Triggered by the regulatory need to reduce promoter stake to 75 per cent by the end of the year, the ₹4300 crore Follow on Public Offer (FPO) of Ruchi Soya comes at a time when the market is past its purple patch. To sweeten the deal, the FPO is priced at ₹615-650, a 25-30 per cent discount to Friday’s close price. Promoter holding, which is currently at 98.9 per cent is expected to come down to 81 per cent post the offer. The FPO is a fresh issue and the proceeds will be used to predominantly repay debt, with the remaining set aside for working capital and general corporate purposes. The offer opened on Friday and closes on Monday, March 28.

The offer is priced at 33 -34.6 times the company annualized earnings for the first half of FY22, on the post-issue equity. Adani Wilmar, its closest peer, trades at 66 times its estimated earnings for FY22 following the steep run up in the stock price post its IPO in January 2022 at 42 times. Marico, a more diversified FMCG player with a footing in the edible oil business trades at a lower 48.5 times.

While the valuation is at a discount to peers, investors need not subscribe to the offer for three reasons:

One, with low public float, the stock has been quite volatile and price discovery so far has not been a meaningful exercise. After relisting in end-January 2020 at ₹16, Ruchi Soya moved up to over ₹1500 by June 2020. On the announcement of the FPO, the stock rose up to 40 per cent in two days. After the discounted price band was announced, it has corrected about 25 per cent from the high.

Two, considering that promoters need to dilute a further 6 per cent before the end of the year, there is a supply overhang for the shares. Agreed, no one can predict the markets, but the mandatory dilution may come at a better price/valuation than the current one.

Three, the edible oil business per se is not an attractive one to be in, considering the low margins. While the branching out into foods (other than essentials such as atta) can be more profitable, this segment is in a very nascent stage with the company having entered into it only recently. Stiff competition from well-established players is here to stay.

Low margin business

Ruchi Soya derives over 80 per cent of its revenues from the sale of vegetable oils (predominantly palm and soybean oil). The company, known for brands such as Nutrela, Sunrich, Ruchi Gold and Mahakosh has about 8 per cent market share in the branded edible oils market in India and is the second largest player in India after Adani Wilmar (17 per cent). The company though is the market leader in palm oil.

However, edible oil is essentially a commodity business with low margins. Raw material cost as a percentage of sales is over 80 per cent. Much depends on reliable supply of raw materials across all seasons, cost control, as well as the ability to pass on cost increases to consumers. India imports 60-70 per cent of the domestic edible oil requirements (predominantly palm, soybean and sunflower oils). Imports are subject to vagaries of government policies which can also play spoilsport on the utilization of domestic refining capacities as well as margins. Ruchi procures crude degummed soybean oil & sunflower oil from suppliers based in Geneva, Rotterdam, Singapore while crude palm oil comes from Malaysia and Indonesia.

While Adani Wilmar is the largest importer of crude edible oil, Ruchi Soya is better placed on this front, having backward integration through its oil palm plantations domestically. Imported raw materials constitutes about 30-40 per cent for Ruchi. Domestically, the company has entered into MoUs with nine state governments, gaining access to access to about 3 lakh hectares under oil palm plantation development. Of this, Ruchi Soya has developed 56,106 hectares as of September 30, 2021. The plantations work on a public-private partnership model, where the company works closely with farmers to plant oil palm on their farmland and provide technical guidance and assistance. Ruchi Soya has four palm mills close to the plantations, to crush the fruits. In the long-term, the government’s focus on reducing import dependency for edible oils, financial assistance for farmers for oil palm cultivation bodes well for Ruchi Soya.

But in the near to medium term, even as domestic sourcing is an advantage that the company has over over Adani Wilmar, upside for margins may not be high. In FY19, 20 and 21, the company’s operating margins have been on an improving trajectory after change of ownership - coming in at 0.9 per cent, 3 per cent and 5.8 per cent respectively. For the half year ended September 2021 too it stands at 5.8 per cent. Adani Wilmar’s margins in the last 2-3 years stands at 3.5 – 4.8 per cent. The Russia -Ukraine conflict pushed up international crude palm oil prices to over $1900 per metric tonne, though prices have now cooled off to $1500 levels now. Prices have been on a steady rise since the $400-500 levels at the start of the pandemic. Lag or gaps in passing on price increases, down trading within the edible oil segment and increase in other expenses such as advertising can exert pressure on margins.

Wait and watch on foods

Though edible oils bring four fifths of the revenues, the company also sells vanaspathi, bakery fats, oleochemicals and soy protein meals. In the last two years, it has entered the foods segment as well. In fiscal 2021, the company launched Nutrela high protein chakki atta and Nutrela honey. In May /June 2021, the Company acquired the biscuits, cookies, rusks product portfolio as well as noodles and breakfast cereals from Patanjali. Currently, the food business is at best a fringe segment for Ruchi Soya but this trend of edible oil makers branching into segments which could bring better margins is not new. Marico (Parachute, Saffola) adopted a similar route. Adani Wilmar too is already into soaps, handwash and sanitizers and is also eyeing entry into dishwash, floor cleaner, noodles /pasta, aside of functional oils and fortified staples. But an expansion into foods/FMCG is easier said than done. The presence of well-entrenched players including MNCs is a big challenge. In honey for instance, Dabur and Patanjali have the lion’s share of the market. Nutrela is just an also-ran. In biscuits business, Patanjali ( now with Ruchi soya) has just a 2 per cent market share , competing with the likes of Britannia, Parle and ITC which rule the market. In noodles and pasta too, Nestle and ITC are more established than Patanjali. Though Patanjali boasts of healthier ingredients, it has so far not been able to take on established players in a big way.

Points to note
Low float masks price discovery
Edible oil highly raw material intensive
Expansion into foods faces tough competition

Already high penetration levels in many categories implies that market share, pricing power and margin expansion is not a given. The recent foray into the niche and high growth nutraceutical segment ( dietary supplements / functional foods and beverages ) holds some promise though. Ruchi Soya proposes sale of these products under the joint branding of Patanjali and Nutrela. However, here too Dabur, Himalaya and other pharma players have a foothold. It is noteworthy that  personal care, which is generally the most profitable among FMCG segments has not been transferred to Ruchi Soya and will remain with the unlisted Patanjali.

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