MCap < 1,000 CRORE : SKM Egg Products
In the previous article, we explored a microcap company operating a commodity business in the calcined petroleum coke (CPC) space — essential for the manufacture of aluminium — which could benefit from the infrastructural development in India.
Our search for potential multi-baggers continue and in this article, we will explore another commodity business in the food processing space.
A lot of commodity businesses trade at low valuations because commodity businesses don’t really have a LOT of purchasing power — which means that these companies cannot grow earnings exponentially and are cyclical businesses — due to which these companies don’t command premium valuations.
So, our task is to understand whether a commodity business — can somehow come up with a more differentiated product? Can it scale? Can it expand earnings? How can it multiply shareholder value? Even if it remains a commodity business — can it outperform it’s competitors?
The company that we’re talking about is — SKM Egg Products — a microcap in the egg processing space, which has been in this business for close to 3 decades.
As you can see from the chart above, the stock has corrected by >30% in the last 6 months due to a decline in net profits and a sharp reduction in operating profit margins.
Does this offer a value opportunity for investors? Or could it be a value trap? Let’s understand the company’s biz to be able to answer this Q.
The Business
SKM Egg was founded by SKM Shree Shivkumar in 1995 in Erode, Tamil Nadu. In the early 1960s, Shivkumar’s father was a distributor of animal feeds to large companies like Godrej, Lipton etc. With a legacy in the poultry industry, Shivkumar took a bold step to start an export business of egg-derived products.
Fast forward to today, it has market presence in 23 countries in key markets including Japan, Russia, Southeast Asia, Middle East & Singapore.
It makes money from the following sources:
Egg Powders & Egg Liquids — SKM Egg derives majority of it’s revenue from the export of egg powders and egg liquids.
The company began operations with 3 kinds of egg powders — whole egg, egg white & yolk. It subsequently introduced chilled liquid eggs in tetra packs (for domestic market) + frozen egg white cubes (for exports).
Egg powders are convenient to handle compared to regular eggs. Produced through the drying process, it retains the nutritional value + taste of fresh eggs. Has a longer shelf life. Widely utilized in several meals from baked goods to savory meals.
SKM also makes tailored blends for bakeries + a special product for the Russian market (used in making mayonnaise).
Yolk powder is the company’s highest selling product (by volume)
In the early stages, SKM had a technical / marketing partnership with a Belgium company called Belovo (for export sales). However, the company subsequently developed it’s own distribution network in all these export markets — saving on commissions.
Sale of Eggs & Poultry Feed — the company also makes money from sales of eggs and poultry feed, mostly from the domestic market.
Egg has high nutrient density providing 12% of the daily value for protein and a wide variety of other nutrients like vitamins, essential amino acids and minerals.
The Tailwinds
Now that we have a firm grasp on the sources of revenue, let’s look at some of the positives that SKM could ride on.
Industry tailwinds — the global egg powder market was valued at $1.95B in 2023 expected to grow at a CAGR of 7.46% during 2024 - 2033 to $4B. Growth in the industry would directly benefit SKM Egg Products as it establishes it’s presence in more countries.
Manufacturing Facilities — it has one of Asia’s largest egg processing plants — with a capacity to process 1.8M eggs per day (equivalent to 6,900 tonnes of egg powder per annum).
SKM’s own poultry farm is ISO 22000 certified + maintains stringent biosecurity measures + complies with EU regulations.
Invested in 6 LAKH birds for the company’s poultry farm in Karur which produces 5 LAKH eggs daily. SKM also sources 10 LAKH eggs from other leased farms (not owned by SKM). Own production covers 80% of the company’s needs.
The company has planned a capex of INR 70 Crore towards setting up a environmentally controlled shed for birds + a bio gas plant. This project is expected to be completed by Q1FY25. [No management commentary available to check if this is completed]
SKM claims that it’s eggs are pesticide & residue free. Quality of raw materials (i.e. feed for chickens) is maintained since SKM has it’s own feed mill.
Company has control on the entire lifecycle of egg processing.
Supplies its own feed > chickens are regularly inspected > automated system for tracking egg processing > export level quality maintained.
It’s manufacturing unit is strategically located near poultry farms providing easy access to raw materials (eggs) + ensuring lesser breakage of eggs in transit.
Strategies to create a differentiated product — One of the key things that we want to find out is whether a commodity business has the potential to build differentiated products. Some of the things that SKM Egg is doing to differentiate itself:
Hens are fed a 100% vegetarian diet to ensure eggs are safe and of the highest quality. Egg powders are made from carefully selected fresh eggs with no added colors / preservatives.
Their value added products include Whole Egg Liquid, Egg White Liquid and Egg White Cube (packaged similar to paneer). Instead of normal shelled eggs, SKM offers both the yolk & white in tetra packs with a 3 month shelf life.
Their protein supplement line include Egg Albumin Powder, Egg Pro Sports Plus, Egg Pro Life and other high margin B2C products.
Note: SKM Eggs has an associate company — SKM Universal Marketing Company — which it uses to sell various products in India. It is a possibility that the high margin B2C products are being sold through SKM Universal in which case the primary beneficiaries would be the promoters (since SKM Egg holds only a 26% stake in SKM Universal)
The company plans to develop bakery mixes for both domestic / export markets and is exploring opportunities in the food & pharmaceutical sectors.
Growing into different geographies — SKM derives majority of it’s income from the export market, with Japan being the major contributor.
SKM is starting to expand it’s presence in India — with domestic market sales touching 50+ Cr. However that is still <10% of total topline.
After 3 years of continuous efforts, SKM was able to enter into the Russia — which is a big market for egg products. Getting registration in Russia is difficult and this was a big achievement for the company.
SKM has been getting repeat orders from major markets like Russia, Japan, Indonesia, Thailand, Vietnam etc. It is also expanding into new markets like Ghana, Uganda, Nigeria, Israel + in the process of identifying new customers in markets like Korea, Europe, Madagascar etc.
The company accounts for >50% of processed egg product exports from India. Around 70-80% of the export business happens on a prior contract basis and only 20% happens on spot basis.
However, this would mean that in case raw material costs increase — SKM Egg probably would not be able to pass on the increase costs to customers, which would directly impact gross margins.
Causes of Concern
Apart from the fact that SKM Egg Products is a microcap with low liquidity, there are various other risks associated with the business.
Cyclical business w/high input costs — a major cost for SKM Egg is animal feed — the ingredients used to feed the hens to get quality eggs. It also directly buys eggs from other leased farms. Raw material costs form >75% of revenue.
Animal feed. Feed costs account for >30% of production costs. 70% of feed inputs are corn and soya, therefore prices of these inputs influence gross margins.
Corn prices are rising due to lower output + increasing demand from ethanol production. The poultry industry expects 10-20% of maize could be used for ethanol production, which could increase the demand / supply gap causing maize prices to increase. If this trend continues, it would put further pressure on SKM’s margins.
The Government has fixed a cap of 1.7M tonnes of sugar for ethanol production (due to lower sugarcane output) hoping to fill the gap by using maize in order to achieve its target of 15% ethanol blending with petrol.
Cyclical business — the demand for eggs is not cyclical, people will not stop eating eggs. On the contrary, given it’s nutritional value, demand for eggs is on the rise. The cyclicality is more from the supply side.
Egg laying hens are more productive during warmer months — hence, one bad summer could affect the business quite adversely.
fluctuations in the cost of feed ingredients such as grains and protein sources can affect egg prices. If feed prices rise, the company might need to pass on those higher costs to it’s customers.
If you look at how the operating profit margin has fluctuated for SKM Egg over the years — it is reasonable to assume that the company is unable to pass on higher costs to it’s customers.
Extreme weather conditions such as droughts, floods can affect feed availability & transportation of eggs. Possible outbreaks of bird flus, H5N1 can also hamper egg production.
To combat supply side cyclicality — SKM has it’s own feed mill with labs to ensure nutrient composition and a feed free of toxins, pesticides. It creates specific formulations for different types of chicks. They have high end infrastructure to minimize external effects to the production cycle and have kept outbreaks of bird flu etc. in check.
This helps SKM reduce a lot of the cyclicality involved in a cyclical business — which is a HUGE advantage.
Customer concentration — for FY23, top 10 customers of SKM contributed around 49% of total sales + Japan / Russia contributed around 60% of total sales. Any demand slowdown in these geographies would adversely affect SKM’s business.
Related Party Transactions — there are a lot of unlisted subsidiaries / associate companies where the MD / CEO is involved. Also, the company markets some of it’s BEST Eggs brand in India through SKM Universal (which is an associate company).
There is no management commentary on how much sales is happening through SKM Universal — which derives majority of it’s income from the domestic market. Why is it selling in the domestic market via SKM Universal and NOT SKM Egg Products? This is a question that begs to be answered.
IT Raid on Promoter Group — a few years back an IT raid was conducted on various premises of the SKM Group. Unaccounted income of INR 300 Crore was detected in such raid.
This is a BIG RED FLAG and raises questions on the integrity of the management and on the accuracy of the numbers reported in the financial statements.
Succession planning required? — Mr. Shivkumar in a recent interview stated that he plans to retire from the business once the company reaches a turnover of INR 1,000 CRORE — a goal he hopes to achieve in the next 5-6 years. FY24 revenue was around INR 700+ CRORE. So, in a few years — who is going to replace Mr. Shivkumar? A change in leadership can be tricky & is something that potential investors should be aware of.
Conclusion
The reason why SKM Eggs came into my screener is because it is trading at a P/E of <10 times. Has a market capitalization of <1,000 Cr. And, most importantly a ROCE of >30%. These are impressive numbers.
But in all honesty, in a commodity business — P/E is not always the right metric to look at. One bad year, a contraction in earnings and the P/E could shoot up.
As you can see from the chart above, the operating profit margins have wildly fluctuated QoQ [probably due to fluctuations in prices of raw materials] — which makes you wonder what is the baseline (normalized) margins for SKM?
Also, there is no trend to revenue growth, which makes it very difficult to chart out a clear growth plan for investors. Especially since there is little information from the management, apart from the fact that they want to reach the INR 1,000 CRORE topline mark in the next few years.
[BIG SHOUT OUT to the ValuePickr Community through which I could learn a ton of stuff about the company. This article wouldn’t have been possible without the valuable inputs of the members of that forum ❤️]
In summary — this is a commodity business, with high global competition, fluctuation in margins, high concentration of revenue in select countries, high raw material costs, little to no purchasing power, subject to forex fluctuations, operating in a cyclical industry (bird flu, extreme weather conditions etc), with limited opportunity to scale without substantial capex.
And then, there is also SKM Universal through which the promoters sell their egg derived products in India. Since this is an associate company, major benefit doesn’t flow to the shareholders of SKM Egg Products.
That said, at this valuation — I don’t see a lot of downside. The stock could deliver some good short term returns for investors, however I don’t see this becoming a multi-bagger unless they can streamline margins + expand earnings substantially over the next few years.
We’ll keep close tabs to see how the company evolves over time.
If you liked this article, share it in your investing network. Comment, like, show some love! I spend a lot of time in research & it would mean the world to me if you could recommend this blog to your friends as well OR you could contribute by donating a small token to fund my research!
[Note: The author is not a SEBI registered investment advisor and the contents of this article do NOT constitute investment advice. Always do your own research before you invest in a company]