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K S Oils: Growth by expanding operations

Mar 13, 2009

We recently met K S Oils, the largest integrated manufacturer of edible oils particularly mustard oil to understand the sector prospects and the company’s future plans. Here are the key takeaways. Business: K S Oils is the largest processor of rapeseeds in India and largest exporter of rapeseeds de-oiled cake. It also earns revenues through sales of refined soyabean and palm oils. Its other products include vanaspati, solvent and fatty acids and other oils. The company’s revenues have grown at a CAGR of approximately 66% during FY05 to FY08. The company’s increased scale of operation, increased focus on retail segment and brand building has helped it expand its EBITDA margins from 3.1% in FY05 to 10.7% in FY08. During 9mFY09, the company reported 65% YoY growth in topline, while bottomline growth stood at 53% YoY.

Edible oil sector overview: The growth of the edible oil sector is linked to consumption. Recently, consumption has taken a hit but this has been in the case of discretionary products and not necessity goods. Edible oil being a necessity product the demand for it has not waned despite economic slowdown. The sector and the company have not seen any major impact of economic changes. The edible oil market is growing at the rate of 6% p.a, while the branded (organised packaged oil market) is growing at the rate of 20% p.a. The branded segment is expected to continue to grow at the same rate in the long run on account of increased health care consciousness and preference for packaged products (avoidance of adulteration). To bank upon this opportunity the company has planned to ramp up its capacity.

Expanding scale: Currently, the oil mill capacity stands at 2,675 tonnes per day (tpd) which the company plans to increase to 4,875 tpd towards the end of the current financial year. Solvent extraction capacity will be scaled up from 2,900 tpd to 4,500 tpd by FY10. Refinery capacity will be scaled up from 1,550 tpd to 1,850 tpd by FY10. The company is funding its growth plans by diluting equity and by leveraging its balance sheet.

Integrating facilities to create entire value chain: The company has outlined huge expansion plans to cater to the increasing demand for edible oil particularly mustard oil. It has also planned to integrate operations in order to sustain margins and stay competitive. The company is catering to the demand of Northern and Eastern India. In order to have a manufacturing facility in one of the key markets, to improve logistics efficiencies that will result in easy accessibility to Eastern markets, the company has acquired an edible oil refinery at Haldia port for a consideration of Rs 1.25 bn. The acquisition will increase the company’s refining capacity by 500 metric tonnes per day. The company has 6 plants in North and Central India and this additional facility will enable the company to cater to its existing markets and enable it to achieve pan India presence over the long run. The acquisition is being funded through a mix of long term debt and internal accruals.

The company has also acquired 20,000 hectares of palm plantation in Indonesia as a part of its strategy to ensure secure supply of raw materials. The acquisition is also likely to provide a shield against price fluctuations. The company plans to supply 80,000 tonnes oil to its manufacturing and refining plants in India from its new plantation in Indonesia. The company not only plans to secure supplies for its own facilities but also earn revenues in the long run by supplying oil to other players. The full benefit of this acquisition will start flowing in two to three years once the company develops plantations and commences the oil mill. The cost of setting up the oil mill and the acquisition of plantation works out to Rs 3.3 bn and the same is funded through a mix of debt and internal accruals.

Growth strategies: To enhance revenues K S Oils needs to increase its reach and visibility. The company has increased its network of distributors from 600 to over 900 to boost sales volumes. To boost earnings by way of cost savings, the company has opted for the rail route to dispatch produce instead of road ways. The company is focusing on usage of railway rakes as cost per carton/tin is lower to the extent of 60% in case of rail transport. Apart from this, the company has increased focus on branded and retail segment as they earn higher margins.

Funding growth: The company has recently subdivided its share of face value of Rs 10 per share to Re. 1 per share. Further, for the purpose of expansion it had issued warrants in 2006. The same have been converted in the current financial year at Rs 41.9 per share (face value of rupee 1). There will not be any need to further dilute the equity base to support growth plans. The company has secured loans and is utilising internal accruals to fund expansion plans. Despite leveraging its balance sheet the company is likely to end the year at a gearing ratio of below 1. With increase in scale of operation, the company will be better placed in terms of procuring raw materials and will benefit from economies of scale. But increased borrowings are likely to pressurise margins till the time full benefit of capex starts flowing in.

On a concluding note…

Considering increased health care consciousness and edible oil demand supply mismatch there is significant scope to explore untapped markets. The company operates in a competitive environment. With the downturn, established FMCG players are also increasing focus on retail packs and value added products (by introducing health conscious brands) that enjoy better margins. Inability to sustain brand premium can affect the margins of the company. While we do not foresee that as a major threat as the company’s brands are well established in the existing markets, the possibility of the same cannot be ruled out. The company is likely to witness stiff competition particularly in new markets as it ventures into new geographies with a motive to establish pan India presence.

At the current price of Rs 41, the stock is trading at 8.9 times trailing 12-month earnings. Considering the growth prospects and huge expansion plans of the company to maintain its market share, we expect KS Oils to grow in line with the sector growth.

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