BHAVIKK SHAH's BLOG: S H KELKAR AND COMPANY LTD

Scrip Code: 539450 / SHK

CMP: Rs. 246.60; Market Cap: Rs. 3,566.34 Cr; 52 Week High/Low: Rs. 275.80 / Rs. 180.00

Total Shares: 14,46,20,801 shares; Promoters : 8,20,14,414 shares – 56.71 %; Total Public holding : 6,26,06,387 shares – 43.29 %; Book Value: Rs. 37.88; Face Value: Rs. 10.00; EPS: Rs. 4.87; Dividend: 11.30 %; P/E: 50.63 times; Ind. P/E: 47.70; EV/EBITDA: 26.17x ; Total Debt: Rs. 242.64 Cr; Enterprise Value: Rs. 3,732.98 Cr.

S H KELKAR AND COMPANY LIMITED: The Company was founded on July 1, 1955 and is headquartered in Mumbai, India. S H Kelkar & Company Ltd (Keva) is one of the largest fragrance and flavour companies in India. The journey of the company begins in 1922 as a manufacturer of industrial perfumes in British India regime. Company has a large and diverse mix of over 3,500 customers, including leading national and multi-national FMCG companies, blenders of fragrances and flavours and fragrance and flavour producers. The flavour products produced by the company are used as a raw material by producers of baked goods, dairy products, beverages and pharmaceutical products. S H Kelkar has dedicated research team of 21 scientists operating out of their facilities located in Mumbai and Barneveld. It also has a team of 12 perfumers, 2 flavorists, evaluators and application executives at their 5 creation and development centers in Mumbai, Bengaluru, Netherlands and Indonesia. The company provides Fragrances for Personal care, Hair Care, Skincare & Cosmetics, Fabric Care, Household Products, Fine Fragrances. It provides Flavours for Dairy Products, Beverages, Confectionery, Bakery Products, Pharmaceuticals. Provides services like Bio Technology Research services, cosmetic Research service, Cosmetic Testing Laboratory, Custom Synthesis Services. It also provides Ingredients. The company has expertise in manufacturing plant, quality control and R&D centre. The company sells its products under brands like SHK, Keva and Cobra brands which enjoys substantial brand equity in India. Company's research team has developed 12 molecules over the last three years of which company has filed patent applications for three. The Company has four manufacturing facilities, three of which are located in India and one in Netherlands, with a total installed manufacturing capacity of over 19,819 tons annually. Last year company manufactured and supplied over 6,300 fragrances, including fragrance ingredients and flavours for the personal and home care products, food and beverage industries, either in the form of compounds or individual ingredients. The company came out with an IPO on Oct 28, 2015 offering 1,65,65,161 equity shares of Rs. 10 each for Rs. 180 per share raising Rs. 298 Cr. The shares of the company got listed on November 16, 2015 at Rs. 223.70 making a high of Rs. 225.05 on listing day. The object of offer for sale was to achieve the benefits of listing and for repayment and pre-payment in full or in part of certain loans availed by the company and Investment in its subsidiary K.V. Arochem Pvt Ltd and for repayment and pre-payment in full or part of certain loans availed by KVA and for general corporate puroses. Company's subsidiaries includes: Keva Fragrances Pvt Ltd, Keva Flavours Pvt Ltd, Saiba Industries Pvt ltd, Keva Chemicals Pvt Ltd, Keva UK Ltd, Keva Fragrance Industries Pte. Ltd, PT SHKKeva Indonesia, PFW Aroma Ingredients B.V. S H KELKAR Ltd is locally compared to Panama Petrochem Ltd, Manali Petrochemicals Ltd, Vinati Organics Ltd, Adi Finechem ltd, Camphor and Allied Products Ltd, Resonance Specialties Ltd, Camlin Fine Sciences Ltd, Diamines And Chemicals Ltd, and globally with Elizabeth Arden of USA, Atlas Pearls and perfumes Ltd of Australia, ID Perfumes Inc of Athens, Chanel from France, L’Oreal & LVMH ,Givaudan, IFF, Firmenich, Symrise, Goldfield.

Investment Rationale:

Incorporated in 1955, the company has over the years built strong relationships with its FMCG clients and they now understand the requirement of the end customer. SHK has 3,700 customers in the FMCG industry, which includes biggies like Godrej Consumer Products, Marico, Wipro Consumer Care, Hindustan Unilever and around 400 customers for their flavors products. SHK is the largest domestic fragrance producer commanding 20.5 % market share in the Indian fragrance industry with over 9,700 fragrances, fragrance ingredients and flavors created, manufactured and supplied as on FY15. It has a long standing reputation developed over the year’s history as a supplier of quality fragrances for use by FMCG companies in personal and home care products, food and beverage industries with exports to over 52 countries. It is also an emerging flavor producer in India with exports of its flavor products reaching 15 countries. SHK has a large and diverse mix of over 4,100 customers which include leading national and MNC FMCG companies, blenders as well as producers of fragrances and flavors. The fragrance and flavour business is a consolidated industry globally with 12 players controlling 83 % of the market and the top four players accounting for 53 % of the market share. The sector has been growing at around 4.2 % over the last five years and has a global market size of around $26.3 billion. Since the demand for fragrance and flavours is influenced by factors like urbanisation, rise of modern retail and high consumption of FMCG products, the biggest growth is expected to happen in emerging markets. India’s FMCG sector itself may touch $37 billion by 2020, which is a growth rate of 14 % (2012-20), annually. It is this growth rate and the size of the FMCG business that SHKCL plans to cash in on. In general, the Indian market has grown at twice the rate of the global market in the last five years and this growth is expected to continue for a long time. The top five companies in the Indian fragrance industry account for 70 % of the entire market, despite the presence of 1,000 odd players. Overall, SHKCL has a market share of 35 % in the Indian market. The company has 3,700 customers but it never allows one customer to account for more than 4 % of the total turnover, to maintain diversification. The management feels that this is like a mutual fund approach to risk management where they do not have to depend on one particular customer for solid returns. The global fragrance and flavour industry is estimated to be worth US$ 23.90 billion with an almost equal split between the fragrance and flavour markets. The global fragrance and flavour industry is expected to grow at a CAGR of 4.7 % by 2017 to reach an estimated value of US$ 27.5 billion. There are top 12 companies in this market and can be further broken down into the top four companies, consisting of Givaudan SA, Firmenich, International Flavors and Fragrances, Inc. and Symrise AG, that individually hold a market share of above 10.0 %, and collectively hold 57.0 % of the overall global fragrance and flavour industry among them. The remaining eight companies individually have a market share of between 1.0 % to 10.0 %, and collectively hold 26.0 % of the global Fragrance and flavour industry. Regional companies make up the balance of companies in the global fragrance and Flavour industry. The global flavour market accounts for approximately 49.0 % of the total global fragrance and flavour industry in terms of value at US$ 11.7 billion. Over the last six years, from calendar year 2007 to Calendar year 2013, the global flavour market has increased its share of revenues from 44.0 % to 49.0 %. The main product categories in the global flavour market for the calendar year 2013 were beverages contributing 34 %, savory 16 % and convenience foods and dairy accounting for 34 % of the global flavour market. Many top fragrance and flavour companies are placing greater focus on the emerging markets of Asia Pacific like India due to urbanization and changing lifestyles that are expected to benefit FMCG companies and their Fragrance and flavour suppliers. In particular, higher consumer credit coupled with rising incomes will lead to a sustained period of above average consumer spending, including the consumption of FMCG products. Fragrance and flavour companies with exposure to emerging markets also have a significant competitive advantage with respect to their customer base. SHK has always pushed its boundaries with new unique offerings to help enhance user experience of FMCG products containing these fragrances. In FY15 itself, SHK developed over 502 new fragrance and flavour compounds which have been sold commercially. Its research team developed 12 molecules over the last 3 years, out of which it has filed patent applications for 3. It combines its innovation efforts with a strong quality control system which enables traceability and repeatability for each batch of its products. This has led to a contribution of 14.3 % of revenues in FY15 from product launches of the last 3 financial years. SHK has built a Very strong reputation through delivery of quality products and customer satisfaction in the 90 years of its existence. With a solid business model, an 8,000 wide fragrance product range and strong sales & marketing Capabilities as demonstrated by its robust sales team of 95 people from 9 centres in India and overseas, SHK would be able to sustain its market share in this Rs. 20 billion Indian fragrance industry which in itself has witnessed a CAGR of 10.1 % over the last 4 years. The fragrance industry is primarily a niche market. Customers majorly include FMCG players who mainly use these fragrances in the manufacture of demand inelastic daily utilities like home and personal care products. With demand inelasticity is expected to drive demand in the Indian fragrance industry, S H Kelkar and company Ltd is expected to do better.

Outlook and Valuation:

S H Kelkar & Company Ltd famously known as Keva is one of the largest fragrance and flavour companies in India. Company has a large and diverse mix of over 3,500 customers, including leading national and multi-national FMCG companies, blenders of fragrances and flavours and fragrance and flavour producers. The flavour products produced by the company are used as a raw material by producers of baked goods, dairy products, beverages and pharmaceutical products. Company has over 300 customers for its flavour products. S H Kelkar has a small 2 % share in the Indian flavor industry which is dominated by global leaders. With the capacity of 19,819 tons available with SHK will help company to take advantage of an industry which is growing at a stable CAGR of 10.4 % over the last 4 years. SHK has established brand equity with its fragrance and flavor products and a growing clientele of over 400, SHK is all set to increase its market share in an expanding industry thereby further augmenting its growth. Fragrance manufacturers are highly involved from an early stage of product development and there is a requirement for consistency in its smell and quality. Most FMCG companies depend on the reliability & quality of service of fragrance producers and their knowledge & understanding of their products and needs. In addition to this, fragrance procurement has a relatively small share in overall production costs for FMCG goods. Thus, there is an element of customer stickiness on account of these factors which helps fragrance producers in long term client retention. SHK enjoys a competitive edge, and has its own Economic Moat (A competitive advantage is, that one company has over the other companies in the same industry – by Warren Buffett) and is expanding its moats which is a very strong sign of SHK commanding better market share in future also. The global fragrance and flavour industry is characterized worldwide by high barriers to market entry. Some of these barriers to entry’s are like an establishing long term relationships between fragrance and flavour companies and their customers, especially FMCG manufacturers, which are an entry barrier for new players to the global fragrance and Flavour industry. Most FMCG companies greatly depend on the reliability, quality of service and fragrance and flavour company’s knowledge and understanding of their products and needs. Fragrance and flavour companies typically have to enter at an early stage of product development and such timely opportunities may not always be available to new entrants. Most FMCG manufacturers usually avoid replacing their fragrance and flavour supplier as the overall cost of fragrance or flavour products in the context of the final FMCG product is relatively small. This sector faces compliance with strict quality and regulatory standards, particularly in relation to FMCG products, such makes it difficult and costly for new entrants to enter the global fragrance and flavour industry. The global fragrance and flavour industry is characterized by an abundance of new and innovative products due to the dynamic nature of consumer preferences. Large fragrance and flavour companies spend approximately 6.5 % to 10.0 % of their sales proceeds on research and development, while global FMCG companies spend less than 4.0 % of their sales proceeds on research and development. In order to stay competitive, fragrance and flavour companies have to invest significantly on research and development to continue offering a wide range of innovative products. However, smaller fragrance and flavour companies or new entrants may not be in a position to spend such significant amounts on research and development. SHK plans to deepen its distribution network and plans to introduce new products and new application methods for its Fragrance such as small packs business. SHK also has a small pack fragrance business which it operates through its Cobra brand. This business includes sales of its fragrance products in package sizes ranging from 25 gm to 25 kg to several hundred traders and resellers spread country-wide. Thus the Cobra brand will grow and support SHK’s top-line growth. SHK also advantages from its low customer concentration. Out of the net revenue from operations of Rs. 840 Cr and Rs. 220 Cr in FY15 and Q1FY16E, revenue from SHKs largest customer was just Rs. 24 Cr and Rs. 8.80 Cr respectively. This amounts to only just 2.9 % and 3.9 % of revenues from SHKs biggest customer in FY15 and Q1FY16E. Thus, with a low concentration risk, SHK has managed to effectively mitigate the adverse effect of client loss on its top-line and bottom-line. Revenues from exports form a significant part of SHKs top-line. With negligible debt and consequent low interest burden, SHK would enjoy the benefits of reduced financial risks and low leverage. This would help the company sustain its high growth phase where its bottom-line has grown at a CAGR of 15.4% from FY11 to FY15. Revenues of SHK have grown at a healthy CAGR of 13.0 % from Rs. 470 Cr in FY11 to Rs. 860 Cr in FY15 driven by consistent demand for its fragrances from FMCG companies in India and overseas where it has a significant exposure in A & MENA. The fortunes of SHK depend of the level of FMCG consumption in India and overseas. With average household incomes of SHKs target market expected to significantly expand with an increasing share of disposable income, a favorable population composition and expansion of modern retail formats, consumption of FMCG products is all set to follow a healthy growth trajectory. Also, in order to keep up with changing preferences of the ultimate consumer, SHK consistently invests in research and development. It spent Rs. 26.4 Cr and Rs. 6.2 Cr in FY15 and Q1FY16E which comes to 3.1 % and 2.8 % of revenues respectively. With capacity available in its flavour manufacturing facility, established brand equity and a growing clientele, SHK can increase its market share in the flavour industry which has grown at a CAGR of 10.4 % over the last 4 years. SHK has raise money through IPO and will use part of its proceeds to repay some of its debts. SHK has already completed its capex cycle for the next 3-5 years with its Indian plants working at 35 % to 45 % capacity. Thus the repayment of significant debt post issue combined with an absence of material capex plans would ensure that financial risk is contained over the medium term. With a growing FMCG sector in Asia, North Africa and Middle East which constitutes 83.7 % of SHKs revenues, favourable demographics in place & customer diversity both in terms of low client concentration and 43.5 % of revenues coming from exports, SHK is surely to be an effective FMCG proxy. At the current market price of Rs. 246.60, the stock is trading at a PE of 44.83 x FY16E and 34.25 x FY17E respectively. The company can post Earnings per share (EPS) of Rs. 5.50 in FY16E and Rs. 7.20 in FY17E. It is expected that the company’s surplus scenario is likely to continue for the next three years keeping its growth story in the coming quarters also.

KEY FINANCIALS	FY14	FY15	FY16E	FY17E
SALES (₹ Crs)	761.40	837.00	937.50	1,064.00
NET PROFIT (₹ Cr)	79.10	64.40	79.60	104.50
EPS (₹)	5.50	4.50	5.50	7.20
PE (x)	36.70	45.20	36.50	27.80
P/BV (x)	6.00	5.70	3.70	3.40
EV/EBITDA (x)	22.30	25.50	19.90	17.60
ROE (%)	16.40	12.60	10.10	12.20
ROCE (%)	22.90	20.60	16.30	17.40

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*As the author of this blog I disclose that I do not hold S H KELKAR & COMPANY Ltd in my any of the portfolios.

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