of EPS for stock price appreciation.
  • To give you a sense of the enormity of debt, the company reported post-merger, a Goodwill of 1795 crore (which includes Pantaloons, Madura and Forever 21) but the debt with accrued interest stood at 1881 crore.
  • Premium brands do not necessarily lend to margins – Compare ABFRL with Kewal Kiran that manufactures discount brands such as Killer Jeans. Kewal Kiran has an OPM of 15% while ABFRL with its premium brand portfolio clocks under 10%. What matters more is getting the right product-market mix and returns on operating assets.
  • Even in the same omnichannel format, COGS is 93% of sales while Future Lifestyle Retail (Central, Brand Factory etc.) manages costs more efficiently (COGS 90% of sales).

Continue reading “Aditya Birla Fashion and Retail – Good Brands don’t equal Good Business?”

Fineotex Chemicals: Stock Market Recursion

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

The Indian stock market has all types of companies. The deeper you look down the spectrum of market capitalization, the stranger things you will find, growing away from the analyst spot light. Fineotex Chemicals Limited (FCL) is one such micro-cap company. With only 72 employees on its rolls in India, FCL operates in the attractive space of speciality chemicals competing with foreign MNCs that dominate the space of textile finishing. Continue reading “Fineotex Chemicals: Stock Market Recursion”