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Lower cotton seed volumes drag down overall performance

Earnings below estimates

* Kaveri Seeds (KSCL)’s 1QFY22 revenue fell 12% on account of de-growth in the Cotton and Maize, offset by growth in the Hybrid Rice and Vegetables segments. Cotton seed sales volumes were impacted by lower cotton acreage and the use of herbicide-tolerant Bt (HTBt) seeds, which further impacted branded seed sales. Also, the pandemic affected the supply chain, resulting in the lower absorption of cotton hybrids by dealers and distributors and the consequent unavailability for the farmer.

* Operating performance was further impacted by write-offs over government dues and the absence of operating leverage.

* Factoring in the 1QFY22 performance, we lower our earnings estimate for FY22 by 34% as 1Q contributes ~70% to annual revenue. We lower our earnings estimate for FY23 by 11%, primarily due to a decrease in cotton seed sales volumes (7m packets v/s 7.5m earlier) as well as margin estimates for the segment.

* We value the stock at 13x FY23E EPS to arrive at TP of INR710. Maintain Buy.

Absence of operating leverage drags down overall earnings

* 1QFY22 revenue (consolidated) was down 12% YoY to INR6,298m (v/s est. INR7,945m), weighed by lower cotton revenue and no maize sales to governments. EBITDA fell 30% YoY to INR1,996m (v/s est. INR3,205m). The EBITDA margin contracted 820bp YoY to 31.7%, primarily due to the absence of operating leverage and higher-than-average returns of seeds (35% in 1QFY22 v/s average of 20%). This led to the provisioning of INR220m and a drop in market share.

* Adj. PAT fell 31% YoY to INR2,037m (v/s est. INR3,186m). PAT de-growth was due to lower revenue and provisions for bad debts, against realized revenue for government business amounting to INR149m in FY20.

* Cotton seed volumes de-grew 29% to 4.97m packets, thereby leading to revenue de-growth of 28% to INR3,079m. Despite market share gains in Gujarat and Haryana, KSCL reported loss of sales in AP, Karnataka, and Telangana – coupled with a drop in volume contribution from new products to 21.3% (v/s 36.2% in 1QFY21).

* Maize seed volumes fell 18% to 4,348mt and corresponding revenue degrew 8% YoY to INR842m. The weak performance was attributable to no government sales in 1QFY22 (v/s INR175m worth of sales in 1QFY21).

* Hybrid rice volumes increased 33% to 6,569m packets, leading to 43% revenue growth to INR1,635m. Selection rice volumes increased 5% to 11,709mt and revenue 15% to INR860m.

* Vegetable seed revenue grew 22% YoY to INR185m, driven by 2.2x volume growth to 38m packets.

Highlights from management commentary

* Industry cotton seed sales were impacted as 15% of the seeds sold during the quarter were illegal HTBt seeds. The sale of illegal cotton seeds and low branded seed sales have nearly doubled v/s last year, impacting the company’s performance. Industry branded cotton seed sales declined 30% YoY during the quarter.

* Every year, ~20% of seeds produced by KSCL are returned to the company. However, as per KSCL’s internal estimates, 35–36% of seeds are expected to be returned (the majority in the Non-Cotton Crops segment) in FY22. As a result, the company has already created provisions worth INR220m.

Valuation and view

* Despite market share gains in cotton seed in Gujarat and Haryana, KSCL lost sales in AP, Telangana, and Karnataka due to (a) lower acreage, (b) loss of volume market share due to lockdown related restrictions, and (c) higher HTBt seed sales. This resulted in overall revenue decline of 12% in 1QFY22; thereby, the company lost the season for FY22.

* However, KSCL is well on track to diversify from cotton seed sales by increasing the share of rice and vegetables – which are not only growing at a faster pace but also yielding higher margins (v/s the Cotton segment).

* Factoring in the 1QFY22 performance, we lower our earnings estimate for FY22 by 34% as 1Q contributes ~70% to annual revenue. We lower our earnings estimate for FY23 by 11%, primarily due to a decrease in cotton seed sales volumes (7m packets v/s 7.5m earlier) as well as margin estimates for the segment.

* We value the company at 13x FY23E EPS (in line with five-year average P/E) to arrive at TP of INR710. Maintain Buy.

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