Coverage Stock: S H Kelkar & Company Ltd. - Edelweiss

1 GWM

Edelweiss Investment Research

S H Kelkar & Company Ltd (SHK) is the largest domestic Fragrances & Flavours (F&F) player in India with ~14% market share in an oligopolistic

industry. Robust spurt in the flavours segment coupled with recovery in volume growth in the fragrances segment, mix shift in favour of more value-

added products in the fragrances business and significant cost efficiency measures are envisaged to lead to revenue and PAT CAGR of ~9% and

21% over FY17-19E, respectively. The company is trading at significant discount to growth adjusted valuation multiples of global peers as well as

its own historical valuations, while additional upside could accrue from tuck-in acquisitions. Initiate coverage with ‘BUY’ and target price of INR

348.

Burgeoning FMCG market to spearhead domestic spurt; Expanding footprint, premium product focus to boost international operations

SHK is the largest domestic player in the F&F space and its market share has expanded by ~200 bps over the past three years. We estimate the

company’s fragrance sales to jump ~8.7% and flavours sales by ~16.4% over FY17-19E resulting in overall sales CAGR of ~9.4%. We expect domestic

growth to be driven by an anticipated ~20% CAGR in the domestic FMCG market till CY20 and sharp increase in per capita FMCG spending. On

the international business front, SHK is eyeing entry in high growth markets in SEA (South East Asia) and MENA (Middle East and North African)

regions, which coupled with product mix shifting in favour of more premium products is bound to boost top line as well as bottom line.

Mix shift towards flavours and cost efficiency initiatives to lead margin improvement; Presence in small pack and tier-2 space to bolster growth

The company is eyeing rapid scale up in the flavours business, which currently entails higher margin compared to the fragrances segment. We

estimate margins to improve slightly riding this mix change and also cost efficiency initiatives. Moreover, presence of a significant number of SME

enterprises (~42% market share) in the domestic flavours market provides SHK opportunities to grow inorganically in the segment. The company’s

presence in the small pack segment is an added advantage as it is not a key focus area for MNCs, which coupled with significant wallet share

among tier-2 FMCG players (expected to grow at twice the growth of FMCG majors), are significant growth levers.

Outlook and valuations: Attractive prospects and limited downside; initiate with ‘BUY’

Key drivers envisaged to spur SHK are: 1) surging FMCG demand; 2) sweating of existing capacities; 3) mix change in favour of flavours; 4) cost

efficiency measures; and 5) sustained R&D and monetization of encapsulation technology. We initiate coverage on the stock with ‘BUY’

recommendation and target price of INR 348 based on ~33x FY19E earnings (60% discount to global PEG multiples). The stock is currently trading

at 32x and 25x FY18E and FY19E earnings, respectively.

Year to March FY15 FY16 FY17 FY18E FY19E

Revenues (INR Cr) 836 927 986 1,039 1,180

Rev growth (%) 9.7 10.9 6.5 5.4 13.5

EBITDA (INR Cr) 119 151 167 188 231

Net Profit (INR Cr) 61 72 103 122 152

P/E (x) 61.7 53.7 37.5 31.7 25.4

EV/EBITDA (x) 33.3 25.7 23.3 20.5 16.5

RoACE (%) 14 17 19 19 22

RoAE (%) 16 14 15 15 17

Bloomberg: SHKL:IN

52-week range (INR): 363 / 236

Shares in issue (cr): 14.5

M cap (INR cr): 3,814

Avg. Daily Vol. BSE/NSE :(‘000): 243

Promoter Holding (%) 57.4

Coverage Stock: S H Kelkar & Company Ltd.

‘Flavour’ of the season likely to ‘smell’ success

CMP INR 268 Target INR 348

Rating: BUY Upside: 30%

Date: 09th October 2017

Jigar Jani

Research Analyst

[email protected]

S H Kelkar & Company Ltd.

2 GWM

SHK is expected to deliver an PAT CAGR of 21% over FY17-19E driven by strong topline growth in the flavours business while improvement in

margins due to cost efficiency measure and mix improvement

Rebound in fragrances

volume and robust growth

in flavours business to drive

topline growth

Improved profitability,

lower capex and higher

utilization likely to drive

return ratios higher

SHK is available at 60%

discount to global peers on

growth adjusted PEG

multiple

FY15 FY16 FY17 FY18E FY19E

Total Sales 837 927 986 1039 1180

Fragrances Sales

776 863 857 900 1012

Flavours Sales 61 58 124 139 168

Total PAT 70 73 105 122 152

At CMP, FY19E P/E is

25x

At Target Price,

FY19E P/E is 33x

Upside of 30%

FY19E RoCE of 22.2%

FY15 FY16 FY17 FY18E FY19E

RoACE 13.5% 17.4% 19.0% 19.4% 22.2%

RoAE 16.1% 13.7% 15.1% 15.4% 16.9%

PE Multiple FY19E EPS CMP / Target

25x (CMP) 10.5 268

33x (Target) 10.5 348


3 GWM

Risk-reward extremely favourable

Price Target INR 348

Our TP is arrived at by assigning 33x P/E multiple to FY19E EPS of 10.5 giving 60% discount to the

average CY18E PEG ratio of global peers of 3.9x to arrive at PEG ratio of 1.58x and multiplying

it with a base case EPS CAGR of 20.6% over FY17-19E.

Bull

40x Bull Case FY19E EPS

INR 440 Assuming a higher growth of 25% for the flavours division and 15% for the fragrances division

for FY19 while assuming FY18 estimates to be the base as the base case, and assigning a higher

40x P/E, we arrive at TP of INR 440.

Base

33x Base Case FY19E EPS

INR 348 Assuming CAGR of 8.7% for the fragrance division and 16.4% for the flavours division over FY17-

19E coupled with 267 bps improvement in EBITDA margin over FY17-19E and assigning 33x P/E,

we arrive at TP of INR 348.

Bear

24x Bear Case FY19E EPS

INR 229 Assuming CAGR of 7% for the fragrance division and 14% for the flavours division over FY17-19E

and assuming 140 bps improvement in EBITDA margin over FY17-19E and assigning 24x PE, we

arrive at TP of INR 229.


4 GWM

Average Daily Turnover (INR cr) Stock Price (CAGR) Sensex CAGR (%)

3 months 6 months 1 year 1 year 2 years 5 years 10 years 1 year 2 years 5 years 10 years

2.3 3.2 3.3 -11.5% NA NA NA 13.2% NA NA NA

Bu

sin

ess

Va

lue

Driv

ers

Nature of Industry Highly consolidated industry with the top 5 players accounting for 59% of global F&F market and 70% of total F&F market in India. The

industry has high barriers to entry in terms of reliability & product quality, technical know-how and long-term relationships with FMCG

players coupled with stringent regulatory compliance.

Opportunity Size

Currently, while the domestic F&F market is ~USD 770 mn, the global market is ~ USD 24.7 bn in size. Globally, the market is expected to

grow at ~5%, while the domestic market is expected to grow more than 2x the global rate. Moreover, 42% of the domestic flavours

market is occupied by small and medium sized players, which makes it an attractive proposition for larger organized players to gain

incremental share inorganically.

Capital Allocation The company has been focused on the F&F business and all its recent acquisitions and expansions have been in the F&F space. The

company intends to invest free cash flows in expansion of facilities in India, R&D, cost saving initiatives and tuck-in acquisitions.

Predictability The F&F business is sticky in nature with ~90% of the business coming from existing customers. Moreover, the company generates ~10%

revenue from products launched over the past three years, indicating a steady stream of revenue from new product launches.

Sustainability The company’s end customer is the non-cyclical FMCG industry which coupled with customer stickiness renders the business highly

sustainable. Moreover, the FMCG industry in India is expected to be on the cusp of a strong growth trajectory.

Future Prospects The company intends to grow at twice the market rate over the long term. It intends to be a USD 1 bn topline company over the next

decade.

Business Strategy &

Planned Initiatives

Current focus is to ramp up in utilization of existing facilities along with investments in R&D focused on fragrance innovation and strategic

cost initiatives to improve margins. The company also intends to enhance its inventory management system by moving it to a

centralized location, which will help improve working capital. It also intends to shift its product mix towards more value- added products

like fine fragrances, especially in the international fragrance market.

Near Term Visibility Strong visibility for 20.6% CAGR bottom line growth along with 267 bps improvement in EBITDA margin over FY17-19E.

Long Term Visibility To remain the largest F&F player of Indian origin with an ambition to clock USD 1 bn in sales over the next decade.


5 GWM

Focus Charts – Story in a nutshell

Largest Domestic Player in F&F

space

Higher margin Flavours Business to grow

rapidly on a low base

Per Capita FMCG spending to increase rapidly over next five years

Diversified Customer Base Presence in high growth tier-2 F&B segment an

advantage

Valuations inexpensive compared to global

peers considering growth prospects

3,600 + Fragrance Customers

500 + Flavours Customers

Source: Company, Edelweiss Investment Research

21.0%

2.0%

12.0%

22.5%

4.0%

14.3%

Fragrances Flavours F&F Market

SHK’s market share in flavours

and fragrances

CY2013 CY2016

17 1837 41

61 58

124 140168

198

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

E

FY

19

E

FY

20

E

Flavours business expected to grow

rapidly

15% 14% 15% 16%11% 13% 14%

17%

59%

22%18% 16% 19%

27%

FY11 FY12 FY13 FY14 FY15 FY16 FY17

Flavours a better margin business

compared to fragrances

Fragrances EBIT Margin Flavours EBIT Margin

Japan

UK

Germany USItaly

South Korea

PortugalMexico

Thailand

India 2020

Brazil

ChinaIndonesia

India 2016

Bangladesh

Philippines

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000 60,000

2,500

2,000

1,500

1,000

500

0

FMCG spending per capita in US$, 2016

20% 30% 40%

CAGR

Tier 1: 16%

Tier 2: 28%

CAGR

Tier 1: 13%-15%

Tier 2: 22%-25%

2008 2014 2019 Givaudan

Symrise

IFF

SHK

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

P/E

EPS Growth Next 2FY (%)

Tier 1 Tier 2


6 GWM

I. Fragrances and Flavours: A niche & consolidated market

F&F blenders a critical component of FMCG value chain

• Fragrances and Flavours (F&F) are small, but critical constituents which

provide smell and taste to FMCG and Food & Beverages (F&B) products,

respectively.

• F&F blends are prepared from a mixture of number of F&F ingredients which

can be natural/ nature identical / synthetic depending on the raw material

used to manufacture those ingredients.

• These F&F blends are then supplied to FMCG players to incorporate into their

products.


• F&F products account for only 2-5% of the overall cost of a product, but are

critical in providing specific characteristic to a particular product.

• Consistency of quality and supply, therefore, become critical factors while

selecting an F&F player. But once approved as a vendor for the product,

customer stickiness becomes strong as the FMCG player is reluctant to switch

suppliers for a small cost, but critical component of a product.

According to an AC Nielsen survey, 78% of consumers buying fine fragrances

rate smell as the most important factor, while 45% buyers of F&B rate smell and

taste as the most critical factors, indicating the critical nature of the F&F

product to a consumer’s purchasing decision.

Important factors influencing consumer purchase decision

Source: AC Nielsen, Company, Edelweiss Investment Research

Raw Material

Natural Sources Fragrance

products Mint, spices and other herbs

Non fragrance products Terpene oil

Synthetic Petrochemical

derivatives

Ingredient

Manufacturers

Mint and essentialoils

Spice oleoresins

Aroma chemicals

Blenders

Manufacturers

Global F&F houses

Indian blenders

End-users

Major FMCG players

Major F&B players

Smaller FMCGplayers

6%3%5%

8%

78%

Fine Fragrances

10%

15%

30%

45%

Flavours

Scent

4-6% of customers COGS

Overall experience

BrandFragrance imageOther

Smell & Taste

0.5% of customers COGS

Brand image

Price

Packaging


7 GWM

Global F&F Market expected to grow at ~5% CAGR

• The global F&F market is expected to be ~USD 24.7 bn and has clocked CAGR

of ~2.1% over the past six years

• The global F&F market is estimated to register CAGR of ~5% over the next five

years, while the domestic market is expected to grow atleast 2x the global

rate.

Global F&F Industry (USD bn)


Domestic F&F Market to grow at twice the global rate

The domestic F&F market is expected to be worth ~INR 5,000 cr (USD 770 mn

at current exchange rate, accounting for ~3% of global market) and has

posted CAGR of ~13% over the past four years.

The domestic fragrances market was worth INR 1,693 cr as of CY12 and is

expected to have reached ~INR 2,500 cr as of CY16 compounding at a rate

of 10.2% over the past four years.

The flavours market in India was worth INR 1,404 cr as of CY12 and is expected

to have reached ~INR 2,500 cr as of CY16 compounding at a rate of 15.5%

over the past four years.

Indian F&F Market growing at ~13% over the past four years


FMCG is the key end market for the F&F industry

The Household, Fabric, Beauty & Personal care industry within the

FMCG space are major end user segments for the fragrances industry,

accounting for ~70% of market.

Beverages and Bakery are major end user segments for the flavours

industry, accounting for ~64% of market.

Key end markets for fragrances (%) Key end markets for flavours (%)


F&F industry is highly consolidated with strong entry barriers

• The F&F industry, globally and domestically, is a highly consolidated

market with strong entry barriers with quality, reliability, range of

products and high switching costs resulting in high level of customer

stickiness. While the top 5 players globally control ~59% of total market,

the top 10 players control ~73% of the total market.

• Similar trend is visible in India with the top 5 players accounting for ~70%

of the market, although the industry has more than 1,000 players.

Top 5 player market share – India and Global


21.8 22.9 23.9 24.9 24.1 24.7

2011 2012 2013 2014 2015 2016

$ b

n

1693 2090 2500

14041715

250030973805

5000

2012 2014 2016

(IN

r c

r)

Fragrances Flavours

Home

Care,

21%

Personal

Wash,

15%

Fabric

Care,

11%

Beauty

Care,

11%

Hair

Care,

10%

Others,

31%

Beverag

es, 41%

Bakery,

23%

Oral

Hygiene

, 12%

Confecti

onary,

4%

Salty

Snacks,

4%

Dairy,

1%

Others,

15%

59%

70%

Global India


8 GWM

II. Largest domestic player with dominant share in fragrances

• SHK is the largest domestic player in the F&F market—market share jumped ~200

bps from 12.0% to 14.3% over the past three years.

SHK’s market share in flavours and fragrances

Source:,Company,Edelweiss Investment Research

• SHK has ~23% market share in the domestic fragrances market and the

company along with Givaudan and Firmenich control more than 60% market.

• The fragrance market is highly consolidated with the top 5 players controlling

~84% of the total market.

Domestic fragrances to continue grow in double digits

• SHK has significant share in the domestic fragrance market with over 40% wallet

share of domestic FMCG players. The company boasts of over 3,600+

customers in the fragrances segment.

3,600 + Fragrance Customers

• We estimate the company to grow organically by 5% in FY18 with the first

quarter impacted by GST implementation and Q2FY18 also likely to be

impacted due to continued transition of small players to the GST regime.

Post FY18, we estimate SHK to register growth of 14% in FY19 and FY20,

respectively, in line with the growth expected in the FMCG sector.

SHK Fragrance Business Revenue


Transition of export mix towards high-end fragrances nearing completion

SHK has been strategically moving its international fragrance business

mix towards more high-value products, while pruning low value high

volume sales from some markets of Middle East, which are increasingly

facing credit risk.

This strategy, coupled with pricing pressure from competition and

global weakness in the international fragrance market, led to 15%

decline in the international fragrance business in FY17.

SHK expects this transition to be over in FY17 and perceives more

steady growth in international markets in FY18 and FY19.

We expect the international fragrances business to grow at 10% driven

by change in product mix and SHK’s strategic plan to enter new

geographies with demographics similar to India.

SHK Fragrance—Domestic / International Revenue split


21.0%

2.0%

12.0%

22.5%

4.0%

14.3%

Fragrances Flavours F&F Market

CY2013 CY2016

442552

629720

776863 857 900

1,012 1,142

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

(IN

R

cr)

488 561 600 630 715 815

285 302 257 270297

327

FY15 FY16 FY17 FY18E FY19E FY20E

(IN

R c

r)

Domestic Fragrances International Fragrances


9 GWM

Flavours: Late entrant, but inorganic approach spearheading market share gains

• SHK is a late entrant in the flavours segment (marketing commenced in 2009)

and currently has ~4% market share in the domestic flavours industry.

• The company has over 500+ customers in the segment and has been

increasing its presence via organic as well as inorganic routes.

500 + Flavours Customers

• The flavours industry is extremely fragmented with 56% market share

controlled by the top 4 players (all global), while the balance 44% market

remains highly fragmented.

• SHK has identified this as opportunity to establish market share in this category

by tuck-in acquisition of these small players.

• The flavours segment is significantly higher margin for the company

compared to the fragrances segment and is expected to grow faster

compared to the fragrances segment for the company on a low base

Flavours a better margin business compared to fragrances


Acquisition of Gujarat Flavours (GFPL) and Hi-Tech Technologies (HTT)

has helped SHK double its market share in the segment.

GFPL ‘s flavours division and HTT registered combined sales of INR 32 cr

in FY17 which also led to a significant margin expansion for the flavours

segment reflecting the management’s ability to successfully integrate

tuck-in acquisitions.

Flavours business to grow organically by 20% domestically and 12%

internationally

• SHK registered strong organic growth of 58% in FY17 (30% in domestic

business and 80% in international business) and management is

targeting organic growth of ~25% in the segment in the near term.

• The company appointed 12 new distributors to address small scale

manufacturers and increased presence in Delhi and Hyderabad in

FY17. In the international business, the company intends to grow its

presence in South East Asia and MENA region.

• SHK also aims to reinforce its domestic presence by entering

unchartered East India (West Bengal – large tea drinking population,

Odisha – local bakery industry growing with large production capacity)

and Central India (Jharkhand, MP and Ranchi).

• We estimate the domestic and international flavours business to clock

20% and 12% CAGR over FY17-19, respectively.

Flavours—Revenue transition


15% 14% 15% 16%11% 13% 14%17%

59%

22%18% 16% 19%

27%

FY11 FY12 FY13 FY14 FY15 FY16 FY17

Fragrances EBIT Margin Flavours EBIT Margin

17 1837 41

61 58

124140

168

198



10 GWM

III. End markets are expected to grow at a rapid pace Recent slowdown in FMCG has impacted sales growth

• SHK’s sales growth has mimicked that of FMCG players. Ergo, the recent

slowdown in the FMCG sector has reflected in lower earnings growth for the

company.

*FMCG growth represented by growth of cumulative sales of Britannia Industries,Dabur India, Emami, GCPL, HUL,

Marico

Domestic FMCG industry estimated to post ~20% CAGR over next 4 years

• The Indian FMCG market size is currently pegged at USD 49 bn with

Household and Personal Care (key end markets for the fragrances segment)

and F&B (key end market for the flavours segment) accounting for ~70% of

total FMCG market.

• The FMCG industry is estimated to clock CAGR of ~20% to USD 103.7 bn

by 2020 driven by urbanization, premiumisation, product customization

and innovation.


FMCG growth follows an S-curve; India is at the cusp and has significant

room to grow in the next 5-10 years

FMCG spending per capita usually follows a S-curve with GDP per

capita as per historical analysis of other countries. According to Bain

publications, India is poised to post exponential growth over the next

5-10 years as it is currently on the cusp of an uptrend of the S-curve.

Notes: FMCG per capita is in PPP terms; PPP is purchasing power parity; India’s current

GDP/capita (PPP terms) is ~$6,800 and is expected to be ~$12,000 by 2020; countries with similar

GDP today include Indonesia, Thailand and China; each dot denotes a country.

Sources: IMF World Economic Outlook (Apr 2016); Euromonitor

0%

10%

20%

30%

201203 201303 201403 201503 201603 201703

S H Kelkar FMCG Growth

FMCG

Food &

beveragesHealth care

Household and

Personal care

19%31% 50%

Health beverages, staples/cereals,bakery products, snacks, chocolates,ice cream, tea/coffee/soft drinks,processed fruits and vegetables,dairy products, and branded flour

OTC products and ethicals

Oral care, hair care, skin care,cosmetics/deodorants, perfumes,feminine hygiene and paperproducts, Fabric wash, householdcleaners

18 21 24 30 35 37 45 47 49

104

2007 2008 2009 2010 2011 2012 2013 2015 2016 2020F

(US$ b

n)

FMCG—Revenue trend over the years

Japan

UK

Germany USItaly

South Korea

PortugalMexico

Thailand

India 2020

Brazil

ChinaIndonesia

India 2016

Bangladesh

Philippines

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000 60,000

2,500

2,000

1,500

1,000

500

0

FMCG spending per capita in US$, 2016


11 GWM

Per capita consumption in personal care categories is well below global

standards with opportunity size 2-15x in all categories

The personal care space in India has significant scope for expansion given

the gap in terms of per capita spending in various categories compared to

global averages.

Global averages of per capita spending in various categories of personal

care is between 2x and 15x greater, depending on the category.

HPC penetration compared to global averages

Source: Euromonitor International, Edelweiss Investment Research

Per capita expenditure on food and non-alcoholic beverages in India is second

lowest in world

• Per capita expenditure on food including non-alcoholic beverages in India is

at USD 277, among the lowest in the world, with the world average being

closer to USD 2,000, entailing ample scope for expansion of the flavours

segment.

Presence in tier-2 segment likely to aid faster growth in flavours

• According to a Crisil research report, Tier-2 players in the F&B space

have surpassed established players, thereby gaining incremental

market share.

• This trend is likely to sustain with tier-2 players likely to grow ~2x the rate

in the F&B space.

• SHK, along with smaller unorganized players, caters to this segment and

we expect this phenomenon to help the company sustain growth well

in excess of 20% in the domestic F&F market.

Increasing share of tier 2 in fast growing F&B pie


2.5 2.01.2 1.1 0.5 0.3

6

10

6

15

8

3

Bath and

Shower

Hair Care Oral Care Skin Care Color

Cosmetics

Deodarants

(US$)

Per Capita Spend - India Per Capita Spend - Global

20% 30% 40%

CAGR

Tier 1: 16%

Tier 2: 28%

CAGR

Tier 1: 13%-15%

Tier 2: 22%-25%

2008 2014 2019

Tier 1 Tier 2


12 GWM

IV. Small pack segment and focus on tier 2 customers lend edge

• SHK has developed a niche for itself by working with tier-2 and smaller domestic FMCG players. Smaller domestic FMCG players and the small pack segment

have not been key focus areas of global MNC players, enabling SHK develop a niche in this segment.

• Around 12% of the company’s sales in FY16 came from the small pack segment. These small packs are sold to hundreds of traders and resellers across India

with sizes varying from 25 gm to 500 gm.

• This segment provides an untapped opportunity for the company while also providing an initial testing ground & immediate feedback for new products.

• SHK also works with Tier 2 FMCG players which can become big brands themselves. A case in point is Vini Cosmetics, makers of FOGG brand of deos, which is

one of the company’s customers. FOGG has become a market leader in the deo segment with market share of ~20% and revenue of INR 700 cr within six years

since launch of its products.

Key small pack brands FY16- Percentage of revenues from small pack segment


12% of Total

revenues

from small

pack

segment


13 GWM

V. Cost efficiency measures coupled with operating leverage to boost margin

SHK is planning to enhance its inventory management system via inventory relocation to a central location. This is likely to improve the company’s inventory

days as a centralized hub will lead to better inventory management

The company’s overseas subisidiary PFW Aroma Chemicals, which manufactures aroma chemicals and musk fragrance (Tonalid), currently generates low

gross and operating margins due to the plant’s high cost base and excess supply for the product in developed markets. However, PFW provides backward

integration in terms of raw materials and also has the R&D expertise to register new products in developed markets and supply relationships with MNC clients.

SHK is currently undergoing a strategic investment plan to optimize production at PFW, which will involve shifting production of some of its products to its

production facilities in Vashivali and Vapi and evaluating another low cost manufacturing location in India or around Europe and using the PFW facility to

manufacture more higher margin products and as an R&D hub to develop novel molecules. This change in tack is reflected partly in the utilization levels of

PFW’s Netherlands plant—down from 85% in FY16 to 75% in FY17.

As part of the relocation strategy, the company acquired 100% stake in VN Creative Chemicals Pvt. Ltd. (VNCC) for an consideration of INR 13.59 cr. VNCC is

in the business of aromatic chemicals and is yet to start business operations. The transcation gives SHK access to MIDC leasehold land at Mahad along with

the plant and machinery which will allow backend integration to SHK at a low cost location. The benefits from this transaction are likely to accrue in FY19.

Utilization level of all the plants, with the exception of the Barneveld plant in Netherlands, is currently near 45%. Although utilization levels are not relevant for

the F&F business, SHK believes it has enough capacity to drive medium-term to long term growth reducing the requirement of incremental capex

PFW is currently a low margin business, but provides

backward integration Utilization levels in plants are low providing ample scope for sales growth


Locations

Vapi, Gujarat Mumbai, Maharashtra Vashivali, Raigad,

Maharashtra

Barneveld, The

Netherlands

Area: 18 acres Area: 11 acres Area: 37 acres Area: 3.46 acres

Installed capacity:

2,064 tonnes per annum

Installed capacity:

4,599 tonnes per

annum

Fragrance unit:

Installed capacity:

10,342 tonnes per

annum

Installed capacity:

1,650 tonnes per

annum

Capacity Utilisation:

44.8% in FY17


30.5% in FY17


52% in FY17


75% in FY17

Flavour unit

Installed capacity:

3,000 tonnes per

annum


23% in FY17


14.6%

11.5%

1.5%2.2%

1.0% 0.7%

FY15 FY16 FY17

Gross Margin (%) Operating Profit Margin (%)


14 GWM

VI. Strong R&D provides stream of new products; encapsulation technology can be a game changer for domestic FMCG companies

• SHK has invested steadily in R&D efforts and is first Indian company to bag patent for a novel aromatic molecule.

• The company generates ~10% revenues from products launched over the past 3 years, indicating a steady stream of revenue from new products.

• It intends to keep investing margin generated above 20% in R&D, while SHK also operates five Creation and Development Centers (CDC) in India, Netherlands

and Indonesia wherein new products are developed in conjunction with the customer.

• Over the years, the company has developed over 12 molecules and SHK is one of the few companies worldwide to file patents in fragrance and novel aromatic

molecules. It has recently commercialized one of the patented molecules and commenced sale of products using this compound.

• SHK has also acquired rights for fragrance encapsulation technology (FET) from Tanishka Products, a microencapsulation technology specialist, last year.

• For acquiring perpetual FET license and capital investment in TP LLP, SHK paid INR 3 cr and will pay an additional amount at the end of 5 years, which will be

equivalent to a portion of the revenue that would be generated in FET sales using the IP in FET.

• Microencapsulation is predominantly used to increase the stability and life of the product being encapsulated, facilitate the manipulation of the product and

control its liberation in an adequate time & space.

• Fragrance encapsulation technology is ideally used in fabric & laundry industries to ensure that fragrance lasts longer on dry fabrics, however the company is

envisaging using the technology for industrial applications like textiles and paints

• The technology has been around in developed markets for around 20-30 years, but has been used in high-end FMCG products by global FMCG players due

to high cost of usage of the technology.

• SHK intends to introduce the technology at a much lower cost point, hoping to derive scale benefits of this technology.


15 GWM

VII. Vision to be USD 1 bn top line player

• SHK intends to become a USD 1 bn sales company over the next decade, which based on the current exchange rates translates into a top line compounding

of ~20%.

• At the apex of F&F sectoral pyramid, 80% of the market is dominated by just 11 players with individual annual revenues of more than USD 500 mn, while at the

bottom, there are around 4,000 players clocking annual revenues of less than USD 50 mn.

• The company intends to transform its image from being a big small Indian global brand to a small big global Indian brand and achieve this by shifting focus

to export markets, which have demographics and growth rates similar to those seen in India and exploit the space between the aforementioned segments

• The entry into the international markets would be in an phase wise manner and restricted to 10-20 markets. SHK is also planning to transition its product mix in

favour of more value-added products and therby likely to further improve its margins


16 GWM

VIII. Undervalued considering superior growth prospects compared to global peers

• Globally, F&F companies like Givaudan, Symrise and IFF, are currently trading at an average 2- year forward PE of 24x considering the consolidated industry

structure and high return profile of the industry. However, the exposure of these companies is ~50% to developed markets, which are unlikely to post super

normal growth.

• This slackness in growth in reflected in the expected earnings of all the three companies—an average of 6.8% over the next two years.

• When we look at the valuations of peers adjusted for growth expectations, global companies are trading at an average PEG ratio of 3.9x.

• Considering that global peers are significantly bigger in terms of sales, we expect SHK to trade at a small company discount to global peers. Applying 60%

small company discount to the average PEG ratio of 3.9x of global peers, we arrive at a PEG ratio of 1.58x for SHK which is further used to arrive at the fair value

of the company

*Bubble size indicates last fiscal year sales


Givaudan

Symrise

IFF

SHK

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

P/E

EPS Growth Next 2FY (%)

Givaudan

IFF

Symrise

SHK

0.0

5.0

10.0

15.0

20.0

25.0

30.0

0.0% 5.0% 10.0% 15.0% 20.0%

EV

/EB

ITD

A

EBITDA Growth Next 2 FY (%)


17 GWM

Time Line


1955 1979 1981 1994 2007 20162012

1960 1980 1984 2000 2010 2014 2017

Market and Entities Creation and R&D Centre Manufacturing Facilities

• Incorporated as

S.H. Kelkar & Co.

Limited

• Establishment of

the manufacturing

unit at Vapi

• Expansion of

Research Centre

at Mulund

• Expansion of

Fragrance mfg.

facility ata Mulund

for EOU

• New, long term,

fragrance &

flavour Mfg. facility

at Vashivali

• Investment by

Blackstone

• Acquisition of

SAIBA Industries


additional R&D

Centre at Mulund

• Acquisition of Hi-

Tech Technologies

(HTT) and flavours

division of Gujarat

Flavours (GFPL)


R&D Centre at

Mulund


manufacturing

facilities at

Mulund

• Incorporation of

Keva Flavours• Expansion of

Fragrance mfg.

facility at Mulund


the export

oriented Keva

Fragrances

Private Limited

• Expansion of

Fragrances

Centre in Mulund

• Consolidation of

promoter’s

shareholding

• Acquisition &

Integration of

PFW

• Investment in MP

Plant - Vapi• Commercializatio

n of a patented

molecule


18 GWM

Corporate Structure


S H Kelkar and Company Ltd.

S H Kelkar and Company Limited

Domestic Foreign

Keva Fragrances

Pvt. Ltd

Keva Flavours

Pvt. LtdKeva Chemicals

Pvt. Ltd

Saiba Industries

Pvt. Ltd

Pvt. Ltd

Keva UK Ltd. (UK)

(SHK – 84%,

KFG 16%)

Keva Fragrance

Industries Pte. Ltd.

(Singapore)

PFW Aroma

Chemicals B.V.

(Netherlands)

PT SHK Keva

Indonesia

(Indonesia)


19 GWM

Valuations & peers

Attractive in terms of valuation compared to international peers after accounting for growth prospects

SHK has no similar sized listed domestic competitor and its major compeition includes global F&F players. However, most of the global companies have significant

exposure to low growth developed markets and it would be fair to compare the valuation metrics by comparing the PE ratio after adjusting for growth expected

in earnings. We, therefore, compare the PEG ratio of peers and apply a small company discount of 60% to it to arrive at FY19E PEG ratio of 1.58x for SHK. Valuing

SHK at FY19E PEG ratio of 1.58x and considering a bottomline CAGR of ~21%, we arrive at price target of INR 348, implying 30% upside from current level.

FY17/CY16

P/E

EPS growth #

(Next 2 FY)%

FY17/CY16

RoE (%)

FY17/CY16

Sales

FY17/CY16

EV/EBITDA

EBITDA Growth #

(Next 2FY) %

FY17/CY16

RoCE (%)

PEG

Givaudan * 26.7 4.8% 20% 31,799 16.8 4.6% 20% 5.60

Symrise * 27.3 8.3% 16% 21,578 14.1 3.6% 14% 3.29

IFF * 21.3 7.3% 27% 20,934 14.3 6.8% 23% 2.92

SH Kelkar 37.5 20.6% 15% 986 23.3 17.7% 19% 1.19

Average PEG 3.9

Discount 60%

Discounted PE 1.58

Discounted PE 33

Mcap 5,029

Upside 30%

Source: Bloomberg Estimates, Edelweiss Investment Research

* Calendar estimates considered, #CY16-18 EPS and EBITDA growth considered

EPS (FY19E) Target P/E Target Price Current Price Potential Upside

10.5 33 348 268 30%



20 GWM

Key Management

Name Designation Profile

Mr. Ramesh Vaze MD & Chairman

Mr. Ramesh Vaze is the MD and Chairman of the group and has been associated with the company for over 40

years. He holds a Bachelors degree in Science from the Univeristy of Mumbai and also is a trustee of the Kelkar

Education Trust. He was appointed MD of the company in August 2010.

Mr. Kedar Vaze CEO

Mr. Kedar Vaze is a third generation founder-family member and is associated with Keva since 21 years. He has

worked as Chief Technology Officer and Chief Operating Officer in the group before being appointed CEO in

October 2014. He has a number of F&F patents in his name and has done his M.Sc. (Chemistry) from IIT Bombay

and subsequently attended Global Managers Program at Stanford University, USA.

Mr. B Ramkrishnan Director - Strategy

Mr. B. Ramkrishnan took over as Director Strategy effective October 2014 stepping down from the CEO’s position.

He is currently responsible for long-term strategy development, M&A and capital raising activities of the group. He

has been associated with the Keva Group since October 2010 . Prior to Keva, the he was the CEO of Privi Organics

and also headed the flavours business of Givaudan. He holds a degree in Chemical Engineering.


Key Risks

• Sharp slowdown in domestic or global FMCG markets

Inorganic acquisitions may not integrate or scale up as required

• Significant appreciation of EUR against the USD or INR against the USD

• Volatility in raw material prices


21 GWM

Business Overview

Company Description

SHK is the largest Indian-origin F&F company in India with over 90 years of experience. Its fragrance products and ingredients are used as a raw material in personal

wash, fabric care, skin & hair care, fine fragrances and household products. Its flavour products are used as a raw material by producers of baked goods, dairy

products, beverages and pharmaceutical products. The company offers products under SHK, Cobra and Keva brands in the small pack segment.

The company has a strong and dedicated team of scientists, perfumers, flavourists, evaluators and application executives at its facilities and five Creation &

Development Centers in Mumbai, Bengaluru, The Netherlands and Indonesia for the development of fragrance and flavour products. Their research team has

developed 12 molecules over the past three years, of which SHK has filed patent applications for three and commercialized sales from one molecule.

Over the years, SHK has developed a vast product portfolio of F&F products for FMCG, pharmaceutical and F&B industries. The company has a diverse client base

of over 4,100 customers including leading national and multi-national FMCG companies, blenders of fragrances & flavours and fragrance & flavour producers.

Business Model

The company has 2 major segments.

1) Fragrances

2) Flavours

Strategic Positioning The company is the leading Indian player in the domestic Fragrances & Flavours market with an market share of ~14%

Competitive Edge

Presence in the business since 90 years

Overall capacity utilization of 45% currently providing ample operating leverage

One of the few companies worldwide to hold patents for novel aromatic molecules

Presence in a highly consolidated and niche market with very high levels of customer stickiness with an diversified client base with no client

accounting for more than 4.9% of the revenue

No long term debt on the company

Financial Structure

The company has no long term debt on its book currently providing ample scope for financial leveraging to do tuck in acquisitions. As per the

management there is minimal need for any capex as there is ample spare capacity. Investments would be made towards R&D and operational

excellence initiatives

Key Competitors IFF, Givaudan, Firmenich, Symrise, Takasago

Industry Revenue Drivers The company’s fortunes are directly linked to the performance of the FMCG industry which is expected to grow at 20% CAGR till CY2020

Shareholder Value

Proposition

The company can do an EPS of INR 10.5 in FY19E. A 33x valuation can give price target of INR 348 for the company which gives an upside of

~30% over the next 12 months.


22 GWM

Financial Analysis

Revenue growth stimated to pickup subsitantially in FY19

SHK’s revenue is estimated to clock CAGR of 11% over the next 3 years inspite of

a subdued FY18 (H1FY18 likely to be impacted by implementation of GST). We

expect the fragrances segment to post CAGR of 10% over FY17-20 with the

domestic market likely to drive growth, while the flavour segment is likely to clock

CAGR of 17% on a lower base and stronger growth prospects in domestic as well

as international markets.


Higher capacity utilisation coupled with shift in mix in international fragrances

will lead to uptick in EBITDA margin

SHK’s EBITDA margin is estimated to improve from 16.9% in FY17 to over 19.6% in

FY19 due to improving capacity utilzation in domestic capacities, mix shift

towards flavours, cost efficiency improvements and shift to higher margin

products in the international fragrance market.


PAT and PAT margin like to surge substantially

Improving sales growth coupled with improvement in gross and EBITDA

margins is likely to lead to improved profitbaility and PAT margins. We

expect PAT to post CAGR of 20% over FY17-20.


Return ratios to improve as utlilisation picks up

We expect return ratios to improve as capacity utilization improves in

existing capacity and mix change coupled with cost efficiency boost

margins. We peg cash adjusted RoCE at ~22% by FY19.


330460

570666

761 836927 986 1039

11801339

40%

24%

17% 14%10% 11%

6% 5%

14% 14%

0%

10%

20%

30%

40%

50%

0

500

1000

1500

2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E

Revenues % Growth

14.1%

18.5% 17.6% 18.0%

14.2%16.3% 16.9%

18.1%19.6% 20.3%

2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E

46 32 42 5479 70 73

105125

152182

14%

7% 7%8%

10%

8% 8%

11%12%

13% 13%

0%

5%

10%

15%

0

100

200

300

400

2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E

(IN

R c

r)

PAT PAT Margin (%)

12.2

16.1 17.019.1

13.5

17.419.0 19.4

22.2 23.1


(%)


23 GWM

Financials

Income statement (INR cr)


Income from operations 836 927 986 1039 1180

Total operating expenses 717 775 820 852 949

EBITDA 119 151 167 188 231

Depreciation and amortisation 29 30 19 21 25

EBIT 89 121 147 167 207

Interest expenses 19 22 6 5 2

Other income 25 10 12 16 18

Profit before tax 94 110 153 178 222

Provision for tax 24 37 48 56 70

Core profit 70 73 105 122 152

Extraordinary items -9 -1 -1 0 0

Profit after tax 61 72 103 122 152

Adjusted net profit 61 72 103 122 152

Equity shares outstanding (mn) 14 14 14 14 14

EPS (INR) basic 4 5 7 8 11

Diluted shares (Cr) 14 14 14 14 14

EPS (INR) fully diluted 4 5 7 8 11

Div idend per share 1 1 1 1 2

Div idend payout (%) 21 21 17 17 17

Common size metrics- as % of net revenues (INR cr)


Operating expenses 85.8 83.7 83.1 81.9 80.4

Depreciation 3.5 3.2 2.0 2.0 2.1

Interest expenditure 2.3 2.3 0.6 0.5 0.2

EBITDA margins 14.2 16.3 16.9 18.1 19.6

Net profit margins 7.4 7.8 10.5 11.8 12.9

Growth metrics (%)


Revenues 9.7 10.9 6.5 5.4 13.5

EBITDA (13.4) 27.3 10.4 12.6 23.0

PBT (12.9) 16.7 38.5 16.7 24.8

Net profit (11.0) 3.8 43.5 16.5 24.8

EPS (92.2) 14.9 43.1 18.2 24.8

Balance sheet (INR cr)

As on 31st March FY15 FY16 FY17 FY18E FY19E

Equity share capital 141 145 145 145 145

Preference Share Capital 0 0 0 0 0

Reserves & surplus 368 571 667 769 896

Shareholders funds 510 716 812 914 1,040

Secured loans 243 85 74 54 4

Unsecured loans 0 0 0 0 0

Borrowings 243 85 74 54 4

Minority interest 0 0 0 0 0

Sources of funds 752 802 886 968 1,045

Gross block 535 270 346 421 471

Depreciation 261 43 49 71 95

Net block 274 227 296 350 376

Capital work in progress 10 18 7 0 0

Total fixed assets 284 245 304 350 376

Unrealised profit 0 0 0 0 0

Investments 0 35 50 50 50

Inventories 318 335 350 356 404

Sundry debtors 195 229 217 228 259

Cash and equivalents 76 82 55 82 73

Loans and advances 28 29 27 28 32

Other current assets 0 0 0 0 0

Total current assets 615 675 649 694 768

Sundry creditors and others 147 188 162 171 194

Provisions 30 6 17 17 17

Total CL & provisions 176 195 179 188 211

Net current assets 439 480 470 506 557

Net Deferred tax 5 -1 -3 -3 -3

Misc expenditure 24 41 65 65 65

Uses of funds 752 802 886 968 1,045

Book value per share (INR) 36 50 56 63 72

Cash flow statement (INR cr)


Net profit 79 74 106 122 152

Add: Depreciation 29 30 19 21 25

Add: Misc expenses written off -5 -17 -24 0 0

Add: Deferred tax -3 6 2 0 0

Gross cash flow 101 92 104 143 177

Less: Changes in W. C. 36 35 17 9 60

Operating cash flow 65 57 87 134 117

Less: Capex 12 -9 78 75 50

Free cash flow 53 66 9 59 67

Ratios


ROAE (%) 16.1 13.7 15.1 15.4 16.9

ROACE (%) 13.5 17.4 19.0 19.4 22.2

Debtors (days) 85 90 80 80 80

Current ratio 3.5 3.5 3.6 3.7 3.6

Debt/Equity 0.5 0.1 0.1 0.1 0.0

Inventory (days) 139 132 130 125 125

Payable (days) 64 74 60 60 60

Cash conversion cycle (days) 160 148 150 145 145

Debt/EBITDA 2.0 0.6 0.4 0.3 0.0

Adjusted debt/Equity 0.3 0.0 0.0 0.0 -0.1

Valuation parameters


Diluted EPS (INR) 4.3 5.0 7.1 8.4 10.5

Y-o-Y growth (%) (92.2) 14.9 43.1 18.2 24.8

CEPS (INR) 7 7 9 10 12

Diluted P/E (x) 61.7 53.7 37.5 31.7 25.4

Price/BV(x) 7.4 5.4 4.8 4.2 3.7

EV/Sales (x) 4.7 4.2 3.9 3.7 3.2

EV/EBITDA (x) 33.3 25.7 23.3 20.5 16.5

Diluted shares O/S 14.1 14.5 14.5 14.5 14.5

Basic EPS 4.3 5.0 7.1 8.4 10.5

Basic PE (x) 61.7 53.7 37.5 31.7 25.4

Div idend yield (%) 0.4 0.4 0.5 0.5 0.7


24 GWM

Edelweiss Broking Limited, 1st Floor, Tower 3, Wing B, Kohinoor City Mall, Kohinoor City, Kirol Road, Kurla(W)

Board: (91-22) 4272 2200

Vinay Khattar

Head Research

[email protected]

Rating Expected to

Buy appreciate more than 15% over a 12-month period

Hold appreciate between 5-15% over a 12-month period

Reduce Return below 5% over a 12-month period

0

20

40

60

80

100

120

140

160

180

No

v-1

5

De

c-1

5

Jan

-16

Feb

-16

Ma

r-1

6

Ap

r-1

6

Ma

y-1

6

Jun

-16

Jul-1

6

Au

g-1

6

Se

p-1

6

Oc

t-1

6

No

v-1

6

De

c-1

6

Jan

-17

Feb

-17

Ma

r-1

7

Ap

r-1

7

Ma

y-1

7

Jun

-17

Jul-1

7

Au

g-1

7

Se

p-1

7

(In

de

xe

d)

SH Kelkar Sensex

Disclaimer

25 GWM

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26 GWM

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Coverage Stock: S H Kelkar & Company Ltd. - Edelweiss

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