Stock Analysis #2: Can normalized soya and maize prices unlock some value in Venky’s (India) Ltd?

(Disclaimer: This article is purely for educational purposes and not to recommend any buy, hold, or sell action on the stock being analyzed. Please consult a registered financial/investment advisor before making any investment decision. I, hereby, declare that I currently do not have any vested interest in the stock discussed below.)

VENKEYS generated approximately 19% CAGR if one bought the stock in 2012 at INR 368 per share. The company has, since then, quadrupled its sales and compounded its net profit at an average rate of 15% per annum.

Winner-winner chicken dinner? Let’s dive a bit deep to see how much more gravy this stock still has to offer. Before me move on to the analysis bit, here is a brief introduction of the company:

Venky's (India) Limited engages in the production and sale of poultry products in India. The company operates through three segments: Poultry and Poultry Products, Animal Health Products, and Oilseed. The Poultry and Poultry Products segment produces and sells day old broiler and layer chicks, specific pathogen free eggs, processed chicken products, poultry feeds, and other miscellaneous poultry products. The Animal Health Products segment produces and sells medicines and other health products for birds. The Oilseed segment produces and sells edible refined soya oil and soya de-oiled cake. It also operates a quick service restaurant under the Venky's XPRS name. The company was formerly known as Western Hatcheries Limited and changed its name to Venky's (India) Limited. The company was incorporated in 1976 and is based in Pune, India. Venky's (India) Limited is a subsidiary of Venkateshwara Hatcheries Private Limited.

Investment Thesis

VENKEYS has pan India presence in more than 20 states and is a prominent supplier to fast food chains like Pizza Hut, KFC, Brinkers, TGI Friday, McDonalds, Burger King, and Vista Foods. Such huge presence gives Venky’s (India) Ltd a strong network as a source of moat. While this source of moat may be wide and tough for small players to breach, the depth of this moat is short-lived and recurring. The management of the company highlights that in the last 3-4 years, the small players have emerged equally strong and they tend to switch on and off this industry based on seasonal fluctuation. Thus, the large players enjoy incremental market share for a period of six months to a year. The industry is currently facing challenges from steep soya and maize prices which has forced small players out of business and a potential dial down in raw material prices may bode well for the company.

Apart from a wide network, the company’s operations are vertically and horizontally integrated ranging from Pure Line Farms (PLF) rearing of parent chicks, broiler breeding, hatcheries, layer birds for table/ value added eggs, processing of chicken, retail stores, feed mills, vaccines, AHP, Solvent extraction, etc.

One area where VENKEYS has a rock-solid moat is its production of specific pathogen-free (SPF) eggs. The company has almost 100% market share for supplying SPF eggs to Serum Institute of India and Hester Biosciences and it is also the 4th largest SPF eggs producer in the world. Venky’s (India) Ltd maintains continuous interaction with Charles River Laboratories Inc. for absorption of this technology (SPF egg production and Reagent production technologies were imported from Charles River). Nonetheless, sales from SPF eggs form a miniscule portion of the total revenue.

From a demand perspective, India still has a good amount of potential for higher meat consumption. India’s per capita consumption of 79 eggs and 4.5kgs of meat falls short of National Institution of Nutrition’s recommended level of 180 eggs and 11kgs of meat. The management also expects demand from QSRs to bounce back and are foreseeing 25%+ growth post-Covid. Incremental demand is likely to come after FTA agreement as India is now permitted to export processed chicken food products to the Middle East, particularly the UAE.

VENKEYS ended March 2022 with 61 stores (Venky’s XPRS and Chicken Experience) and plans to add more outlets going forward. The company is also working on its Animal Health Product segment expansion and expects additional revenues of around 30% in FY24 in phase-1 (Capex of INR 35 crores). Phase-2 will see Capex of approximately INR 12-15 crores.

The company has been reducing its debt burden consistently as debt-to-equity ratio reduced from 34% in FY17 to 16% in FY21 while the management did not raise any additional funds through equity in the same timeframe. Moreover, VENKEYS generated positive free cash flow thrice in the past 5 years with a cumulative figure of INR 305 crores.

Risks to investment

Despite VENKEYS’s large presence in India, the poultry industry remains fragmented and after some scuttlebutt it turns out that it’s really tough for a big player like VENKEYS to harden switching costs. Big players like Godrej, Suguna Foods, Skylark, and IB Foods offer good quality poultry products with an ideal feed conversion ratio (FCR).

Running a quick fundamental analysis portrayed that VENKEYS have not been efficiently handing its trade receivables as they have been growing much faster than revenue growth in each cohort of past 10, 5 and 3 years. Also, company’s R&D expenditure have been reducing consistently over the past 3 years (FY20: INR 3.96 crores; FY21: INR 2.93 crores; FY22: INR 1.49 crores)

From an industry point of view, lack of adequate cold storage facilities in key locations and retail infrastructure are the main reasons which are impacting poultry industry’s growth in India.

Valuation

Deploying an average cost of capital of 15%, VENKEYS’s intrinsic value pans out to be INR 1,620 per share compared to its CMP of INR 2,139 per share.

Sales are assumed to grow in line with average industry’s expected CAGR of circa 11% through FY27 (given VENKEYS is one of the big players of the industry and is likely to comfortably ride the growth curve of the Indian poultry industry) before slowing down to an average growth rate of 8%. Operating margin is expected to gradually reach its historical average of 8% as soya and maize prices are projected to normalize going forward.

Given that poultry industry requires a good amount of capital influx in regular intervals, an average reinvestment rate of circa 60%, observed in the past 3-5 years, has been used as an assumption through the next decade in this model.

This gives us an Enterprise Value of INR 2,268 crores and an Equity Value of INR 2,282 (considering latest available balance sheet figures for cash, debt, contingent liabilities, non-operating assets and liabilities).

Running a sensitivity analysis with different discount rates, one can expect to earn an IRR of circa 11% at VENKEYS’s CMP of INR 2,139 per share, keeping the above assumptions intact. At our current discount rate of 15%, there is downside potential of 24%.

Coming back to the first statement of the article - VENKEYS generated approximately 19% CAGR if one bought the stock in 2012 at INR 368 per share. Can one expect to reap a similar reward over the next decade?

TTM P/E ratio for VENKEYS currently stands at 19x which compares to its previous 5-10 years’ average of approximately 16x. If we are to assume that Venky’s (India) Ltd will be trading at 16x after a decade (considering its strong position in the poultry industry) and a reasonable assumption that its earnings will compound at a slighter slower pace (say 12%, as sales growth projection is expected to be lower than the preceding decade and the business model doesn’t offer any scope for exploiting operating leverage – majority of the costs are commodity driven) than what we have observed in the previous 10 years’ time (15%), VENKEYS’s share price ought to compound at an average annual rate of 10%.

Financial Snapshot