Edit (20th Jan 19) – Updated valuation present in https://youtu.be/GlGAZMqMNWY
The objective of this article is to analyze the fundamentals of LT Foods (Daawat Rice) Stock and estimate a fair value per share based on its fundamentals. I have attempted to compare the stock with its peers using certain key financial ratios. I have gone ahead and modeled the financial statements of the firm for the next 5 years and then used the forecasts to ballpark the Free Cash Flow to the Firm (FCFF) in order to arrive at a projected fair value per share
One of the reasons I have chosen this industry is that India is the largest exporter of rice with a 25% share in total exports (in value terms) and also India is the 2nd largest producer and consumer of rice after China (However, China’s share in exports is ~2%). Moreover, globally basmati rice production forms ~1.5% of which India contributes 65-70%. Of late rice firms (with the exception of a few) in India have seen a significant rally and hence I was tempted to analyze one – LT Foods. As per my research and valuation, I have found LT Foods to be overpriced as of this writing (no wonder it is undergoing some correction). Before I begin with the analysis, here is a brief on the firm and its standing amidst its peers –
LT Foods is a leading rice brand in India with a 20% market share in branded basmati rice market. India Business has been growing at a CAGR of 14% over the period FY 2012-17.
It also enjoys leadership position in the US with a 40% market share under brand – Royal with a CAGR of 20% over the last 5 years
Table presents revenue growth and distribution in different geographiesโฉโฉRegion Revenue Growth Revenue DistributionโฉUS 20% 28%โฉIndia 14% 45%โฉROW 5% 15%โฉMiddle East 10% 12%โฉ
Out of total revenue of over Rs. 3,300 crore in FY2017, more than Rs. 1,900 crore has been contributed by branded business (i.e. ~60% of the overall top line). Branded business contributes over 71% of the company’s overall volumes and saw a 23% growth in volume terms in FY2017 (and 19% growth in value terms in the same period)
Last year LT foods acquired two brands – Gold Seal Indus Valley and Rozana, from HUL in the Middle East. Besides, they also acquired iconic brand 817 Elephant for American and European market
Table below presents comparison of the fundamentals of this stock with its listed peers (We discuss the comparison of only Chamanlal Setia and KRBL with LT foods in this article. Both Lakhmi energy and Kohinoor have registered negative growth hence we omit them) –
Fundamentally, the stock appears reasonably sound, however, operational efficiency and debt management require improvement –
a.) Inventory Days and Cash Cycle of LT foods (and also KRBL) is quite high in comparison to Chamanlal Setia. Both are measures of the operational efficiency. Cash cycle is defined as the time it takes to convert raw materials into cash. Hence, there is room for improvement in Operations. This view is further bolstered by the slightly lower annual operating margin % vis-a-vis its peers. However, there has been a more or less consistent improvement in operating (EBIDTA) margin over the last 5 years as evident from the exhibit below
b.) Debt to Equity (D/E) ratio of 2.4 seems quite high when compared to its peers. Higher debt ideally should result in a higher ROE, but ROE of LT foods is lower than that of Chamanlal Setia and KRBL. Having said that the company has been able to reduce its D/E from 2.77 in FY2016 to 2.4 in FY2017 as depicted in the exhibit below
c.) Debt has marginally been increasing, so the consistently decreasing D/E can be attributed to increases in retained earnings (share capital remaining the same). High interest on debt adversely affected PAT growth in FY15 and FY16 despite consistently increasing Sales and EBIDTA
Relative Valuation
From a relative valuation standpoint, Chamanlal Setia appears attractive and valuation of KRBL seems stretched. KRBL has the highest P/E, EV/EBIDTA and M Cap/Sales of the lot. Worth noting is that LT Foods M Cap is less than its Sales
Absolute Valuation
Below is an attempt to arrive at the fair value using DCF. There are two methods – Free Cash Flow to Equity (FCFE) and Free Cash Flow to Firm (FCFF).
a.) FCFF is used to estimate Free Cash available to both debt and equity holders. It is arrived at by estimating cash flow generated from operations (CFO), some of which is invested in the purchase and maintenance of fixed assets (Net CapEx) and some of which is used for the working capital (WC). Any cash over and above Net CapEx and WC is available to both debt and equity holders. This is called Free Cash Flow to Firm (FCFF). Present Value of future FCFF is the Enterprise Value (EV). Additionally, removing present debt from EV and dividing by number of shares gives an estimate of fair value
b.) FCFE is used to estimate free cash available for equity holders. We start with forecasting Net Income (NI), some of which goes into Net CapEx and WC and then the left over NI is added along with Net debt issues (or for better understanding, any debt payment is subtracted and new debt issues are added) to arrive at Free Cash Flow available to Equity holders. FCFE is then discounted and divided by the number of shares to determine fair share value
For this valuation, we will use FCFF since FCFE requires forecasting of net debt issues for future years which is difficult for a heavily leveraged company. Another reason is that if net debt issues are high (as is the case with LT Foods), then it increases FCFE beyond Net Income. FCFE estimated in this case if heavily skewed because of inflated debt. Hence, we instead use FCFF in this valuation
Below piece of writing only talks of the key components used in this FCFF valuation
- Income Statement Projections
- Forecasted Net Sales assuming 12.5 % y-o-y sales growth, which is the growth attained in FY2017 over FY2016
- Expenses to Sales %age assumed to be same as that in FY2017
- Depreciation & Amortization estimated using useful life of tangible and intangible assets using the straight line method as mentioned in the latest Annual Report. The investment %age (projections) on each PPE component is assumed to be the same as that in FY2017 (Annual Report)
2. Working Capital (WC) Projections โ This schedule is prepared with the purpose to forecast cash flow from operations and use it in FCFF valuation
First, we calculated turnover ratios and using them we calculate average days of sales, inventory and payable outstanding. We then go on to assume that past averages of (receivables, inventory and payables) days outstanding data (albeit with slight improvements) will hold true for future years
For e.g. assuming Days of Sales Outstanding is 45 (days) for future years (47 is the past average. Here we assume slight improvement in Operations resulting in marginal decrease in Days of Sales Outstanding and likewise Receivables and Payables as well)
- Projected Receivables every future year = (Forecasted Net Sales of that year * Days of Sales Outstanding of that year) / 365
- Projected Inventory every future year = (Forecasted Net Sales of that year * Days of Inventory Outstanding of that year) / 365
- Projected Payables every future year = (Forecasted Cost of Sales that year * Days of Payables Outstanding of that year) / 365
- Net WC = Non Cash Current Assets – Non Cash Current Liabilities
- Change in (or increase in Net WC) = ( Net WC (in year t) – Net WC (in year t-1) ) / Net WC (in year t-1)
To summarize, we first assume Days of Current Assets and Liabilities Outstanding (based on marginal improvement on past averages) and then use these to forecast Current Assets and Liabilities in future years (by using the formulas mentioned above)
3. CapEx & Depreciation Projections โ This schedule is prepared with the purpose to forecast Net CapEx (= CapEx โ Dep) to use in FCFF valuation
- CapEx for future years is estimated using the past average CapEx as a %age of Net Sales. This is a very crude assumption to estimate CapEx. I didn’t come across any specific announcement on future investments by company’s management. In case there is any then I would replace this crude assumption with a more realistic number
- Depreciation & Amortization estimated using useful life of tangible and intangible assets using the straight line method as mentioned in the latest Annual Report. The investment %age (projections) on each PPE component is assumed to be the same as that in FY2017 (Annual Report)
4. Shareholder Equity Projections โ This is prepared with the purpose to forecast equity, which in turn is used to forecast Return on Capital (ROC)
ROC = Forecasted NI / Forecasted Borrowings and Equity
- It is difficult to predict future dividend payout ratio (even more so when the annual report does not state out explicitly any target dividend payout). Dividend payout ratio is assumed to be same as in FY2017
- Ending equity for each year is estimated by using Previous yearโs Equity + Net Income โ Dividends (paid)
2 Stage FCFF valuation
- This method assumes that growth of the company will continue (stable growth rate) and the return on capital (from 10.8% to 12.1% in 1st 5 years to 10% during stable growth) will be more than cost of capital (9.5% in stable growth period assuming beta goes down from 1.4 to 1.1 and capital structure remaining the same) Another reasonable estimate of the stable growth rate could be the GDP growth rate of the country
FCFF = After Tax Operating Margin OR EBIT(1-T) โ Net CapEx โ Changes in WC
Risk free rate = 6% (the risk free rate is computed as the current yield on 10-year Indian government bond (7.5%) minus the default risk of the Indian government (1.50%)
Stage 1: High Growth Period
- Since, as per the latest annual report, interest rates (i.e cost of debt) range from 10.70% to 13.15% per annum in 2017 (previous year 10.70% to 13.50% per annum). Here, we have assumed overall cost of debt to be 12% * (1 – Tax Rate)
- Cost of Equity = 6% + (5% * 1.4) = 13% ; since, Cost of Equity = RFR + (ERP*Beta)
- Cost of Capital = (12%*(1-0.3)*0.65) + (13% * 0.35) = 10% ; [Pre-Tax Cost of Debt * (1 – T) * Debt as a % of Capital] + [Cost of Equity * Equity as a % of Capital], Debt as a % of Capital is 0.65
- All Reinvestment Rates in Stage 1 are estimated by calculating forecasted (Net CapEx + change in WC ) as a pecentage of forcasted After Tax Op. Margin or EBIT(1-T)
Stage 2: Stable Growth Period
- Assumed overall cost of debt to be same as in Stage 1
- Cost of Equity = 6% + (5% * 1.1) = 11.5% ; assuming beta goes down to 1.1 since the company would be relatively less risky in stable growth period
- Cost of Capital = (12%*(1-0.3)*0.65) + (11.5% * 0.35) = 9.5% ; Debt as a % of Capital assumed to be same as in Stage 1. Cost of Capital reduces effectively due to reduced cost of equity. Even if cost of debt reduces in stage 2, then lets just assume that beta reduction compensates for any reduction in cost of debt with the overall effect of a reduced cost of capital
- Since India is a growing economy, we assume growth rate in stable period which is 1% higher than India’s risk free rate. Hence, growth rate = 7% in stable growth period (Stage 2)
- Reinvestment Rate in Stage 2 estimated using the formula = Assumed Growth Rate (7%) / ROC (9.5%)
- After Tax Operating Margin after FY2022 = [ EBIT(1-T) in year FY2022 * (1 + assumed stable growth rate 7%)]
- FCFF = After Tax Operating Margin after FY2022 * ( 1 – Reinvestment Rate in Stage 2)
- Terminal Value = After Tax Operating Margin after FY2022 / (Cost of Capital 9.5% – assumed stable growth rate 7%)
Enterprise Value (EV) = Net Present Value of FCFF in Stage 1 discounted at Cost of Capital 10% + Terminal Value discounted at Cost of Capital 9.5%
Projected Fair Value Per Share = (EV – Present Debt in FY2017 ) / Number of Shares
Projected Fair Value Per Share is less than the current market price (as on 25th Feb 18) using the 2 stage FCFF model
3 Stage FCFF Valuation
3 Stage Model is typically employed when a high growth period (stage 1) gradually transitions (stage 2) into a stable growth period (stage 3)
With stage 1 and stage 3 assumptions largely remaining the same as in the stage 1 and 2 respectively in the earlier 2-Stage model, we introduce a transition phase (stage 2) with assumed growth rate of 9% (less than that of stage 1 and more than that of stage 3)
Projected Fair Value using this 3 stage method is almost the same as that determined in the earlier 2 stage 2 method
The stock appears slightly overvalued as of this writing (25th Feb 18)
It would be interesting to value ChamanLal Setia using this absolute method since it appears the most attractive relatively
Assuming a more optimistic y-o-y growth (15%) due to acquisition of new brands and also assuming a more than marginal improvement in Operations (10% decrease in inventory and receivables days), fair value jumps to 80 per share. Hence, range of fair value can be pegged to be between 65 – 80