Hindustan Foods


(Kanwal Sudan) #1

About company -

  • Started in 1988. Was single product manufacturer of Farex of Glaxo from plant in Goa
  • Strategic alliance with Vanity Case group in 2013
    • Vanity case engaged in contract manufacturing for last two decades
    • Turned around Goa unit with better capacity utilisation
    • Company’s financial position was strengthened with restructuring and equity infusion
  • Building the contract manufacturing business
    • Added clients such a Pepsico, Reckitt & Benckiser, HUL, Hush Puppies, Steve Madden, US Polo, Gabor
    • Increased manufacturing to six plants making pest control products, detergents and packaging teas
  • Company is ready with contract manufacturing solutions to suit any type or size of FMCG customer across diversified categories

Board of Directors -

  • Shrinivas Dempo - Chairman
  • Sameer Kothari - MD
    • Over 20 yrs of manufacturing experience, promoter of Vanity Case, CA + MBA (Cornell)
    • Took over as MD from Ganesh Argekar on 22nd May, 2017
  • Ganesh Argekar - ED
    • 22 yrs of work experience, BSc Chem + PGDMM (IIMM) - Head Supply Chain of Vanity Case
  • Nikhil Vora - Non-executive director
    • Founder, CEO of Sixth Sense Ventures - India’s first domestic consumer-centric venture fund
  • Rajesh Dempo - Non-executive ED
  • Honey Vazirani - Independent director
    • Served as VP - Labels and International Business Division at Huhtamaki PPL
  • Shashi Kalathil - Independent director
  • Sudin Usgaonkar - Independent director - Senior advocate - Bombay High Court

Shareholding (as of June 2018)

  • Promoter group
    • Vanity case - 60.40%
  • Sixth Sense - 14.95%
  • Nikhil Vora - 4.23%

Managerial remuneration

  • Total managerial remuneration ~ 17 lakhs ~ 3% of PAT
  • Only ED gets salary of 12 lakhs - everybody else including MD gets sitting fees only

Statutory Auditors - MSKA Associates appointed on 27th Sep, 2017

Business strategy -

  • FMCG companies are focusing on leveraging brand building and marketing to address growing demand and outsource manufacturing
    • Development and manufacturing of FMCG products require significant capital investment and has high operating costs
  • HFL has ability to offer unique and customised solutions to reduce overheads and risks associated with manufacturing
  • Goal to become leader in contract manufacturing for FMCG
  • Besides contract manufacturing, HFL plans to partner with pvt. labels and smaller brands to offer formulation, packaging, branding, marketing and distribution

Business models -

  • Contract manufacturing -
    • Manufacturing units utilised for various companies with temporary contracts
    • HFL can offer product and volume flexibility to clients and cater to long term and seasonal product manufacturing
    • Advantages to client - cost reduction, sample production + testing, quality production, easy to scale up production, time saving
  • OEM model -
    • Entire manufacturing facility dedicated to single product of FMCG player
    • Contracts have longer tenure of 5-7 years
    • Generally require huge capital expenditure - can either be set up as greenfield project under direction from client or acquired on going concern basis
    • Post completion, company looks after end-to-end supply chain management
    • Types -
      • Dedicated manufacturing -
        • All decisions after due approval from client
        • Fixed returns for long period based on return on investment or cost plus basis
      • Anchor tenant model -
        • Anchor client has say in all matters but may share facility with some other clients
        • Agreement on quote base or cost plus basis
  • Private label model -
    • End to end manufacturing including formulation, product design and packaging design for small players
    • Cost effective way to produce product without investment into large manufacturing facilities, etc.
    • HFL responsible for procurement of raw material, development to packaging and owns product formula for these private labels
  • Own brands - build own products that are sold under branded names
    • UN:OR - leather brand with store launched in Goa in 2017
    • ESTD 1977 - under leather product basket of G Shoe Export
    • Saucery (proposed) - currently acquiring stake in this spreads/dips/sauces venture founded by Gayatri Bhatia

Plants -

  • Existing -
    • Goa - Pepsico, Danone, HUL, Marico
      • Expanded capacity from 3k to 6k tonnes in 2015
    • Puducherry - leather products for Hush Puppies, Gabor, Richter, Jomos, Kenneth Cole, Steve Madden, TBS, Hidesign, Arrow, US Polo, Louis Philippe
      • Acquired for HUL Ponds in FY17
      • Integrated into leather processing by contracted tanneries
      • Annual production of 5 lakh pairs of shoes and 7 lakh pairs of uppers
    • J&K - pest control products (Mortein) for Reckitt Benckiser
      • Acquired in end 2017 and started production on 2nd Jan 2018
      • Claims to be the sole manufacturer of vaporizers and aerosols for Mortein in India
      • Financing and operational performance -
        • PPE cost ~ 27 crs, supported against term loan from Yes Bank ~ 24 crs @ 10.35%,
        • Operations since 2nd Jan 2018: revenue - 35.49 crs, loss of 1.23 crs
        • Expected annual revenue - 130 to 140 crs, profit ~ 3-4 crs, expected NPM ~ 2.85%
    • Mumbai - leather footwear for Espirit, Saks 5th Avenue, Dune
      • Acquisition of G Shoe Export to be completed in 2018
      • Capacity of 3000 pairs of sandals and 1000 pairs of shoes per day
  • Proposed -
    • Coimbatore - tea, coffee, soaps for HUL
      • Greenfield expansion to start operations in Q3 FY19
      • Capacity of 20k and will be operational in two phases
    • Hyderabad - detergent powders for HUL
      • Manufactures 75000 tonnes of powder - apparently only suffices Telangana state requirements
      • Long term contract of 7 years that started in 2015
      • Expected to be merged with HFL this year following demerger from Vanity Case group

From MD’s desk -

  • Money raised from preferential issue was used to strengthen balance sheet and acquire 2 plants and set up Greenfield project for tea packaging
  • Company very confident to achieve near term revenue target of 1000 crs by FY 20
  • GST is slowly leading to decentralisation of manufacturing units
  • A number of small start-ups are coming up to cater to niche product categories - see great demand from here
  • Focus more on OEM model of business to enable longer customer retention
  • FMCG companies will focus more on marketing, distribution, logistics - to get product at right time, quality and cost.
  • Especially FMCG companies from developed countries will shift or outsource production

Financials

Investment rationale

  • Industry structure, premiumisation of FMCG products + launches in more niche categories will lead to increased contract manufacturing
    • Older FMCG players are likely to focus more on brand building and marketing and outsource the manufacturing function to contract manufacturers.
    • Start-ups and newer FMCG players require manufacturing labs to test their products and develop brands
  • Promoters’ experience in contract manufacturing (Vanity Case) across different FMCG product categories - in different geographical locations across many different clients

Key risks

  • Key man risk - Singly handled by MD Sameer Kothari whose absence could seriously dent the company’s fortunes
  • Client concentration - As per AR18, top 4 clients account for 75% of revenue. Any one-off event could dent operations. This is likely to go down as company diversifies across locations and bring more businesses under its wing from Vanity Case.
  • Related party transactions - Although promoter has indicated that they will transfer all businesses to HFL, operations in similar lines of business and RPTs is a risk.
  • Operational capability - MD has indicated very ambitious revenue targets - while most of this will come from transferring business from Vanity Case to HFL, the ability to have more long term OEM contracts in the pipeline will be the main challenge
  • Negative CFO in the last couple of years due to expansion and increasing WC requirements
  • Valuation risk - HFl trades at expensive PE of 75 based on current earnings, providing little margin of safety. If the investment thesis of exponential growth in revenue does not play out, the investment may not provide good returns.

Disc.: Invested, 3% of portfolio


(Susindar) #2

I was invested and hoping that someone will open a thread for this stock. I recently exited due to high valuations. I have the following questions about the business and your insights will be very valuable.

  1. What do you think about the equity dilution risk on merging businesses from vanity case. There is a risk of valuing the merging business fairly as well which belongs to the promoter group.

  2. Promoter infused funds recently and outstanding shares have further increased. The dilution have been huge over the last few years. If they keep diluting this way, the PE would probably remain above 50 even if the sales reaches Rs1000cr.

  3. This is a B2B contract business model for global brands. The brand owners will eventually control how much Hindustan is paid. While there could be a decent ROE and reduced risk, this model could never make high profit margins. So is a PE of 76 warranted for this business model?

  4. The contract for some of the products seems to be seasonal like tea, mosquito repellents etc. this would mean the fixed assets will not be utilized ideally and there will always be downtime during off seasons reducing RoA. Probably this could be a reason the brand owners do not want to backward integrate to begin with?

  5. We do not know what the margin in other products be like. Do you have an estimated profit when the sales could be Rs1000cr by 2020?

My feeling is the management projection seems very rosy and bullish especially given that they do not have the experience to back up their claims. Hindustan foods have been around forever with only the last couple of years business is picking up. Even vanity case, I have not heard much about. There is a high execution risk which the current valuation does not seem to be factoring.


(rupaniamit) #3

Thank you for starting the thread!

How much will it cost Hindustan Foods to transfer business from Vanity Case to HFL? What is the deal? Anyway to confirm if Vanity Case already has 800cr+ revenue? Target to achieve 1000cr revenue by FY20 seems too ambitious if Vanity Case doesn’t transfer and contribute to this target.

Disc: not invested


(Bheeshma Sanghani, PhD) #4

I get a sense that Hindustan Foods as a business has not stabilized as yet and while the future seems interesting it still remains very uncertain. Contracting is fundamentally a low margin endeavour and when low margins are combined with debt you need exceptional management to see the company through. With the amount of integration and dilution etc going in HFL it would make sense to just be a patient observer and wait for a hardened business model to emerge.

Best
Bheeshma


(Kanwal Sudan) #5

This map shows locations of Vanity Case group in India (taken from website), the colour coding has been done by me to illustrate locations - both existing and possible upon merger with Vanity Case.

Current revenue

FY 18 results -

  • Sales - 139 crs

  • EBITDA - 10.17 crs @ 7.33 % margin

  • PBT - 8.65 crs @ 6.22 % margin

  • PAT - 6.28 crs @ 4.52 % margin

Contributing plants - Goa, Pondicherry, Jammu

  • Jammu plant (info from AR18)

    • Started operation in Jan 2018

    • Sales of 35 crs and loss of 1.23 crs up to March 2018 - loss probably because of non-season?

    • If acquisition had taken on 1 Apr 2017, full years sales would have been 130 - 140 crs and profits of 3 - 4 crs

      • This means a PAT margin ~ 2.85%
  • Goa + Pondicherry plant

    • Providing for info above, approx 100 crs revenue came from these two plants

    • PAT were from these two plants alone ~ 6-7 crs

    • PAT margin ~ 6%

  • If full year profits of these three plants is taken, FY19 should have revenues ~ 230 - 250 crs. PAT margin ~ 3-6%

Future plans

  • Hyderabad plant - detergent factory for HUL (some info taken from MCA filings of Avalon)

    • This is to be demerged from Avalon Cosmetics Pvt. Ltd. (ACPL)

    • Management has indicated potential revenues of 250 crs that it already manufactures

    • Already had a turnover of 57 crs in Q1FY19 - which will reflect in books post merger

    • Board has authorised management to invest 100 crs in building liquid detergent in addition to existing detergent facility

      • Not sure of revenue but assuming 2x turnover as for detergent business, potential revenue of ~ 200 crs
    • Past information from ACPL filings for FY15 for margin estimation of Hyderabad plant

      • Revenue - 121 crs

      • Segment assets - 57 crs

      • Operating profit - 20 crores

So combining the Jammu, Goa, Pondicherry and Hyderabad facilities - revenues of at least 500 crs (not considering revenues from Hyderabad expansion)

  • Coimbatore plant - green field expansion tea packaging for HUL

    • Investment of 30 crs

    • To start production from Q3 FY19

    • Not sure of revenue capability

  • Mumbai plant - G Shoe Export

    • Started production in July 2018

    • Not sure of the revenue capability

What else have they got?

From ACPL

As per exchange filing on in May 2018

  • ACPL had total revenue of 235 crs in FY17

  • Out of which Hyderabad plant had revenues of 178 crs in FY17

  • Shareholders of ACPL will get 42.15 shares of HFL for every 1 share of ACPL

    • Based on my calculations this will lead to 37% equity dilution in HFL - I think this is too much dilution

    • Promoter shareholding in HFL likely to go up from 60% to ~72%

  • Based on MCA filings in 2016 other segments under ACPL (along with revenues in brackets) are

    • Cosmetics @ Ponta + Mumbai - 1.38 cr

    • Food @ Nashik - 15 cr

    • Sanitizers @ Coimbatore - 16 cr

Effectively, ACPL’s most prized asset is Hyderabad plant - apart from it, it does not do more than 60 crs revenue. So Ponta, Nashik and Coimbatore(cosmetics) don’t contribute much to topline

From other plants

Other plants (taken from Vanity Case website) that could add more potential revenues.

Not sure how much they can add, if we find out if these are operating presently and the name of the unlisted entity, maybe can know. Is there any way to access list of companies under a particular group - by way of seeing common directors perhaps?

  • Kala Amb -

    • 100,000 sq ft space with excise exemption till March 2020.

    • Started commercial production in Jan 2017

    • Client - Reckitt Benckiser

  • Silvassa -

    • Three units are excise exempted

    • Production of cosmetics

    • Clients - Emami, Jyoti Labs, Piramal Healthcare, Reckitt Benckiser, Wipro

  • Chennai -

    • 95000 sq ft area for cosmetics

Other ventures - Saucery, Unorthodox, etc but these are likely to be small and not move the revenue needle as much.

I’ve uploaded excel sheet with some data from ACPL filings for 2016 and some computations for HFL valuation. acpl_2016.xlsx (12.3 KB)

My investment thesis is the same as @bheeshma for now. I will be attending the AGM in Goa on 21st September so if I can ask 2-3 key questions that might provide answers to:

a. revenue visibility > 1000 crs in the next 5 years + possible margins
c. equity dilution expected as all Vanity Case companies are incorporated into HFL
c. possible debt levels upon consolidation

Please add any more questions on your mind. Unless I find convincing answers, I’m likely to reduce stake going forward.


#6

Nikhil Vora presented about this stock in alphaideas 20-20 summit. Had to take about his claims in presentation with a pinch of salt as he owns around 20% of company