Equity Research: Hindustan Foods Ltd.

Summary

Hindustan Foods at the CMP of Rs475 looks strong for further upside potential, the stock trades at 90x FY22 EPS, reflecting premium valuations driven by a high, 55%, profit CAGR over the last three years and lack of alternatives in the space.

Hindustan Foods is one of the most diversified and versatile contract-manufacturing companies in India, Hindustan Foods has become a one-stop solution for product development, testing and manufacturing across FMCG categories and regions. It has state-of-the-art manufacturing plants at various locations to manufacture different products. It generates 45% of its revenue each from Foods and HPC, with OTC and others comprising the rest. It has registered CAGRs of 61% in revenue and 55% in profits over the last three years, driven by the merger & acquisitions and aggressive capex. Management is looking at doubling revenue in the next three years to Rs40bn and has already partly invested for this. 

Of the few large listed FMCG contract-manufacturers with good revenue assurance. Dedicated third-party manufacturing brings the company 80-85% of its revenue. Its dedicated manufacturing has long-term contracts of from 5- 10 years, providing revenue assurance over the medium to long term. 

Aiming to double revenue to Rs40bn in three years. The commencement of its ice-cream unit in Uttar Pradesh (2-3x asset turn on Rs2bn gross block), the Scholl acquisition from Reckitt Benckiser, foray into colour cosmetics with the AeroCare acquisition and likely additional capex (funded by debt and internal accruals) should help achieve the Rs40bn target by FY25. 

Strong capital allocation policy. Any investment of >Rs300m toward shared manufacturing is barred by the Board. However, investment for dedicated units has no set upper limits, thus, making judicious use of scarce capital resource. 

One of the most diversified and versatile contract-manufacturing companies in India, Hindustan Foods plans to add value by growing organically and inorganically through bolt-on acquisitions, the need of the hour in contract manufacturing. 

The opportunity is vast. FMCG is the fourth-largest sector in India ($103.7bn, Rs8,000bn), of which personal-care is 50%, home-/health-care ~31% and food & beverage ~19%. The company estimates an outsourced manufacturing opportunity of Rs500bn-1,000bn. 

Company Strength:

• One of the largest formal manufacturers (over three decades’ experience. Consequently, it has strong management expertise in contract manufacturing.
• It enjoys long-term relations with leading domestic and multinational customers through a strong foundation of trust and past associations
• State-of-the-art manufacturing plants at various locations to manufacture different products. Further, it is one-stop solution for product development, testing and manufacturing FMCG, which helps it become a preferred partner
• Ability to create its own formulation of any FMCG helps attract leading FMCG clients
• The emphasis on self-reliance and localisation of sourcing by the government should further help generate opportunities.

Strong Client Base: Hindustan Foods has one of the most diversified range of products across foods & beverages, home-care, personal-care, beauty & make-up, pest control and leather & sports shoes. It recently made a foray into ice-cream, adding one more line to its product range. With three decades of experience in the sector, it has created a strong clientele, which include the topmost manufacturers in FMCG. Of its business, 80% comes from its top three clients, with contracts ranging from five to 10 years. It works with clients to develop innovative products and can assist in speeding the roll-out of a product to the market. This helps customers focus on the core competencies of branding and marketing while it focuses on manufacturing a quality product.

Growth Driver: Favourable macro factors such as Make-in-India, e-commerce, GST implementation, mounting consumer demand, evolving regulatory environment, ease of doing business, and increasing rural incomes are aiding FMCG and the outsourcing of FMCG manufacturing. Given the advantages provided by outsourcing of FMCG manufacturing such as asset-light operating models, cost efficiencies, faster time to market and allowing collaborative innovations, outsourcing is expected to increase. Management expects tailwinds to help in driving growth. Further, along with ice- creams, its recent addition to its product range includes the entire colour cosmetics line to oral- and foot-care, vindicating its ambition to be the most diversified FMCG contract-manufacturer in the country. Management expects to double revenue to Rs40bn by FY25. This would be driven by additional capex for the ice-cream unit in Uttar Pradesh (2-3x asset turns on Rs2bn gross block), the Scholl acquisition from Reckitt Benckiser, foray into colour cosmetics with the AeroCare acquisition and likely future capex (funded by debt and internal accruals).

High Growth Opportunity: Due to the distinct competitive advantage of availability of high intellectual capital and low labour cost, india has been a preferred destination for a range of outsourcing activities. in today’s times, a contract Manufacturer is not just a producer and packer, but a value-adding partner across the entire supply chain. In the current context, FMCG majors rely heavily on Contract Manufacturing companies to meet ever-changing demand dynamic. India stands out as a potential manufacturing powerhouse that is yet to realise its promise. From fiscal year 2006 to 2012, India’s manufacturing-sector GDP grew by an average of 9.5% per year. Then, over the next 6 years, growth declined to 7.4%. In fiscal year 2020, manufacturing generated 17.4% of India’s GDP, little more than the 15.3% contributed in 2000 (By comparison, Vietnam’s manufacturing sector more than doubled its share of GDP during the same interval). Besides, in the past 13 years, India’s manufacturing-sector share of employment increased by just one percentage point, compared with a five-point increase for the services sector.

Well equipped with resources: Today’s Contract Manufacturers are well-equipped with technology and warehouses and provide businesses with deeper technical insights, right from the stage of product development to packaging. Contract Manufacturers are also well-equipped to identify potential risks and take measures to mitigate them. This is owed to decades of expertise, supported by skilled management and experts who understand manufacturing and supply logistics in depth. Hindustan Foods Limited (HFL), have a winning edge, owing to our decades-long experience in producing across FMCG categories, expertise in product packaging, capabilities in developing new products and constant innovation. They can cater over a wide range of clients and manage the operational complexities of the full spectrum of FMCG players. They have, over the years, developed top-of-the-class project management capabilities, that enables us to set up greenfield projects, adapt brownfields and increase capacities all within challenging lead times. They accomplish this while also ensuring that costs of capital-intensive equipment are seriously contained. This enables brand owners to go asset- light and personnel-light and focus on market value-adding activities in a fruitful manner.

Ability to source resources: For a Contract Manufacturer, the variable costs of acquiring raw materials are reduced due to scale. Likewise, the fixed costs are reduced owing to volume play with various lines producing different categories of products. Therefore, a Contract Manufacturer can offer products at lower prices per unit to customers in the aggregate. At HFL, our ability to source raw materials locally saves time and manufacturing costs. Our ability to procure resources from labour to transport to materials at reasonable prices locally, hugely increases productivity and cost efficiency. We also have best-in-class supplier agreements in place. Backed by excellent supplier management and vendor development skills, we keep sourcing on an ever-increasing efficiency uptick.

Quality products: HFL’s unvarying commitment to quality regularly receives appreciation from our clientele. The high degree of difficulty skill is in maintaining the right balance of quality products but at continually lower costs. Quality assurance processes and trained personnel ensure sustained cost-efficient high quality and consistent quality operations.

Skilled labour: The backbone of the Contract Manufacturing industry is skilled labour and the availability of such Indian skilled labour at relatively lower costs provides a significant advantage for global FMCG companies to outsource from India. At HFL, we feel fortunate in our excellent labour relations record. We upskill our labour force constantly through various training programmes. These investments meet labour force aspirations and provide us with increasing skill sets in a win-win relationship. Moreover, various programmes and initiatives taken by governments are further enhancing skilled labour availability.

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The commencement of the company’s ice-cream unit in Uttar Pradesh (with likely 2-3x asset turns on Rs2bn gross block), the Scholl acquisition from Reckitt Benckiser and the foray into colour cosmetics with the AeroCare acquisition should help achieve the Rs40bn target by FY25. The company has indicated additional capex to achieve the stated target, which will be funded through debt and internal accruals. Having proved its mettle in the past, we expect management to deliver on its FY25 revenue target as well. Given its simple business model, it operates at a high, 85%, dedicated contract-manufacture, implying steady revenue and earnings growth assurance. At the CMP of Rs475, the stock trades at 90x FY22 EPS, reflecting premium valuations driven by a high, 55%, profit CAGR over the last three years and lack of alternatives in the space.