Ekansh Mittal believes this seed company is turning into the right kind of ‘hybrid’

It had been tough few years for Kaveri Seed, with the price control and then the Sebi ordering a forensic audit on its books. But now the company seems to have made it to the other side. It remains one of the largest home-grown seed companies in India and is amongst the top-five players in seed segments such as cotton, rice, maize and bajra.

Over the past few years, the seed producer has been working to transform its product portfolio in order to diversify its revenue base and improve profitability. It predominantly has been a cotton-seed producer. However, in the recent past, the revenue share of non-cotton products has been steadily rising and these command margins upward of 30% against around 20% from cotton.

Two periods of growth

The major diversification began post FY15. In fact, the company’s performance can be divided into pre-FY15 and post-FY15 (See: The pivotal year). In the five years from FY10, its sales had increased from   Rs 1.62 billion to over  Rs 11 billion, and profits increased from  Rs 300 million to  Rs 3 billion. At its peak, the company had a market cap of  Rs 65 billion.

Then, in FY15, there were reports of pest attacks and declining yields, and this prompted farmer agitations that eventually led to the government regulating the prices at which cotton hybrids were sold. Under the Cotton Seed Price (Control) Order, 2015, the government has been fixing a maximum sale price for Bt cotton every year, taking into account the seed value, recurring royalty (trait value), trade margins and others. In March 2016, the government slashed royalty fees by 74% and since then the royalty fees has been coming down and has been scrapped completely for FY21.

The introduction of this government regulation had caused reduced sales and profitability in the company’s cotton-seeds business. But, over the following two years, the company increased the share of non-cotton products to its top-line and, from FY17, there has been a gradual improvement in its performance. From that fiscal, there has also been a steady rise in the percentage of R&D expenditure to the total turnover (See: Sowing the right seed). Today, Kaveri has a fully equipped, state-of-the-art biotechnology laboratory, an R&D team comprising of about 145 personnel including more than 40 scientists and an enormous germ plasm bank to sustain innovation.  

Since it began diversifying away from cotton, the revenue contribution from the seeds have fallen from 59% in FY18 to 47% for 9MFY21 (See: Serving a whole new dish). The next target is to reduce the contribution further to 40%.

However, while bringing the revenue share of cotton seeds down, the company has to work at increasing its market share in this segment and develop new hybrids for that. This is because the cotton-seeds industry is well developed, with almost 95% of the total acreage under hybrid seeds. For Kaveri, the vertical’s sales volume and value topped out in FY15 and bottomed out in FY17 (See: Changing the crop cycle). Royalty expense, which is what Kaveri Seed pays Monsanto, fell substantially over the years and does not have to be paid from FY21. The management is hopeful of maintaining a 5% to 10% growth in revenue from this segment. 

Rice with veggies

After cotton, rice has become the second largest contributor to the company’s sales at around 24% in 9MFY21 against only around 3% in FY15 (See: Grains of change). The revenue from rice has been growing at 30-40% CAGR.

The hybrid rice-industry, which has been growing at 5-8%, holds much promise for Kaveri and rice could become the largest revenue contributor for the company. Here’s why:

For one, the acreage under this crop is 3.5x the acreage under cotton. But, only 8% of the former in India uses hybrids against 95% of the latter. So, there is a wide expanse to conquer. China has around 53% of rice acreage under hybrids. 

Besides rice, we believe vegetables can be a major growth driver for the company (See: On a veg binge). From being one of the largest seed producers of cotton, maize and rice, the company has accelerated its efforts to improve the yield of vegetables such as tomato, hot pepper, okra, bitter gourd and others. Currently the company’s market share in the Rs 30 billion vegetable hybrid-seeds market, which is growing at 20%, is extremely low at 1%. However, Kaveri has been working on developing the product portfolio over the last 10 years, and revenue from it has been growing rapidly, though on a small base. The management is targeting Rs 1 billion sales in the next five years.

Maize is the third largest product for the company and its revenue share has gone up from 13% in FY15 to 20% in FY20, because the revenue share of cotton has decreased. However, the growth has been tepid over the last few years. That said, the hybridisation rate in maize in India is only around 60% against the rate in countries such as Canada (94%) and the US (88%), therefore there is a significant untapped opportunity. The company management is also optimistic about this vertical because of the government’s ethanol-blending programme. 

We have to wait and watch.

Similarly, another interesting and significant development that is unfolding is in its exports business (See: Preparing new fields). There is a growing market for agricultural seeds in India and abroad, but our country’s share in the global market is only 9%. That is a growing demand waiting to be tapped, and private players have the potential to produce a significant volume of hybrid seeds at cheaper costs and then sell at competitive prices. Kaveri’s management has said that they have sent samples to nine to ten countries including Egypt, Pakistan, Bangladesh, Nepal, Myanmar and Sri Lanka, and the results have been encouraging. However, it will take another two to three years to get a major breakthrough.

Overall, the company is doing well and the segment in which it operates is on a growth trajectory as well — there has been a steady increase in the adoption of hybrid seeds and the seed replacement rate (SRR), which measures the area sown with hybrid seeds instead of farm-saved seeds. Also, there is a huge potential yet to be unlocked since hybridisation is only around 8% in paddy, 60% in maize and 40% in bajra. 

There have been concerning incidents such as the Sebi-ordered forensic audit in FY16, when it was believed that the cash in the books may not be real, and the income-tax department’s search proceedings in the company in FY18. However, two years after the forensic audit, from FY18, the company has carried out three buy-backs worth around  Rs 2 billion each and also paid dividends worth 8-10% of the PAT. With regard to the IT search, the company filed a writ petition before the High Court of Telangana, Hyderabad, challenging the validity of the department’s action and the court has granted interim stay against assessment proceedings pending disposal of the writ. These two issues seem to be behind the company as of now.

The risks to be considered are around government regulations on price control and taxation, weather changes and execution delays. Like cotton, if other seeds also come under price control, it will hurt the company. Also, the company does not pay taxes on its business income since it is classified as agricultural income, but any change in laws regarding the same can negatively impact the profits. 

Monsoons impact crop patterns and seed sales, and if any variation in it leads to decrease in acreage for crops such as cotton, maize and rice, it will negatively impact the company. Lastly, any laxity in continuous development of new hybrids can impact the market share and sales of the company. 

Valuation

At the current price of around  Rs 556, Kaveri Seed is available at a market cap of  Rs 33.5 billion. The company is debt free on net basis and, at any point in time, holds cash and equivalents surplus of  Rs 3.5 billion to  Rs 4.5 billion. Effectively, the stock is available at an enterprise value of  Rs 30 billion.

Post the FY15-FY17 cotton-seeds fiasco, the business is again gaining traction and it has a more diversified revenue base with a strong possibility of reasonable growth over the foreseeable future. The company has also been paying back over  Rs 2 billion annually to shareholders in buy-backs and as dividends.

For the trailing 12 months, the company has recorded operating PBT/PAT (zero tax on business income) of  Rs 2.78 billion against an enterprise value of  Rs 30 billion. Thus, effectively the stock is available at 10.8x operating earnings. The other two pure-play, listed seed companies besides Kaveri Seed are Nath Bio-Genes and JK Agri Genetics. While the first is trading at similar valuations as Kaveri, the second has reported losses in trailing 12 months.  

On its part, Kaveri has weathered adverse winds and adapted well. The harvest should be golden. 

Disclosure: I am a SEBI Registered Research Analyst. As on the date of this note (April 10, 2021), I have personal investment in Kaveri Seed and the stock has been recommended to our clients as well.