BackKaveri Seed’s valuations may be ignoring industry risks
Kaveri Seed's strengths in the market are its distribution reach and product portfolio but aggressive competition can adversely affect realizations and profitability
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The rally in Kaveri Seed Co. Ltd’s shares raises concerns on whether valuations adequately factor in business risks. Last month, Sharekhan Ltd recommended booking profits in the stock, citing relatively high valuations. “The stock is currently trading at 16x/13x its FY2018E/FY2019E earnings, which is close to the higher end of its long-term historical multiples, leaving limited scope for further upside," Sharekhan wrote in a note.
To be sure, the 35% rise in Kaveri stock so far in 2017 has coincided with an improving business outlook and a proposed share buyback. Cotton prices are up by one-fifth (20%) from a year ago. Higher prices are also expected to raise cotton crop acreages in coming season. Channel checks by Emkay Global Financial Services Ltd indicate higher cotton crop acreages. “Our interaction with seeds distributor in Telangana (one of the large markets) has indicated that cotton acreages are expected to increase by 20-25% while maize and pulses acreages are expected to fall by 30-40%," Emkay wrote in a note.
The change in the mix can benefit Kaveri as the company derives three-fifth of its revenues from cotton seeds. It has a wide reach and products with good brand recall. “Kaveri is likely to gain market share on the back of new product launches such as ‘Money Maker’ which has got encouraging results during trial last year. Jadoo and ATM are also expected to see good demand," Emkay added.
If cotton crop acreages rise as expected then the company’s sales growth may recover. Revenue in the first nine months of the previous fiscal dropped from a year ago on weak demand and moderation in cotton seed prices. Two domestic broking firms estimate 2017-18 revenue growth at around 20%.
These are some of the reasons why its share has been running up. The company had earlier announced a buyback at a significant premium to the market price. Still, the question that lingers is whether its performance will be able to justify valuations, given the risks associated with agriculture. At present, the rains and therefore adequate water availability needs to be watched. The business environment can turn difficult too. If acreages do not expand sufficiently, competition can intensify, putting pressure on profitability. The cotton seed industry is coming out of a bad year and stakeholders are keen to gain or retain market-shares. Kaveri’s strengths in the market are its distribution reach and product portfolio but aggressive competition can adversely affect realizations and profitability.
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