Investment Thesis For JHS Svendgaard
1. Successful Turnaround : JHS has emerged stronger from the woes of near bankruptcy and has experienced all perils related to debt laden expansions. The management has resolved to a debt free status, with future expansion planned through internal accruals and equity.
2. New Capex : As outlined by management, they are facing a double problem – on one side they are still underutilized on total capacity and on the other hand this capacity is not fungible hence they cannot take up multiple SKUs from clients. The retrofitting on new equipment on existing plants and new capacity coming on stream should solve both problem
Moreover, management is exploring inorganic capacity expansion in West and South India. With strong client relationships, JHS can ramp up fast, post-acquisition of new facilities through inorganic route
3. Client Relationships Is A key Entry Barrier : Given that Oral care market is pretty saturated with key incumbents, strong relationships with clients is a key entry barrier. Having walked the whole path with P&G in the past, JHS boasts of the requisite process standards and manufacturing quality certifications which would lead to meeting stringent product quality in a timely delivery schedule. For a new player, getting into the trusted list of suppliers for the key FMCG brands would be costly and time consuming. Hence ramping up with clients is much easier for JHS, compared to a new supplier.
4. GST and Shift from SSI/Unorganized Segment : GST would lead to an immediate pain for a few quarters due to inventory de-stocking however the reduced tax of 18% from earlier ~25% for toothpastes augurs well for the growth of this segment. Already we are seeing a 9% price cut from Colgate and others are bound to follow soon.
The excise duty and other exemptions available to SSI would now be not available any more. Hence private label manufacturers would prefer shifting to large organized players like JHS.
5. Growth in own brand (Aquawhite) : Management has closely guarded the profitability of the own brand sales, citing lack of adequate accounting measures in its system to report segment profitability. We expect very high margins for this segment. If management can indeed ramp up the own brand sales to 50% of overall revenues, it would add significantly to the top line and profitability.
6. Other FMCG Products : Over the next 2 years, management expects traction related to opportunity in liquid filling contract manufacturing. Given that clients like Dabur are already on board, this can be a huge opportunity in the future.
7. Exports : Given that JHS has successfully exported in the past to private label clients in the US and other markets, it can lead to additional opportunities in sales.
The investment thesis is based on the optimism outlined above, that management will be able to deliver on the promise and opportunity and achieve high sales growth both in contract manufacturing and own brand.
However, the key issue had been large and frequent equity dilution. If JHS goes on diluting equity again in immediate future, instead of buybacks, the wealth creation scope would be limited.
There are two growth streams for JHS – contract manufacturing led growth and own brand sales. FY18 would have disruption for GST in short term and capacities coming on board, full effect in new sales would be seen from 2019
The own brand margins would remain higher than contract sales, but would be capped as JHS plans to spend on advertisements in the future. Hence a higher than 21% EBITDA is not estimated.
Valuation wise, it is tricky to value a business which has just turned around. JHS is in between Converters (85% sales) and FMCG (15% sales). Going forward, management expects the FMCG sales to become 40% + of the overall sales, along with strong revenue growth.
It would be interesting to monitor the progress and see if JHS indeed emerges as a strong FMCG player in years to come.
Key Risks
· Revenue dependency on key customers: Company has few large clients who are accountable for bulk of the revenues. In case of any adversities with client businesses JHS would end up with fixed costs and incur huge losses
· Backward integration for clients: If the current buyers decide to go for own manufacturing capacities this can be detrimental for current and future prospects of the company.
· Compliance and Standard checks: Clients conduct regular audits to check standards and compliance. If JHS fails to meet these audits it can lose significant business from clients.
· Dependence on few products: Company is largely limited to few products for the revenue streams. Any adverse development would lead to large sales gaps, difficult to fulfill by other products.
· Dependence on few suppliers: Company is dependent on few suppliers for raw material procurements. Any large disruption in the supply chain will lead to cancelled orders.
· Underutilization of capacity: Delay in timely ramp up of projected order volumes can lead to high fixed costs for the company impacting the profitability.
· Threat of low cost imports: If the large buyers decide on importing from other low cost destinations company would be in a difficult position.
· Exchange Rate Fluctuations: Exchange rate fluctuations might render the company’s exports noncompetitive and impact the revenues.
· Key man Risk: Company has been largely driven by Mr. Nikhil Nanda. There is no dedicated 2nd line of command capable of leading the business in its growth phase.
· Conflict of Interest: If JHS progresses in its own brand journey, it might come into conflict with its large clients in the same line of business, resulting in lost sales.
2. New Capex : As outlined by management, they are facing a double problem – on one side they are still underutilized on total capacity and on the other hand this capacity is not fungible hence they cannot take up multiple SKUs from clients. The retrofitting on new equipment on existing plants and new capacity coming on stream should solve both problem
Moreover, management is exploring inorganic capacity expansion in West and South India. With strong client relationships, JHS can ramp up fast, post-acquisition of new facilities through inorganic route
3. Client Relationships Is A key Entry Barrier : Given that Oral care market is pretty saturated with key incumbents, strong relationships with clients is a key entry barrier. Having walked the whole path with P&G in the past, JHS boasts of the requisite process standards and manufacturing quality certifications which would lead to meeting stringent product quality in a timely delivery schedule. For a new player, getting into the trusted list of suppliers for the key FMCG brands would be costly and time consuming. Hence ramping up with clients is much easier for JHS, compared to a new supplier.
4. GST and Shift from SSI/Unorganized Segment : GST would lead to an immediate pain for a few quarters due to inventory de-stocking however the reduced tax of 18% from earlier ~25% for toothpastes augurs well for the growth of this segment. Already we are seeing a 9% price cut from Colgate and others are bound to follow soon.
The excise duty and other exemptions available to SSI would now be not available any more. Hence private label manufacturers would prefer shifting to large organized players like JHS.
5. Growth in own brand (Aquawhite) : Management has closely guarded the profitability of the own brand sales, citing lack of adequate accounting measures in its system to report segment profitability. We expect very high margins for this segment. If management can indeed ramp up the own brand sales to 50% of overall revenues, it would add significantly to the top line and profitability.
6. Other FMCG Products : Over the next 2 years, management expects traction related to opportunity in liquid filling contract manufacturing. Given that clients like Dabur are already on board, this can be a huge opportunity in the future.
7. Exports : Given that JHS has successfully exported in the past to private label clients in the US and other markets, it can lead to additional opportunities in sales.
The investment thesis is based on the optimism outlined above, that management will be able to deliver on the promise and opportunity and achieve high sales growth both in contract manufacturing and own brand.
However, the key issue had been large and frequent equity dilution. If JHS goes on diluting equity again in immediate future, instead of buybacks, the wealth creation scope would be limited.
There are two growth streams for JHS – contract manufacturing led growth and own brand sales. FY18 would have disruption for GST in short term and capacities coming on board, full effect in new sales would be seen from 2019
The own brand margins would remain higher than contract sales, but would be capped as JHS plans to spend on advertisements in the future. Hence a higher than 21% EBITDA is not estimated.
Valuation wise, it is tricky to value a business which has just turned around. JHS is in between Converters (85% sales) and FMCG (15% sales). Going forward, management expects the FMCG sales to become 40% + of the overall sales, along with strong revenue growth.
It would be interesting to monitor the progress and see if JHS indeed emerges as a strong FMCG player in years to come.
Key Risks
· Revenue dependency on key customers: Company has few large clients who are accountable for bulk of the revenues. In case of any adversities with client businesses JHS would end up with fixed costs and incur huge losses
· Backward integration for clients: If the current buyers decide to go for own manufacturing capacities this can be detrimental for current and future prospects of the company.
· Compliance and Standard checks: Clients conduct regular audits to check standards and compliance. If JHS fails to meet these audits it can lose significant business from clients.
· Dependence on few products: Company is largely limited to few products for the revenue streams. Any adverse development would lead to large sales gaps, difficult to fulfill by other products.
· Dependence on few suppliers: Company is dependent on few suppliers for raw material procurements. Any large disruption in the supply chain will lead to cancelled orders.
· Underutilization of capacity: Delay in timely ramp up of projected order volumes can lead to high fixed costs for the company impacting the profitability.
· Threat of low cost imports: If the large buyers decide on importing from other low cost destinations company would be in a difficult position.
· Exchange Rate Fluctuations: Exchange rate fluctuations might render the company’s exports noncompetitive and impact the revenues.
· Key man Risk: Company has been largely driven by Mr. Nikhil Nanda. There is no dedicated 2nd line of command capable of leading the business in its growth phase.
· Conflict of Interest: If JHS progresses in its own brand journey, it might come into conflict with its large clients in the same line of business, resulting in lost sales.
Happy Investing
Source:Alphainvesco.com
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