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

Ladies and gentlemen, good day, and welcome to S H Kelkar and Company Limited's Q1 FY '20 2 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Anoop Poojari from CDR India. Thank you, and over to you, Mr. Poojari.

Thank you. Good afternoon, everyone, and thank you for joining us on SH Kelkar and Company Limited's Q1 Fiscal Year 2022 Earnings Conference Call. We have with us Mr. Kedar Vaze, Whole-Time Director and group CEO; Mr. Shrikant Mate, EVP and Group CFO; and Mr. Rohit Saraogi, EVP and Group CFO designate 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.

Good afternoon, everyone, and thank you for joining us on our quarter 1 FY '22 earnings call to discuss the operating and financial performance for the quarter. I trust that you and your families are safe. In this quarter, we have reported a resilient performance during this quarter despite a challenging macroeconomic and environment due to pandemic-induced lockdowns and restrictions. While we saw broader operating constraints during the period, our client engagements and wins across the FMCG space remained stable. On the international business front, we are happy to share that CFF and Nova both delivered a healthy performance on the back of improving demand and volume uptake in the European markets. On a consolidated basis, our revenue from operations stood at INR 354.9 crores. The performance includes consolidation of CFF and Nova in quarter 1 and not comparable year-on-year. On a year-on-year comparable basis, revenues grew by 44.4%. This was on account of lower base in the corresponding year last year -- corresponding quarter last year. During the quarter, we continued to witness cost pressures on account of inflation in raw materials, and especially cost in logistics and supply chain. Accordingly, we have undertaken suitable price hikes. This, is in combination with our prudent inventory management practices, enabled us to report stable gross margins, 42.2%. On the EBITDA front, lower revenues moderated EBITDA performance. In addition, our other expenses the quarter was higher as it included onetime deferment of R&D CWIP, amounting to INR 12.9 crores on account of accounting policy change. This change was mandated due to more and more exchange of IP usage between India and Italy operations. Without this adjustment, EBITDA margin stood at 16.1% and PAT stood at 27 crores. On the tax front, I'm happy to share that we have a favorable update on the tax appeal in the matter of our wholly owned subsidiary Keva Fragrances. Recently the Income Tax Appellate Tribunal, ITAT, as per its recent order, set aside the order of the commissioner of income tax and has directed the assessing officer to allow amortization of goodwill as an eligible expenditure. The tribunal has also quashed the department appeal on the other 2 issues favoring by the CIT earlier. Consequently, we have reversed the additional tax provision aggregating to INR 64.5 crores for the period between FY '17 to FY '21. So our reported PAT this quarter has come in at INR 81.4 crores. Excluding this onetime reversal and effect of expense deferment, the adjusted PAT stood at INR 16.9 crores. From a consolidated balance sheet perspective, our net debt position was comfortable at INR 386 crores, with a net debt to equity at 0.4x. The payment for acquisition of Nova in April 2021 of approximately INR 25 crores led to a slight increase in debt of INR 6 crores as compared to March 31st position. As communicated earlier, in FY '22, we have no major CapEx plans on hand and the focus remains on generating healthy free cash flows, which will enable us to further strengthen our balance sheet position. Coming to some key business updates, as we all know the unprecedented rains in Maharashtra in July caused severe flooding in certain areas. Unfortunately, our unit in Mahad was severely affected due to these incessant rains and floods. It resulted in flooding in our plant and major outage in our facility and region. As per our assessment, the factory operations at Mahad are likely to remain suspended until end September. However, we are undertaking all necessary steps to resume operations at the earliest, and also have recently completed the survey with the insurance team. The overall insurance cover being sufficient, it would have no long-term effects to our financials. We are implementing our business continuity plans and plan additional volumes in the China plant. As a responsible corporate citizen, our company has also allocated INR 75 lakhs from its CSR budget to local NGOs and government organizations for carrying out flood release work in the affected region of Mahad. The health and safety of our employees and communities is a key focus area for us. As part of our employee welfare initiatives, we partnered with Apollo Hospital and other local hospitals for vaccination drives for protection against COVID-19 for our employees and employees' families. I'm pleased to share that over 87% of employees have been -- received the first dose and around 22% of the employee base is fully inoculated. In addition, we have extended the vaccination drive for families and secondary manpower in the region. I would now like to cover some developments on the management team side. Mr. Shrikant Mate, Executive Vice President and Group CFO, will be superannuating on September 30, 2021. Shrikant has been with us for over a decade and held various leadership roles at SHK. He was also actively involved in driving our company's IPO and acquisitions, and has been an integral contributor to the growth of SH Chemicals. On behalf of the Keva family, I would like to thank Shrikant for his contributions and wish him the best in his retirement. We have recently appointed Mr. Rohit Saraogi, as Executive Vice President and group CFO designate of the company. Rohit is a chartered accountant and brings with him around 2 decades of finance domain and leadership experience. In the past, he has been associated with large and reputed companies in the FMCG space. We would like to welcome him on board. In the next couple of months, Rohit will work closely with Shrikant to ensure a smooth transition and will formally take charge as Group CFO with effect from 15th November 2021. To conclude, as we look ahead from the demand standpoint, we are currently witnessing steady wins and inquiries across customers in domestic and international markets. While there are concerns with regard to the macro environment, given the uncertainties relating to the pandemic, internally, we have several promising growth initiatives in place. We are confident that our strategic growth levers, along with our robust business model, should enable us to report healthy performance going forward. On that note, I would request the moderator to open the forum for any questions or suggestions that you may have.

[Operator Instructions] The first question is from the line of Payal Lad from Progressive Share Brokers.

I hope everything is safe at your end. Then I have just a couple of questions that needs clarification. Firstly, I would want to know how do you see the traction in the Ayush space of late and going forward? And secondly, in terms of what kind of opportunities or market strategies you foresee in the savory market, like some kind of CapEx, which you are looking at? And one last question in terms of the company having witnessed Amazon and Flipkart orders in the [ natural ] flavor segment, like these were more on this side, was it on the contracts we are there, which is right and how big are these orders, if you could quantify on the sale?

Yes, thank you. I think the overall macroeconomic situation is quite okay. Particularly on the flavors you have asked on the savory. We continue to invest in our developments on the savory market. It's a very large market, as you can imagine, in India. But we are focused on very small part of that, which are the top niches. We have internal CapEx to continue to grow this market without too much new capacity or new investments. On the Ayush front as well, we are seeing continuous robust growth, and it's a small segment for us, where we expect an active business. We'll see a good traction in the coming years as this has become a very big area of focus for the consumer trends. Both of these areas of savory flavor, as well as natural and natural extracts are areas where we are continuing to do our developments and we continue to grow. But they will remain small segments for the few years to come.

Okay. And sir, you mentioned about internal CapEx in the [ B&P ] segment. So like if you could quantify what range would be?

So the CapExes for these activities would be in the 2 crores, 3 crores range. They are not significant. We already have the large building and CapExes for all the utilities, land building in place. The extra capacity would be more in terms of bigger sizing of equipment and would not be in the magnitude more than 2 crores, 3 crores.

Okay. And with regards to the [ organic ] orders, like there as you mentioned in the AR that you are receiving monthly orders in the space, in the flavor segment. So like how good is that number?

So again, flavors is seeing robust growth in the organic business. We have had another year this year when we lost the part of summer season in India because of the pandemic, a lot of the ice cream and beverage flavor sales was deferred, particularly in the month of May and June. All of these sales are very seasonal with the very big peaks in the summer season. So we don't anticipate that the rest of the year will catch up the sale for what is lost. However, our track for the remaining 3 quarters remains intact. Export growth continues to be robust. So I don't foresee any big change in the flavor market. We continue to grow and we should do 15% plus growth year-on-year.

Okay. Okay. And if I could just squeeze in one more question about this -- with regards to the reversed -- provision reversal which has happened in this quarter pertaining to [ 64 crores ] in terms of [indiscernible]. What exactly is that? Was this part disallowed earlier? And then how big is [indiscernible]?

So the tax provision, it was taken in the past and the tax ruling had come in the favor of the company. So we have now reversed that provision.

The next question is from the line of Bharat Sheth from Quest Investment.

On the flavor business, you have given a Y-o-Y growth of 15% which is a little ahead. I mean what earlier we were looking is at 10% to 12%, that is great. And how do we see the profitability once, I mean, the growth really starts kicking in? So what are the operating leverage do we have in the flavor business?

So I think flavor business, we have always maintained the 15% plus growth. There is good profitability margin around 46%, 47%, and it's slowing down to a profitability of 10% plus in the pipeline. It's a steady state business continuing to grow. There is no surprises on the flavor side at all. The environment remains normal. Demand is robust. Then we would continue to grow that business very aggressively. Having said that on the overall fragrance business as well, we have good number of wins, good number of FMCG companies that have approved our products. And so the overall growth in the long term or near term remains very much intact. For the overall margins, this quarter, we have clocked around 16% EBITDA, and in a normal quarter, we should be upwards of 18% to 19% EBITDA level.

Okay. So whatever business that we lost in Q1, those Q1 number include also last previous year's CFF number and so this growth -- top line growth is not really reflected. So if one has to look at, I mean, normalized growth...

Yes, so we have 44% growth year-on-year versus last year, which is the underlying like-for-like business. I think we are probably a 25 crore, 30 crore business momentum loss in the first quarter owing to the pandemic. But we foresee that this will restore some time in this quarter or next quarter.

Okay. So overall growth of around 15% for fragrance business on a normalized basis, is that possible? Or plus little higher growth? Because the kind of...

Yes. No, the share like-for-like has been -- last year, like-for-like 15%, we are still confident to achieve.

Okay. And coming to this write-off, see in last 4 years on R&D expenses, we have capitalized almost 200 crores. And in last 2 years, we have written off 36 crores and now in this quarter 12 crore. So how much, I mean, this kind of one-off will really continue rather -- despite there is a normal depreciation of intangible that we provide? If you can give some...

This 36 crore is for the -- let me talk. 36 crore is not related to R&D accounting impairment of the plant in the Netherlands, it is part of...

That is -- but apart from that 36 crores, there is a difference. In '20 and '21 annual report, R&D, I mean, expenses written of apart from depreciation is 36 crore.

There is -- yes, I understand. What I'm trying to say is that these R&D expenses written off is -- it's basically -- you have the expenses, which are running a project for 1 year or more, it declines. And then the expenses to that in normal situation, about 20% of the projects we will win. 80% of the projects we are we are not winning. This is just a normal part of the business. The reason for doing the amortization is the large projects are running over 2, 3 years, and this policy was in place. Unfortunately, because of the last 2 years of this pandemic and the uncertainty, the wins, while we have won the business, the business launches have not happened in the same manner that was normal case before. Plus, we have now our IP and formulations being used in Italy and it is getting -- so that is why we have changed the policy to expense out the entire R&D. And this INR 12.9 crore is not actually a write-off for a new cost, it is just expense deferment.

Sir, do we continue -- expect to continue same amount kind of a thing in remaining...

No, so we have changed the policy. We have changed the policy that we will expense the R&D expense instead of capitalizing it. Going forward, we will not see any capitalization and write-off, it will directly be expensed in the quarter.

So in that -- that becomes then the normal EBITDA, it will be much lower than what we are guiding. Or that the EBITDA margin that we are guiding is...

No, there is no impact on the EBITDA because it was already a steady state. We had write-offs and we had expense deferment in almost the same quantum. So there was no real change in the quarter-on-quarter expense. By changing to the new policy, it will just be straight expense. There will be no change or effect on the overall EBITDA opportunity.

So my question is now this 13 crore, what we have written off in Q1, so same amount will continue for 9 remaining 4 -- 3 quarters and in future also?

So we are not capitalizing any more the R&D. We are expensing it. So every quarter, we will expense the quantum that is spent in that quarter, and that will have no effect on the EBITDA because in reality, we have some write-offs from the previous CWIP, and we have some expenses getting CapEx in CWIP. So this is a steady state, there will be no difference on account of the change in policy.

Okay. So -- and can you, I mean, give more color on the new win and how do we expect it to ramp up? And second, on the [ biosphonic] opportunity. And third, this new win, whether any multinational FMCG is there or not.

So new win, as of now, we don't have any multinational MNC, I would say, as of now. We are negotiating as always, and hopefully, we will track something this year. The point on the new wins, I think there is a lot of new wins in the last year and even early part of this year, which have not yet launched. So we have a very robust pipeline, with all the big companies in India as well as overseas. And we see this as a phase where, because of the pandemic or various reasons, the launches were delayed. But the products are approved, everything is in place. And at the time when things become more normal for the FMCG business, we see a very big growth spurt coming in.

Okay. Last question, see, Q-o-Q also we have seen a good amount of seen in the staff cost. So is this a normalized run rate? Or we have hired more people? Or how really one should look at it?

So Q-on-Q, the -cost increases this quarter has been largely on the Italian front, with the conversion rate and the new company in Nova coming into the fold. The baseline cost in India, the existing business has not changed much. We will see the effect of salary increases which are our normal yearly increment in the July quarter. So in the first quarter, there was no increase. Second quarter onwards in place, but normal cycle. There will be an increase in employee cost, but it won't be very significant.

Okay. And how do we look at -- I mean, gross margin and raw material availability as well as the pricing scenario?

So raw material availability is still a difficult scenario. We have maintained good inventory and good planning. We have also put out price increases to the plans. And we expect that we will be able to manage our gross margins in the 42%-43% range. There maybe 1 quarter some effect of Mahad plant closure, but eventually, on a longer term, we will be in the 43% gross margin range.

The next question is from the line of [ Sumit Nagal ] from Alba Investments. The next question is from the line of Deepak Poddar from Sapphire Capital Partners.

Sir, I just wanted to understand, you mentioned about the raw material availability remain a difficult scenario. So how do you see that impacting your EBITDA margin going forward?

No. So I think we have had some effect in the flavors in the last quarter and in the fragrances, to some extent, in this quarter on our margin. But we don't see any big effect on the margins or EBITDA, and we will be able to pass on some of these costs to the clients. And get the -- maintain our margins and EBITDA percentage.

So this year, our target has been in the range of 19% to 20% EBITDA margin. So that remains intact?

That's correct.

The next question is from the line of Rohit Ohri from Progressive Shares.

This question is from the annual report. The annual report is saying that you're looking at ambitious target of around USD 1 billion, which is from the global business by the end of the decade. So this translates into around 18% to 22% growth rate. So how do you intend to achieve this? Are you looking at some more acquisitions? Or are you looking at some joint ventures that might come in future?

No. So the overall CAGR growth, we will be able to do with the organic of 12% to 15% and the balance with an inorganic acquisition strategy.

Okay. In your opening remarks, you mentioned that there are some strategic growth initiatives that you're looking at. If you can just take us through that?

So we have certain sort of active molecules that we call health and active, Ayurvedic extract and things like this, which we have alluded last time. So these are all initiatives for the longer term. These are -- this will drive growth on a very big one term, although it is in the nascent stage as of now.

Sir, my last question is the promoter group has created a pledge. And can you just take us through that, the reason for that if you would like to share?

So we have created the pledge just as like OB line for any emergencies. There are obviously family members within the promoters who are at various stages of their life. So there are expected expenses towards buying house, towards other education and other expenses. So we are keeping this as a pledge to keep a line available for any kind of family expenses.

Sir, by when do you think you can [ reverse ] this? Any time line that you have in mind, maybe 1 year, 1.5 year, 2 years?

No, we don't have any time line for this reversion. Normally, we have every year sufficient dividend payout trends that takes care of all the family expenses. This year, during the pandemic has been [ long ] and we may be in a situation which -- with uncertainty, it is difficult to estimate what would have been or what would be the dividend payout. And it was just an action to make sure that we have some liquidity in the family. I am -- personally, I'm also traveling in the European continent at the moment. And given the pandemic and uncertainty, this was the fastest way to draw the line and we have taken it. There are no immediate plans of reversing it anytime soon. But at the same time, the amount which is drawn against these place is less than 5 crores. So it's not a big amount. Only thing is we would like to keep the pledge as an emergency source of funding.

[Operator Instructions] The next question is from the line of Nikhil from SiMPL.

Kedar, just to put it correctly, on the provision side, so if you look at our balance sheet, on the intangible asset under development, there was a closing balance of 13 crores. So this write-off of INR 12.9 crores, which we have taken, is we've completely removed the intangible assets from the balance sheet. Would that be the right...

That's right.

Okay. And margin impact you are seeing is not there because we were taking a write-off of 11 crores in the P&L every year, which was the R&D projects, which get subsumed in the R&D expenses.

That's right.

Okay.

It was almost say 12 crores of capitalization and 12 crore of expense from CWIP was the trend for the last 1.5 years because of the pandemic. So we decided we just go to a simple expenses model, especially since the utilization of this IP in Europe, in Italy and operations also is there. It becomes difficult to quantify the revenue versus the capitalization. So we decided to abandon this capitalization and go to a 100% expense model.

Okay, okay, okay. So just one clarity. So these R&D projects you mentioned are projects we run with the clients. And because these -- either the win rate is not happening or the product, it does not get launched, we have to take a write-off. So is the timeline of these projects generally less than 1 year, 6 months, that kind of? And are these projects only specific to clients? Because I -- my understanding was that we develop products, which can be sold across clients. So just if you can help me understand this part.

So the CWIP policy was specific to client and specific for new molecule IP. The specific client projects actually, last year with the pandemic, there were delays in the launch, so we had to write off quite a lot of projects. Again, this year, with the pandemic situation, we decided that it's better to just move to a simple policy of expensing out. The IP, CWIP of the IP on the molecules is now started to be used also in Italy. And then the question we anticipate from the various tax authorities and how much is used in India, how much is used outside India and so forth for the amortization. So we will just expense it and make it simple from the policy point of view.

Okay, okay. Second question is you mentioned in the start of the call that we have started taking price increases. And I think I would congratulate you because even with the way the cost increases have been, sequentially, gross margin have remained stable. The price increases we are taking are they only covering the RM increases? Or because their increase is also on the freight side and other line items, so does it increase most of the cost element or only the RM increase?

So it's not only the RM increase, but we are trying to offset as much as possible the overall cost increases, like you mentioned freight, other expenses due to COVID and internally from kind of distancing we have some operational inefficiencies on the way we are operating because of the COVID situation. So all of that, we are taking into account when we pass on the cost. I don't think that the cost will cover everything in universally, but we are, at least being -- because on the client side also, it's situation of uncertainty and slower growth environment or perception. So we are taking the middle part, and we are trying to maximize what price increase we can do.