Time to sow Kaveri Seeds

Once an investor favourite, Kaveri Seeds has taken a beating due to aggressive accounting 

When IDFC AMC’s Kenneth Andrade first bought Kaveri Seed Company in December 2007 just after its public issue, the Hyderabad-based company had seen a 263% rise in its net profit for FY07. At that time, Kaveri Seeds was a small-cap with a valuation of only around ₹300 crore, but it was already the fourth-largest seed producer in India, with a turnover of ₹66 crore. The company was largely into corn and sunflower seeds and had — in 2004 — entered into a sub-licensing agreement with Mahyco Monsanto for its Bt cotton technology.

Going soft

Weak demand and softening cotton prices pose a challenge 

S Ranganathan, head of research at LKP Securities, recalls recommending the stock to his clients, given the immense potential that Bt cotton seed had in India. But that wasn’t the only reason. “Even though Kaveri was facing tough competition from unlisted players such as Nuziveedu Seeds and Pioneer Seeds back then, the company showed enormous pricing power,” he says.

The company has recorded furious growth since then. Over the past five years (FY10-15), the company’s market share in the cotton seed segment has gone up from 2% to 17.9%; revenue from this segment has come in at 81% CAGR over the same period and now accounts for 66% of its total revenue. And that’s not the only good news. Overall, the company’s top line has grown at 37.8% CAGR during the period, with foreign institutional investors raising their stake to 21.08% currently from nothing five years ago.

Today, Kaveri Seeds is one of the dominant players in the cotton seed market thanks to its hybrid seed product Jadoo (launched in FY08), which is a hit with farmers in Andhra. Buoyed by its success, the company also launched a pest-resistant cotton seed hybrid called ATM specifically for the Maharashtra market in FY10. 

In recent days, however, its stock price has taken a pounding, with poor monsoon dampening the outlook and analysts unhappy with the company for already accounting for lower royalty payments to Monsanto even though the matter is sub judice. The past two seasons of back-to-back rain-deficit monsoon have especially opened up the proverbial can of worms. For starters, in Q1FY16, the company saw a sharp fall (from 50% to 30%) in its market share in key credit markets like Telangana as part of its strategy to avoid selling on credit so that there is no further accumulation of debtors on the company’s books.

Prashant Kanuru, research analyst, Karvy Stock BrokingDaljeet Singh Kohli, head of research, IndiaNivesh SecuritiesTelangana accounts for nearly 60% of Kaveri Seed’s cotton seed volume. In the first quarter, which is typically considered strong for seed companies, Kaveri Seed’s growth story seems to have taken a wild turn: the company’s top line plunged to ₹664 crore, a 19.7% drop on a y-o-y basis. Additionally, the Maharashtra government’s decision to cut the MRP on cotton hybrid seeds has put pressure on the company. 

Challenges aplenty

“The second consecutive year of bad monsoons, shifting acreage in favour of crops other than cotton, a sudden unexpected regulatory intervention, stiff competition by peers and its aggressive accounting for royalty fees has led to the de-rating,” says Gauri Anand, analyst at PhillipCapital, summarising Kaveri Seeds’ current woes. In Q1FY16, Kaveri Seeds had cut its royalty payment for every packet of cotton seeds sold in Maharashtra to ₹20 from ₹190 on the basis of royalty payments fixed by the state government under the Cotton Seed Act for FY16.

Similarly, the company also cut its royalty payment on sales made in Andhra Pradesh and Telangana, which has led to an overall cut of ₹64 crore in the company’s expenditure. If this ₹64 crore is added back to its profit and loss statement, the company would have actually reported a loss of ₹52 crore in Q1FY16. Instead, it reported an operating profit of ₹22 crore. As Kaveri Seeds is yet to reach a formal agreement on the new rates with Monsanto, analysts see these cuts as a case of aggressive accounting. “The management should have at least made a mention of the lower royalty provisioning in its notes to accounts,” says Anand. The Kaveri Seeds management declined to participate in this story. 

Downward ho

The stock price has dipped in recent months over reservations about aggressive accounting

The company’s accounting practices and loss of market share may have spooked fund managers and some institutional investors, but has the stock seen enough correction to make the risk-reward ratio favourable? Analysts tracking the company think so. “We see this as a temporary phase. The stock is quite attractive at the current valuation as the situation will not remain the same; demand will return,” says Daljeet Singh Kohli, head of research at IndiaNivesh Securities.

Another analyst at a domestic brokerage adds, “Kaveri Seeds has a large distribution network. It is not one of those companies that are strong just on paper — you can see the company’s products bringing in revenue for the company. It is only a bad year that has hampered the company’s performance. If next year is good, funds will continue to throw cash at the company.”

Investors can take succour from the fact that the company is cash-positive and has zero debt on its books. As on March 31, 2015, the cash on the company’s books stood at ₹406 crore. Analysts feel that the promoters can use the cash to do a buy-back. “The seed business is not very capital-intensive, which is why the company should reward minority shareholders by announcing a buy-back,” Anand adds. 

What helps is also the fact that experts think the monsoon is going to be better the next time around, statistically speaking. “Including last year, there have now been two back-to-back years of deficit rainfall. Only once so far has there been three years of back-to-back deficit rainfall (1985-87),” says GP Sharma, vice-president of meteorology at Skymet. If the rain gods show their benevolence, the seed sector has a fertile ground from which it can continue to grow. 

Contrarian call

While initiating coverage on Kaveri Seeds with a ‘buy’ call, analysts at Kotak Institutional Equities say that they expect the company to recover market share lost in its home markets of Andhra Pradesh and Telangana and continue to gain market share in Maharashtra and Gujarat. The analysts add that the seed industry will benefit from the likely rollout of new technologies in cotton seeds, namely high-density planting (HDP) and round-up ready flex BT. Prashant Kanuru at Karvy, which has also initiated coverage with a ‘buy’ call, feels that over the next two-and-a-half years, there could be a 40-50% upside in valuation.

Crop failure

Kaveri Seeds is likely to see a subdued FY16 because of a poor monsoon

“The company has developed an HDP variety called 3-to-1, where instead of sowing the seeds in a 3 ft x 2 ft area, the farmer can sow it in a 3 ft x 1 ft area. This and another brand called Super-Duper has started gaining traction in Maharashtra, helping Kaveri Seeds increase its market share,” adds Kanuru. 

Rising hybridisation in the maize, rice, fruits and vegetable segments, farmers focusing on increasing their crop yield, the expected launch of new technologies such as HDP and herbicide-tolerant Bt cotton seed and the expectation that farmers’ spend on seeds will outpace spend on other agri inputs in the long term — as is observed in other major agriculture markets — are some of the tailwinds that the sector could ride on, going ahead.

According to analysts, the recent fall in market share should not worry investors either, as the management looks set to return to the credit markets next year. “The company’s products command strong brand loyalty. As far as seeds are concerned, farmers prefer not to take chances. So, once the company returns to the credit markets, it will be able to regain market share,” says an analyst on the institutional desk of a domestic brokerage. Avoiding the credit markets has actually helped the company improve its operating margin to 34% in Q1FY16 from 28.1% in the previous quarter. 

The first half of the fiscal has been bad for Kaveri with a revenue of ₹757 crore, 27% lower than the corresponding period last year. Last quarter, it had to take write-offs due to the return of non-cotton crops (which have a shorter shelf life), as dealers were unable to push the goods. However, LKP’s Ranganathan believes that a massive correction from this level is unlikely. Although the stock touched a 52-week low of ₹380 post Q2 results, it has since bounced back and now trades at ₹417. Time to sow again, perhaps.