Dear Sir,

We would like to share with you a detailed report on Chaman Lal Setia Exports (BSE – 530307).

Recently, in Nov’16 we shared our findings on Chaman Lal Setia (BSE – 530307) which is one of India’s leading processor and exporter of Basmati rice. The report was initiated for Alpha and Alpha plus members in November 2016 at around levels of 60 (CMP – 103).


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Note: The report is being shared only for the purpose of information and is not an investment advice. In case you invest in Chaman Lal Setia or for that matter any company, please carry out your own due diligence.

Chaman Lal Setia Exports – Basic details
(27th Nov’16 note on the stock)

Promoted by Chaman Lal Setia, Vijay Setia and Rajeev Setia, Chaman Lal Setia Exports Limited (CLSE) was incorporated as a partnership firm in 1975, under the name Chaman Lal & Sons. In 1995, it went public under its present name to finance the expansion and modernisation of the units.

CLSE is engaged in the business of milling and processing of basmati rice. The company has a paddy unit in Karnal (Haryana) and Amritsar (Punjab) with a rice processing capacity (including both milling and sorting) of 14 tonnes per hour. The company also has a rice grading and sorting facility in Delhi.

We like the company on several fronts, though at the same time one will have to be watchful of risks/concerns as discussed in the risks/concerns section below.

As far as positives are concerned we like the way the operating performance of the company has shaped up over the years, company’s increasing focus on exports, increasing focus on improving the share of branded sales under “Maharani” brand, induction of third generation promoters, high promoter holding, well managed working capital and lastly the valuations.

Business

As mentioned above, CLSE mills, processes, and trades in basmati rice in the domestic and export markets.

CLSE derives its revenue primarily from only one segment i.e. sale of rice. Besides purchasing paddy and processing at its own unit, the company is also engaged in procurement and sales of semi-processed rice. The company’s product range covers raw, steamed and parboiled rice. The company also has two innovative products in its portfolio i.e. diabetic’s basmati rice and pesticide-free basmati rice.

At present, the company operates rice milling units in Punjab at Amritsar and Karnal. The Karnal sheller also has a Sortex machine which incorporates state of-the-art technology for cleaning rice and removing impurities.

The company has a wide marketing network spread throughout the country and sells a whole range of basmati rice, including the premium variety, under its famous brand, ‘Maharani’. Apart from this, it also exports rice under its own brand and in the form of private labels. As of date it operates with a capacity of 14 tonnes per hour.

Chaman Lal is recognized as a star export house by the Government of India; also accredited with ISO 9001:2008, HACCP and FDA (USA) certifications.

Geographically, the company’s revenues are diversified across domestic and international markets. Exports account for around 80% of the company’s revenues. Exports are further diversified across the countries such as USA, UAE, Mauritius, Saudi Arabia, Malaysia, Kuwait, New Zealand, Australia and Singapore, among others.

The company is also focused on carrying out R&D and coming out with new products. In the past the company has come out with products like: Maharani Rice with Low Glycemic Index Suitable for Diabetics and Bhathi Sella Rice (Roasted Parboiled Rice)

Further, as per the management they have developed a novel process for reducing energy and water requirement in paddy parboiling process. As a result the water consumption and energy expenditure in mechanical parboiling of paddy has greatly reduced. The Company has also developed the novel process of recycling of most of hot water used for soaking of paddy during parboiling of rice, thereby generating little waste water and still having a high quality product.

Industry overview – Rice is one of the most crucial food crops in the world and a staple diet for nearly half the global population. Over 90% of the global rice output and consumption is centred in Asia, wherein the world’s largest rice producers, China and India, are also the world’s largest rice consumers.

Basmati rice accounts for ~2-3% in terms of volumes of the overall rice industry. India accounts for over 70% of the world’s basmati rice production and the rest is accounted for by Pakistan. Basmati is unique to the region. It can be grown where precise climatic conditions, soil quality and temperature exist and this only occurs in the Indo-Gangetic area of the Himalayas. It is also legally protected as a trade name. “Basmati” is protected under “The Geographical Indications of Goods (Registration & Protection) Act, 1999” of India, which prevents any rice grown outside of the Indo Gangetic area from being called Basmati.

Basmati rice constitutes a small portion of the total rice produced in India. By volume, the share of basmati rice was around 6% in 2014-15, even as by value, basmati rice exports accounted for 57% in 2014-15; of India’s total rice exports.

Basmati rice exports have increased at a compounded annual growth rate (CAGR) of 27% from Rs 28.24 billion in 2004-05 to Rs 275.98 billion in 2014-15.

While basmati rice is consumed across the globe, West Asian countries accounted for 75% of Indian basmati rice exports in 2014-15. Within West Asia, Iran and Saudi Arabia are the two largest buyers, together accounting for over 50% of basmati rice exports from India.

However, even as Iran emerged as one of the largest importers of basmati rice in recent years, the country imposed a ban on basmati rice imports from India in 2014-15, citing its own healthy rice crop and large basmati inventory.

As per ICRA basmati paddy is also vulnerable to cyclical price fluctuations. Higher prices in the market encourage higher basmati paddy cultivation, which increases supply in the next season.

This depresses the price, thereby erasing gains and shifting farmers away from basmati paddy cultivation. During the procurement season of 2012-13 and 2013-14, there was a steep rise in paddy prices from around Rs 18,000 per tonne (MT) in 2011-12 to around Rs 37,000 MT in 2013-14, due to strong demand in the international market.

Subsequently, the last two seasons were not so good due to excess supply and weak demand. However, the situation is expected to improve now on account of two factors: The supply of basmati paddy is expected to witness some moderation as farmers are likely to shift away from basmati, given the non-remunerative prices in the last two crop cycles, and since Iran has removed the ban on import of rice, demand is also expected to witness some improvement.

Promoters/Management

Chaman Lal Setia Exports is an owner operated business with Mr. Chaman Lal Setia and his sons Mr. Vijay Setia and Mr. Rajeev Setia at the helm of the affairs of the company.

Mr Vijay Setia is an Ex-President of All India Rice Exporters Association. Regd. (AIREA), Delhi and has been associated with an international company namely M/s. Gerson Lehrman Group as a consultant in the field of Food Technology for having in-depth knowledge of the subject.

The company has also seen induction of 3rd generation promoters with Mr. Ankit Setia and Mr. Sukarn Setia taking keen interest in the operations of the company.

As per one of the reports of CRISIL, with the induction of 3rd generation promoters the company has again started focusing on expansion of business and the results have paid off with opening of new export markets like Australia, New Zealand, Singapore, etc. It is also planning to increase marketing spend for its brand ‘Maharani’ to increase retail presence.

Overall the promoters have run the company well and much more efficiently than some of the larger listed peers.

The promoters of the company own more than 70% stake and therefore their interests are directly aligned with those of shareholders. Further, they have been continuously paying dividends since 2003.

We have also not come across any major red flags in terms of related party transactions.

Operating Performance

One of the major positives of CLSE is its operating performance which has improved significantly over the years.

Processing and sale of rice is a capital intensive business; more so in the form of working capital needs due to ageing process. Ageing is necessary to (a) ensure a higher recovery of head rice and reduce the proportion of broken rice while processing, (b) remove moisture and (c) increase the aroma. Both paddy and rice are aged though there is a limit to the effectiveness of ageing paddy beyond six months. Rice can be aged for longer periods and rice aged beyond a year has a price premium but remains a niche product.

As per one of the reports there is minimal benefit of holding excess paddy inventory. The reason is that ‘aged’ paddy no matter whatever vintage (in terms of harvest year) is priced the same. Consequently, if paddy is stored for more than a year then its value is determined by the next year’s paddy prices. Rice processors like REI Agro, Usher Agro, etc have suffered immensely on account of holding excess inventory.

As far as CLSE is concerned, it’s among the more efficient rice processors. Considering excess rice processing capacity in the country, the company hasn’t expanded its capacity since long and has also focused on procurement of semi processed rice.

On account of the above steps, the company has spent negligible amount on CAPEX, while still has been able to grow its sales. Also, its working capital requirement is much lower in comparison to other rice processors.

With lower CAPEX and relatively lower working capital requirement, the company has much better balance sheet in comparison to its peers and there hasn’t been any major dilution in equity over the last 10 years. Over the last few years the inventory days of the company have reduced from around 80-90 days to around 35-50 days. Similarly debtor days have reduced from around 120-130 days to around 60-80 days.

On the growth front, despite no major CAPEX the company has been able to grow its sales at 17.5% CAGR over the last 6 years. This has been achieved on the back of growth in both volumes and realizations. In FY 16, the company reported lower sales in comparison to FY 15 despite more than 27% increase in volumes as the realizations for basmati rice declined.

What is interesting to note, that barring FY 16, from FY 10 to FY 15 the company could consistently maintain its EBITDA margins in the range of 7-9%. In FY 16, the EBITDA margins expanded to 12% + on the back of expansion in gross margins to 29% from ~20% in FY 15. We believe, lower decline in realizations against much higher decline in procurement of paddy and semi-processed rice helped the cause of margin expansion.

It remains to be seen if the company is able to sustain high gross margins of FY 16 or reverts back to previous levels of 21-22%.

As far as return ratios are concerned, the company has consistently been recording ROE and ROCE in excess of 15-20%.

Valuations

At around current price of 60 the market capitalization of the company is Rs 310 crores and the enterprise value is ~ Rs 270 crores. The enterprise value is lower than market cap as the company is cash rich with surplus of around 40 crores as of 30th Sep’16.

For the trailing twelve months the stock has recorded PAT of Rs 37 crores and EBIT of Rs 55 crores. The stock is therefore trading at 8.38 times trailing twelve months earnings and EV/EBIT multiple of 4.90.

We believe the current valuations on absolute basis look low; however we would like to take average profitability of last 3 years as that would normalize the impact of gross margins expansion in FY 16 and H1 FY 17. Further, the last 3 years sales were in the range of 400-500 crores and therefore better indicative of performance of the company in comparison to previous years when the sales were much lower. Going forward, we expect sales to improve on the back of expected improvement in realizations of basmati rice.

The average net profit for the last 3 years is Rs 25 crores and the stock is trading at 12.4 times 3 years average PAT. In the rice processing segment, KRBL commands the highest valuations at 18 times TTM PAT; however KRBL has much bigger operations, well known brands like India Gate and also both forward and backward integrated operations.

Risks and Concerns

CLSE derives 80% of its sales from exports. Import ban from major basmati rice importing nations like Iran, UAE, Kuwait, etc. can impact the sales and the profitability of the company.

Basmati rice commands premium over regular rice; however the pricing and branding power in the industry is still very low.

High volatility in the prices of paddy and semi-processed rice can have a negative effect on profitability for CLSE.

Despite increase in sales, profitability can remain flat or decline if the company isn’t able to hold on to its gross margins of 29% reported in FY 16.

Disclosure: I don’t have any investment in Chaman Lal Setia Exports and have not traded in the stock in the last 30 days.

Best Regards,

Ekansh Mittal
Research Analyst
http://www.katalystwealth.com/
Ph.: +91-727-5050062, Mob: +91-9818866676
Email: info@katalystwealth.com

Research Analyst Details

Name: Ekansh Mittal     Email Idekansh@katalystwealth.com    Ph: +91 727 5050062

Analyst ownership of the stock: No

Details of Associates: Not Applicable

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Disclaimer: www.katalystwealth.com (here in referred to as Katalyst Wealth) is the domain owned by Ekansh Mittal. Mr. Ekansh Mittal is the sole proprietor of Mittal Consulting and offers independent equity research services to retail clients on subscription basis. SEBI (Research Analyst) Regulations 2014, Registration No. INH100001690

Ekansh Mittal or its associates including its relatives/analyst do not hold beneficial ownership of more than 1% in the company covered by Analyst as of the last day of the month preceding the publication of the research report. Ekansh Mittal or its associates/analyst has not received any compensation from the company/third party covered by Analyst ever. Ekansh Mittal/Mittal Consulting/analyst has not served as an officer, director or employee of company covered by Analyst and has not been engaged in market-making activity of the company covered by Analyst.

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