Godrej Agrovet; Commodity business with scale advantage; valuation unjustified

Issue Date: Oct 4, 2017 – Oct 6, 2017

Face Value: INR 10 per equity share

Issue Type: Book Built Issue IPO

Issue Size: Fresh Issue: Rs 291 Cr Offer for Sale: Rs 866 Cr

Issue Size: Rs 1157 Cr

Price Band: Rs 450 – Rs 460 Per Equity Share

Market Lot: 32 Shares approx

Minimum Order Quantity: 32 Shares

Listing at: BSE, NSE

About the company

Godrej Agrovet is a diversified, research and development focused agri-business company with operations across five verticals namely; animal feed, crop protection, oil palm, dairy, poultry and processed foods.

  • Animal Feed: The portfolio of products comprises of cattle feed, poultry feed (broiler and layer), aqua feed (fish and shrimp) and specialty feed. It has aggregate production capacity of 23,00,000 MTPA, as of June 30, 2017. Also, its joint venture company in Bangladesh named ACI Godrej has two manufacturing facilities with an aggregate production capacity of 5,70,000 MTPA, as of June 30, 2017.
  • Crop protection: Under this segment, company manufactures a wide range of products that cater to the entire crop lifecycle including plant growth regulators, organic manures, generic agrochemicals and specialized herbicides. It has a major stake in Astec LifeSciences that manufactures agrochemical active ingredients (technical), bulk and formulations and sells its products in India as well as exports them to the United States and countries across Europe, West Asia, South East Asia and Latin America.
  • Oil palm: Company produces range of products including crude palm oil, crude palm kernel oil and palm kernel cake. It has entered into MOU with nine state governments, which provides an access to approx. 61,700 hectares under oil palm plantation, which is equivalent to approximately one-fifth of India’s area suitable for oil palm cultivation.
  • Dairy: It sells milk and milk products under the ‘Jersey’ brand across the states of Telangana, Andhra Pradesh, Tamil Nadu, Karnataka and Maharashtra.
  • Poultry & processed foods: Company manufactures and markets processed poultry and vegetarian products through the brands ‘Real Good Chicken’ and ‘Yummiez’. It has set up two processing plants with integrated breeding and hatchery operations.

MoneyWorks4me Opinion

As per management, Godrej Agrovet has scale advantage in production as well as distribution. This gives it an edge to maintain costs, operational profitability and working capital.

Around 47 per cent of Godrej Agrovet’s revenue comes from animal feeds business, followed by dairy and crop protection at 23 per cent and 20 per cent, respectively. Bulk of the cost in animal feed raw materials (75%) like commodity maize and soyabean. Prices are highly fluctuating based on crop yields. Rest of the cost are fixed costs. In such situations, maintaining high capacity utilization is the key to ensure profitability.

We believe it is difficult to earn more than cost of capital in this business. ROCE of this business is likely to hover around 12-14% on long term basis. Leverage would add another 5-6% leading to 17-20% in ROE in a favourable year.

In last year, the management has delayed payments to vendors and paid off debt thereby strengthening the balance sheet. We believe it was done for purpose of IPO to attract investors.

The small fresh issue will not be used for capacity expansion but repayment of debt and working capital. Rest of the money raised in IPO will go to existing investors including promoters.

We believe 8-10% long-term CAGR is expected from this business. The company can generate sufficient funds for clocking this growth rate hence it won’t require fresh funds. The business is likely to be seasonal as well as cyclical which isn’t highlighted in DRHP. The management has shown interest in growing the business via inorganic route. Given the history of the promoters in acquisition space, we believe the balance sheet will always be leveraged.

Though the management emphasizes the role of R&D in this business, we believe its otherwise. R&D has little role to play in this industry. We do agree that process improvement and scale does have an advantage in determining the return ratios.

After we were done with the analysis of the business and estimating potential growth rates, we were astonished looking at the valuations it demands in IPO. The commodity like business with probably the highest margins in this year is priced at 30X EPS. Even if we were to assume the margins to be sustainable, 30X PE ratio is quite steep.

As the business model is average and valuations are stretched, we recommend AVOID.

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As lot of hands are chasing handful of stocks, IPO issues may experience rapid increase in share price in short term. You may wish to ‘speculate’ with small capital.

But as an advisor, our duty to inform you what is right and refrain you from risk taking behaviour in this market. We will definitely recommend you select issues which are worth investing. We are equally interested in making money as you are!

 

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