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Are Edible Oil companies good investment bets?

Mar 6, 2012

India with its huge 1.2 bn population, and GDP growth of approximately 8%, generates a major demand for edible oil. Despite being one of the largest producers of oilseeds in the world, India's domestic production of edible oil is insufficient to meet these overall needs. As much as of 50% of the edible oil demand is met through imports. Palm oil constitutes the lion's share of 78% whereas soyabean oil, sunflower oil and other edible oils form the balance of the import basket (as per Solvent Extractors Association of India). Due to the huge reliance on imports, domestic edible oil companies are vulnerable to global demand-supply dynamics and currency rate movements. Seasonality coupled with higher share of imported inputs entails longer inventory holding thereby stretching the working capital of the companies. To add to this, the huge presence of the un-organised market arising from low entry barriers keeps the profitability of the industry woefully low.

Resulting from these competitive market conditions with no product differentiation, most edible oil companies are operating on wafer-thin margins of less than five per cent (see Table below). Also, companies such as BCL Industries and Ruchi Soya Industries, having piled on debt of nearly two times their equity components, are further financially stressed. These companies are literally on tenterhooks and reported net margins of a mere one per cent of sales in FY11. However, Raj Oil Mills earns slightly better margins than peers as it sources raw materials domestically and so has more comfortable leverage with a debt/equity ratio of 0.4. Thus volatile earnings, high leverage and poor margins make edible oil companies susceptible to losses in a cyclical downturn. A classic case is KS Oils, which has the most stretched balance sheet, and was pushed into the red in FY11. Although, Amrit Banaspati and JVL Agro have managed to give attractive returns on equity, these companies historically have been big importers raising doubts on the sustainability of future returns.

Profitability on the edge (FY11)
Company nameSales (Rs bn)Input imports (%)Operating margin (%)Debt/equity (times)Net margin (%)RONW (%)
Amrit Banaspati Company Ltd.10.1032.414.040.782.1849.66
BCL Industries & Infrastructures Ltd.4.8030.853.491.871.1312.36
JVL Agro Industries Ltd.21.8178.193.950.672.2925.07
KS Oils Ltd.56.2816.001.202.14-6.31-28.16
Marico Ltd.23.485.2715.620.6313.4343.66
Raj Oil Mills Ltd.4.69 10.220.405.5310.43
Ruchi Soya Inds. Ltd.166.7856.574.201.621.2810.58
Source: Ace Equity

Brand strength shields Marico

In the low margin edible oil market, one company that has forged way ahead of its counterparts is Marico. This company is present in the super-premium edible oil market with its Saffola brand, and clocks net margins of around 13%. Saffola edible oil was launched way back in the 1960s, but was promoted as healthy oil for the heart in the 1990s. Marico set up the Saffola Healthy Heart Foundation in 1991, and followed it up with several rounds of mass-media campaigns. The Foundation conducts camps to build awareness about risks that our modern lifestyle poses to the heart, and helps people lower those risks. These initiatives have created a 'good for the heart' image for the Saffola brand. This unique brand acceptance allows Marico to command a substantial premium over other edible oil brands and shields it from vagaries of the industry dynamics.

To conclude...

Given the large demand in India, there is a huge dependence on raw material imports. The intense competition in a market with little product differentiation and vulnerability to commodity cycles, has squeezed the profitability of the edible oil companies. Marico has overcome these structural problems by successfully building the Saffola brand with healthy heart image. So, Marico, having "cooked" its brand strategy well is clearly a safer investment bet among edible oil stocks.

Madhu Gupta

Madhu Gupta (Research Analyst), ValuePro has a post graduate degree in both physics and finance. Having worked with India's leading economic research agency, she has a natural flair for numbers and analytics. She brings with her a near-decade long rich experience in the field of finance. A firm believer of the principles of value investing, she looks for robust businesses with durable competitive advantages.

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