Reader's Query: Vadilal Industries Ltd.

Mr. Ravindra Murali shared his analysis on Vadilal Industries and requested for my views on the business. I appreciate the hard work put in by him to study the business.  Let's first study Ravindra's analysis before deep diving in the business. 

Ravindra's analysis (produced with consent):  

Quote

I am analyzing an ice cream companies "Vadial industries" 

What caught my eyes is excellent free cash flow from operations. 

Last three-year average cash flow is around 56cr. The company is using this cash flow to reduce debt which is 122cr by the end of FY16. Approximate maintenance Capex is around 11cr.

I have made simple projections to calculate net profit in future years without assuming any growth in sales. As per this calculation, net profit by the end of FY20 is 29cr which is more than double of FY16 net profit. This is around 15% CAGR growth. 

Assumptions:

1 Average maintenance capex of 11cr is assumed as per previous history and management guidance 

2 Tax of 30% is assumed. 

3 An interest rate of 13% is assumed

4 Depreciation is assumed 13cr as per history 

Other Positive Points:

1. No growth in sales is assumed and as per history and management guidance company is poised to grow at 12 to 15%. So FY20 net profit shall be way higher than calculated.

2. The company stopped commodity type food processing business and concentrating on branded frozen food products. This segment is made around 6cr losses in FY16. Any turnaround ( shall be as per management) this segment will add up in profits.

Valuation:

Company is presently trading at 25PE TTM. Though this looks higher if we see from cash flow point of view it's trading at 7.1 times average operating cash flow and  9.4 times EV/ Avg cash flow.

Please provide your views. Thank you.

Unquote

Ravindra’s analysis intrigued me study the business further.

Business:

Vadilal is India’s second-largest ice-cream brand by sales with around 150 flavours sold in 300 packs and forms.

Vadilal Industries has 2 broad business segments: ice-cream and food processing. 

Ice-cream segment contributes 87% of Vadilal’s annual revenue. Vadilal has strong ice-cream brands like Badabite, Flingo & Gourmet. Vadilal’s strategy is to launch innovative products to maintain leadership and expand in mass premium products. Mass premium products have better margins and are growing a faster pace. This segment, however, remains only a small portion of overall ice-cream segment. 

Excerpts from FY2016 Annual Report:  

Vadilal has two ice cream production facilities – Pundhra, Gujarat and Bareilly, Uttar Pradesh. Vadilal has strong backward integration with the farmer community for milk procurement for ice creams at its plant near Ahmedabad. Leveraging this network, Vadilal has recently forayed in the flavoured milk segment under the brand name “Power Sip”.  

Vadilal processed food division has been aggressively focusing on widening product range i.e vegetables, Indian breads, snacks, curries & paneer. Vadilal supplies ‘malai paneer’ to Gulf and USA. 

Vadilal intends to increase it’s dairy products portfolio by introducing Ghee, Shreekhand and other milk based products. Processed food makes up 12.5% of the overall revenue but is a loss making segment.  

Interestingly, Vadilal is RBI approved Authorized Dealer Category II and carries out Money Changing and current account related transactions. This business is unrelated to the Vadilal’s line of business and makes up for very small portion of revenue. 

Management analysis: 

Vadilal is led by Mr. Rajesh R Gandhi and Mr. Devanshu L. Gandhi, belonging to the promoter group. Mr. Rajesh’s son Kalpit R. Gandhi and Mr. Devanshu’s wife Mrs. Devalben D. Gandhi are also on the board of the company. 

Mr. Rajesh and Mr. Devanshu’s salaries (including commissions) totalled to INR 2.25 cr in FY2016, which is around 16% of the company’s FY2016 profit after tax (PAT). The ratio of their salary is 1:36 to the median renumeration of the employees. While the Annual Report mentions that salaries are within the regulatory guidelines, investor should be apprehensive when management draws significantly high salary as percentage of PAT. 

Promoter group holds around 65% of the equity shares at the end of FY2016. Large shareholding by promoters is a good sign. 

Disputes in promoter’s family:

Ranchodlal Vadilal Gandhi started the Vadilal ice-cream business in 1935. His sons Ramchandra Gandhi  (father of Virendra, Rajesh and Shailesh) and Lakshman Gandhi (father of Devanshu) joined the business in 1945. 

The genesis of the dispute between children and nephew of Ramchandra Gandhi lies in the memorandum of understanding (MoU) signed in 1999 among family members. As per the agreement, Ramchandra's sons Virendra and Rajesh, and his brother Lakshman's son Devanshu had an equal share or one-third each of the total promoter stake in all Vadilal Group companies, including the unlisted Vadilal Chemicals. Ramchandra's third son Shailesh Gandhi had separated from the family business in the early 1990s but owned territorial rights for the Vadilal brand in Maharashtra and South India. 

Virendra Gandhi approached the Company Law Board alleging that his brother Rajesh and cousin Devanshu had joined hands and unlawfully taken control over Vadilal Chemicals from him. Virendra's petition alleged that his brother and cousin changed the company's auditors and transferred Rs 14 crore to Veronica Constructions, a company majority owned by Rajesh and Devanshu's family. 

An investor should take into account the possibility of misappropriation of funds, as alleged, while analysing the investment opportunity. Many well run family businesses falters on the way due to family feuds. These disputes may lead to destruction of shareholder’s wealth. 

Political connections:

Family seems to have close relations with the Congress party. Mr. Rajesh’s daughter Aasth Aastha Gandhi is married to Congress leader Abhishek Singhvis’s son. 

http://economictimes.indiatimes.com/magazines/panache/abhishek-singhvis-son-weds-vadilal-groups-aastha-gandhi-in-a-star-studded-ceremony/articleshow/49653184.cms

Auditor’s comment on CSR funds: 

Management has not spent the required sum on the CSR activities as required by the Act. Investors should be careful investing in companies which violates company's laws.

Financial Analysis: 

Vadilal Sales have grown at CAGR of 16% over last 10 years and at CAGR of 11% in last 3 years. Management expects annual growth rate of ~20-25% over next 3 years. 

While top line has shown good growth, the operating and net profit have remained suppressed for the business. Net margins have hovered around 0-3% over last few years. Margins may improve in future with company's focus on mass premium products. 

The total CFO and capex over last 10 years were INR 302 cr INR 270 cr respectively. Vadilal’s business looks capital intensive - 89% of the CFO spent in capacity expansion.   

Vadilal’s debt to equity is on the higher side ~1.8. 

Company has been able to improve its receivable days to 15-17 days from highs of ~70 days 8-10 years back. Asset Turnover has worsened over last 10 years and remained stagnant over 4-5 years.  

While cash flow from operations are strong, Vadilal needs to borrow from time to time for bringing in new technologies and capacity expansion.

Valuation: 

Many investors feel comfortable paying up higher price for future growth. The stock price tumbles if business falls short of the growth target. 

We believe an investor should apply objective parameters like traditional P/E or P/B ratios. One may miss out on some opportunities with these stringent objective parameters, but this approach ensures significant margin of safety for the investor. 

Vadilal’s earning should grow at signifiant pace (20-25%) to justify any price appreciation from current levels. If growth falters, Mr. Market may readjust the price to lower levels. 

   

Conclusion:

Vadilal Industries is a ~100 year old family run business which has shown good growth over last few years. Management has indicated launch of innovative products to strengthen top and bottom line over next 2-3 years. 

Large capex requirements, strong competition and family disputes are strong headwinds to the business. The current valuation doesn’t provide margin of safety to the investor. 

Disclaimer:

All data has been taken from public sources. I don't have any financial interest in Vadilal Industries or any of its affiliate. I don’t own shares of Vadilal Industries at the time of writing this article. I may or may not invest in Vadilal or its affiliates in future. An investor should do her own analysis before making an investment decision. The views expressed are personal and doesn't represent that of my employer’s.

This article is just a collection of my thoughts about the company.

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations.

Please refer to 'Disclaimer' page for further details.