A couple of years ago I had the opportunity to present on Gujarat Ambuja Exports Ltd. at Tamil Nadu Investors Association’s 20:20 conference held in Chennai. I had under half an hour to explain the entire business model, investment thesis along with upside triggers, management assessment, valuation, the risk & concerns, among other pertinent factors. The video is there on Stalwart Advisors’ Youtube channel, the link is shared at the end of the post.

This post is a brief update on how (or not) the thesis is playing out. But before I jump to that, let us do a quick recap of what the company does. The key segment contributing to the majority of sales and bulk of the profitability is their ‘Maize Processing’ segment, under which the company buys maize (corn) from the farmers and processes it to extract starch and its derivatives. While basic starch is a pure commodity and is largely supplied to paper and textile mills, the derivatives like Sorbitol, High Maltose Corn Syrup, Liquid Glucose, etc., are value-added products and supplied to quality-conscious manufacturers in Pharma and Food & Beverage industries.

Despite being a so-called commodity business, GAEL’s maize segment boasts of a long history (13+ years) of maintaining steady operating margins and a 25% average return on capital employed. Thanks to:

1. Its mammoth scale with 25% market share,
2. Its geographically spread out plant locations minimizing the operating cost,
3. The strategy of bulk cash purchases during harvesting season ensuring the cheapest procurement cost among peers,
4. Focus on in-house engineering and R&D to ensure the lowest Capex, and,
5. Its financial discipline ensuring a net debt-free balance sheet.

All of this ensures GAEL is the most efficient (lowest-cost producer) in the industry and always the last man standing (least vulnerable of the lot).

2019 – An abnormal year

The maize crop was badly affected due to the army-worm pest attack as well as the erratic monsoon in some of the key producing regions. As supply and quality went down drastically, the maize prices started climbing up – from levels of around Rs 15-16 per kilo, it went all the way up to Rs 25 per kilo. The industry never experienced such an abnormal spike in raw material prices in such a short span of time. This squeezed gross margins as it takes a while to pass on the higher cost to buyers, which could not be passed on fully given weak demand and high competition. The impact on operating margin was even worse as volume also dropped due to a lack of availability of quality maize.

This was a rare occurrence (once in decades) and the maize pricing at those levels was clearly unsustainable. The recent harvest has been normal and as things stand, the maize prices have dropped back to Rs 14-15 per kilo with substantial improvement in availability as well as quality, thanks to a good monsoon and ample water in reservoirs across the country. This shall ensure a quick and sustained recovery in gross margins over the next few quarters, as is also evident in Q1FY21 segment results. Further, this steep drop in input prices should again make Indian starch globally competitive while maintaining some premium as it is non-GMO maize. During FY19 GAEL had exports of over Rs 1,200 Cr. (30% of the turnover) and this fell sharply to Rs 570 Cr during FY20 but can make a recovery going forward.

Capex on track, market share to reach 30%

Until 2018, GAEL had three plants spread across Gujarat, Uttaranchal, and Karnataka with a cumulative processing capacity of 1,950 tons per day (TPD). Later, the fourth plant in Maharashtra got added at a CAPEX of over Rs 300 Cr. increasing the total processing capacity by 50% to 3,000 TPD. During 2019, this remained under-utilized due to maize being in short supply. Phase II (derivatives facility) in this new plant got recently commissioned. The civil work for the 5th plant, a greenfield project of 750 TPD in West Bengal has also initiated and should get completed in 2021, raising GAEL’s market share to over 30%. The 6th plant is already on the drawing board and the company overall plans to invest about Rs 500 Cr in Capex over next 2-3 years.

Despite such Capex intensity, the company has been able to manage funds entirely from internal accruals staying away from borrowed capital and the balance sheet quality has remained pristine despite having one of the worst crop years for maize since inception. Besides, the company still managed to post a net profit of Rs 146 Cr. in FY20, as against 198 Cr. in FY19. The current market capitalization is Rs 2,200 Cr (20% cheaper since the original presentation in Oct’ 2018) while based on the expected recovery in operating margins and market share gains supported by on-going expansion, the potential profitability is over Rs 300 Cr.

Similar to what I mentioned in my recent post on real estate, while overall starch industry demand could be down due to COVID disruption, but supply is down too as the biggest brunt of lockdown (unfortunately) is borne by unorganized/regional players. Leaders like GAEL which continue to expand consistently without leverage could emerge stronger – a larger share of a smaller pie.

Optionalities

High Fructose Corn Syrup (HFCS): As a product category this hasn’t got the FSSAI approval yet, however, things are moving in the right direction. This has the potential to replace sugar for sweetening beverages (Coke/Pepsi) as is the norm globally, making it a large opportunity. GAEL is almost ready with the plant and once approvals are in place, it will be the first company with capacity, capability, and customer tie-ups to enter this product category.

Capital (Mis)Allocation: Regarding the textile mill, the management has been saying it is non-core and they are open to restructuring including closing/selling. While no new capital has been deployed in this segment in the last five years, it continues to bleed (Operating loss of Rs 13.5 Cr. in FY20). However, there’s a positive development – they have recently entered into an agreement with a large textile company to provide this plant on a dedicated basis for contract manufacturing, most likely on a cost-plus basis. This should finally address the capital allocation concern the market may have. The other segment of agro-processing (Solvent extraction & edible oil refining) is synergistic and generates Rs 70-80 Cr of operating profit in a good year (lesser in bad ones), more importantly, it doesn’t need any incremental capital and thereby provides free cash for redeployment in maize.

To summarize, Maize continues to be a structural story and after hitting a speed bump in 2019, the segment should rebound sharply this year. The segment contributed 52% to FY20 consolidated revenue and 73% to operating profit. Once the new capacities come on stream, its share is expected to rise further. The management execution, in an otherwise challenging industry, continues to be noteworthy and Capex commitment of another Rs 500 Cr (with asset turns of 2-2.5x) in the Maize segment gives confidence on the scalability. Promoters have been buying GAEL stock from the open market which is another positive indicator.

Free Access: SA’s research on GAEL is freely accessible on our guest dashboard, including the Initiating Coverage Report (ICR) & all subsequent updates like AGM takeaways and quarterly result updates: https://investor.stalwartvalue.com/

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Disclaimer: GAEL is one of the core positions in Stalwart Advisors’ Model Portfolio. This is not a recommendation to buy/hold/sell. As always, our job involves betting on the future, a lot of assumptions go into forming an opinion and we reserve the right to go wrong as we have also been in the past. Please consult your financial advisor before acting on it.

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