Kaveri Seed Company

A small-sized company with a sizeable portfolio of sunflower, maize, cotton, and paddy hybrids, Kaveri Seed has sustained strong financial performance since its IPO in September 2007. The per share earning for the past year now stands at Rs 18.5 (excluding one-off items) against Rs 8 at the time of the IPO.

Yet, the market meltdown has whittled down the stock’s valuation; its PE shrinking from about 16 times to its current 11 times (market price of Rs.209). Given the bright growth prospects for the seeds and micronutrients business, the company’s growth history and established presence, the stock deserves a better valuation. Kaveri’s larger rivals — Monsanto India and Rallis India — the only other listed companies which have a presence in seeds, have already seen a sharp re-rating and now trade at 17 and 12 times earnings respectively.
High entry barriers

With a two-decade presence in the seeds business, Kaveri Seed has a portfolio of about 40 certified hybrids in corn (12 hybrids), sunflower (5), cotton (6) and paddy (13). Building a product portfolio of this size requires a fairly long gestation period, as development of each hybrid strain usually takes four-six years.

Production of hybrid seeds also calls for access to proprietary germplasm (genetic material) with the required traits making for high entry barriers to the business. The company also sells crop micronutrients under the brand name Microtek; another business with good potential.

Kaveri Seeds’ IPO in 2007 raised Rs 68 crore to fund acquisition of farmlands, upgradation of seed processing plants and working capital requirements. The bulk (Rs 62 crore) of the proceeds have already been utilised.
Potential in seeds

The bright demand prospects for domestic seed companies arise from the huge shortfall in availability of quality seeds and increasing adoption of hybrids, given the need to improve agricultural yields on food and feed crops (Indian yields are far below world standards).

The Indian market has been seeing a substantial deficit in the supply of certified seeds over the past few years. Data put out by the Agriculture Ministry for kharif 2009 suggests that crops such as paddy (shortfall of 28 lakh quintals for the season), maize (2.2 lakh quintals), sunflower (0.59 lakh quintals) and cotton (1.15 lakh quintals) saw persistent shortfalls over the past four years.

All of these crops feature in Kaveri Seed’s portfolio. The policy regime for the sector is likely to be friendly over the next few years, given the incumbent government’s stated intention of improving seed availability.
High on growth

In terms of financials, Kaveri Seed has managed to deliver impressive and yet consistent growth over the past four years, with a compounded annual growth of 22 per cent in sales and over 100 per cent growth in profits in this period, albeit on a low base.

Operating profit margins over this period have expanded from the low single-digits to well over 25 per cent for the past three years; the bulk of this improvement coming from a backward integration move into foundation seeds in 2006-07.

That performance was sustained over the past year. For the nine months ended December 2008, net profits rose 46 per cent while net sales grew 23 per cent, driven by a higher contribution from the seeds business and overall margin expansion. The micronutrients division despite more sedate growth than seeds, managed improved margins.

Going forward, the company appears well placed to sustain margins at healthy levels, mainly due to pricing power. Focussed on lucrative cash crops such as sunflower, maize and cotton, the company may be comfortably placed to pass on any cost increases to consumers, given the strong demand.

The upward bias in farm product prices and the sharp hikes in the minimum support prices of key crops last year are likely to have lifted the purchasing power of farmers and may lend support to both volumes and pricing power for Kaveri’s target crops.

Kaveri’s balance sheet remains quite strong, with near zero debt (thanks to the IPO proceeds of Rs.68 crore), healthy ROCE and RONW (22 per cent and 16 per cent respectively).

This apart, the recent upward spiral in crude oil (and in tandem, ethanol) prices, if sustained, may lift export prospects for Indian which have been lacklustre since last year’s ban (lifted in October). The sharp spiral in freight rates may also make Indian corn exports more cost competitive for shipping to the South-East Asian markets.

The key risks to the business arise from the weather-related risks enedemic to any agri-business and relatively high working capital requirements, due to a long debtor cycle.

For investors, the stock’s small cap status would peg up volatility and render the investment quite vulnerable to any broader market decline.

via BL