Kaveri Seed Company Review: Buy; Rising cotton prices bode well

Crude oil prices are up 26% year-on-year, which will likely lead to higher prices for nylon, a major competitive cotton product. We note that cotton prices (WPI) also rose to 114 in February 21 from 92 in October 20. Rising cotton prices will stimulate cotton planting. Kaveri generates around 50% of its income from cottonseeds and is therefore likely to be one of the main beneficiaries of rising cotton prices. The increase in cottonseed income is also a factor in boosting margins.

We remain positive on Kaveri given the success of its non-cotton seeds and market share gains in cotton seeds in Gujarat and Haryana, among other states. This will likely reduce the risk of Kaveri’s current business model, which focuses on cottonseed in southern India. The stock is trading at an attractive valuation below the average P / E-1 SD and FCF yield of 9% on FY21E. Hold the buy with a DCF-based target price of 710 (10x FY23E P / E).

Kaveri generates around 50% of income from cottonseeds: Rising cotton prices are likely to increase cotton seedlings, resulting in better demand for cottonseeds. Kaveri is likely to be the biggest beneficiary of this trend. A higher share of cottonseed income increases margins. Most of Kaveri’s other business segments (eg corn seeds, breeding and hybrid rice seeds) generate relatively lower margins than cotton seeds. Vegetable seeds are still in investment mode.
Multi-pronged approach to growth: Kaveri pursues the dual objective of expanding both its product portfolio and its global geographic presence. It entered western and northern India and also started its exports to five countries. We note that Kaveri has launched several variants of rice (selection + hybrid), corn and vegetable seeds. The success of these initiatives will create new avenues for growth and reduce the risk of the current cottonseed-centric business model in southern India.

Maintain Buy: Kaveri has created strong value (FCF) over the past decade and we remain optimistic about its medium-term growth prospects. We model the company to report revenue and PAT CAGRs of 12.8% and 17.7%, respectively, in fiscal years FY20-FY23e. We value the stock at the DCF-based target price of Rs 710.