This article provides in-depth fundamental analysis of Kaveri Seeds Company Ltd (KSCL), a leading producer of Cotton, Corn, Bajra, Paddy seeds in India.
Kaveri Seeds (KSCL) Research Report by Reader
Dear Vijay, I have been following your blog for quite some time and I find it extremely educative. Thanks for educating the investor community.
Based on you framework, I have analyzed the stock Kaveri Seeds (KSCL). Please find below my investment rationale.
- 10 years – 41.78%
- Company has been growing at a phenomenal rate of 40% consistently.
- Operating Margin – consistently above 20%
- The operating margins for the current financial year stands at 35%, I feel this is due to the decrease in the royalty payment to the Foreign JV partner Monsanto.
- Since the interest payout is almost negligible, the net profit margin is almost the same as the Operating Margin.
- There are very few companies that have grown at a phenomenal rate without compromising on the Operating margins.
- This implies that the company is able to pass on the increase in cost to its consumers, and need to reduce cost to increase sales.
- Company is not paying enough tax despite profits, the reason could be that the company is operating in the agricultural space and is entitled to tax breaks.
- The company is a ZERO debt company.
Cumulative PAT vs. CFO:
- Sum of CFO from Mar 05 to Mar 15 – ₹638.9 crores
- Sun of PAT from Mar 05 to Mar 15 – ₹823.51 crores
- Here we can see that there is a gap between the Profit after tax and the Cash flow generated from Operations.
- This implies that the company is not managing its receivables at desired levels.
- The company is currently quoting at 10.4 times its earnings
- As per Graham, since the price to earnings multiples is more than 10, there is no margin of safety.
Management Analysis of Kaveri Seeds (KSCL):
- There are no negative news about the promoters and the salary levels of the senior management seem under control.
- Also it is worth mentioning that the JV partner Monsanto has sued Kaveri Seeds (KSCL) for paying royalty of ₹20 for every bag sold instead of ₹120. The loss that could arise if the case is lost is calculated to be ₹64 crores for which the there are no provisions.
Please let me know your opinion.
Dr Vijay Malik’s Response
Thanks for writing to us!
I appreciate the time & effort put in by you in analyzing Kaveri Seeds (KSCL) and sharing your analysis for the benefit of author and readers of www.drvijaymalik.com
Let us first analyse the financial performance of Kaveri Seeds (KSCL) over last 10 years.
Kaveri Seeds (KSCL) has been reporting standalone financials until FY2012 and consolidated financials since FY2013 implying that it started establishing its subsidiaries since FY2013. To assess the complete business performance of Kaveri Seeds (KSCL), over the years, I have analysed standalone financials until FY2012 and consolidated financials since FY2013.
Financial Analysis of Kaveri Seeds (KSCL):
Kaveri Seeds (KSCL) has been growing its sales consistently at an excellent pace of 40-45% year on year since last 10 years (FY2006-15). You have rightly pointed out that this sales growth has been accompanied by sustained profitability.
Operating profit margins (OPM) of Kaveri Seeds (KSCL), though witnessing a long cyclical trend i.e. decreasing from 26% in FY2008 to 21% in FY2012 and then increasing to 27% in FY2015, has been consistent at 20-25% throughout last decade. This sustained profitability margins indicate that the Kaveri Seeds (KSCL) has been able to pass on any cost increase to its customers. This is a good sign.
Kaveri Seeds (KSCL) has communicated in its annual report for FY2015, the reasons for such sustained margin, which is the willingness of the farmers to pay a premium for good seeds:
“Given the importance of seed in the livelihood of millions of farming families, the quality in terms of yield and consistency in performance is paramount. Further, as the cost of seed is not considerable to the total cost of cultivation, the farmer would be willing to pay a premium for the right product.”
The sustained sales growth and profitability margins indicate that there are certain barriers to entry for new players. Kaveri Seeds (KSCL), mentions in its annual report for FY2015:
“Hybrid seeds are produced to surpass the yield of the varieties, with built-in genetic buffering to withstand the onslaught of a biotic stresses such as moisture stress, salinity, etc. Value addition to the genetic makeup is through introgression of source of resistance to the biotic stresses. Therefore, learning curve evolution by established companies confers a great competitive edge, translating to entry barriers of new entrants.”
Kaveri Seeds (KSCL) faces a risk of counterfeit and copied products. Nevertheless, the management acknowledges this risk and is clear about their approach towards the mitigants present in the operating environment:
“The patenting process in India is not very robust, resulting in competitors and small time companies rushing to replicate popular seeds in the marketplace opportunistically. Nevertheless, the imitation takes at least two to three years for duplication. In the meantime, an established player like Kaveri can garner significant market share for its product.”
However, overall Kaveri Seeds (KSCL) has handled the competition well and grown its business from a corn only player initially to one of the largest cotton seed developer and a multi-crop seed player of India. As per the company:
“Kaveri is among the top three seeds companies in the cotton, corn, sunflower, and pearl millet/ bajra segments, and top five in the paddy segment. Combined, these crops account for majority of the revenues of the Indian hybrid seed industry.”
Similarly, net profit margins (NPM) of Kaveri Seeds (KSCL) have also followed its operating profit margins, first decreasing from 20% in FY2009 to 16% in FY2012 and then increasing to 26% in FY2015. However, NPM of Kaveri Seeds (KSCL) has been consistently above 16%, which is a very good sign.
One of the major reasons for high profitability margins of Kaveri Seeds (KSCL) is that it has been paying taxes at a very low rate of 3-5% currently, which is far less than the standard corporate tax rate in India. Kaveri Seeds (KSCL) used to pay the tax at standard rate of 30-34% until FY2008, however, since FY2009, the tax rates have plunged significantly.
An investor needs to understand, the tax benefits that Kaveri Seeds (KSCL) started getting since FY2009, as the withdrawal of these incentives would lead to significant drop in net profit margins.
Also Read: How to do Financial Analysis of a Company
Operating Efficiency Analysis of Kaveri Seeds (KSCL):
Over the years, Kaveri Seeds (KSCL) has been reflecting improved utilization of its assets. Net fixed assets turnover (NFAT) has been improved from 4.88 in FY2007 to 7.63 in FY2015.
NFAT witnessed a decline in the initial years from 4.88 in FY2007 to 2.55 in FY2011. An investor would notice that this period is marked by the start of major capex by Kaveri Seeds (KSCL). Net fixed assets increased from ₹20cr in FY2007 to ₹104cr in FY2011. As is obvious that the new capacity takes some time to start contributing to the revenues, the capacity addition done during this phase has resulted in higher sales and the NFAT improved thereafter, significantly to 7.63 in FY2015.
Business operations of Kaveri Seeds (KSCL) are working capital intensive as has been witnessed by deteriorating inventory turnover ratio (ITR) over the decade. Inventory turnover ratio of Kaveri Seeds (KSCL) has declined from 9.4 in FY2007 to 2.3 in FY2015, indicating that the profits generated by the company are getting stuck in the inventory. Even though the ITR has improved in last two years from 1.4 to 2.3, however, it is still at a very low level than what Kaveri Seeds (KSCL) has seen in the past.
Kaveri Seeds (KSCL) has tried to improve its receivables position over the years and has improved its receivables days from 116 days in FY2009 to 24 days in FY2014. However, in FY2015, the receivables days have increased from 24 days to 38 days.
Receivables profile of Kaveri Seeds (KSCL) presents a peculiar picture that most of the receivables are outstanding for a period of more than 6 months. The following snapshot from the FY2015 annual report of Kaveri Seeds (KSCL) indicates the status of receivables position of the company:
An investor would notice that out of total receivables of ₹176.8cr, about 68% (₹120cr) are outstanding for a period of more than 6 months. Such delay in collection of receivables is not a good sign.
Many a times, companies are not able to collect such delayed receivables at all, as has happened with Kaveri Seeds (KSCL) as well. The investor would see in the above snapshot that Kaveri Seeds (KSCL) has been writing off almost ₹4-4.5cr of receivables each year on account of non-collection.
Management has also acknowledged this issue and has shown inclination to curb this problem even at the cost of subdued growth, as indicated in the FY2015 annual report:
“As a Company we expect moderation in cotton volumes as a result of our planned calibrated move to offer lesser credit with an eye on managing our receivables and protecting margins. We are optimistic of maintaining our cotton market share position in Telangana and expect to make meaningful gains in the non-credit markets of MP, Gujarat and Maharashtra.”
It remains to be seen whether Kaveri Seeds (KSCL) is able to manage the sudden deterioration in receivables collection by taking appropriate steps.
Kaveri Seeds (KSCL) has PAT for last 10 years (FY2006-15) of ₹823 cr. whereas the CFO over the similar period is ₹635 cr. Inability to convert PAT into CFO is visible from the above observation that Kaveri Seeds (KSCL) has been finding its funds getting caught up in the inventory as witnessed from deteriorating inventory turnover ratio over the years.
Margin of Safety in the Business of Kaveri Seeds (KSCL):
i) Self-Sustainable Growth Rate (SSGR):
Self-Sustainable Growth Rate (SSGR) of Kaveri Seeds (KSCL) is about 50-70% as marked by increasing fixed asset turnover ratio and net profit margins over recent years. As mentioned in the article on Self-Sustainable Growth Rate, SSGR does not factor in working capital changes. However, we can estimate whether funds are being tied up in working capital by comparing cPAT with cCFO.
Analysis of SSGR indicates that if Kaveri Seeds (KSCL) can manage its working capital management and operating efficiency properly, then it can grow continuously at about 50-70% growth rate without creating additional debt burden on the balance sheet.
As Kaveri Seeds (KSCL) has been growing at a rate of 40-45%, it has been able to manage its grow story without leveraging its balance sheet despite some of its funds getting stuck in inventory. As rightly pointed out by you Kaveri Seeds (KSCL) is a debt free company.
These findings of SSGR get re-affirmed when an investor analyses the cash flow from operations (CFO) of Kaveri Seeds (KSCL) with its capital expenditure (Capex) requirements over last 10 years (FY2006-15).
ii) Free Cash Flow Analysis of Kaveri Seeds (KSCL):
During FY2006-15, Kaveri Seeds (KSCL) realized total CFO of ₹635 cr. and out of it Kaveri Seeds (KSCL) spent ₹288 cr. into capital expenditure, thereby releasing free cash flow (FCF) of ₹347 cr. as surplus for shareholders. It is important to note that the ₹635 cr. of capex resulted in sales growing from ₹48 cr.in FY2006 to ₹1,161 cr. in FY2015.
This data indicates that Kaveri Seeds (KSCL) is a good example of efficient capital utilization. Despite meeting its entire capex requirements, Kaveri Seed Company was able to generate FCF of ₹347. out of which it distributed ₹121 cr. as dividend to shareholders (including dividend distribution tax).
The ability of Kaveri Seeds (KSCL) to grow its sales with limited capex from its CFO and generating good amount of free cash flow (FCF) indicates that until now the company has been enjoying a good advantageous business model.
The investors would agree that a company which generates good amount of free cash flow (FCF) post meeting entire capex requirement from its operating cash flow (CFO) would not need to raise any external debt. The same is true for Kaveri Seeds (KSCL); it is a debt free company.
Kaveri Seeds (KSCL) has been paying regular dividend to its shareholders. Company has been increasing its dividend payout with increasing profits. It amounts to sharing the fruits of growth with shareholders.
Share market too seems to have recognized it. The market capitalization of the Kaveri Seeds (KSCL) has increased by ₹2,675 cr. against retained earnings of ₹702 cr. over last 10 years (FY2006-15). Management has created a value of ₹3.8 for the shareholders from every ₹1 of earnings retained & not distributed to shareholders.
These are signs of a shareholders’ friendly management. However, while studying the FY2015 annual report for Kaveri Seeds (KSCL), I noticed certain issues, which an investor should pay attention closer attention to while assessing management:
Additional aspects and annual report analysis of Kaveri Seeds (KSCL):
1) Declining promoters’ stake:
Promoters’ stake declined significantly from 63.64% to 57.66% in FY2015, which further reduced to 57.49% at September 30, 2015. This is a significant reduction in stake and an investor should convince herself about the reasons for such stake reduction before taking any investment decision about Kaveri Seeds (KSCL).
Further advised reading: How to know if Promoters are Losing Commitment to the Company
2) Related party transactions:
Kaveri Seeds (KSCL) has been taking a lot of land on lease which is owned by its promoters and related entities. Similarly, it has been entering into sales transactions another related party Aditya Agritech Pvt. Limited, where Kaveri Seeds (KSCL) has 70% stake.
An investor needs to check whether the land lease transaction are at the prevalent market rate in the area. The investor also needs to find out the whether the sales being done to Aditya Agritech Pvt. Limited are at market rate and the details of the shareholder owning balance 30%.
3) Not spending the mandatory CSR (corporate social responsibility) amount:
Kaveri Seeds (KSCL) has not utilized the money it is mandated by law, to spend on social initiatives as reflected in the FY2015 annual report:
The reason given by the management in the annual report, for the amount remaining unspent seems frivolous:
“The Company is making efforts to identify the projects for spending the unspent amount and the same will be spent during the following financial years.”
It is difficult to believe that a company, which works in the rural area among one of the most deprived section of Indian society is finding it difficult to identify projects of social importance. It is difficult to refute the assumption that the management is not prioritizing its statutory social responsibilities.
4) Not disclosing disputed tax liabilities in the auditor’s report:
Kaveri Seeds (KSCL) has been disputing certain tax demands amounting to ₹22.36 lac, where the cases are pending in the court of law and tax authorities. These tax demands are shown in the contingent liability section of the annual report:
However, the auditor somehow has missed out disclosing these disputed tax liabilities in its report for such details:
An investor might think that the involved amount is small at ₹22.36 lac and is not material. However, I would advise the investors to ignore the monetary amounts in such incidences and focus more on the disclosure standards being adopted by the company.
I believe that an investor should analyse the above issues in detail and convince herself about the management quality before taking any investment decision about Kaveri Seeds (KSCL).
Margin of Safety in the market price of Kaveri Seeds (KSCL):
Kaveri Seeds (KSCL) is currently available at a P/E ratio of about 14.2, which does not offer any margin of safety as described by Benjamin Graham in his book The Intelligent Investor.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
The cotton seed industry is currently facing a lot of challenges, which are highlighted by Kaveri Seeds (KSCL) in its annual report:
“On a near term basis the cotton sector faces headwinds in the form of lower cotton seed inventory, discounted selling by unorganized players and MRP cut by Maharashtra government”
As the state government has reduced the MRP for cotton seeds, the companies seem to have in turn reduced the royalty payments to Monsanto in order to protect their margins. This has led to the dispute with Monsanto, which has resulted in a lawsuit in Telangana High Court.
You are right in pointing out that the lawsuit, if settled against Kaveri Seeds (KSCL), would result in significant financial impact for the company and the shareholders. The same should be disclosed in contingent liabilities. Management should be upfront in informing to shareholders all such developments, the impacts these might have on the business & finances and the steps being taken by the company in response to such developments.
Overall, Kaveri Seeds (KSCL) appears to be a company growing at a fast pace, with sustained profitability margins & operating efficiency. It has been able to meet its capex requirements from its cash flow from operations and able to generate free cash flows. Kaveri Seeds (KSCL) has a very healthy SSGR, which can ensure that it can keep on growing without needing debt to fund its growth, if it can manage its working capital efficiently.
However, there are certain management related issues involving reduction of stake by promoters, disclosure standards etc. that should be analysed further by investors.
These are my views about Kaveri Seeds (KSCL). However, you should do your own analysis before taking any investment related decision about Kaveri Seeds (KSCL).
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Additionally, the investor should keep track of the future performance of the company for signs of improvement or worsening as part of their monitoring exercise. She may use the steps explained in the following article for monitoring stocks in her portfolio.
Also Read: How to Monitor Stocks in your Portfolio
Hope it helps!
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- The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
- I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
- Currently, I do not own stocks of the companies mentioned above in my portfolio.