Heritage Foods Ltd

There are issues with demand side of Heritage business too, in spite of the high brand credibility, as the sales are going southwards since Sep19 quarter. The political ramifications are felt on the supply side. The question is about their ability to ensure sourcing while facing the political headwinds and to keep their sales from declining.

Heritage Foods. 220crs ebitda in 9m… annualized implies 280-290crs in fy21. Approx 35% on gross block vs long-term median of 30% (ex of retail losses, which is now sold).

Record year perhaps in ebitda… mktcap is approx 1300crs and little debt…
Possible that the ratio/ operating profit mean reverts at some point, but there is comfort on the valuation and b/s side.

So a little over 4x ebitda.

Risk: Political. Maybe right too but has history of over 25 years.
Disclosure: I own it

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I commend the good results, obviously.

But these kind of Margins are not sustainable at all. This is not just the case with Heritage though. Many companies have been seeing Cost Rationalization and one-time Savings due to the reduced business activity. When things go back to “normal”, I doubt all of it can be retained.

Either way, my key concern about Heritage is in turning VADP Profitable, which hasn’t made much progress. But I suppose we can wait until after this pandemic is over and then give them some time to scale up the business. Let’s see.

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The Heritage - Novandie JV has officially started Production. Let’s hope something good comes out of this. They’re starting with a line of Yogurts first.

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Enough has been said on the business and I appreciate the comments made in favour of and against. All considered, it does seem that the stock is pricing in all negatives and offering a high margin of safety. Sharing my brief take on valuations:

• On FY22 est. nos., Heritage trades at MCap/ Sales of 0.5x; PE of 12x and EV/EBITDA of 7x. The current PE of 11x compares with previous five years trading range of 11-40x with an average of 20x. For comparison, Hatsun Agro trades at FY22 PE of 50x and EVEBITDA of 20x. The current 75% discount to Hatsun is too steep although Hatsun grows a bit faster, is larger and has a more established VAD portfolio.
• India FMCG companies trade at an average PE of 35x and EV/EBITDA of 25x. Heritage deserves to trade at a discount to some of the more established companies due to lower margins and return profile, weaker brand equity in VAD, weaker mgmt. quality, lower pricing power, weaker FCF profile and higher earnings volatility.
• That said, in my view, a fair and at the same time conservative one year forward earnings multiple would be 15x PE or 10x EV/EBITDA. If the business can deliver a low teens growth over the next 3-4 years (obviously we know it will be lumpy), stock seems well placed to give a 20+% IRR from here.

Disc: Not invested; only studying the business right now. Do your research before taking action.

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In stock market, what matters in the short to medium term is sentiment. Promoter family is a huge negative as far as sentiment is concerned as of now. Numbers alone won’t tell the story.

Not Invested.

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Does anyone know when new production unit will start?

• Heritage has announced an entry into the fast growing and underpenetrated ready to eat segment (RTE) with the launch of pre-marinated paneer tikka which needs to be oven heated for less than a minute before consuming. The initial launch is in the core markets in and around Hyderabad.
• Heritage already produces and sells packaged paneer which in itself is a large opportunity as the market shifts from loosely sold to packaged and branded paneer. The same raw material will also be used to sell this RTE product. The curd used to marinate the paneer tikka is also made by Heritage and sold separately as a value added product. So the product launch makes sense – the key raw material is already available with Heritage and I do not foresee any major capital investment in putting together this final product.
• Distribution is already available with their Heritage parlours and all the kirana stores where their dairy products are sold. However, my sense is this will need to be stocked as a refrigerated product so may find more acceptance in modern retail stores. Such products, while an opportunity in themselves, also serve as good brand building ambassadors which may help sales of other value added products.
• This is Heritage’s first foray into the RTE segment and the press release says that more will follow but only those which can make use of existing capabilities. This is certainly a positive as RTE products will come at high gross margins, are non-seasonal and can travel far unlike fresh dairy products.
• What we need to watch out is whether the management sticks to dairy based VAD or ventures into other meat and non-meat based RTE on the lines of Godrej Agrovet’s Yummiez brand. That may be stepping out of their core competence.
• Separately, the flavoured yoghurt JV with the French company Novandie is finally and up and running. The manufacturing facility is on the outskirts of Mumbai and the products have been launched in cities in Maharashtra, Gujarat and also in Hyderabad. Capex has already been incurred by this JV (Rs10cr by Heritage and the same amount by the partner) so the incremental investment will only be marketing based.

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View on this

This can be great business

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New professional CEO announced - comes with 14 years of experience with Coca Cola.

His prior exp is as below:

Vice President Marketing, Juices and Value-added Dairy Category,
Coca-Cola India & South-West Asia BU
• Director Operations (East Franchises, India). Coca-Cola INSWA BU
• Country Head/ General Manager Olam International Limited
(Gabon, West Africa)
• General Sales Manager/Sales Manager, Coca-Cola India, HCCB
• Control Systems Engineer, Oil & Natural Gas Corporation, Bombay
High South

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This company came up on one of my screens so had a detailed look at it…
Disclosure : NO Position in this stock as of now

Heritage primarily sells processed milk (67% revenue in FY21) and Value Added products like curd, ice-creams, milk shakes etc. (24% of revenue in FY21) in South India. Revenue has grown at 8% pa CAGR over last 10 years but has since slowed down to 1% 3 year CAGR and 0% 5 year CAGR (see trend below). This is only partly because of COVID. Primarily this is due to the politically sensitive nature of this stock.

I. Political sensitivity + Farmer sensitivity + Geographic concentration in South India : Heritage Foods was started in 1990s by N. Chandrababu Naidu, former Chief Minister of Andhra Pradesh & his wife and daughter-in-law are MD and ED of the company respectively. Suffice to say the company is likely to do better in times when the Naidu family is leading the Andhra Pradesh govt. Notice the difference in revenue growth when Mr. Naidu was CM from 2014-19 (20% in FY15 & 15% in FY16) & from FY19 onwards (6% in FY19 and 8% in FY20).

Stock Price similarly performed very well when Mr. Naidu was in power - giving 40% annualized return in 2014-19 & (-24)% annualized return after 2019.

Combination of politics, farmers & geographic concentration doesn’t bode well for long term investors and I usually tend to stay away. For eg. a political rival might target Heritage’s already meager margins & win himself/herself farmer’s political support as well by asking Heritage to pay higher prices for farmers’ raw milk.

Here is another example of how political rivalry might hurt Heritage investors. YS Jagan Mohan Reddy, new state CM elected in 2019, called out Heritage for buying land at dirt cheap prices because of Naidu’s political patronage & promised to investigate (at ~15 mins in this interview).

II. Future Group deal : The company sold its 124 Heritage Retail stores to Future Retail Ltd & received 1.78 crore shares for ₹295 crores in 2016. This stake has been sold in FY21 for ₹132 crores so the company made a loss on this deal due to debt woes at Future Group & its slump sale to Reliance. But the good thing is Heritage Foods used this money to pay down Long term debt and reduce leverage.

IV. ROE analysis : Net Profit margin is 2-3% and leverage is low implying that main driver of ROE performance is Asset turnover. in FY21, ROE jumped to 27% as a result of doubling of Net Margin to 6% and rebound in Assets Turnover as Future Group investments were disposed off. There is further scope for ROE expansion if Heritage achieves its Average Asset Turnover of 3.9 (from FY12-16).

Net margins sustainability at FY21 level & rebound in Assets turnover could be one potential source for re-rating in this stock.

Assuming a conservative 80% earnings retention and 20% ROE going forward, Heritage should grow earnings by ~15-16% pa. I am comfortable with this growth estimate also because earnings usually grow by 2x long term revenue growth which is 8% as seen above.

V. Working Capital Management : Dairy business is a “get paid first” business & this reflects in the Negative working capital trend & excellent cash conversion cycle of Heritage (see trend below) :

VI. Valuations at CMP are higher than FY11-FY16 averages (see below) : I have chosen this period to remove the impact of Future Group investments on P&L & valuation ratios from FY17-20

VII. Conclusion : From what we have seen above, Heritage is

  • mired in politics & farmer issues with geographical concentration in South India,
  • improving margin profile (if sustained by growth in Value Added Products %),
  • has healthy ROE (if improved by rebound in Asset Turnover to historical avg),
  • declining leverage
  • excellent Working capital mgt., &
  • Balance Sheet issues related to Future Group investments cleaned up
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• The recent key highlight was the appointment of the new CEO – Mr. Srideep Kesavan, who comes with 14 years of leadership experience at Coca Cola and 6 years of international experience with Olam. His expertise lies in areas of marketing, sales & distribution, and category management. In his previous role, he was the Vice President Marketing – Juices and Value-added dairy category for Coca Cola India.
• His mandate is to accelerate the growth trajectory towards an aspirational 20% CAGR with focus on building the valued added portfolio. He is expected to build FMCG like organisational capabilities. Mgmt. intends to penetrate deeper in tier 2/3 markets in South. Among non-South markets, only Delhi and Mumbai would be targeted for VAD products. There is no plan to enter other new states.
• Last quarter Heritage appointed a new CEO - Mr. Viney Vatal (a veteran from Godrej Agrovet) to head their fast-growing cattle feed business. There is a clear intent to induct professional management to prepare the business for future growth. Management clarified that Brahmini will remain involved in the business for strategic oversight while leaving the execution to professionals. This is common in other consumer companies where family members work alongside professionals, e.g.: Pidilite, GCPL.

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Decent Results.
VAP growth 31% yoy , 25% of sales

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Sales growth of 10% YoY; highest in the last eight quarters. QoQ sales have grown for the last three successive quarters marking steady pick up in sales, after having declined successively for the previous six quarters. Two year sales CAGR was flattish versus -5% in 1Q (this should start showing +ve trends from 3Q). Growth has not fired like Hatsun but acceptable versus expectations.

Margins were the key +ve. EBITDA margin has come in at ~9.7% which is much higher than the expected normal range of 7-8% for steady state dairy business. YoY it shows a contraction due the unusual base (milk prices crashed), but 1HFY22 margins of 9% are highest in Heritage’s history barring FY21. Milk spreads showing more resilience than we thought and VAD recovery may have also helped. Note that the improvement in margins is largely gross margin led.

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Con-call snippets









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The promoter holding in Heritage is also 50%+ but one of the holding vehicles (Nirvana holdings) gets classified as non-promoters.

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Decent Revenue Growth at 10% YoY
EBITDA margins at 6% .
VAP at 25% of sales grew 21% YoY.

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For VAP, I’m concerned about whether they’re just trying to hit internal Sales Targets. So far, there’s been no plan expressed for achieving Profitability and Returns. And every year they delay making Profits, it’ll be that much more difficult to earn good Returns on IRR basis.

I hope in the coming Concalls, we at least get some semblance of a plan to VAP Profitability.

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