S H Kelkar – Proxy to FMCG Exposure Rs 190
In the past few quarters, sectors such as capital goods, infra, power, PSU, defence etc. have gone up several times leaving investors dizzy with confusion regarding their potential to generate future returns. At the same time, several sectors like FMCG, IT, private banks, insurance companies etc. have given miniscule or negative returns.
Most of the laggard sectors have some ‘structural’ concern that has the market worried.
IT is facing a slowdown in the West and there are doubts about the impact on AI on their business model.
Private banks are facing contraction in their Net Interest Margins with the cost of deposits rising faster than the lending rates.
Insurance companies have been facing roll back of tax incentives making insurance policies less appealing to savers.
FMCG sector has however been facing a ‘cyclical’ downturn rather than any structural concern. Rural India has seen contraction of income and with around 50% FMCG sales coming from the rural segment, their volume growth has been affected. This cyclicality is part and parcel of all economies and is bound to reverse sooner or later leading to normalization in volume growth. Additionally, the valuations in the sector have contracted to more reasonable levels. There could be decent upside in the FMCG universe once attention of market participants turns to them.
Within the FMCG space, there are evergreen heroes like Hindustan Unilever, Nestle, Marico which are monopolies and will always remain so. Without taking anything away from them, there is a trend that needs to be highlighted. Few years back, distribution reach of these behemoths was their greatest strength. Smaller players just could not match it and hence were constrained to remain fringe players. But with amazingly deep reach and adoption of online commerce, this barrier to competition has been chipped away. Perhaps a data point about Quick Service Restaurants (QSR) like Dominos, KFC, McDonalds vs Zomato/Swiggy can explain this better. It is estimated that all QSR chains put together have 5000-6000 outlets in India as compared to over 2.7 lac restaurants partners for Zomato and Swiggy each! Customers now have a choice to buy from any of the listed restaurants thereby diluting the growth of QSR’s. This is why QSR sales are lagging while Zomato/Swiggy sales are galloping.
Due to this democratization of the distribution channel, smaller FMCG companies are witnessing higher growth than their listed peers. But these smaller players are unlisted. One way to hitch a ride on them is through players supplying raw materials to both listed and unlisted players. These raw material suppliers also enjoy high barriers to entry since FMCG companies do not easily change their vendors until the lifetime of the finished product.
One such listed raw material supplier is S H Kelkar. It is the largest domestic Fragrance & Flavour supplier in India with 20% fragrance market share. It caters to the domestic market (57% revenue contribution in FY24) and exports (43% contribution). It came out with decent results in FY24 (Revenues up 15%, Ebitda up 36%, PAT up 92%) due to export buoyancy and increased focus on smaller players. Management expects revenue growth to be around 12% in coming few years with margins maintained at current levels. With Operating Leverage kicking in, its profits could grow at higher rates.
Its valuation at PE of 21 basis FY24 EPS of Rs 9, ROE of 10-11% and D/E of 0.42x appears reasonable. Company has a 30-40% dividend distribution policy which provides comfort regarding management’s attitude towards minority shareholders. Q1FY25 will be weaker because of a fire in one of its facilities in Apr 2024 but it will be made up in rest of the year as per the management. Investors looking for diversification away from red hot sectors into pockets of reasonable valuations going through cyclical oscillations can keep S H Kelkar on their investment watchlist.