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Equity | India | Consumer Discretionary

Venky’s (India) Ltd

The golden egg laying chick December 05, 2011

BUY

Analyst Sunil Sewhani

+91-22- 6614 2690 [email protected] GEPL Capital Research 1

Initiating Coverage

CMP (`) Target (`)

440 544

Potential Upside Absolute Rating

24% BUY

Market Info (as on 02nd December, 2011)

BSE Sensex 16,846

Nifty S&P 5,050

Stock Detail

BSE Group B

BSE Code 523261

NSE Code VENKEYS

Bloomberg Code WH IN

Market Cap (`bn) 4.13

Free Float (%) 45%

52wk Hi/Lo 789 / 365

Avg. Daily Volume (NSE) 39887

Face Value / Div. per share (`) 10.00 / 5.00

Shares Outstanding (mn) 9.39

Shareholding Pattern (in %) Promoters FIIs DII Others

56.12 0.22 3.68 39.98

Financial Snapshot (`mn)

Y/E Mar FY10 FY11 FY12E FY13E

Net Sales 7,055 8,520 10,169 12,401

EBITDA 916 1,135 994 1,676

PAT 545 733 585 1,003

EPS 57.8 77.8 62.3 106.8

ROE (%) 29.9 30.4 19.5 26.9

ROCE (%) 21.1 22.3 14.6 19.5

P/E 5.8 8.2 7.1 4.1

EV/EBITDA 4.3 6.2 5.2 3.2

Share Price Performance

40

50

60

70

80

90

100

110

Dec-

10

Jan-

11

Feb-

11

Mar

-11

Apr-

11

May

-11

Jun-

11

Jul-

11

Aug-

11

Sep-

11

Oct

-11

Nov

-11

Dec-

11

Venky's (India) BSE SENSEX

Rel. Perf. 1Mth 3 Mths 6Mths 1Yr

Venky’s (%) (12.9) 6.4 (29.2) (40.8)

SENSEX (%) (3.5) 0.2 (8.9) (15.7)

Source: Company data, GEPL Capital Research

Investment Rationale

India’s Poultry Industry - set to lay golden eggs in the years to come We expect the Indian poultry industry to grow at +9.5% CAGR in FY11-13E considering a) we are the 6th largest poultry populated nation, b) the cheapest Country in the World in terms of cost of eggs sold, and c) amongst the cheapest Countries for day old chicks (Sri Lanka is the cheapest). Moreover, the potential to grow remains intact with the Indian Egg industry having achieved a mere 29% of its true potential (per capita consumption of 53 eggs vis-a-vis NIN’s recommended 180 eggs). Similarly, the poultry meat segment has achieved a 32% of its potential (per capita consumption of 3.5 kgs as compared to NIN’s recommendation of 11kgs). With a low export share, low per capita consumption and lack of other alternatives like beef and pork due to religious reason, we believe there is plenty of scope for the Poultry industry to continue its growth trajectory.

The best bird amongst the flock in India’s Poultry Industry Venky’s is amongst the best candidates to capture the growth in the Indian poultry industry in FY11-13E (+9.5% CAGR) due to its healthy track record and a strong parent company backing. Venky’s is part of the VH group and with a group turnover of `35 bn offering a whole host of benefits like a) Pan-India presence (Venky’s has a strong presence in North and West India while VH group has its presence in South and East India), and b) the large scale of operations result in operating leverage with lower transportation, marketing storage cost per unit enabling higher margins. The Pan-India presence has helped Venky’s to increase its presence across the value chain as well diversified portfolio with AHP and solvent extraction insulating its risk at times of flu’s and viruses and poultry products being non-impacted by global slowdown.

Venky’s XPRS – the future wings of growth Venky’s has entered the hospitality industry with the launch of ‘VENKYS XPRS’ to serve their customers with a range of healthy, hygienically cooked, and yet reasonably priced chicken delicacies. The first store was rolled out in Jan, CY10 and currently five stores in India are operational. The company plans to invest ~`2.5 bn for its research and development and set up over 100 Venky’s XPRS outlets (including London) over the next three years. Though currently the contribution from this segment is minimal, the scope for growth remains high given the changing demographics in India with a rise in disposable income, higher working population (both youth and women).

Strong Financials – Fine feathers With a strong growth in the Indian poultry industry we expect Venky’s to grow at 20.6% CAGR in FY11-13E to `12.4 bn driven by 23% CAGR in poultry and poultry products, 11.5% CAGR in animal health products and a 16.4% CAGR in the solvent extraction division. We expect high raw material prices to impact margins in FY12E with a strong bounce back in FY13E with retracing feed prices. Consequently, we expect the EBITDA to witness 21.5% CAGR from FY11-13E to `1.68 bn. With a higher interest cost (higher capex and debt and higher interest rates), higher depreciation rate and lower other income, we believe the PAT growth would be marginally lower at 17.2% CAGR from FY11-13E to `1.0 bn.

Valuation

At CMP Venky’s is currently trading at 7.1x FY12E EPS and 4.1x FY13E EPS, a 34% discount to its historical one-year forward P/E band of 6.2x and a 45% discount to its average one-year forward P/E band over the last 12 months of 7.4x. We have valued the company on the four year average of its historical P/E band (5.1x) to capture the cyclicality of the industry and its profits. We believe there is good potential upside in the stock and initiate coverage with a Buy rating and target price of `544 per share (5.1x FY13E).


Venky’s (India) Ltd December 05, 2011

GEPL Capital Research| Initiating Coverage 2

Investment Rationale Indian Poultry Industry set to lay golden eggs in the years to come

The World Poultry Industry is expanding at an exceptional rate over the last decade with strong consumption demand. Factors such as a) growth in per capita income, b) population growth, c) direct price effect under the influence of productivity improvement and cost reduction, d) product innovation, and e) development of modern distribution systems have led to this growth.

Hence an industry predominantly dominated by developed countries’ exporters a few years ago, is largely shared by developing countries today. With the variation in growth of per capita consumption; faster rates of increase in developing countries than in the developed world, we expect the developing Nations to gain in the growing share of the Global Poultry Industry.

Rise of the Indian Poultry Industry

The Indian Poultry Industry too is constantly on the rise with modern techniques and changing from live bird to fresh chilled and frozen product market. Several breakthroughs in poultry science and technology have led to the development of genetically superior breeds capable of higher production, even under adverse climatic conditions that offer opportunities for overseas entrepreneurs to expand export and import of poultry products on a large scale.

Indian poultry industry India’s Poultry industry and GDP growth

350380 400

450 450

550

-

100

200

300

400

500

600

CY05 CY06 CY07 CY08 CY09 CY10

Rs m

n

0

5

10

15

20

25

%

Poultry Industry YoY growth

8.09.0 8.7

7.0 7.28.5

10.0 10.0 10.0 10.0

8.0

10.0

15.0

20.0 20.019.0

18.0

20.0

5

7

9

11

13

15

17

19

21


%

Annual GDP (%) Poultry layer (%) Brolier (%)

Source: Company data, GEPL Capital Research Source: Company data, GEPL Capital Research

The Indian poultry industry has grown at 9.5% CAGR in the last five years and is a major force to reckon with. The industry is worth `550 bn and provides employment to over 20 mn people. India is the second largest egg producing nation in the world with an annual production of 53 bn eggs and ranks third in the World for broiler production with an estimated 3.5 mn tons of production. India’s Poultry layer and Poultry broiler industry have seen a higher growth than our GDP over the last 10 years. The broiler industry has grown at a rate of 18-20% over the last five years while the layer industry has witnessed a steady 8-10% CAGR in the same period. We expect India’s Poultry industry to continue growing at 9.5% CAGR over FY11-13E and to be worth `659 bn by FY13E.




India is the 6th largest poultry populated nation in the World

Chickens are physiologically comfortable in intensive conditions at temperatures between 28-32 degrees Celsius. It is due to this factor that the industry remains extremely country concentrated. Currently 65% of the World Chick population is found in 10 countries with China alone accounting for 25% of the World chick population. India too is fast emerging as a strong poultry operator and currently has the 6th largest World chick population.

India is the 6th largest poultry populated nation

3,860

1,970

1,200 1,100

540 425 340 286 280 250

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Chin

a

USA

Indo

nesi

a

Braz

il

Mex

ico

Indi

a

Russ

ia

Japa

n

Iran

Turk

ey

mn

chic

ks

Source: Indiaagronet, GEPL Capital Research

Chicken is the cheapest source of protein with limited substitutes in India Poultry meat production accounts for 26% of the total meat production in the World and ranks third with pig meat (pork) leading at 40% followed by beef meat at 28%. Chicken is the dominant source of poultry meat (88%) followed by Turkey (12%).

Global Meat Production

6

40

28

23.4

2.6

26

Others Pork Beef Chicken Turkey

Source: Indiaagronet, GEPL Capital Research




Pig meat is not consumed by Muslims while beef meat is not consumed by Hindus, both due to their respective religious reasons. Since most of the butchers in India are Muslims they do not sell pig meat. Similarly, since a large population of India is Hindus beef meat is not sold in order to not hurt their sentiments. Even at large format retail chains like ‘Natures Basket’ etc, pig meat and beef meat are not sold. Hence chicken is best and most widely available option. This has also resulted in the taste for pig meat and beef meat not being developed in India despite the change in demographics.

To add to this, poultry is the cheapest source of protein available and hence we see longer term drivers of poultry consumption in India remaining intact. We also believe with return of economic growth, poultry consumption is set to grow in India as per capita poultry consumption in India is still low. Moreover, Indian meat is preferred because it is lean and contains less fat. However in India, the sporadic bird flu outbreaks in different parts of the country along with lack of storage and processing facilities and rising prices of feed stocks including soya meal and maize have severely impacted poultry exports.

India is the amongst the cheapest Nations in terms of cost eggs and day old chicks

Dumping of egg powder by America and other European countries, supported by heavy dose of subsidies has resulted in the decline of egg powder prices. Many countries are exporting eggs at prices lower than production costs. This has resulted in Poultry industry in these countries where investments are high coming under threat of extinction. To counter this, various Nations have implicated a ban on imports.

In terms of the global prices of eggs, India is the cheapest; costing 50 US cents a kg. The prices across other Asian Countries are slightly higher (Sri Lanka 0.58 cents, Taiwan - 108 cents and Bangladesh 117 cents) while that of developed Nations (USA –80 cents, France - 102 cents, Great Britain – 102 cents, New Zealand – 136 cents, ) also remain high with Argentina being the costliest in at 145 cents per kg.

Even in terms of day-old chicks, India is one of the cheapest Nations with day old chicks costing 39 US cents a chick. Though the price is slightly higher than Sri Lanka’s 29 cents (cheapest Nation), prices are still competitive when compared to other developed Nations like USA (47 cents), UK (70 cents) or Japan (132 cents).

Cost of Eggs sold across Countries Cost of Day-old chicks across Countries

5058

80 86

102 102117

127136

145

0

20

40

60

80

100

120

140

160

Indi

a

Sri L

anka

USA

Hol

land

Fran

ce UK

Bang

lade

sh

Japa

n

New

Zea

land

Arge

ntin

a

cent

s pe

r kg

2939 47

70 76

132

172

020

4060

80100

120140

160180

200

Sri L

anka

Indi

a

USA UK

Cana

da

Japa

n

New

Zea

land

cent

s pe

r ch

ick

Source: Indiaagronet, GEPL Capital Research Source: Indiaagronet, GEPL Capital Research




As per media reports, the egg price are selling at a flat rate of `2.9 per piece after witnessing a marginal increase in November due with onset of winter. The prices remained flat due to resistance of buyers; need to perk up demand and high competitive scenario.

Broiler chicken meanwhile continues its slide and the prices have been reduced to as low as `46 per kg on account of the Sabarimala season. The prices may remain under pressure due to the festive season is South India which is a main consumer market. However, we do not expect this to impact sales of Venky’s significantly as the company is strongly present in the Western and Northern regions on India. The National Egg Coordination Committee (NECC) has also slashed the price of layer birds to `43 per kg as compared to `46 per kg earlier.

Higher raw material prices could impact margins

The poultry industry is highly dependent on the feed industry as feed alone constitutes 65% of the cost of broiler and egg production. Therefore, any price movement in the feed sector (maize, soya, rice, and other cereals) has a direct impact on the prices of eggs and broilers. As per Mckinsey’s report, the Indian poultry can compete at an international level if it is able to successfully reduce feed cost. As maize costs are key for the growth of the Indian poultry market, the report has suggested that the poultry players may integrate into feed and maize seed production.

The nature of the poultry industry is such that product pricing is a major weapon in companies’ competitive pricing. The cost of production comparison favor countries with ample low cost raw material feedstuff supplies and low labour cost. Hence the drive becomes to minimize the cost added per unit sold in process between the base input costs and the overall cost. Poultry industry with high investments in these countries is under threat of extinction. Many countries have saved their poultry industry with a ban on imports. In the global poultry market, Indian eggs are cheapest while that in Argentina are the costliest.

Maize prices Feed cost for eggs across Countries

2,298

1,490

1,8361,730

1,4421,621

1,937 2,205

2,437

500

1,000

1,500

2,000

2,500

3,000

Nov

-10

Dec-

10

Jan-

11

Feb-

11

Mar

-11

Apr-

11

May

-11

Jun-

11

Jul-

11

Aug-

11

Sep-

11

Oct

-11

Rs p

er K

g

18

24 25 25 27

44 4550

0

10

20

30

40

50

60

Zim

baw

e

Sri L

anka

Paki

stan

Fran

ce UK

Indi

a

Phill

ipin

es

USA

cent

s pe

r kg

Source: Bloomberg, GEPL Capital Research Source: Indiaagronet, GEPL Capital Research




Strong potential to grow

Fast urbanisation, changes in life style and food habits of consumers, improvement in standards of living etc. have resulted into increase in per capita consumption of egg and poultry meats but per capita consumption of these commodities in India is still far below that of developed countries showing enormous potential/scope for poultry development

The industry has grown at a 9.5% CAGR over the last 5 years aided by a 3.3% CAGR in egg production and an 11.8% CAGR in broiler production. Despite this the Indian Egg industry has achieved a mere 29% of its true potential with a vast gap between per capita consumption (53 eggs) and National Institute of Nutrition’s recommended level (180 eggs). Similarly, the poultry meat segment has achieved a 32% of its potential with per capita consumption of 3.5 kgs as compared to the National Institute of Nutrition’s recommendation of 11kgs of poultry meat. Here, again, there is considerable variation in per capita consumption between rural and urban areas and also across the region.

Egg consumption per capita and potential of achieved Poultry meat consumption in India and potential achieved

29.4

25.0

27.8

28.9 28.929.4

40.0

42.0

44.0

46.0

48.0

50.0

52.0

54.0


per

capi

ta c

onsu

mpt

ion

22.0

23.0

24.0

25.0

26.0

27.0

28.0

29.0

30.0

%

Egg consumption (nos per capita) Potential achieved

31.829.128.228.2

20.0

18.2

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0


per

capi

ta c

onsu

mpt

ion

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

%

Poultry meat consumption (kgs per capita) Potential achieved


The growth potential for the Indian poultry industry is further evident if our per capita consumption is compared with that of USA (300 eggs and 49.8 kgs of poultry meat). Realising the massive untapped potential of this industry, the Central Government has reiterated its commitment to create an enabling environment for steady growth in agricultural and agro-based industries production and diversification from traditional crops to ancillaries, including animal husbandry. The allocation for Mid-Day Meal program has been stepped up significantly by Central and State Governments.

Fuelled by burgeoning demand for broiler meat and eggs, the poultry industry in the country, the Business chamber, Assocham, has pegged the market size for the poultry products at `1.32 tn by CY15E. They believe there is a huge opportunity for foreign direct investment (FDI) in the poultry sector in areas like breeding, medication, feed production, vertical integration and processing.




The best bird amongst the flock in India’s Poultry Industry

Venky’s has a witnessed a revenue CAGR of 17.3% in FY06-11 to `8.52 bn driven by a 21.6% CAGR in poultry and poultry products. We expect the company to grow steadily with operational leverages due to a) strong parent lineage in the form of VH group which offers it a Pan-India presence, b) presence across the geographies, and value chain, and c) large scale operation leverages like lower transportation and storage cost.

Strong parent lineage

Venky’s is part of the (VH) group which was established in 1971 in Pune, India, by founder Chairman Late Padmashree Dr. B.V.Rao, referred to as “The Father of the Indian Poultry Industry”. With a unique combination of expertise and experience and supported by strategic collaborations, the company diversified its activities to include SPF eggs, chicken and eggs processing, broiler and layer breeding, genetic research and Poultry diseases diagnostic, Poultry vaccines and feed supplements, vaccine production, bio-security products, Poultry feed & equipments, nutritional health products, soya bean extract and many more.

With a focus on technology and return on investments, the company embarked upon new ventures, and has grown to over 30 units spread across India. The strategic collaborations has helped combine expertise and experience, and diversify into Specific Pathogen Free (SPF) eggs, processed chicken products, solvent oil extraction, chicken and eggs processing. The company’s SPF Egg unit, in technical collaboration with SPAFAS Inc is among four such units in the world.

The company has also added to its credit, manufacturing facilities for nutritional health products for humans, and pet food and health care products. With a product mix of more than 40 unique poultry health products, Venky’s offers complete solutions to all concerns in poultry farming right from ‘field to fork’.

Geographical presence





Presence across geographies, and value-chain

Currently, the group is the largest fully integrated poultry group in Asia. The VH group has an annual turnover of over `50 bn (Venky’s contributes 17% to the top line). Moreover, while Venky’s has a strong presence in the Northern and Western regions of India, the VH group has a remarkable presence down South and in East India. Also the brand recall for the ‘Venky’s chicken’ is one of the highest in the country. This has helped Venky’s expand its product portfolio as well as increase sales over the last few years.

The company is also present across segments (branded and unbranded) as well across markets (organised and unorganised). In the organised market the company markets its presence through processed chicken where the brand recall remains high for Venky’s chicken. The company has also started its new retail store formats- VENKYS XPRS on a small scale to cater to the organised market and earn higher margins though the revenue pie remains miniscule as compared to the group turnover. In the unorganised market as well the VH group has a strong presence and supplies grown-up chicks, grown up commercial broilers and grow-up commercial layers to other players and operators in the industry. Such innovative steps has made it possible for the VH group to command a 85% market share in the commercial layer industry and a 60% market share in the commercial broiler industry.

Large scale benefits According to a study by the Food and Agriculture Organization (FAO) of the United Nations, small producers of poultry enjoy fewer advantages when compared with large producers in terms of obtaining information, marketing, and transportation and storage facilities (transaction costs). At the same time, small producers are observed to spend more effort per unit of poultry output than large producers on collecting; drying and transporting poultry manure (pollution abatement costs).

Speculatively, this could be due to the lower opportunity cost of their labor, or perhaps due to the greater incentive to keep the surrounding household and neighborhood environment clean in a close-settled smallholder setting. In addition to transaction costs and pollution abatement costs, differences in the amount of implicit policy subsidies received by farms across regions/states are also found to affect the relative profit efficiency of small and large producers.

Due a strong parent company backing, Venky’s is able to enjoy the benefits of economies of scale, a larger distribution network, lower transportation cost and lower effort per unit with a strong management in place.

Benefits of large scale production

Parameters Large scale production Smaller scale production

Information gathering Lesser time to gather information

More time and effort to gather information

Transportation Lower transportation cost due to economies of scale Higher transportation cost per egg

Storage Storage cost per unit lower Higher storage cost per unit

Transaction Lower transaction costs per unit Transaction cost per unit is higher

Marketing Lower marketing effort due to strong presence Higher marketing efforts

Labour Lower labour cost per unit Higher labour cost per unit

Effort per unit Lower effort to production ratio Higher effort to production ratio

Source: GEPL Capital Research




VENKYS XPRS- the future wings of growth

Besides being a prominent supplier of chicken products to various International Quick Service Restaurant chains in India like Kentucky Fried Chicken, Pizza Hut, Domino’s, TGIF and Vista Foods etc., Venky’s have also developed a whole range of Ready-to-eat, Freezer-to Fryer and Easy-to-Cook products based on three types of cooking, i.e. flash fried, kettle cooked and oven cooked products.

The food services industry in India is expected to witness a 5% CAGR in the next four years driven by the changing demographics in India, rising urbanization, concept of nuclear families, rising income levels, growth of middle class, higher percentage of youth population and growth in working women ratio. Among the various formats, Quick Service Restaurants (QSR) and cafes have had the maximum growth over the last few years.

Venky’s has hence entered the hospitality industry with the launch of ‘VENKYS XPRS’ to serve their customers with a range of healthy, hygienically cooked, and yet reasonably priced chicken delicacies. This will help them cater the increasingly popular QSR segment. ‘VENKYS XPRS’ brand sell various delicacies like garlic & pepper roast chicken, tender grilled chicken, tandoori chicken roast, grilled chicken burger, chicken hot dog, Kathi roll, etc.

The first store was rolled out in Jan, CY10 and currently five stores in India are operational. The company plans to invest ~`2.5 bn for its research and development and set up over 100 Venky’s XPRS outlets (including London) over the next three years. It expects a break-even for the new initiative within 15 months. The company also has a technical agreement with Campden BRI of the United Kingdom to get food technologies.

India’s answer to foreign QSR’s Venky’s XPRS seems to be India’s answer to international QSR’s due to:

Healthier Products: Venky’s XPRS is set up with the intention to cater to the niche health conscious consumers who want quick food but do not want to compromise on quality. With a focus on health, the UK stores are expected to gain immediate traction. Moreover, the concept of healthy food is gaining momentum in Tier I cities in India and should lead to a stronger growth in the years to come. Even as the current menu is limited, Venky’s XPRS serves their frozen products fried n hot right in front of the customer. This ensures that the products are fresh and healthy

Effective Pricing: The pricing remains extremely competitive when compared to other QSR’s like KFC and McDonalds. Given the price sensitivity of Indians, we believe this should help them gain market share in the time to come.

Lower pricing than competitors

Menu Venky’s XPRS McDonalds KFC

Chicken Burger 50 69 99

Chicken Roll 40 129 110

Roast Chicken (2 pieces) 60 NA 120

Source: various companies, GEPL Capital Research

Though currently the contribution from this segment is minimal, the scope for growth remains high given the changing demographics in India with a rise in disposable income, higher working population (both youth and women). The management is focused towards the growth of its brand and plans to expand the XPRS network and open restaurants all over India and overseas, in the near future.




Financials

Revenues to record 20.6% CAGR in FY11-FY13E Venky’s has a witnessed a revenue CAGR of 17.3% in FY06-11 to `8.5 bn driven by a 21.7% CAGR in poultry and poultry products and a 15.4% CAGR in the solvent extraction business. Consequently, the poultry and poultry products segment contributed 65% to the consolidated revenues in FY11 as compared to 55% in FY06. While the revenue contribution of the solvent extract division declined marginally over the same period to 20% from 21%, the contribution from the animal health product segment declined to 10% from 16%.

Revenue mix in FY11 Revenue mix in FY13E

65%10%

20%

5%

Poultry and poultry products Animal health products

Solvent extraction Others

69%

8%

5%18%

Poultry and poultry products Animal health products

Solvent extraction Others

Source: Company data, GEPL Capital Research Source: Various Companies, GEPL Capital Research

With the a) strong growth in the Indian poultry segment, b) vast gap between the present per capita consumption and NIN’s recommended level, and c) strong market position of Venky’s, we expect it to be the biggest beneficiary and capture a larger pie of the growth. We expect the company to witness a 20.6% CAGR in FY11-13E to `12.4 bn driven by a 23% CAGR in poultry and poultry related products. We expect the AHP segment to grow at 11.5% CAGR and the solvent extraction business with witness a 16.4% CAGR in the same period.

Net revenues

5.69

7.05

8.52

10.17

12.40

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

FY09 FY10 FY11 FY12E FY13E

Rs b

n





Operational efficiencies has helped EBITDA grow four fold in FY06-FY11

The company has witnessed a four-fold increase in EBITDA in FY06-FY11 while the EBITDA margin has doubled to 13.3% in FY11 from 6.6% in FY06. The poultry and poultry related segment contributed ~73.5% of the company’s EBIT in FY11 and going forward we expect this segment to drive revenue and profitability growth for the other segments as well.

The growth trend is clearly visible in the poultry segment (contributed ~73.5% of EBIT in FY11) of where EBIT margins have doubled from 7.2% in FY08 to 14.4% in FY11. The company has also been able to maintain its animal health product margins at 17-19% over the last five years. Given the interlinked business activities with promoters and the Pan-India presence we expect the margins to remain in this range. While the animal health product segment has seen a constant margin, the picture is very different for solvent extracts with EBIT margins ranging from 5-11.8% in FY07-FY11. The high volatility in margins is due to higher commodity prices.

EBIT mix in FY11 Segmental margins

73.6%

13.3%

13.1%

Poultry and poultry products

Animal health products

Solvent extraction

9.5

7.2

5.0

15.414.4

2.2

17.719.1

17.518.5 17.9

5.0

9.6

6.9

11.8

0.0

5.0

10.0

15.0

20.0

25.0

FY07 FY08 FY09 FY10 FY11

%

Poultry and poultry products Animal health products Solvent extraction


EBIDTA to witness 21.5% CAGR as margins improve by 20bps in FY11-13E

The company has been able to constantly scale up its operations. This coupled with a strong bargaining power due to its track record and parent company backing has resulted in operational efficiencies with employee expenses as a percentage of sales improving by 100bps in FY06-FY11 while other expenses have improved by 440bps in the same period. However, the poultry margins depend highly on the raw material cost (75-80% of which consist of feed ingredients like maize and soya).

Despite the fact that there has been an improvement of 280bps in raw material expenses as a percentage of sales due to better operations by the company, the pressure on margins due to increase in prices of soya and wheat is visible. Moreover, a strong demand all through put the entry of newer players who are ready to sell products below the cost of production has resulted in lower realizations for the company and the industry, these two factors have resulted in margin erosion in FY12 so far.

We expect the company to maintain a double digit margin in FY12E and witness a strong recovery in FY13E due to the historical cyclical nature of the business with cycles lasting for 3-4 years and a typical downtrend lasting for 6-9 months. We expect the margins to improve by 20bps over the next two years despite the current scenario of higher competition, lower realization and higher raw material prices. Consequently, we expect the EBITDA to witness 21.5% CAGR from FY11-13E to `1.68 bn.




Cost break up EBITDA and EBITDA margin

70.7 67.4 65.9 67.3 65.3

7.2 6.2 6.6 7.0 6.4

14.813.5 14.1 16.0 14.7

0.0

20.0

40.0

60.0

80.0

100.0


%

RMC Employee expenses Other expenses

7.3

13.0 13.3

9.8

13.5

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800


Rs m

n

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

%

EBITDA EBITDA margin(%)

Source: Bloomberg, GEPL Capital Research Source: Company data, GEPL Capital Research

Net profit to record 39.9% CAGR in FY11-13E due to higher tax rate

The company has capex of `1.10 which would spill over till FY13E owing to which the interest cost is expected to increase. We expect the PAT CAGR to be marginally lower led by the a) higher interest costs owing to the rise in interest rates, b) higher depreciation, c) a flattish other income component, and d) marginal rise in tax rates. Hence, we expect the PAT to witness a 17.2% CAGR in FY11-FY13E despite a 20% de-growth in FY12E owing to a sharp bounce in FY13E.

Net profit

206

543

730

1,003

585

0

200

400

600

800

1,000

1,200


Rs m

n

(50.0)

0.0

50.0

100.0

150.0

200.0

%

Profit after tax YoY growth Source: Company data, GEPL Capital Research




Key Risks

Strong input cost could hurt margins

The poultry industry faces the threat of relentless increase in prices of fee ingredients like maize and soya which account for 80% of the cost of production. A sharp surge in prices has impacted margins in the past and can do so in the future.

However, the overall demand scenarios are favourable for continued growth of the industry. Moreover, the poultry industry has pleaded with the Government to ban forward trading in maize and soya and channelises the export of maize and soya meal through a designated government agency and to put a ceiling on the volume of export.

Virus and diseases

In the last quarter of the FY06, poultry industry suffered a major set back due to reports of bird flu in Maharashtra. The panic caused a steep fall in consumption of both eggs and chicken. Similarly, bird flu in February, 2006 had affected the performance of the company during the first half of the FY07. Any further such virus and diseases can impact the financial performance of the industry and the company going forward.

However, the fact is that India is second to none as far as poultry technology is concerned and has the most advanced technology outside USA. With the increasing awareness amongst consumer led by the company and various government initiatives we believe the company is prepared to tackle such a situation in a much better way if the need arises.

Competition

The poultry business due to its constant growth has become extremely competitive. The expenses are increasing even as customers want quality products at cheaper rates. Due to this fact newer players are offering products even at below cost prices which have impacted realizations. Continuation of such a scenario can be harmful to the industry.

However, India with abundant land, technical people, and irrigation systems can offer the best place for world’s poultry industry. Being a large Pan-India player with a strong backing and strong brand recall, we expect the company to be able to absorb the marginal pain.

Lower Global slowdown

The global economic slowdown witnessed in 2008 had adversely impacted all the major economies of the world including that of India. The global slowdown impacted the poultry industry at large as well as Venky’s. A threat of global slowdown persists.

However, while most of the industries showed a severe decline, the poultry industry managed to withstand the impact to a certain extent as the industry in India is primarily domestic demand driven.




Valuations

Currently, Venky’s is trading at 7.1x FY12E EPS and 4.1x FY13E EPS, a 34% discount to its historical one-year forward P/E band of 6.2x. The discount is wider (45%) when compared to its average one-year forward P/E band over the last 12 months of 7.4x.

However, the stocks has traded within a wide band over the last few years with it commanding a one-year forward P/E of 12.5x in its best year (FY06) and 2.8x during FY10. A volatile earning scenario with a drop in profits after every two-three years due to the cyclical nature of the business coupled with the systemic risks (break-out of diseases and virus like Bird flu) have led to this erratic movements in the one-year forward P/E bands.

We have hence taken a four year average of its historical P/E band (5.1x) to capture the cyclicality of the industry in terms of pricing, downtrend in the industry, lower realisations and lower profits once in every four years. We believe Venky’s should be viewed as a turnaround story in FY13E despite the below expected performance seen in HiFY12.

We believe there is good potential upside in the stock and initiate coverage with a Buy rating and target price of `544 per share (5.1x FY13E EPS).

1 year forward P/E

0

200

400

600

800

1,000

1,200

Apr-

05

Aug-

05

Dec-

05

Apr-

06

Aug-

06

Dec-

06

Apr-

07

Aug-

07

Dec-

07

Apr-

08

Aug-

08

Dec-

08

Apr-

09

Aug-

09

Dec-

09

Apr-

10

Aug-

10

Dec-

10

Apr-

11

Aug-

11

Dec-

11Price 2.0x 5.0x 8.0x 11.0x

Source: Bloomberg, GEPL Capital Research

1 year forward EV/EBITDA

-200

0

200

400

600

800

1,000

1,200

1,400

Apr-

05

Aug-

05

Dec-

05

Apr-

06

Aug-

06

Dec-

06

Apr-

07

Aug-

07

Dec-

07

Apr-

08

Aug-

08

Dec-

08

Apr-

09

Aug-

09

Dec-

09

Apr-

10

Aug-

10

Dec-

10

Apr-

11

Aug-

11

Dec-

11

Price 3.0x 5.0x 7.0x 9.0x Source: Bloomberg, GEPL Capital Research




Company background: A Chick laying golden eggs

Venky’s India Limited (Venky’s) formerly known as Western Hatcheries Limited was established in 1976, mainly to produce day-old layer and broiler chicks for the dense poultry markets of North India. It is part of the Venkateshwara Hatcheries (VH) group established in 1971, by Late Padmashree Dr. B.V.Rao, “The Father of the Indian Poultry Industry” in Pune, India.

Its main products can be broadly classified into

1. Poultry and poultry products

2. Animal health products

3. Solvent extraction

Company Structure

Venky’s

Poultry & Poultry Products (65%)

Animal Health Products (10%)

Solvent Extraction (20%)

Chicks

SPF Eggs

Grown up Commercial broiler

Grown up commercial layers

Grown up broiler parents

Poultry Feed

Processed Chicken

Animal Health Products- Powder

Animal Health Products- Liquid

Refined Oil

De oiled cake for poultry

Venky’s

Poultry & Poultry Products (65%)

Animal Health Products (10%)

Solvent Extraction (20%)

Chicks

SPF Eggs

Grown up Commercial broiler

Grown up commercial layers

Grown up broiler parents

Poultry Feed

Processed Chicken

Animal Health Products- Powder

Animal Health Products- Liquid

Refined Oil

De oiled cake for poultry


1. Poultry and Poultry Products The Company’s major business segment is poultry and poultry products which consisted of 65% of the total revenues in FY11. The business involves production and sale of day old broiler and layer chicks, specific pathogen free eggs, processed chicken products and poultry feed.

a) Chicks: The Company produces over 55 mn chicks a year for both their meat and their eggs. Chickens raised for meat are called broilers, whilst those raised for eggs are called laying hens.




b) SPF Eggs: SPF Eggs are fertile chicken eggs produced from known SPF parent flocks and are free from the vertically transmitted agents and laterally transmitted infections. Venky’s is the only company in Asia and one of the 6 companies in the world to produce SPF eggs.

c) Grown up commercial broilers: Broiler grown up birds are slaughtered for production of whole chicken, portions in fresh and frozen form and sold in retail and institutional market under “Venky’s” brand. The products are also sold to institutional buyers, major hotels and leading Quick Service Restaurant chains like KFC, Pizza Hut, Dominos, Vista Foods who supply to McDonalds, etc. Venky’s are also in further processing, value added Chicken-in-minutes products like freezer to fryer, completely cooked, ready-to-eat products sold under “Venky’s” brand. Venky’s chicken products are sold through distributors and retail outlets and are available in all leading super markets / food malls.

d) Grown up broiler parents: Venky’s sources one day old broiler breeder parents who are grown in farms and females are artificially inseminated to obtain the hatching eggs which are hatched in incubators. Chicks coming out of the eggs are called commercial chicks which are sold to various commercial poultry farmers and integrators who grow the commercial chicks in their own/contract farms and when the commercial chicks are grown to an age of 40 to 45 days they are sold as grown up broiler birds for meat purpose meant for human consumption.

e) Grown up commercial layers: Venky’s sells commercial layer chicks to various poultry farmers who, in turn, grow them for obtaining “table eggs” – meant for human consumption.

f) Poultry Feeds: Venky’s manufactures and sells poultry feed under the Venky’s brand name for captive consumption to the VH Group as well as to the major poultry markets of Western and Northern states of India.

g) Processed Chicken: Venky’s is the first national brand in the processed chicken segment and sells its processed and further processed chicken under the Venky’s brand name. It is a preferred supplier to the Indian outlets of McDonalds, KFC, Pizza Hut, and Domino’s.

2. Animal Health Products (AHP) The Company has its animal health products manufacturing facility at Pune which constituted 9% of the company’s revenues in FY11. AHPs are manufactured in powder as well as liquid forms in the manufacturing plant. It has more than 35 unique products ensuring better health and better performance in breeders as well as commercial broilers and layers.

Nutritional supplements: Venky’s offers a unique range of Nutritional supplements to poultry farmers as profit enhancers to the business. The blend of vitamins and minerals is standardized after research of more than 2 decades depending upon the needs of various kinds of birds.

3. Solvent Extraction The solvent extraction segment contributed 26% to the revenues of Venky’s in FY11. However, lower realisation in oil prices was the main reason for the fall in profit. The solvent extraction business can be further classified into

a) Refined oil: The Company’s soya processing plant is located near Solapur, Maharashtra. Edible oil obtained from the processing activity is sold in bulk to traders while the de-oiled cake is used in poultry feed.

b) De-oiled soya cake (DOC) for poultry: is an important ingredient of poultry feed. To meet the growing demand for the DOC of feed mills of VH Group, Venky’s set up a solvent extraction plant in 1954.




Income Statement Y/E march (`mn) FY09(A) FY10(A) FY11(A) FY12(E) FY13(E)

Total net revenues 5,693 7,055 8,520 10,169 12,401

COGS 4,024 4,752 5,616 6,844 8,102

Gross Profit 1,668 2,302 2,904 3,325 4,299

Employee Cost 410 437 566 707 796

Selling & Admin Exp. 427 493 617 0 0

Other Expenditure 415 456 586 1,624 1,827

EBITDA 416 916 1,135 994 1,676

EBITDA Margin (%) 25 39.8 39.1 29.9 39

Depreciation 86 90 96 124 162

Other Income 60 49 87 80 80

Interest (Net) 79 50 46 77 97

PBT 311 825 1,080 873 1,496

PBT Margin (%) 5.5 11.7 12.7 8.6 12.1

Tax 105 280 347 288 494

Minority Interest 0 0 0 0 0

Adjusted PAT 207 545 733 585 1,003

Extraordinary items 0 0 0 0 0

Reported PAT 207 545 733 585 1,003

Balance Sheet Y/E March (`mn) FY09 FY10 FY11P FY12E FY13E Equity capital 94 94 94 94 94 Reserves & Surplus 1,477 1,973 2,648 3,167 4,093 Preference Capital 0 0 0 0 0 Net worth 1,571 2,067 2,742 3,261 4,187 Minority interest 0 0 0 0 0 Deffered tax liability 134 146 153 153 153 Total debt 939 899 1,145 1,545 1,945 Total Liab. & Equity 2,510 2,966 3,887 4,806 6,132 Net block 1,175 1,238 1,515 2,191 3,029 Capital WIP 87 97 245 345 445 Total fixed assets 1,262 1,335 1,760 2,536 3,474 Investments 521 813 928 928 928 Goodwill 0 0 0 0 0 Current Assets 1,471 1,595 2,108 2,631 3,373 Inventories 710 866 1,223 1,254 1,563 Debtors 523 514 599 655 781 Cash & bank 108 85 135 569 842 Loans & advances 130 130 151 153 187 Other Current Assets 0 0 0 0 0 Current Liab. & Prov. 609 632 756 1,136 1,489 Creditors 409 444 523 563 644 Other liabilities 78 89 129 149 190 Provisions 123 98 104 424 656 Net Working capital (134) (146) (153) (153) (153) Miscellaneous Exp 0 0 0 0 0 Total Assets 2,510 2,966 3,887 4,806 6,132

Key Ratio Y/E (`mn) FY09 FY10 FY11P FY12E FY13E Per Share Ratios Fully diluted E P S 22 58 78 62 107 Book Value 167 220 292 347 446 Dividend per share 4 4 5 6 7 per share FCFO 4 5 5 11 11 Valuation Ratio P/E 3 6 8 7 4 P/BV 0 2 2 1 1 EV/EBITDA 4 4 6 5 3 EV/Sales 0 1 1 1 0 Price/ FCFO per share 19 62 133 42 40 Growth Ratios Sales Growth 9 24 21 19 22 EBITDA Growth (23) 120 24 (12) 69 Net Profit Growth 4 8 9 6 8 EPS Growth (23) 164 35 (20) 71 Common size Ratios Gross Margin 29 33 34 33 35 EBITDA Margin 7 13 13 10 14 PAT Margin 4 8 9 6 8 Employee Cost 7 6 7 7 6 S&G Expenses 8 7 7 0 0 Return ratios RoAE 14 30 30 20 27 RoACE 10 21 22 15 20 Turnover ratios (days) Debtors ( Days) 32 27 24 22 21 Creditors ( Days) 37 33 31 29 27 Inventory (Days) 49 41 45 44 41 Net working capital 56 47 50 51 50 Solvency Ratios Total Debt/Equity 1 0 0 1 1 Interest coverage 3 12 17 8 11


Cash Flow Y/E March, (`mn) FY09 FY10 FY11P FY12E FY13E PBT 311 825 1,080 873 1,496

Add: Depreciation 86 90 96 124 162

Add: Interest expense 79 50 46 77 97

Less: Other Income (60) (49) (87) (80) (80)

Other Adjustments 0 0 0 0 0

Change in working cap. 50 (125) (339) 291 (116)

Taxes paid 105 280 347 288 494

CF from operations 362 511 449 997 1067 Change in fixed assets (121) (163) (521) (900) (1100)

Changes in Int. Asset 0 0 0 0 0

Change in investments 5 (292) (115) 0 0

Other income 60 49 87 80 80

CF from investing acti. (56) (406) (549) (820) (1020) Change in debt (165) (40) 246 400 400

Change in Equity cap. 0 0 0 0 0

Changes in Pref. capital 0 0 0 0 0

Dividend & dividend tax (38) (44) (55) (66) (77)

Interest paid (79) (50) (46) (77) (97)

Other Adjustments (5) 8 7 0 0

CF from financing acti. (287) (126) 153 257 226 Change in cash 18 (24) 50 434 272

Opening cash 91 108 85 135 569

Closing cash 108 85 135 569 842

Du-Pont Analysis (%) FY09A FY10A FY11E FY12E FY13E

Net Profit Margin 3.6 7.7 8.6 5.8 8.1 Asset Turnover 2.3 2.4 2.2 2.1 2 Leverage 1.6 1.4 1.4 1.5 1.5 ROE 13.8 29.9 30.4 19.5 26.9

* FY09 is only for 9 months as the company had changed its FY end date, ** FY12 includes financials of Henkel India




NOTES

Recommendation Rationale

Recommendation Expected Absolute Return (%) over 12 months

BUY >20%

ACCUMULATE <20% and >10%

NEUTRAL <-10% and <10%

REDUCE >-10% and <-20%

SELL >-20%

Expected absolute returns are based on share price at market close unless otherwise stated. Stock recommendations are based on absolute upside (downside) and have a 12-month horizon. Our target price represents the fair value of the stock based upon the analyst’s discretion. We note that future price fluctuations could lead to a temporary mismatch between upside/downside for stock and our recommendation.

GEPL CAPITAL Pvt Ltd (formerly known as Gupta Equities Pvt. Ltd.)

Head Office: D-21/22 Dhanraj mahal, CSM Marg, Colaba, Mumbai 400001

Reg. Office : 922-C, P.J. Towers, Dalal Street, Fort, Mumbai 400001 Analyst Certification The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Name : Sunil Sewhani Sector : Consumer Discretionary Disclaimer: This report has been prepared by GEPL Capital Private Limited ("GEPL Capital "). GEPL Capital is regulated by the Securities and Exchange Board of India. This report does not constitute a prospectus, offering circular or offering memorandum and is not an offer or invitation to buy or sell any securities, nor shall part, or all, of this presentation form the basis of, or be relied on in connection with, any contract or investment decision in relation to any securities. This report is for distribution only under such circumstances as may be permitted by applicable law. Nothing in this report constitutes a representation that any investment strategy, recommendation or any other content contained herein is suitable or appropriate to a recipient’s individual circumstances or otherwise constitutes a personal recommendation. All investments involve risks and investors should exercise prudence in making their investment decisions. The report should not be regarded by the recipients as a substitute for the exercise of their own judgment. Any opinions expressed in this report are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of GEPL Capital as a result of using different assumptions and criteria. GEPL Capital is under no obligation to update or keep current the information contained herein. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. Any prices stated in this report are for information purposes only and do not represent valuations for individual securities or other instruments. There is no representation that any transaction can or could have been effected at those prices and any prices do not necessarily reflect GEPL Capital’s internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions, by GEPL Capital or any other source may yield substantially different results. GEPL Capital makes no representation or warranty, express or implied, as to, and does not accept any responsibility or liability with respect to, the fairness, accuracy, completeness or correctness of any information or opinions contained herein. Further, GEPL Capital assumes no responsibility to publicly amend, modify or revise any forward-looking statements, on the basis of any subsequent development, information or events, or otherwise. Neither GEPL Capital nor any of its affiliates, directors, employees or agents accepts any liability for any loss or damage arising out of the use of all or any part of this report. In no event shall GEPL capital be liable for any direct, special indirect or consequential damages, or any other damages of any kind, including but not limited to loss of use, loss of profits, or loss of data, whether in an action in contract, tort (including but not limited to negligence), or otherwise, arising out of or in any way connected with the use of this report or the materials contained in, or accessed through, this report. GEPL Capital and its affiliates and/or their officers, directors and employees may have similar or an opposite positions in any securities mentioned in this document (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). The disclosures contained in the reports produced by GEPL Capital shall be strictly governed by and construed in accordance with Indian law. GEPL Capital specifically prohibits the redistribution of this material in whole or in part without the written permission of GEPL Capital and GEPL Capital accepts no liability whatsoever for the actions of third parties in this regard.

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