S H Kelkar and Company Limited (SHK) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining us on S H Kelkar and Company's Q2 and H1 FY '21 Earnings Conference Call. We have with us Mr. Kedar Vaze, Whole-Time Director and Group CEO; Mr. B. Ramkrishnan, Head Strategy; and Mr. Shrikant Mate, VP and Group CFO of the company. We will begin the call with opening remarks from the management, following which we'll have the forum open for a question-and-answer session. Before we start, I would like to point out that some statements made in today's call may be forward-looking in nature, and a disclaimer to this effect has been included in the earnings presentation shared with you earlier. I would now like to invite Kedar to make his opening remarks.

Thank you, Anoop. Good afternoon, everyone, and thank you for joining us on our quarter 2 and H1 FY '21 earnings call, to discuss the operating and financial performance for the quarter. I trust you and your families are safe and maintaining all precautions against the spread of COVID-19. To begin with, I'm pleased to share that we have delivered a robust performance during the quarter on the back of healthy uptick in demand across both the domestic and the international markets. Increased traction in engagement with large and mid-sized FMCG customers led to new business wins across various categories, further laying a solid foundation for us to deliver multiyear growth. In addition, our wholly owned subsidiary, CFF, also delivered an encouraging performance. I would like to highlight here that the quarter's performance includes consolidation of CFF numbers with effect from August 1, 2020. So on a consolidated basis, our revenues from operations stood at INR 351.9 crores. And on a like-to-like basis, excluding the CFF, our revenues in quarter 2 was higher by 14% year-on-year. On the profitability front, higher operating leverage and better product mix enabled us to report strong performance during the quarter. This, along with a stable raw material environment and cost optimization measures executed over the last few quarters, further enhanced margin performance during the quarter. Our gross margins during the quarter stood at 44%, while EBITDA margins improved to 21%. CFF also delivered steady performance in its core Fragrance division, driven by increased demand and volume offtake in the Italian and other European markets. Gross margins in the core Fragrance segment remained strong at 54%. Reported PAT, included an exceptional income of INR 12.5 crore, which was recorded on account of remeasurement of our stake in CFF after it was recognized as a wholly owned subsidiary. Excluding this amount, the PAT stood strong at INR 41.3 crores, higher by 176% year-on-year. On the segmental basis, the Fragrance division witnessed healthier pickup in demand and saw improved business wins as the country moved to the unlocked down phase. The Flavour division we launched new product offerings which saw strong acceptance in the domestic and international markets. This in addition to improved recovery in the demand environment resulted in healthy sales during the quarter. From a consolidated balance sheet perspective, as on September 30, 2020, the company's net debt position stood at INR 454 crores. This includes consolidation of the CFF debt and the payment of the second and final tranche of the CFF acquisition of about INR 141 crores. Excluding CFF debt and acquisition payments, our net debt was steady at INR 249 crore. Going forward, we have no major CapEx plans on hand, and the focus remains on sweating current investment and generating healthy free cash flows. Accordingly, I'm also happy to share here that the Board of Directors has declared an interim dividend of INR 1 per share. This is in line with our dividend distribution policy, while maintaining a healthy balance sheet position. As we look ahead, a combination of improving economic indicators and the festival season should help strengthen demand and consumption across the country. This will enable us to sustain our momentum going forward. After witnessing one of the most challenging periods in the F&F industry over the past few years, we believe we are strongly back on track to deliver healthy and sustainable growth in the near to medium term. While there is reasonable optimism on the domestic front, the second wave of COVID in Europe and elsewhere needs to be factored. We are taking all measures to mitigate the risk and ensure the safety of our people. Furthermore, we are monitoring our operations and processes, such that it poses minimal risk for the spread of this disease. However, it is difficult to estimate the impact of this development on the results of the rest of the year. On that note, I would request the moderator to open the forum for any questions and suggestions that you may have.

[Operator Instructions] The first question is from the line of Alpesh Thacker from Motilal Oswal Financial Services.

Yes. First of all, congratulations for a very good set of numbers, sir. My first question is on, we have talked about new customer wins across categories. Can you please throw some light on the customers where we have won these deals and segments, whether it is in Flavors or Fragrances? And how huge is this opportunity in terms of annual run rate, because it's a multiyear deal that we are talking about? So any information on that would be very helpful, sir?

So it is both wins in Fragrances as well as Flavors. We have pretty much across the board, all the customers. We have seen good traction of new development, particularly in the health and wellness, new launches around health soaps, around sanitizers, around specific health benefit products. So we have got a large number of deals. On an estimated first half, we have clocked roughly INR 35 crores of new win potential, which should help us continue the growth trajectory in the years to come.

Okay. So are these domestic or the international side? Hello? [Technical Difficulty]

Sir, requesting you to please stay online. We're trying to reconnect, sir, back to the conference. Requesting participants to please stay online, we are just trying to reconnect the Chairperson back to the call. In the meanwhile, the other host is unmuted, so you all may please go ahead while I connect the speaker. Mr. Ramkrishnan and Mr. Shrikant Mate, your line is unmuted. I'm just trying to reconnect Mr. Kedar Vaze.

Yes.

Ladies and gentlemen, thank you for patiently holding the line. We have the speaker reconnected to the conference. Sir, we had the question from the line of Alpesh Thacker.

Yes, yes. So second question was, sir, in the Flavours division, we saw a very big jump in the margin. So that was, I guess, because of the product mix that you have talked about. So can you elaborate a little bit on that? And what can be the sustainable margin in that business?

So I think as the Flavours business, we have higher share of exports in this quarter that is boosting the overall margin profile. I think we still are at kind of maybe 2%, 3% higher gross margin overall than the trend line which we expected. And it will be around the same 50% gross margin level where we expect Flavours to be on a sustainable basis.

Okay. That was helpful. And just 1 clarification from the earlier question. So you were talking about INR 35 crore run rate. So was that the quarterly run rates on the new win?

No, so INR 35 crores is the new revenue from the new wins of this year. So next year, we should expect INR 35-odd crore of new revenue from what we have made new developments this year.

The next question is from the line of Mr. [ S. Bhaiyaa ], individual investor.

Hello?

Yes, please go ahead.

Yes. Congratulations on a good set of numbers. Sir, just on a broad level, we have had a couple of challenging times in the past few years, and we have steered through them pretty well. But just in hindsight, is there anything you would have done differently? And going forward, will we change our approach in any way? If you can...

No, sir, we had this same question earlier 2 quarters back. I think in hindsight, we could have taken lesser risk and been more conservative in our investment and growth strategy. As I mentioned at that time, we have now restructured the outlook of the business on a business unit by business unit and region by region, which helps us to react to any specific changes in a much faster manner.

Okay. Okay. And last question, just how do you see the raw material prices going in the next few quarters? If you can give some sense of how it might...

So I think the raw material prices are -- at the beginning of this year after the pandemic has been at a very low level. We expect that the raw material prices will more correct slightly in the coming quarters. There is a lot of factors which are playing out. And at this moment, it is difficult to assess how the market trend or the raw material situation will be. We have a fair visibility on our contracts and stock in hand for the next 2 quarters. For us, the raw material prices will remain more or less the same, maybe a couple of percentage higher cost towards the end of the fiscal year.

The next question is from the line of Sabyashachi Mukerji from Centrum PMS.

I have 2 questions. Firstly, on your quarterly performance, we have clocked around INR 350 crores of revenue and EBITDA margin of 20%. This has been with -- this INR 350 crore number and the 20% kind of EBITDA margin number has not been seen probably in the last 10, 12 quarters, in a long time. What is the sustainability of such run rate in the quarterly, both in terms of revenue and margins, if you can throw some light?

So I think if you look at the revenue run rate, excepting for the last quarter, we have been looking at a 2% to 3% sequential quarter-on-quarter growth. That has been the track. So this quarter is on the same trend. I would expect subject to -- just keeping in mind the second wave of corona internationally to understand its effect, if any. But otherwise, I would expect the demand to continue to grow at this pace, 10%, 12% per annum, and we will continue to grow sequentially 2%, 3% per quarter. On that line, our last couple of years have had a lot of macro events with GST and gross margin. And as I mentioned earlier on the call, we have had to take corrective steps. And we have taken most of those and built our business back in line with the current revenue and cost structure. So I think this is now the reset of the business post the couple of years. And from here on, we see this to be sustainable. We have already guided 43% gross margin and a ballpark 20% EBITDA level. And we will maintain that guide path with a 10%, 12% growth rate year-on-year.

Just related to that, is it something that some of the Q1 revenues got spilled over to Q2, and that's why we are seeing such a sharp Y-o-Y jump in Q2? Is that a correct understanding?

To some extent, although I see a similar trend in the first half of this quarter. So there is no sharp drop in the demand situation. So we believe that we will have similar quarters going forward. There is no specific kind of one-off or catch-up demand in this quarter.

Okay. My second question is a bit on the longer term. If I look at your numbers from FY '16 or FY '17, and I look at the gross assets, gross block -- gross net block number and the sales number. Your gross block or the net block, it has almost doubled because I think you have done good amount of CapEx in '19 and '20 and now this inorganic acquisition. But your sales have almost hovered from INR 900 crores to INR 1,000 crores to INR 1,100 crores kind of a range. Now what is your long-term outlook that we see as 5 years? You are currently at probably USD 150 million kind of a revenue where the other global players are much, much bigger in size. Can we reach to a level of something of $0.5 billion in probably 5 years? What is your long-term outlook on this scene?

So our Chairman and my father, Ramesh Vaze, has already put out a few years ago to direct us to making a $1 billion Fragrance and Flavour company. So we are making all steps necessary to go in that direction. I think the question of the results, we have continued to do the right investments and the right management steps. There have been many factors partly outside our control, which has affected the last 2, 3 years. We wish to just continue to do the right things, and we are very confident that these results will be sustainable, and we will be on this track going forward.

The next question is from the line of Deepak Poddar from Sapphire Capital.

So just wanted to understand on your debt part. So now that you mentioned that we don't have any major CapEx plan, and we are focusing on generating free cash flow, and considering our improved performance. So how do you see your debt repayment over the next 1 to 2 years?

We had already indicated earlier in the year that we intend to be around the same level at the end of March, so around the INR 300 crore net debt position end of March. Our expected debt levels in CFF, working capital has been slightly higher. They have continued to grow double-digit in the last 3, 4 months despite the events around the COVID. So there has been a bit of increase in their working capital debt level. So today, we stand at INR 454 crores net debt as of end of September. So I would look to bring that down by around INR 125 crores to INR 130 crores in the -- by end of the year.

Yes. And about next year?

So we continue to have cash -- month-on-month, quarter-on-quarter cash-generating business. So the trend line would continue to be in that. We have no major CapEx outlined for this year or for next year. And we will continue to bring down the debt if there are no opportunities for the investment.

The next question is from the line of [ Naresh Vaswani ] from [ Sameeksha ] Capital.

Congratulations on great set of numbers. Sir, this EBITDA margin, which has improved, how much of this was due to operating leverage? And you also mentioned about cost savings which you have done. So how much was on that account? And also, we had operations shift from Netherlands to India. If you can quantify into these 3 factors that would be helpful. And second, on the 14% growth, which we have done, how much of this was due to COVID-related increased demand of your products? And your 12% guidance, how do you plan to achieve that, whether it's by adding new clients or by adding new wins? That would be helpful if you could, right.

Okay. So I will answer that question in reverse order. So on the growth, I think I have already alluded, we have roughly INR 35 crores of new business in the first half of this year. That will add to our top line next year. Plus, we have continued to grow with our current clients, and we see double-digit growth in many of our current clients, both domestic as well as internationally. In Fragrance exports, particularly Southeast Asia, we have lost some business on the supply disturbances in the first quarter. We hope to regain that business as well. If you can -- if you look at the sustainability, you talk about a 14% year-on-year growth. I think there will be some impact, probably 1% or 2% impact of the previous quarter coming into this quarter in terms of growth. Being mindful of that, I think we are still poised for a steady 12% plus sustainable growth. As regards to cost, we had alluded 2 quarters back and before, that we are taking steps. The cost structure of moving the Netherlands operations to India has already resulted in roughly INR 12 crores to INR 13 crores of annualized cost savings in this year. And you can see those effects of that following through. We have also restructured our business internally and made it more cost efficient. So that -- all of those things you can see in the cost structure. We are now on a sustainable cost level where we have no specific changes: neither new increases, neither any further reductions, which are planned. And from here on, we will closely monitor the growth and the resourcing that we need on a quarter-on-quarter basis.

All right. So we are confident of clocking 20% margins?

So at the gross margin level, 43%, and around the 20% EBITDA level, we are confident to be sustainably around that level. I would just put a small caution that some of the international business is directly affected by the COVID situation in the first quarter. Given the second wave, there might be one quarter up or down in the second half of the year, which depends on how the global demand pans out for the ingredients.

And the second question on the balance sheet, the intangible assets have increased by INR 265 crores in this first half. So this entire acquisition has gone into that? And are there no tangible assets in CFF right now?

Shrikant, you may want to answer this question? Shrikant?

Sir, sure, I'll just unmute the line.

Yes. Large part of the acquisition purchase price was fair value, and intangibles are largely arising out of that by way of formulations, the value by your customer relationships, and goodwill. So you're right, large part of that is directly linked with completion of tranche 2 acquisition.

Okay. So any amount in the tangible asset for CFF right now?

Sorry? I didn't quite hear that.

Shrikant, what is the fair value of the tangible assets?

Oh, fair value of the tangible assets. So fair value of tangible assets is roughly INR 37 crores.

Okay. And this intangible assets, which we have created. So what would be the expected amortization per year?

So we have well-defined policy for amortization of these intangible assets, depending upon what type of assets these are. So it typically ranges between 10 to 15 years based on the useful economic life. Goodwill is not amortized. This is tested for impairment every year as required by the IFRS or IND AS.

Sure. And one last question. Sir, you have mentioned that whenever you look for acquisitions, we target 20% ROCE. But right now, CFF is around -- if you see the ROE, it is around 7.8%. So how do you plan to take it to 20%?

So Kedar, you want to take that question?

No, sir, I think the 20% ROCE is in INR. When you look at the European situation, we have a very low debt rates, roughly around -- hovering around 2%. So at 7%, 8%, we are still seeing a very high value. Plus as things restart to grow, there is synergies, which are not taken into account in the current results. So we can drive roughly around $0.5 million of cost savings and additional $0.5 million of synergy benefits as we start to operate the 2 companies and take benefit of the product development and supply chain on both sides.

Okay. And just last one. What was the capacity utilization in Q2 across all your assets?

So capacity utilization was similar to the last quarter of the previous fiscal, hovering around the 50% for the Fragrance and Flavor businesses and 80% for Mahad and Vapi facilities. At this moment, our China facility is operating at a very low level, 20-odd-percent, given the demand slackness on some of the raw materials.

[Operator Instructions] The next question is from the line of Bharat Sheth from Quest Investment.

Kedar, congratulations on excellent performance. Hello?

Yes, thank you.

Kedar, I mean if you can give a little more color, what kind of a synergy that we have -- can have with CFF going ahead? That is one. Second, we were working to win some international client and then converting them -- our local MNC also has a client. So where -- in this whole journey, where we are?

So firstly, on the CFF, as I alluded, we have roughly EUR 0.5 million synergy, which is low-hanging immediate synergy on buying and supply chain. We also see an estimate another EUR 0.5 million of synergy based on management cost and development cost-sharing across the various businesses. So this is the road map for the synergies of CFF integration into Keva Group. On the second question -- can you -- the second question. First question was on synergy. Second question was on MNC?

Yes.

We do have some inroads in global MNC. We are continuing our efforts, and we are very close to actual business. So we have some products which are approved at various stages. And there were some delays on account of COVID situation where the launches were put ahead. But we are already ready with the products and designs, and we should be getting some actual business very soon.

Will it be for India business or international export also?

Both India and export.

And how big is the opportunity?

So, initially, it will be small, INR 1 crores or INR 2 crores annualized business, but this will start to grow subsequently.

And can you please say -- give some color on this working capital scenario? Because in this quarter, I mean, inventory has shot up because of [ you ] and -- CFF also as well as trade payable also has gone up. So if you can -- what kind of a normal -- working capital cycle will be going ahead?

No. I think the normal working capital cycle, as we have mentioned earlier, we expect it to be lower, around the same levels as March end last year. This year -- quarter, we have taken steps to take additional inventory with longer payment cycles to the vendors. Even the supply chain, there were a lot of logistic issues. We have chosen to keep the inventories in our plants, rather than on contracts, which will come in subsequently. I think this -- the operations side in India is fairly normalized in terms of logistics and deliveries. And we will then look to restore to our normal levels and reduce the inventory which we hold at this point. So another roughly INR 25 crores to INR 30 crores of additional inventory is present in the balance sheet as of end of September.

And receivable and payable, sir?

So receivables remains in the similar range. Payable, we have made a conscious effort and conscious discussion with the vendors that we will extend credit terms. And we will keep the inventory in our books rather than taking the material on a deferred supply basis, given that logistics and -- so all of these steps were taken in the first quarter when corona was disturbing the supply chain, and with a much higher level of uncertainty. The effect of that is seen in this quarter. We have subsequently restored and restoring our supply chain to normal levels or a normal basis. So that will start to flow out and inventories will come down in the second half of the year.

Okay. And last question, again, I mean this cost benefit or supply chain as well as synergy with CFF, so -- which is around EUR 1 million. So in what time frame do we expect to achieve that?

So the supply chain synergies, we expect to be around EUR 0.5 million and EUR 0.5 million is on the product development cost and management cost, which will get offset over both the -- all the businesses. The supply chain synergy, typically we should start to see from January, as we have a 6-monthly procurement cycle at CFF. In the next cycle, we can start to work jointly, but within a year, we should be able to start to get benefit of the supply chain.

The next question is from the line of Levin Shah from Valuequest.

Congratulations for a wonderful set of numbers. So firstly, on the -- if you look at the margins, our gross margins have been around 44%. But because of the lower cost, we have been able to report like a 21% kind of margin. In terms of other costs now, so despite this kind of growth, we have seen flat other costs and also employee cost has remained largely flat. So going forward, do we see some of these costs coming back and consequently that's impacting the EBITDA margins or most of this cost is like a steady state costs going ahead?