Vidhi Specialty: Beneficiary of strong entry barriers in food colour industry

Anubhav Sahu
Moneycontrol Research

Highlights:

- Largest listed company in the Indian food colour industry
- Undergoing a business model shift, resulting in margin expansion
- Aims for more than doubling sales in the next two years
- Valuation attractive given the regulated nature of the business
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The food and beverages colour industry — a niche segment of the dyes and pigment industry — not only benefits from growth in the end market (FMCG sector) but also has significant barriers to entry, due to its highly regulated business. As a result, the industry has an oligopolistic structure, where only a few companies are up the scale in terms of technical knowhow and quality control.

Vidhi Specialty Food Ingredients Ltd. (Market Cap: Rs 357 crore) is among the very few in the listed space which meet these criteria and offers a palette of colour solutions vetted by a stringent client approval cycle across the globe. Established in 1994, Vidhi is led by promoters (64 .3 percent share) with decades of experience in the food colour business.

Measuring opportunity size

The size of the global food and beverages colour market is estimated to be about USD 1.1 billion, with half contributed by natural food colours and the other half by synthetic food colours. It is relatively small compared to the global dyes and dye intermediates market of about USD 4 billion, but the prospects of the food colour business are underpinned by relatively steady growth trends.

Market researchers forecast mid to high single digit CAGR (compounded annual growth rate) in the medium term driven by regulatory requirements, urbanization and structural demand drivers for the food and beverage industry.

Table: Market size

Source: Bodal Chemicals, Vidhi, Sensient, Dynemic products, Moneycontrol research

Table: Select companies capacity

Source: Company

Key global manufacturers of food colors are Sensient Technology Corporation, CHR Hansen, GNT and Roha Dyechem and Dynemic Products.

Vidhi Specialty, a leading player in the synthetic colours market, faces competition from Sensient and Roha Dyechem.

Applications – end markets
Food colour is used in confectionary, bakery products, desserts, dairy products, seasonings, beverages, pet foods etc. The usage varies from enhancing naturally occurring colour, masking natural variation in colours and protecting flavours and vitamins from environmental damage.
Prominent customers for Vidhi includes Proquimac, Univar, Nestle, Mars, Pedigree and Sanofi.

Regulatory requirement – key barrier to entry
The use of colours in food is closely regulated and varies from region to region. It is reported that about 14 colours are permitted for use in food in Europe, 6 in USA and 8 in India. Roha Dyechem says there are some colours permitted in Europe, USA but not allowed in India (like Allura). So continuously maintaining various approvals (BIS, FDA, EU & WHO) and certifications (Kosher & Halal) backed by an appropriate lab with testing facilities is an ongoing requirement.

Why do we prefer Vidhi Specialty?

1.Change in operating model – Earnings accretive

Vidhi’s business model has transformed over the last one year. It has pursued debottlenecking initiatives which has increased its production efficiency to about 300 tons per month from 225 tons earlier. In addition, its sales mix has changed as Vidhi has cut down its reliance on trading.

In FY17, trading accounted for 45 percent of sales which has reduced to about 29 percent now. On account of this two-pronged strategy while the company’s topline has been steady, operating margins have increased significantly. Sales for the first nine months of FY19 have increased by a steady 7 percent but EBITDA has surged by 49 percent on YoY basis. Note that the gross margin for Sensient’s colour division of Sensient is still way above Vidhi’s, at about 42 percent.

Table: Financials

Source: Company

2. Targeting more than 2x turnover CY 2020

The company plans to double turnover to Rs 500 crore in CY 2020 (vs Sales of Rs 212 crore in FY18). This would be served by its plan to double food colour capacity and go in for higher margin products. The company’s capex plan appears on track and it is looking forward to getting the environmental clearance.

3. Strong balance sheet

As per September 2018 numbers, the company’s debt is lower by 40 percent compared to the level at the end of FY17 leading to Debt/Equity ratio of 0.41x (down from 0.94x). Management expects to retire its debt in the current fiscal before new working capital related need arises for the expanded facility.

4. Export orientation
Ninety five per cent of Vidhi’s sales of manufactured products caters to the overseas markets. This makes it vulnerable to currency fluctuation but since 65 per cent of the raw material is imported it is a significant natural hedge.

Chart: High imports act as a natural hedge for currency fluctuations (Rs crore)

Source: Company

Key risk - With respect to raw materials, availability of dye intermediates from China and its pricing is a key concern to watch out for.

Outlook
While the capacity expansion plan remains on track, improving product mix, lower share of trading business and backward integration are expected to improve earnings. Operating margins should settle north of 20 percent. Hence we expect 49 percent CAGR in EBITDA for the next two years.
The stock is currently trading at a P/E multiple of 9.2x FY20 estimated earnings, which seems attractive given the regulated nature of the business.Follow @anubhavsays

(Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here)