AVT Natural Products Ltd. is India’s largest producer and exporter of Marigold Oleoresins and its derivatives. Marigold flowers (Gende ka phool) are the richest natural source of lutein and zeaxanthin. These find applications in 1). Pharmaceutical (eye care, for cataract and macular degeneration) & Nutraceutical industries & 2). Poultry feed industry as an additive natural pigment (colouring agent). Since 2009 AVT has an exclusive supply agreement with Kemin Industries Inc. of USA, which is one of the largest consumers globally. Recently, they renewed agreement with Kemin for another decade, along with addition of new value added products like Rosemary (for 5 years). Rosemary is a popular natural ingredient widely used in Food & Beverage for its anti-oxidant properties. 93% of AVT’s revenue is from exports, largely to US and EU.

After few years of bad cycle led by erratic monsoon, this segment has entered a positive cycle in 2020 and we expect volume and profitability to trend higher.

Until 2015, AVT was heavily dependent on this segment, largely catering to a single customer (Kemin) from a single plant in Kerala. Over the last five years, the company has undertaken several strategic initiatives to de-risk in multiple ways. It has recently added second plant in Karnataka closer to marigold producing region which shall help in improving yield as well as in optimising logistics cost. It has also developed high-yielding hybrid seeds (distributed to farmers through contract manufacturing across 25,000 acre) which shall help it become the lowest-cost producer in the world.

Further, it has focussed on growing the other segment of Spice Oleoresin while seeding newer niche segments of Decaffeination of Tea, Instant Tea and more recently Animal Nutrition, leveraging by-products and existing capabilities in natural ingredients. A significant capital has been invested upfront to enter and scale up these categories which has optically depressed P&L including recurring R&D costs (30% of FY20 Net Profit). A lot of these initiatives shall bear fruits starting this year. For FY20, the revenue contribution of the legacy segment of Marigold is already down to 40%, while the other categories continue to show steady double digit growth. There is a global trend towards healthier ingredients across Pharma, F&B, Personal Care etc by replacing synthetic ones. This company is well positioned to benefit from this structural trend and has been investing heavily in building capabilities and mastering the cost curve, to serve global MNCs like Nestle and McCormick as a trusted and reliable supplier of high quality natural ingredients.

The company belongs to century-old and reputed AV Thomas Group based out of Chennai. The second and third generation run the show along with senior professionals. It meets all our hygiene filters - Promoters own 75% with no pledging, it pays tax at full rate and shares 30% of profits as dividend, has a net debt-free balance sheet despite investing heavily in last 2-3 years, has got no major contingent/off-balance sheet liabilities or questionable related party transactions.

The company entered a positive cycle of earnings growth starting FY20 and we expect this to continue. On normalised owner earnings, we are paying low double-digit multiple for a decent quality business with some sustainable triggers in sight.

Over the years, we have been lucky to be early in some quality companies operating in niche segments; notable ones include the likes of Tasty Bite, Garware-Wall Ropes, Amrutanjan among others. AVT too falls in similar basket in the sense that it has zero institutional ownership or sell-side coverage despite having a reasonable scale - Rs 400+ Cr in annual sales and Rs 50+ Cr. in normalised owner earnings. But as always investing is probabilistic, and a lot depends on how opportunities unfold for them and their execution from here on.

Also, no opportunity is without risks - If the export incentives which are being phased out by Govt. of India by Dec 2020 are not replaced by some other scheme, it could dent the profitability (30% of pre-tax profit). Being agri dependent, weather patterns and monsoon has a major bearing on supply of key raw material. China has a global market share of around 75% and leads to wild swings in realization based on their internal demand/supply. Client concentration like in most B2B/FMIG businesses is also a concern. The operational metrics disclosed by the management is minimal and being a B2B business it could be tricky to do maintenance research on a quarterly basis. It took us serious effort to do scuttlebutt from multiple sources and triangulate the data to understand the business segments, however in absence of investor con-calls/presentations/sufficient disclosures in Annual Reports, tracking remains a challenge.

Keeping in mind the risk-reward, we are restricting the initiating allocation to 4% and will monitor how the thesis plays out.