Sunday, 4 November 2018

CCL Products (India) Valuation: Freshly Brewed Value

Everyone loves coffee and not just in India. Coffee is loved globally and even today, it is one of the most sought-average hot beverage by a long margin. So, it's not far-fetched to say that CCL Products (India) is in a sweet spot, operating in such a niche industry.

The Company

CCL Products (India), a 24-year old firm, is a private label coffee exporter having a repertoire in over 90 countries. In fact, it's the largest private label instant coffee exporter in the world. The company produces several different types of coffee based on customers requirements, which in turn means that they have a decent amount of pricing power. Of course, growth in private label exports isn't as rich as domestic retailing, which the company has been trying to crack for a short while now. Recently, there has also been a change in the top management, with the wise-and-experienced Mr. Challa Rajendra Prasad (The Executive Chairman) giving up the role of MD & CEO to his son, Mr. Challa Srishant. The company has skinny dipped in to the domestic retailing market in India, going toe-to-toe against the big boys like Nescafe and Bru. But that is not sucess story we will weave around CCL Products (India). In fact, at this point, it is not a story at all. This will be one of a steadily growing business with good margins, being handled by a new, younger business manager.

The Industry

For more almost half a decade, Italy had claimed exclusive knowledge on how to perfectly roast coffee beans in order to extract the most aroma from them. In reality, it wasn't until the twenty first century that this illusion was broken by several private label coffee makers.

Nielsen has a research article on Private Labels in general (All industries combined), which gives us good insights into the minds of its customers:

(Source: Nielsen Report)

Of course, if you want to understand the Private Labelling industry for Coffee in specific, refer to the articles by CarliniCoffee and CoffeeTalk.

The Numbers

I have pulled the following numbers from CCL Product (India)'s Annual Report, their latest Quarterly Report and Statement of Assets and Liabilities combined. Also, in absence of some information here, I have taken data points from Screener.

For calculating the Beta and Indexed Returns, I have done something a little different this time around. I tried calculating a 5-year CAGR for the NIFTY 50, but because of the recent market turmoil, the figure came out to be in the low 10%+, which I personally think is misrepresented, especially since India's T-Bill itself is at 8%+ or so. That is to say, the recent market turmoil has distorted this value. So, I choose to ignore 2018 altogether and go for a 4-year period estimation of both NIFTY 50's CAGR and CCL Products (India)'s Beta. You can look at the calculations below:

(Download CCL Products Beta)

The Capital Conversions

This is the part where we convert expended financial numbers into Capital. For instance, Advertisement Expenditure (At least, a part of it), usually serve the company for several years put together. Expending it in a single year would be wrong.

Advertisement Expenditure

In their latest Concall, Mr. Challa Srishant mentions that they're planning for a Rs. 20 Crore Advertisement budget.

(Source: Q2 Concall Transcript)

I would assume that at least half of that should be Capitalized. Using this piece of information, I calculated the proportionate levels of Advertisement Expenditure for 5 previous years. Then, these expenses were Capitalized accordingly.

If you have a keen eye, you may notice that I usually Capitalize Research & Development Expenditure as well. But look what their Annual Report has to say regarding R&D:

I find this a little odd, but in the absence of any relevant information, I will ignore this.


CCL Products (India) has a considerable amount of Debt on its books, the latest D/E Ratio being almost 0.50 (Which is on the lower side, I know, but not something you'd expect to see on the books of a company operating in a niche space--maybe it's not so niche after all, huh?)

Anyway, there's not much to worry. Most of their debt is either secured or short term in nature:

It might interest you to know that a big chunk of their Debt is in the form of an External Commercial Borrowing (ECB). ECBs already come with several sets of benefits, so it begs the question of why the company felt the need to secure the ECB loan. But let's not nitpick here.

So I have converted the remaining part of the loan and ended up with a Market Value of Debt of Rs, 453 Crores (As opposed to the Book Value of Debt of Rs. 390 Crores).

The Assumptions

Now we've arrived at the most engaging part of the exercise.

As it is usually with me, I will attempt to justify every input I have entered here:

High Growth Period

20 years, because CCL Products (India) operates in a niche space with only a handful of competition in each geography they operate in. In fact, entering new geographies will only further reinforce their Competitive Advantage.

Sales Growth

As admitted by the management itself, the business is facing headwinds. Here is what they had to say about Growth guidance:

(Source: Q2 Concall Transcript)

So, we can put things together like this:

In the past, however, the management guidance hasn't been accurate. There has always been some negative difference between the Guided and the actual Growth. So, I have been a little conservative here and used a lower figure for the first 5 Years: a little above around 8% or so. Eventually, I have assumed, that CCL Products (India) will be able to realize their full potential, growing at the Self Sustainable Growth Rate of 16% or so.

I usually assume the Terminal Growth for all companies I value in the 4-5% range (i.e. Half of the long term Risk-free Rate). However, since CCL Products (India) also has the option of venturing into Retailing in several countries (Including India), I have given it a Terminal Growth rate of 6.50%, a tad above the normal.

Operating Margin

Once again, the management itself has admitted that the sudden spike in Margins in the past few years has been due to the a sharp decrease in Raw Material prices.

(Source: Q2 Concall Transcript)

You don't have to take the management at its word though. In fact, I highly suggest that you don't. You can verify things for yourself easily. Here is a chart showing the price history of Raw Coffee (CCL Products' Raw Material) over the last decade:


So, instead of continuing the High 22%+ Margins, I am starting from the long-term average of 18%+ instead. I have also assumed that the Margins will slowly increase from there (Due to decent pricing power) and then settle on the Industry Average of 14.82% (Based on Prof. Aswath Damodaran's 'Useful Data Sets').

Tax Rate

CCL Products (India) enjoys some Tax Benefits due to it being an Exporter. I have simply assumed that these Tax Benefits will vanish over time, closing in on India's Corporate Tax Rate of 30% and later settle of the Global Average Tax Rate of 25%

Capital Turnover

I have no malice towards Mr. Challa Srishant, but it's only true that as a new management takes over, the productivity (The ability to generate incremental returns on invested capital) will take a temporary hit. I have done the same here, starting with the long term average Capital Turnover and growing it slowly at first and then a little faster, before settling down to normal levels.

Cost of Capital

The Cost of Capital has been determined based on the Capital Asset Pricing Model. Not much to discuss here. The average Cost of Capital for firms in India is around 13.50%, so it looks like the market views CCL Products (India) as a safer bet than most listed stocks.

Reinvestment Rate and Return on Capital

These two aren't inputs in the Valuation, but you can see how the story of CCL Products evolves over time here:

  • Low reinvestment initially, because of the lack of growth opportunities, but slowly picking up.
  • Return on Invested Capital stunted at first (Due to the new management taking over), but slowly picking up to manageable levels.
  • Terminal Return on Invested Capital still above the Cost of Capital, indicating the existence of a Moat.

With the assumptions done, let's move on.

The Diagnostics

No sign of trouble. Let's move on.

The Cash Flows

This is how CCL Products (India)'s Cash Flows will evolve, based on our assumptions:

I guess our earlier statement of "This will be one of a steadily growing business with good margins, being handled by a new, younger business manager" is well supported by the steadily growing Cash Flows, without any surprises.

The Value

We are here, at last. Here is how I value CCL Products (India):

The Value I have calculated, Rs. 316, indicates a 17% undervaluation in the stock. So, clearly I think there is some value to be had in CCL Product (India)'s Equity. This may very well be due to fact that it is trading at the same levels as it was in 2015, returning little to nothing over the 3-year period. This kind of behavior of a stock is positively termed as a 'Time Correction' by market experts. But if you know me, I am not willing to settle for euphemisms. I will take statistics over hearsay any time.

The Sensitivity of Value

The Sensitivity of Value tool shows you different values for a stock based on varying Terminal Growth Rates and Terminal Cost of Capital:

The Monte Carlo Simulation

However, the true test of a company's stock is a simulation across a range of parameters that go into its Value. It's essentially compatible with the real world. Just because I assumed a X% growth, doesn't mean that the actual growth would be that much. It would usually be a range of values. Every change in an input parameter will change the Value of the stock. So, I will attempt to stress-test the Value of CCL Products (India)'s Equity using the following range of assumptions:

1. Sales Growth: Simulated between 5% (Recent Average) and 11.80% (Medium-term Average)

2. Operating Margins: Simulated between 11% (Lowest ever) and 23% (Highest ever)

3. Capital Turnover: Simulated between 0.92 (Lowest ever) and 1.43 (Highest ever)

4. Cost of Capital: Simulated between 10.44% (CAPM Cost of Capital based on 5-year Average Beta and Indexed Returns) and 11.40% (CAPM Cost of Capital based on 4-year Average Beta and Indexed Returns)

While these change, the underlying story will stay intact (For instance, regardless of whether the Capital Turnover starts at 0.92 or 1.43, the improvement in Capital Tunrover will stay the same i.e. Slow at first and then a little faster later).

Here's how the initial output looks like:

A better way to interpret the above Normal Graph ("Histogram") would be this way:

So, with everything said and done, it looks to me like at the current market price of Rs. 268, there's a Probability of Undervaluation of around 67% and change. Is that enough? Only you can answer that question for yourself. I personally buy a stock only if there's a 90-95% Probability of Undervaluation (Yours truly is a student in the Buffet-Graham School of Investments). This would place my Expected Purchase Price at Rs. 200-220 levels.

The Model

But yes, you do not have to agree with me at all. If you do disagree with me, by all means, download the model and change the inputs as you see fit:

(Download Numbers and Narratives - CCL Products)

If your Value differs drastically from mine, feel free to let me know in the comments below. We can have a healthy discussion over our difference of opinion.

Recently, I was watching a series of videos titled "Principles of Success: An Ultra Mini-series Adventure", based on Ray Dalio's famous book "Principles". In one of the videos, he notes:

"Going from seeing things through just my eyes to seeing things through the eyes of these thoughtful people was like going from seeing things in black and white to seeing them in color. The world lit up. That's when I realized that the best way to go through the jungle of life is with insightful people who see things differently from me."

It would be an understatement to say that I too believe the same. Humans are social animals. It would be extremely value-additive for us to discuss our differences in a productive manner. So dear reader, all I ask is that we do the same.


  1. The market chart you have shown for coffee prices is for NY coffee Arabica. The coffee which is mostly used in Soluble products is Robusta which is traded on London exchange.

    1. Hello,

      Thanks a lot for pointing out the mistake. I have changed the graph now.

  2. Fairly detailed valuation. However I feel in a business like this, predicting sales growth is extremely difficult. I feel we will reduce errors if we instead focus on volume growth and value using per kg numbers rather than revenue and margin %. Also I feel terminal growth of >6% is way too optimistic given the volume growth of coffee consumption globally is only 2-3%. >6% growth assumes the company continues to gain market share forever.

    1. Thank you for the comment.

      1. The reduction in number of components that go into the value of a company doesn't promise a better valuation. In fact, a multiples valuation is the simplest one out there. We could just pull out our P/E Ratios, EV/EBITDAs and get the valuation done by a simple multiplication. However, it doesn't change a fact that a company's value indeed compromises all these components. May I note here that no valuation is perfect. That's why we either use a Margin of Safety or look at Value a range of Probabilities rather than a single number. All a good valuation does is limit the investor's downside. It does not tell you if the stock will become a 'multibagger'. There exists literally zero tools which can do that.

      2. You make a good point. But don't you think size is also an important thing to note? Don't you think using the same Terminal Growth for companies like Nestle, HUL, as well as CCL Products sounds a little odd? As I'd mentioned, I generally use half of the Risk-free Rate as the Terminal Growth for most companies, except in cases where there's growth potential (Which in the case, is the off-chance that CCL Products becomes a decent Retail player in India and other countries). But by all means, you should value a company as you see its story, not as anyone else does (Including me). Feel free to download the model and modify the assumptions as you wish.

      P.S. I don't think coffee consumption is the figure to look at while talking about growth in Sales of a coffee maker. Coffee makers don't increase Sales just by selling to newer and newer customers, they also largely increase Sales by selling more to existing customers as well.

    2. Thanks. Your point is well taken. Just continuing this discussion further as a constructive measure to learn from you as well and have a healthy discussion.
      1) The reason I made the point about reducing errors by eliminating revenue and margin % is due to the fact that for CCL products, revenue is dependent on green coffee prices. If prices fall then revenue falls but margin % increases and vice versa. Now when we are trying to model this, we have to 1st estimate a)Yearly green coffee prices going ahead b) Estimate the yearly revenue by multiplying with sales volume c) And estimate what will margin % be for each year separately as margins vary with coffee prices. Ooph. Seems like a very difficult thing to do.
      Even if we take a margin of safety on the valuation number that we get from this, I feel it might not do justice because we are essentially taking discount from the number which is extremely prone to error.
      Solution? I feel just trying to estimate sales volume growth and then EBITDA or EBIT/kg numbers (If you look at this, CCL's per kg numbers are actually increasing every year for the past 10 years irrespective of green coffee prices due to rise in freeze dried sales and higher utilization in Vietnam which has better per kg numbers - a very good place to start with) will actually do a better job at calculating FCF. Capex can also be estimated by taking plant setup costs per kg of capacity and just increasing annual capacity by incremental sales volume assuming a particular utilization. There is no need to estimate revenue and EBITDA % at all.
      I am not telling this kind of valuation is error free. Hence I will still take a margin of safety on this number. HOwever, I will be more confident on the margin of safety on this number rather than taking revenues and margin %.

      2) On the terminal growth. I take your view on CCL's size being small and hence deserves a higher terminal growth. In that case, I would rather increase my forecast period from 10 to say 15 to 20 years and then take terminal growth of Nestle/HUL post that. The reason is simple. When we use the formula C/(r-g) for approximating terminal value, a very high g value will increase the terminal value (T) in an exponential way. For example, let's assume some values for r and g. Case 1: r = 13.5%, g=4% and hence 1/(r-g) equals 10.53x Case 2: r = 13.5%, g=5% and hence 1/(r-g) equals 11.8x Case 3: r = 13.5%, g= 6% and hence 1/(r-g) equals 13.3x . I hope you see the point. If you plot the graph between terminal multiple in y axis and g in x axis with a given r, then the multiple basically increases in an exponential way as g approaches r. Clearly, we are over estimating the terminal multiple. Add to that we are discounting it for lesser time periods. Instead a high growth period of even more than terminal growth of 6.5% for the 1st 15 to 20 years and then taking a lesser terminal growth of 2-5% might do a better job.
      Again, this is not error free and I am not claiming this to be the only way to value. I just learnt this from my experience and felt like sharing.
      On whether to use coffee consumption growth for terminal growth, I concur with you that this company might actually grow faster than coffee consumption growth. Hence, my terminal growth assumption will be only after say 15 to 20 years and the company has reached a big enough size.

      Finally because of all the assumptions and things that can go wrong, I agree with you that we should still try to look at a margin of safety on our valuation number.
      Looking forward to your views.

    3. 1. "I feel just trying to estimate sales volume growth and then EBITDA or EBIT/kg numbers". That's exactly what I do as well. 'Operating Profit' is nothing but EBITDA. Even if I assume that EBIT/Kg is somehow more trustworthy (I don't see how), you will still have to end up 'estimating' the Margins, directly (The way I do) or indirectly (The way you do). Sales Growth and Margins are inherent parts of a company's value, whichever way you slice it.

      2. That is indeed a true observation. But why bother using examples? We can look at this valuation itself. At 6.49% Terminal Growth, the Intrinsic Value turns out to be Rs. 285. At 4.06% Terminal Growth, the Intrinsic Value turns out to be Rs. 246. In fact, you can argue that several of the other assumptions I have made aren't 'stationary' too. The future is uncertain and the outcomes are many. So, that's exactly why I always run the 'Monte Carlo Simulation' for all my Valuations. It allows us to see the Value of a stock as a range of probabilities (Linked to different outcomes, just like the future). The more 'Probability of Undervaluation' we allow ourselves, the better off we'll be.

    4. Well I meant EBITDA/kg or EBIT/kg. Not EBITDA as in by taking revenue and margin %. I feel per kg numbers are more apt for commodity type businesses and especially for CCL for multiple reasons. One of them includes the dependency of revenue on commodity prices and estimating such macro variables is a tough task. However, I do see your view point as well in terms of limiting risk by looking at a wide range of possibilities and buying the company at a higher probability of undervaluation. It makes sense and avoids one being over reliant on the valuation model and assumptions. Looking forward to your future posts and discussions

  3. hello, I have again same issue in debt section. How have you came up with maturity of 2.5??Is it ok if we take ECB as in some cases you use and in this case you have not used it?/

    1. I likely used a Maturity of 2.5, because the original Maturity in the 2017-18 Annual Report must have been 3. Since 6 months have passed since the 2017-18 Annual Report, I have reduced the Maturity by that amount.

      I have not converted the ECB, but the way the model works, it is automatically taken at Book Value (Rs. 162.61 Crores). This is because, as I have mentioned, this ECB is completely secured. It felt a little odd to clump it with the other, local loans. But sure, you can add it to the mix. There wouldn't be much of an impact on the final value.