‘Kwality’ business at low valuations with good upside potential
Kwality Ltd (KDL) is one of the largest and fastest growing private dairy companies in India with milk processing capacity of 4.3mlpd across six plants, strategically located close to key consumer markets in North India. Many consumer centric global FMCG players are on the verge of entering into Indian Dairy business, and Kwality can be biggest beneficiary as it has strong institutional business, highest capacities and repetitive orders from Britannia, Mother dairy, HUL, Coffee Day and ITC. It has worked with largest dairy player in India (Amul) for almost a decade since 2003.
Rising focus on B2C segment:
Over the last few years, KDL has started focusing on B2C segment by launching fresh milk products under own brand name ‘Kwality’ and it is spending aggressively on branding and A&P. Fresh milk products under own brand name is expected to fetch higher realizations and it’s a high ROE business as asset turnover is higher as compared to other value added products. Revenue contribution from B2C segment has increased to ~40% in 1HFY18 from 12% in FY12. The target is to reach 70% by FY20. It has identified low margin but high ROE fresh milk products and developed its portfolio around it. Its product range includes variants of pouched milk, ghee, cow ghee, UHT milk, UHT cream, curd, skimmed milk powder, wake up creamer, flavored milk, buttermilk, and other varied dairy products.
In 4QFY17, Kwality commenced commercial production at its new unit at Softa, Haryana, dedicated primarily for VAP (valueadded products). The unit has fully automated world-class machinery & quality control systems and R&D lab. The unit has milk handling capacity of 0.9mlpd primarily for VAP such as Flavored Milk, Paneer, Cheese, UHT milk, Cream in tetra packs, Table- Butter and Yoghurts. With this unit cumulative milk processing capacity of Kwality is 4.3mlpd across its six plants in North India.
Strengthening its milk procurement model:
KDL has focused on improving procurement model and has established a robust procurement network in UP, Haryana, and Rajasthan. Kwality currently procures ~26% of its total milk requirements through its own VLCC and remaining from large contractors and aggregators. KDL started its procurement from its own MCCs in 2008 and currently set up 29 MCCs in northern states near its milk processing facilities. For procurement of quality milk, KDL plans to open another 30 MCCs in next 2 years to ensure uninterrupted supply of milk and to reach the target of procuring milk from its own MCCs at 50% in next 3 years.
Aiding farmers in various ways to create long term relationships:
KDL has taken many initiatives to strengthen its relationship with farmer in rural areas by providing them with veterinary doctors to look after animal health and artificial insemination need, subsidized animal feed and annual FMD vaccination. In FY17 it has inked an MoU with Bank of Baroda to disburse `40b of firstname.lastname@example.org% to ~1 lac farmers in initial phase, to buy milching animals, a smart phone & a two-wheeler; to boost direct procurement. The scheme was aimed to provide financial assistance to improve socio-economic lives of farmers and steer them towards digitization. This initiative has received well by farmers and expected to create a win-win situation for both.
Strong distribution network in largest consumption markets of North India:
KDL has major presence in NCR, Haryana, Uttar Pradesh and Rajasthan where its products are available on general and modern trade channels. Kwality aims to enhance its presence to 100,000+ points of sale from 50k at present over next 2-3 years including modern trade channels, exclusive brand stores, and select online modes in sync with brand salience and launch of new products.
Financial Performance and Valuations:
KDL has maintained its consistent growth in revenue and profitability over last decade as demand for milk and milk products improved consistently in its key markets. KDL is also cognizant of its delay in increasing direct procurement of raw milk from farmers and taking steps in right direction. Over last few years it is working strategically improving direct procurement, spending on branding, distribution and covering gaps in its product portfolio. Over FY11-17, KDL has delivered 27%, 29% and 27% CAGR in revenue, EBITDA and PAT, respectively.
KDL just trades at 11x FY18E earnings which appear attractive considering the size of business in the strong consumption Northern India market however recent incidences of inefficient management of capital allocation have created doubts on company’s corporate governance image. PE of 13x is more than 50% discount to its peer valuations. We expect management to learn from its past mistakes, maintain its focus on dairy business and improve operational efficiencies over next two years. Medium to long term Investors can consider buying the stock at current levels.