Edelweiss Investment Research

CMP INR 268 Target INR 348

Coverage Stock: S H Kelkar & Company Ltd. Rating: BUY Upside: 30%

Flavour of the season likely to smell success Date: 09th October 2017

S H Kelkar & Company Ltd (SHK) is the largest domestic Fragrances & Flavours (F&F) player in India with ~14% market share in an oligopolistic
industry. Robust spurt in the flavours segment coupled with recovery in volume growth in the fragrances segment, mix shift in favour of more value-
added products in the fragrances business and significant cost efficiency measures are envisaged to lead to revenue and PAT CAGR of ~9% and
21% over FY17-19E, respectively. The company is trading at significant discount to growth adjusted valuation multiples of global peers as well as
its own historical valuations, while additional upside could accrue from tuck-in acquisitions. Initiate coverage with BUY and target price of INR
348.
Burgeoning FMCG market to spearhead domestic spurt; Expanding footprint, premium product focus to boost international operations
SHK is the largest domestic player in the F&F space and its market share has expanded by ~200 bps over the past three years. We estimate the
companys fragrance sales to jump ~8.7% and flavours sales by ~16.4% over FY17-19E resulting in overall sales CAGR of ~9.4%. We expect domestic
growth to be driven by an anticipated ~20% CAGR in the domestic FMCG market till CY20 and sharp increase in per capita FMCG spending. On
the international business front, SHK is eyeing entry in high growth markets in SEA (South East Asia) and MENA (Middle East and North African)
regions, which coupled with product mix shifting in favour of more premium products is bound to boost top line as well as bottom line.
Mix shift towards flavours and cost efficiency initiatives to lead margin improvement; Presence in small pack and tier-2 space to bolster growth
The company is eyeing rapid scale up in the flavours business, which currently entails higher margin compared to the fragrances segment. We
estimate margins to improve slightly riding this mix change and also cost efficiency initiatives. Moreover, presence of a significant number of SME
enterprises (~42% market share) in the domestic flavours market provides SHK opportunities to grow inorganically in the segment. The companys
presence in the small pack segment is an added advantage as it is not a key focus area for MNCs, which coupled with significant wallet share
among tier-2 FMCG players (expected to grow at twice the growth of FMCG majors), are significant growth levers.
Outlook and valuations: Attractive prospects and limited downside; initiate with BUY
Key drivers envisaged to spur SHK are: 1) surging FMCG demand; 2) sweating of existing capacities; 3) mix change in favour of flavours; 4) cost
efficiency measures; and 5) sustained R&D and monetization of encapsulation technology. We initiate coverage on the stock with BUY
recommendation and target price of INR 348 based on ~33x FY19E earnings (60% discount to global PEG multiples). The stock is currently trading
at 32x and 25x FY18E and FY19E earnings, respectively.
Bloomberg: SHKL:IN
Year to March FY15 FY16 FY17 FY18E FY19E
52-week range (INR): 363 / 236
Revenues (INR Cr) 836 927 986 1,039 1,180
Rev growth (%) 9.7 10.9 6.5 5.4 13.5 Shares in issue (cr): 14.5
EBITDA (INR Cr) 119 151 167 188 231
M cap (INR cr): 3,814
Net Profit (INR Cr) 61 72 103 122 152
P/E (x) 61.7 53.7 37.5 31.7 25.4 Avg. Daily Vol. BSE/NSE :(000): 243

EV/EBITDA (x) 33.3 25.7 23.3 20.5 16.5 Promoter Holding (%) 57.4
RoACE (%) 14 17 19 19 22
RoAE (%) 16 14 15 15 17
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Jigar Jani
Research Analyst
jigar.jani@edelweissfin.com
S H Kelkar & Company Ltd.

SHK is expected to deliver an PAT CAGR of 21% over FY17-19E driven by strong topline growth in the flavours business while improvement in
margins due to cost efficiency measure and mix improvement

Rebound in fragrances Improved profitability, SHK is available at 60%

volume and robust growth lower capex and higher discount to global peers on
in flavours business to drive utilization likely to drive growth adjusted PEG
topline growth return ratios higher multiple

FY15 FY16 FY17 FY18E FY19E FY15 FY16 FY17 FY18E FY19E CMP /
PE Multiple FY19E EPS
Target
Total Sales 837 927 986 1039 1180 RoACE 13.5% 17.4% 19.0% 19.4% 22.2%
25x (CMP) 10.5 268
Fragrances
776 863 857 900 1012
Sales RoAE 16.1% 13.7% 15.1% 15.4% 16.9% 33x (Target) 10.5 348
Flavours Sales 61 58 124 139 168
Total PAT 70 73 105 122 152

At CMP, FY19E P/E is At Target Price,

FY19E RoCE of 22.2%
25x FY19E P/E is 33x

Upside of
30%

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S H Kelkar & Company Ltd.

Risk-reward extremely favourable

Our TP is arrived at by assigning 33x P/E multiple to FY19E EPS of 10.5 giving 60% discount to the
Price Target INR 348 average CY18E PEG ratio of global peers of 3.9x to arrive at PEG ratio of 1.58x and multiplying
it with a base case EPS CAGR of 20.6% over FY17-19E.

Bull Assuming a higher growth of 25% for the flavours division and 15% for the fragrances division
INR 440
for FY19 while assuming FY18 estimates to be the base as the base case, and assigning a higher
40x Bull Case FY19E EPS
40x P/E, we arrive at TP of INR 440.

Base Assuming CAGR of 8.7% for the fragrance division and 16.4% for the flavours division over FY17-
INR 348 19E coupled with 267 bps improvement in EBITDA margin over FY17-19E and assigning 33x P/E,
33x Base Case FY19E EPS
we arrive at TP of INR 348.

Bear
Assuming CAGR of 7% for the fragrance division and 14% for the flavours division over FY17-19E
INR 229
and assuming 140 bps improvement in EBITDA margin over FY17-19E and assigning 24x PE, we
24x Bear Case FY19E EPS
arrive at TP of INR 229.

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S H Kelkar & Company Ltd.

Average Daily Turnover (INR cr) Stock Price (CAGR) Sensex CAGR (%)
3 months 6 months 1 year 1 year 2 years 5 years 10 years 1 year 2 years 5 years 10 years
2.3 3.2 3.3 -11.5% NA NA NA 13.2% NA NA NA

Highly consolidated industry with the top 5 players accounting for 59% of global F&F market and 70% of total F&F market in India. The
Nature of Industry industry has high barriers to entry in terms of reliability & product quality, technical know-how and long-term relationships with FMCG
players coupled with stringent regulatory compliance.

Currently, while the domestic F&F market is ~USD 770 mn, the global market is ~ USD 24.7 bn in size. Globally, the market is expected to
grow at ~5%, while the domestic market is expected to grow more than 2x the global rate. Moreover, 42% of the domestic flavours
Opportunity Size
market is occupied by small and medium sized players, which makes it an attractive proposition for larger organized players to gain
incremental share inorganically.

The company has been focused on the F&F business and all its recent acquisitions and expansions have been in the F&F space. The
Capital Allocation
company intends to invest free cash flows in expansion of facilities in India, R&D, cost saving initiatives and tuck-in acquisitions.
Business Value Drivers

The F&F business is sticky in nature with ~90% of the business coming from existing customers. Moreover, the company generates ~10%
Predictability
revenue from products launched over the past three years, indicating a steady stream of revenue from new product launches.

The companys end customer is the non-cyclical FMCG industry which coupled with customer stickiness renders the business highly
Sustainability
sustainable. Moreover, the FMCG industry in India is expected to be on the cusp of a strong growth trajectory.

The company intends to grow at twice the market rate over the long term. It intends to be a USD 1 bn topline company over the next
Future Prospects
decade.

Current focus is to ramp up in utilization of existing facilities along with investments in R&D focused on fragrance innovation and strategic
Business Strategy & cost initiatives to improve margins. The company also intends to enhance its inventory management system by moving it to a
Planned Initiatives centralized location, which will help improve working capital. It also intends to shift its product mix towards more value- added products
like fine fragrances, especially in the international fragrance market.

Near Term Visibility Strong visibility for 20.6% CAGR bottom line growth along with 267 bps improvement in EBITDA margin over FY17-19E.

Long Term Visibility To remain the largest F&F player of Indian origin with an ambition to clock USD 1 bn in sales over the next decade.

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S H Kelkar & Company Ltd.

Focus Charts Story in a nutshell

Largest Domestic Player in F&F Higher margin Flavours Business to grow Per Capita FMCG spending to increase rapidly over next five years
space rapidly on a low base
SHKs market share in flavours Flavours business expected to grow198
and fragrances rapidly 168 FMCG spending per capita in US$, 2016
124 140 2,500
22.5%
21.0% 61 58
37 41 Japan
17 18
UK
2,000

FY18E

FY19E

FY20E
FY11

FY12

FY13

FY14

FY15

FY16

FY17
Italy Germany US
14.3%
12.0%
1,500 Portugal
Mexico
Flavours a better margin business Brazil
compared to fragrances South Korea
4.0% 59% Thailand
1,000
2.0%
India 2020

27% Philippines
Fragrances Flavours F&F Market 22% 19% China
17% 14% 18% 16% 500
15% 15% 16% 14% Indonesia
11% 13%
CY2013 CY2016 India 2016
Bangladesh
FY11 FY12 FY13 FY14 FY15 FY16 FY17 0
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000 60,000
Fragrances EBIT Margin Flavours EBIT Margin

Diversified Customer Base Presence in high growth tier-2 F&B segment an Valuations inexpensive compared to global
advantage peers considering growth prospects
45.0
3,600 + Fragrance Customers
CAGR CAGR 40.0
2008 2014 2019
Tier 1: 16% Tier 1: 13%-15% Givaudan SHK
Tier 2: 28% Tier 2: 22%-25% 35.0
30.0 Symrise
25.0

P/E
20% 30% 40%
20.0
15.0 IFF
10.0
Tier 1 Tier 2 5.0
500 + Flavours Customers
0.0
0.0% 5.0% 10.0% 15.0% 20.0% 25.0%
EPS Growth Next 2FY (%)
Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

I. Fragrances and Flavours: A niche & consolidated market Important factors influencing consumer purchase decision
F&F blenders a critical component of FMCG value chain
Fragrances and Flavours (F&F) are small, but critical constituents which
provide smell and taste to FMCG and Food & Beverages (F&B) products, Smell & Taste
45%
respectively. 0.5% of customers COGS
F&F blends are prepared from a mixture of number of F&F ingredients which 78% Scent
can be natural/ nature identical / synthetic depending on the raw material 4-6% of customers COGS
used to manufacture those ingredients.
30% Brand image
These F&F blends are then supplied to FMCG players to incorporate into their
products.
8% Overall experience 15% Price
5% Brand
3% Fragrance image Packaging
Ingredient Blenders 6% Other 10%
Raw Material End-users
Manufacturers Manufacturers
Fine Fragrances Flavours

Natural Sources Mint and essential Source: AC Nielsen, Company, Edelweiss Investment Research
Fragrance Global F&F houses Major FMCG players
oils
products Mint,
spices and other
herbs Spice oleoresins Indian blenders Major F&B players

Non fragrance Smaller FMCG

products Aroma chemicals
players
Terpene oil

Synthetic
Petrochemical
derivatives

Source: Company, Edelweiss Investment Research

F&F products account for only 2-5% of the overall cost of a product, but are
critical in providing specific characteristic to a particular product.
Consistency of quality and supply, therefore, become critical factors while
selecting an F&F player. But once approved as a vendor for the product,
customer stickiness becomes strong as the FMCG player is reluctant to switch
suppliers for a small cost, but critical component of a product.
According to an AC Nielsen survey, 78% of consumers buying fine fragrances
rate smell as the most important factor, while 45% buyers of F&B rate smell and
taste as the most critical factors, indicating the critical nature of the F&F
product to a consumers purchasing decision.

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S H Kelkar & Company Ltd.

Global F&F Market expected to grow at ~5% CAGR FMCG is the key end market for the F&F industry
The global F&F market is expected to be ~USD 24.7 bn and has clocked CAGR The Household, Fabric, Beauty & Personal care industry within the
of ~2.1% over the past six years FMCG space are major end user segments for the fragrances industry,
accounting for ~70% of market.
The global F&F market is estimated to register CAGR of ~5% over the next five
Beverages and Bakery are major end user segments for the flavours
years, while the domestic market is expected to grow atleast 2x the global
industry, accounting for ~64% of market.
rate.
Global F&F Industry (USD bn) Key end markets for fragrances (%) Key end markets for flavours (%)

Others, Home Dairy,

24.9 31% Care, 1%
23.9 24.1 24.7 21% Salty
21.8 22.9 Snacks, Others,
$ bn

4% 15%
Confecti
Beverag
Personal onary,
es, 41%
Wash, 4%
2011 2012 2013 2014 2015 2016 15% Oral
Hygiene
Source: Company, Edelweiss Investment Research Hair , 12%
Care, Bakery,
Fabric
Domestic F&F Market to grow at twice the global rate 10% Beauty Care,
23%
Care,
The domestic F&F market is expected to be worth ~INR 5,000 cr (USD 770 mn 11%
11%

at current exchange rate, accounting for ~3% of global market) and has
posted CAGR of ~13% over the past four years. Source: Company, Edelweiss Investment Research
The domestic fragrances market was worth INR 1,693 cr as of CY12 and is
expected to have reached ~INR 2,500 cr as of CY16 compounding at a rate F&F industry is highly consolidated with strong entry barriers
of 10.2% over the past four years. The F&F industry, globally and domestically, is a highly consolidated
market with strong entry barriers with quality, reliability, range of
The flavours market in India was worth INR 1,404 cr as of CY12 and is expected products and high switching costs resulting in high level of customer
to have reached ~INR 2,500 cr as of CY16 compounding at a rate of 15.5% stickiness. While the top 5 players globally control ~59% of total market,
over the past four years. the top 10 players control ~73% of the total market.
Similar trend is visible in India with the top 5 players accounting for ~70%
Indian F&F Market growing at ~13% over the past four years of the market, although the industry has more than 1,000 players.
5000
Top 5 player market share India and Global
3805 70%
3097
(INr cr)

2500
1715 59%
1404
2090 2500
1693

2012 2014 2016 Global India

Fragrances Flavours Source: Company, Edelweiss Investment Research
Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

II. Largest domestic player with dominant share in fragrances SHK Fragrance Business Revenue
1,012 1,142
SHK is the largest domestic player in the F&F marketmarket share jumped ~200 900
863 857
bps from 12.0% to 14.3% over the past three years. 720 776
629
552

(INR cr)
442
SHKs market share in flavours and fragrances

21.0% 22.5%

14.3%
12.0%
FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
2.0% 4.0%
Source:,Company,Edelweiss Investment Research

Fragrances Flavours F&F Market

Transition of export mix towards high-end fragrances nearing completion
CY2013 CY2016
Source:,Company,Edelweiss Investment Research SHK has been strategically moving its international fragrance business
mix towards more high-value products, while pruning low value high
SHK has ~23% market share in the domestic fragrances market and the volume sales from some markets of Middle East, which are increasingly
company along with Givaudan and Firmenich control more than 60% market. facing credit risk.
This strategy, coupled with pricing pressure from competition and
The fragrance market is highly consolidated with the top 5 players controlling
global weakness in the international fragrance market, led to 15%
~84% of the total market.
decline in the international fragrance business in FY17.
Domestic fragrances to continue grow in double digits
SHK expects this transition to be over in FY17 and perceives more
SHK has significant share in the domestic fragrance market with over 40% wallet
steady growth in international markets in FY18 and FY19.
share of domestic FMCG players. The company boasts of over 3,600+
We expect the international fragrances business to grow at 10% driven
customers in the fragrances segment.
by change in product mix and SHKs strategic plan to enter new
geographies with demographics similar to India.
3,600 + Fragrance Customers
SHK FragranceDomestic / International Revenue split

327
297
302 257 270
(INR cr)
285
We estimate the company to grow organically by 5% in FY18 with the first 488 561 600 630 715 815

quarter impacted by GST implementation and Q2FY18 also likely to be

impacted due to continued transition of small players to the GST regime. FY15 FY16 FY17 FY18E FY19E FY20E

Post FY18, we estimate SHK to register growth of 14% in FY19 and FY20, Domestic Fragrances International Fragrances
respectively, in line with the growth expected in the FMCG sector.
Source:,Company,Edelweiss Investment Research

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S H Kelkar & Company Ltd.

Flavours: Late entrant, but inorganic approach spearheading market share gains
SHK is a late entrant in the flavours segment (marketing commenced in 2009)
and currently has ~4% market share in the domestic flavours industry.
The company has over 500+ customers in the segment and has been
increasing its presence via organic as well as inorganic routes.
Acquisition of Gujarat Flavours (GFPL) and Hi-Tech Technologies (HTT)
has helped SHK double its market share in the segment.
GFPL s flavours division and HTT registered combined sales of INR 32 cr
in FY17 which also led to a significant margin expansion for the flavours
segment reflecting the managements ability to successfully integrate
tuck-in acquisitions.

500 + Flavours Customers
The flavours industry is extremely fragmented with 56% market share
controlled by the top 4 players (all global), while the balance 44% market
remains highly fragmented.
SHK has identified this as opportunity to establish market share in this category
by tuck-in acquisition of these small players.
The flavours segment is significantly higher margin for the company
compared to the fragrances segment and is expected to grow faster
compared to the fragrances segment for the company on a low base
Flavours a better margin business compared to fragrances
59%
Flavours business to grow organically by 20% domestically and 12%
internationally
SHK registered strong organic growth of 58% in FY17 (30% in domestic
business and 80% in international business) and management is
targeting organic growth of ~25% in the segment in the near term.
The company appointed 12 new distributors to address small scale
manufacturers and increased presence in Delhi and Hyderabad in
FY17. In the international business, the company intends to grow its
presence in South East Asia and MENA region.
SHK also aims to reinforce its domestic presence by entering
unchartered East India (West Bengal large tea drinking population,
Odisha local bakery industry growing with large production capacity)
and Central India (Jharkhand, MP and Ranchi).
We estimate the domestic and international flavours business to clock
20% and 12% CAGR over FY17-19, respectively.
FlavoursRevenue transition

198
168
27%
22% 140
16%18% 19% 124
15%17% 14% 15% 16% 13% 14%
11%
61 58
37 41
17 18
FY11 FY12 FY13 FY14 FY15 FY16 FY17
Fragrances EBIT Margin Flavours EBIT Margin
FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Source: Company, Edelweiss Investment Research Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

III. End markets are expected to grow at a rapid pace The FMCG industry is estimated to clock CAGR of ~20% to USD 103.7 bn
Recent slowdown in FMCG has impacted sales growth by 2020 driven by urbanization, premiumisation, product customization
SHKs sales growth has mimicked that of FMCG players. Ergo, the recent and innovation.
slowdown in the FMCG sector has reflected in lower earnings growth for the
company. FMCGRevenue trend over the years
30%
104

(US$ bn)
20% 37 45 47 49
21 24 30 35
18

10%
2007 2008 2009 2010 2011 2012 2013 2015 2016 2020F

0% Source: Company, Edelweiss Investment Research

201203 201303 201403 201503 201603 201703
S H Kelkar FMCG Growth
FMCG growth follows an S-curve; India is at the cusp and has significant
*FMCG growth represented by growth of cumulative sales of Britannia Industries,Dabur India, Emami, GCPL, HUL,
Marico
room to grow in the next 5-10 years

Domestic FMCG industry estimated to post ~20% CAGR over next 4 years FMCG spending per capita usually follows a S-curve with GDP per
The Indian FMCG market size is currently pegged at USD 49 bn with capita as per historical analysis of other countries. According to Bain
Household and Personal Care (key end markets for the fragrances segment) publications, India is poised to post exponential growth over the next
and F&B (key end market for the flavours segment) accounting for ~70% of 5-10 years as it is currently on the cusp of an uptrend of the S-curve.
total FMCG market.
FMCG spending per capita in US$, 2016
2,500

Japan
FMCG UK
2,000
Italy Germany US

1,500 Portugal
Mexico
Food & Household and
Health care Brazil
beverages Personal care
South Korea
Thailand
1,000
31% 19% 50% India 2020

Philippines
500 China
Indonesia
OTC products and Health beverages, Oral care, hair care,
ethicals staples/cereals, skin care, India 2016
bakery products, cosmetics/ Bangladesh
snacks, chocolates, deodorants, perfumes, 0
ice cream, feminine hygiene and 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000 60,000
tea/coffee/soft drinks, paper
processed fruits and products, Fabric wash,
vegetables, household Notes: FMCG per capita is in PPP terms; PPP is purchasing power parity; Indias current
dairy products, and cleaners
branded flour GDP/capita (PPP terms) is ~$6,800 and is expected to be ~$12,000 by 2020; countries with similar
GDP today include Indonesia, Thailand and China; each dot denotes a country.
Sources: IMF World Economic Outlook (Apr 2016); Euromonitor

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S H Kelkar & Company Ltd.

Per capita consumption in personal care categories is well below global Presence in tier-2 segment likely to aid faster growth in flavours
standards with opportunity size 2-15x in all categories According to a Crisil research report, Tier-2 players in the F&B space
The personal care space in India has significant scope for expansion given have surpassed established players, thereby gaining incremental
the gap in terms of per capita spending in various categories compared to market share.
global averages. This trend is likely to sustain with tier-2 players likely to grow ~2x the rate
in the F&B space.
Global averages of per capita spending in various categories of personal
SHK, along with smaller unorganized players, caters to this segment and
care is between 2x and 15x greater, depending on the category.
we expect this phenomenon to help the company sustain growth well
in excess of 20% in the domestic F&F market.
HPC penetration compared to global averages
15
Increasing share of tier 2 in fast growing F&B pie
10
CAGR CAGR
8 2008 2014 2019
Tier 1: 16% Tier 1: 13%-15%
6 6 Tier 2: 28% Tier 2: 22%-25%
(US$)

2.5 3
2.0
1.2 1.1 0.5 0.3
20% 30% 40%
Bath and Hair Care Oral Care Skin Care Color Deodarants
Shower Cosmetics
Per Capita Spend - India Per Capita Spend - Global

Source: Euromonitor International, Edelweiss Investment Research

Tier 1 Tier 2

Per capita expenditure on food and non-alcoholic beverages in India is second Source: Company, Edelweiss Investment Research
lowest in world
Per capita expenditure on food including non-alcoholic beverages in India is
at USD 277, among the lowest in the world, with the world average being
closer to USD 2,000, entailing ample scope for expansion of the flavours
segment.

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S H Kelkar & Company Ltd.

IV. Small pack segment and focus on tier 2 customers lend edge
SHK has developed a niche for itself by working with tier-2 and smaller domestic FMCG players. Smaller domestic FMCG players and the small pack segment
have not been key focus areas of global MNC players, enabling SHK develop a niche in this segment.

Around 12% of the companys sales in FY16 came from the small pack segment. These small packs are sold to hundreds of traders and resellers across India
with sizes varying from 25 gm to 500 gm.

This segment provides an untapped opportunity for the company while also providing an initial testing ground & immediate feedback for new products.

SHK also works with Tier 2 FMCG players which can become big brands themselves. A case in point is Vini Cosmetics, makers of FOGG brand of deos, which is
one of the companys customers. FOGG has become a market leader in the deo segment with market share of ~20% and revenue of INR 700 cr within six years
since launch of its products.

Key small pack brands FY16- Percentage of revenues from small pack segment

12% of Total
revenues
from small
pack
segment

Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

V. Cost efficiency measures coupled with operating leverage to boost margin

SHK is planning to enhance its inventory management system via inventory relocation to a central location. This is likely to improve the companys inventory
days as a centralized hub will lead to better inventory management
The companys overseas subisidiary PFW Aroma Chemicals, which manufactures aroma chemicals and musk fragrance (Tonalid), currently generates low
gross and operating margins due to the plants high cost base and excess supply for the product in developed markets. However, PFW provides backward
integration in terms of raw materials and also has the R&D expertise to register new products in developed markets and supply relationships with MNC clients.
SHK is currently undergoing a strategic investment plan to optimize production at PFW, which will involve shifting production of some of its products to its
production facilities in Vashivali and Vapi and evaluating another low cost manufacturing location in India or around Europe and using the PFW facility to
manufacture more higher margin products and as an R&D hub to develop novel molecules. This change in tack is reflected partly in the utilization levels of
PFWs Netherlands plantdown from 85% in FY16 to 75% in FY17.
As part of the relocation strategy, the company acquired 100% stake in VN Creative Chemicals Pvt. Ltd. (VNCC) for an consideration of INR 13.59 cr. VNCC is
in the business of aromatic chemicals and is yet to start business operations. The transcation gives SHK access to MIDC leasehold land at Mahad along with
the plant and machinery which will allow backend integration to SHK at a low cost location. The benefits from this transaction are likely to accrue in FY19.
Utilization level of all the plants, with the exception of the Barneveld plant in Netherlands, is currently near 45%. Although utilization levels are not relevant for
the F&F business, SHK believes it has enough capacity to drive medium-term to long term growth reducing the requirement of incremental capex

PFW is currently a low margin business, but provides

Utilization levels in plants are low providing ample scope for sales growth
backward integration
Locations
14.6%
Vashivali, Raigad, Barneveld, The
Vapi, Gujarat Mumbai, Maharashtra
Maharashtra Netherlands
11.5%
Area: 18 acres Area: 11 acres Area: 37 acres Area: 3.46 acres
Fragrance unit:
Installed capacity: Installed capacity:
Installed capacity: Installed capacity:
4,599 tonnes per 1,650 tonnes per
2,064 tonnes per annum 10,342 tonnes per
annum annum
annum
2.2% Capacity Utilisation: Capacity Utilisation: Capacity Utilisation: Capacity Utilisation:
1.0% 1.5%
0.7% 44.8% in FY17 30.5% in FY17 52% in FY17 75% in FY17
Flavour unit
FY15 FY16 FY17
Installed capacity:
Gross Margin (%) Operating Profit Margin (%) 3,000 tonnes per
annum

Source: Company, Edelweiss Investment Research Capacity Utilisation:

23% in FY17
Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

VI. Strong R&D provides stream of new products; encapsulation technology can be a game changer for domestic FMCG companies
SHK has invested steadily in R&D efforts and is first Indian company to bag patent for a novel aromatic molecule.
The company generates ~10% revenues from products launched over the past 3 years, indicating a steady stream of revenue from new products.
It intends to keep investing margin generated above 20% in R&D, while SHK also operates five Creation and Development Centers (CDC) in India, Netherlands
and Indonesia wherein new products are developed in conjunction with the customer.
Over the years, the company has developed over 12 molecules and SHK is one of the few companies worldwide to file patents in fragrance and novel aromatic
molecules. It has recently commercialized one of the patented molecules and commenced sale of products using this compound.
SHK has also acquired rights for fragrance encapsulation technology (FET) from Tanishka Products, a microencapsulation technology specialist, last year.
For acquiring perpetual FET license and capital investment in TP LLP, SHK paid INR 3 cr and will pay an additional amount at the end of 5 years, which will be
equivalent to a portion of the revenue that would be generated in FET sales using the IP in FET.
Microencapsulation is predominantly used to increase the stability and life of the product being encapsulated, facilitate the manipulation of the product and
control its liberation in an adequate time & space.
Fragrance encapsulation technology is ideally used in fabric & laundry industries to ensure that fragrance lasts longer on dry fabrics, however the company is
envisaging using the technology for industrial applications like textiles and paints
The technology has been around in developed markets for around 20-30 years, but has been used in high-end FMCG products by global FMCG players due
to high cost of usage of the technology.
SHK intends to introduce the technology at a much lower cost point, hoping to derive scale benefits of this technology.

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S H Kelkar & Company Ltd.

VII. Vision to be USD 1 bn top line player

SHK intends to become a USD 1 bn sales company over the next decade, which based on the current exchange rates translates into a top line compounding
of ~20%.

At the apex of F&F sectoral pyramid, 80% of the market is dominated by just 11 players with individual annual revenues of more than USD 500 mn, while at the
bottom, there are around 4,000 players clocking annual revenues of less than USD 50 mn.

The company intends to transform its image from being a big small Indian global brand to a small big global Indian brand and achieve this by shifting focus
to export markets, which have demographics and growth rates similar to those seen in India and exploit the space between the aforementioned segments

The entry into the international markets would be in an phase wise manner and restricted to 10-20 markets. SHK is also planning to transition its product mix in
favour of more value-added products and therby likely to further improve its margins

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S H Kelkar & Company Ltd.

VIII. Undervalued considering superior growth prospects compared to global peers

Globally, F&F companies like Givaudan, Symrise and IFF, are currently trading at an average 2- year forward PE of 24x considering the consolidated industry
structure and high return profile of the industry. However, the exposure of these companies is ~50% to developed markets, which are unlikely to post super
normal growth.

This slackness in growth in reflected in the expected earnings of all the three companiesan average of 6.8% over the next two years.

When we look at the valuations of peers adjusted for growth expectations, global companies are trading at an average PEG ratio of 3.9x.

Considering that global peers are significantly bigger in terms of sales, we expect SHK to trade at a small company discount to global peers. Applying 60%
small company discount to the average PEG ratio of 3.9x of global peers, we arrive at a PEG ratio of 1.58x for SHK which is further used to arrive at the fair value
of the company

45.0 30.0

40.0

Givaudan 25.0
SHK
35.0 Givaudan
SHK
Symrise
30.0 20.0

EV/EBITDA
25.0
P/E

15.0
Symrise
20.0

IFF
15.0 10.0
IFF
10.0
5.0
5.0

0.0 0.0
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 0.0% 5.0% 10.0% 15.0% 20.0%
EPS Growth Next 2FY (%) EBITDA Growth Next 2 FY (%)

*Bubble size indicates last fiscal year sales

Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

Time Line

Market and Entities Creation and R&D Centre Manufacturing Facilities

1955 1979 1981 1994 2007 2012 2016

Incorporated as Establishment of Expansion of Expansion of New, long term, Investment by Acquisition of Hi-
S.H. Kelkar & Co. the manufacturing Research Centre Fragrance mfg. fragrance & Blackstone Tech Technologies
Limited unit at Vapi at Mulund facility ata Mulund flavour Mfg. facility Acquisition of (HTT) and flavours
for EOU at Vashivali SAIBA Industries division of Gujarat
Establishment of Flavours (GFPL)
additional R&D
Centre at Mulund

Establishment of Incorporation of Expansion of Expansion of Consolidation of Investment in MP Commercializatio

R&D Centre at Keva Flavours Fragrance mfg. Fragrances promoters Plant - Vapi n of a patented
Mulund facility at Mulund Centre in Mulund shareholding molecule
Establishment of Establishment of Acquisition &
manufacturing the export Integration of
facilities at oriented Keva PFW
Mulund Fragrances
Private Limited

1960 1980 1984 2000 2010 2014 2017

Source: Company, Edelweiss Investment Research

17 GWM
S H Kelkar & Company Ltd.

Corporate Structure

S H Kelkar and Company Ltd.

S H Kelkar and Company Limited

Domestic Foreign

Keva Fragrances Keva Flavours Keva Chemicals Saiba Industries Keva UK Ltd. (UK) Keva Fragrance
Pvt. Ltd Pvt. Ltd Pvt. Ltd Pvt. Ltd (SHK 84%, Industries Pte. Ltd.
KFG 16%) (Singapore)

PFW Aroma PT SHK Keva

Chemicals B.V. Indonesia
(Netherlands) (Indonesia)

Pvt. Ltd

Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

Valuations & peers

Attractive in terms of valuation compared to international peers after accounting for growth prospects
SHK has no similar sized listed domestic competitor and its major compeition includes global F&F players. However, most of the global companies have significant
exposure to low growth developed markets and it would be fair to compare the valuation metrics by comparing the PE ratio after adjusting for growth expected
in earnings. We, therefore, compare the PEG ratio of peers and apply a small company discount of 60% to it to arrive at FY19E PEG ratio of 1.58x for SHK. Valuing
SHK at FY19E PEG ratio of 1.58x and considering a bottomline CAGR of ~21%, we arrive at price target of INR 348, implying 30% upside from current level.

FY17/CY16 EPS growth # FY17/CY16 FY17/CY16 FY17/CY16 EBITDA Growth # FY17/CY16

P/E (Next 2 FY)% RoE (%) Sales EV/EBITDA (Next 2FY) % RoCE (%) PEG
Givaudan * 26.7 4.8% 20% 31,799 16.8 4.6% 20% 5.60
Symrise * 27.3 8.3% 16% 21,578 14.1 3.6% 14% 3.29
IFF * 21.3 7.3% 27% 20,934 14.3 6.8% 23% 2.92
SH Kelkar 37.5 20.6% 15% 986 23.3 17.7% 19% 1.19

Average PEG 3.9

Discount 60%
Discounted PE 1.58
Discounted PE 33
Mcap 5,029
Upside 30%

Source: Bloomberg Estimates, Edelweiss Investment Research

* Calendar estimates considered, #CY16-18 EPS and EBITDA growth considered

EPS (FY19E) Target P/E Target Price Current Price Potential Upside

10.5 33 348 268 30%

Source: Company, Edelweiss Investment Research

19 GWM
S H Kelkar & Company Ltd.

Key Management

Name Designation Profile

Mr. Ramesh Vaze is the MD and Chairman of the group and has been associated with the company for over 40
Mr. Ramesh Vaze MD & Chairman
years. He holds a Bachelors degree in Science from the Univeristy of Mumbai and also is a trustee of the Kelkar
Education Trust. He was appointed MD of the company in August 2010.

Mr. Kedar Vaze is a third generation founder-family member and is associated with Keva since 21 years. He has
worked as Chief Technology Officer and Chief Operating Officer in the group before being appointed CEO in
Mr. Kedar Vaze CEO
October 2014. He has a number of F&F patents in his name and has done his M.Sc. (Chemistry) from IIT Bombay
and subsequently attended Global Managers Program at Stanford University, USA.

Mr. B. Ramkrishnan took over as Director Strategy effective October 2014 stepping down from the CEOs position.
He is currently responsible for long-term strategy development, M&A and capital raising activities of the group. He
Mr. B Ramkrishnan Director - Strategy
has been associated with the Keva Group since October 2010 . Prior to Keva, the he was the CEO of Privi Organics
and also headed the flavours business of Givaudan. He holds a degree in Chemical Engineering.

Source: Company, Edelweiss Investment Research

Key Risks
Sharp slowdown in domestic or global FMCG markets

Inorganic acquisitions may not integrate or scale up as required

Significant appreciation of EUR against the USD or INR against the USD

Volatility in raw material prices

20 GWM
S H Kelkar & Company Ltd.

Business Overview
Company Description
SHK is the largest Indian-origin F&F company in India with over 90 years of experience. Its fragrance products and ingredients are used as a raw material in personal
wash, fabric care, skin & hair care, fine fragrances and household products. Its flavour products are used as a raw material by producers of baked goods, dairy
products, beverages and pharmaceutical products. The company offers products under SHK, Cobra and Keva brands in the small pack segment.

The company has a strong and dedicated team of scientists, perfumers, flavourists, evaluators and application executives at its facilities and five Creation &
Development Centers in Mumbai, Bengaluru, The Netherlands and Indonesia for the development of fragrance and flavour products. Their research team has
developed 12 molecules over the past three years, of which SHK has filed patent applications for three and commercialized sales from one molecule.

Over the years, SHK has developed a vast product portfolio of F&F products for FMCG, pharmaceutical and F&B industries. The company has a diverse client base
of over 4,100 customers including leading national and multi-national FMCG companies, blenders of fragrances & flavours and fragrance & flavour producers.

The company has 2 major segments.

Business Model 1) Fragrances
2) Flavours

Strategic Positioning The company is the leading Indian player in the domestic Fragrances & Flavours market with an market share of ~14%

Presence in the business since 90 years

Competitive Edge
Overall capacity utilization of 45% currently providing ample operating leverage
One of the few companies worldwide to hold patents for novel aromatic molecules
Presence in a highly consolidated and niche market with very high levels of customer stickiness with an diversified client base with no client
accounting for more than 4.9% of the revenue
No long term debt on the company

The company has no long term debt on its book currently providing ample scope for financial leveraging to do tuck in acquisitions. As per the
Financial Structure management there is minimal need for any capex as there is ample spare capacity. Investments would be made towards R&D and operational
excellence initiatives

Key Competitors IFF, Givaudan, Firmenich, Symrise, Takasago

Industry Revenue Drivers The companys fortunes are directly linked to the performance of the FMCG industry which is expected to grow at 20% CAGR till CY2020

Shareholder Value The company can do an EPS of INR 10.5 in FY19E. A 33x valuation can give price target of INR 348 for the company which gives an upside of
Proposition ~30% over the next 12 months.

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S H Kelkar & Company Ltd.

Financial Analysis PAT and PAT margin like to surge substantially

Revenue growth stimated to pickup subsitantially in FY19 Improving sales growth coupled with improvement in gross and EBITDA
SHKs revenue is estimated to clock CAGR of 11% over the next 3 years inspite of margins is likely to lead to improved profitbaility and PAT margins. We
a subdued FY18 (H1FY18 likely to be impacted by implementation of GST). We expect PAT to post CAGR of 20% over FY17-20.
expect the fragrances segment to post CAGR of 10% over FY17-20 with the
domestic market likely to drive growth, while the flavour segment is likely to clock 400 14% 13% 13% 15%
12%
CAGR of 17% on a lower base and stronger growth prospects in domestic as well 10% 11%
300
as international markets. 7%
8% 8% 8% 10%
7%

(INR cr)
200 182
152
125
105 5%
1500 1339 50% 79 70 73
1180 100 46 42 54
40% 986 1039 40% 32
927
1000 761 836
666 30% 0 0%
570 24%
460 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
330 14% 14% 20%
500 17% 14%
10% 11% 10% PAT PAT Margin (%)
6% 5%
0 0% Source: Company, Edelweiss Investment Research
2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E

Revenues % Growth Return ratios to improve as utlilisation picks up

We expect return ratios to improve as capacity utilization improves in
Source: Company, Edelweiss Investment Research existing capacity and mix change coupled with cost efficiency boost
margins. We peg cash adjusted RoCE at ~22% by FY19.
Higher capacity utilisation coupled with shift in mix in international fragrances
will lead to uptick in EBITDA margin
22.2 23.1
SHKs EBITDA margin is estimated to improve from 16.9% in FY17 to over 19.6% in 19.1 19.0 19.4
FY19 due to improving capacity utilzation in domestic capacities, mix shift 16.1 17.0 17.4
towards flavours, cost efficiency improvements and shift to higher margin 13.5
12.2
products in the international fragrance market.

(%)
18.5% 19.6% 20.3%
17.6% 18.0% 18.1%
16.3% 16.9%
14.1% 14.2%
FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Source: Company, Edelweiss Investment Research

2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E

Source: Company, Edelweiss Investment Research

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S H Kelkar & Company Ltd.

Financials
Income statement (INR cr) Balance sheet (INR cr) Ratios
Year to March FY15 FY16 FY17 FY18E FY19E As on 31st March FY15 FY16 FY17 FY18E FY19E Year to March FY15 FY16 FY17 FY18E FY19E
Income from operations 836 927 986 1039 1180 Equity share capital 141 145 145 145 145 ROAE (%) 16.1 13.7 15.1 15.4 16.9
Total operating expenses 717 775 820 852 949 Preference Share Capital 0 0 0 0 0 ROACE (%) 13.5 17.4 19.0 19.4 22.2
EBITDA 119 151 167 188 231 Reserv es & surplus 368 571 667 769 896 Debtors (days) 85 90 80 80 80
Depreciation and amortisation 29 30 19 21 25 Shareholders funds 510 716 812 914 1,040 Current ratio 3.5 3.5 3.6 3.7 3.6
EBIT 89 121 147 167 207 Secured loans 243 85 74 54 4 Debt/Equity 0.5 0.1 0.1 0.1 0.0
Interest expenses 19 22 6 5 2 Unsecured loans 0 0 0 0 0 Inventory (days) 139 132 130 125 125
Other income 25 10 12 16 18 Borrowings 243 85 74 54 4 Payable (days) 64 74 60 60 60
Profit before tax 94 110 153 178 222 Minority interest 0 0 0 0 0 Cash conversion cycle (days) 160 148 150 145 145
Prov ision for tax 24 37 48 56 70 Sources of funds 752 802 886 968 1,045 Debt/EBITDA 2.0 0.6 0.4 0.3 0.0
Core profit 70 73 105 122 152 Gross block 535 270 346 421 471 Adjusted debt/Equity 0.3 0.0 0.0 0.0 -0.1
Extraordinary items -9 -1 -1 0 0 Depreciation 261 43 49 71 95
Profit after tax 61 72 103 122 152 Net block 274 227 296 350 376 Valuation parameters
Adjusted net profit 61 72 103 122 152 Capital work in progress 10 18 7 0 0 Year to March FY15 FY16 FY17 FY18E FY19E
Equity shares outstanding (mn) 14 14 14 14 14 Total fixed assets 284 245 304 350 376 Diluted EPS (INR) 4.3 5.0 7.1 8.4 10.5
EPS (INR) basic 4 5 7 8 11 Unrealised profit 0 0 0 0 0 Y-o-Y growth (%) (92.2) 14.9 43.1 18.2 24.8
Diluted shares (Cr) 14 14 14 14 14 Inv estments 0 35 50 50 50 CEPS (INR) 7 7 9 10 12
EPS (INR) fully diluted 4 5 7 8 11 Inv entories 318 335 350 356 404 Diluted P/E (x) 61.7 53.7 37.5 31.7 25.4
Div idend per share 1 1 1 1 2 Sundry debtors 195 229 217 228 259 Price/BV(x) 7.4 5.4 4.8 4.2 3.7
Div idend payout (%) 21 21 17 17 17 Cash and equiv alents 76 82 55 82 73 EV/Sales (x) 4.7 4.2 3.9 3.7 3.2
Loans and adv ances 28 29 27 28 32 EV/EBITDA (x) 33.3 25.7 23.3 20.5 16.5
Common size metrics- as % of net revenues (INR cr) Other current assets 0 0 0 0 0 Diluted shares O/S 14.1 14.5 14.5 14.5 14.5
Year to March FY15 FY16 FY17 FY18E FY19E Total current assets 615 675 649 694 768 Basic EPS 4.3 5.0 7.1 8.4 10.5
Operating expenses 85.8 83.7 83.1 81.9 80.4 Sundry creditors and others 147 188 162 171 194 Basic PE (x) 61.7 53.7 37.5 31.7 25.4
Depreciation 3.5 3.2 2.0 2.0 2.1 Prov isions 30 6 17 17 17 Dividend yield (%) 0.4 0.4 0.5 0.5 0.7
Interest expenditure 2.3 2.3 0.6 0.5 0.2 Total CL & prov isions 176 195 179 188 211
EBITDA margins 14.2 16.3 16.9 18.1 19.6 Net current assets 439 480 470 506 557
Net profit margins 7.4 7.8 10.5 11.8 12.9 Net Deferred tax 5 -1 -3 -3 -3
Misc expenditure 24 41 65 65 65
Uses of funds 752 802 886 968 1,045
Growth metrics (%)
Book v alue per share (INR) 36 50 56 63 72
Year to March FY15 FY16 FY17 FY18E FY19E
Rev enues 9.7 10.9 6.5 5.4 13.5
Cash flow statement (INR cr)
EBITDA (13.4) 27.3 10.4 12.6 23.0
Year to March FY15 FY16 FY17 FY18E FY19E
PBT (12.9) 16.7 38.5 16.7 24.8
Net profit 79 74 106 122 152
Net profit (11.0) 3.8 43.5 16.5 24.8
Add: Depreciation 29 30 19 21 25
EPS (92.2) 14.9 43.1 18.2 24.8
Add: Misc expenses written off -5 -17 -24 0 0
Add: Deferred tax -3 6 2 0 0
Gross cash flow 101 92 104 143 177
Less: Changes in W . C. 36 35 17 9 60
Operating cash flow 65 57 87 134 117
Less: Capex 12 -9 78 75 50
Free cash flow 53 66 9 59 67

23 GWM
S H Kelkar & Company Ltd.

Edelweiss Broking Limited, 1st Floor, Tower 3, Wing B, Kohinoor City Mall, Kohinoor City, Kirol Road, Kurla(W)
Board: (91-22) 4272 2200

Vinay Khattar

Head Research

vinay.khattar@edelweissfin.com

Rating Expected to

Buy appreciate more than 15% over a 12-month period

Hold appreciate between 5-15% over a 12-month period

Reduce Return below 5% over a 12-month period

180
160
140
120
(Indexed)

100
80
60
40
20
0
Oct-16
Mar-16
Apr-16
May-16

Aug-16

Mar-17
Apr-17
May-17

Aug-17
Nov-15
Dec-15

Jul-16

Sep-16

Nov-16
Dec-16

Jul-17

Sep-17
Feb-16

Feb-17
Jan-16

Jun-16

Jan-17

Jun-17
SH Kelkar Sensex

24 GWM
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25 GWM
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Edelweiss Broking Limited ("EBL" or "Research Entity") is regulated by the Securities and Exchange Board of India ("SEBI") and is licensed to carry on the business of broking, depository services and related activities. The business of EBL and its
associates are organized around five broad business groups Credit including Housing and SME Finance, Commodities, Financial Markets, Asset Management and Life Insurance. There were no instances of non-compliance by EBL on any matter
related to the capital markets, resulting in significant and material disciplinary action during the last three years. This research report has been prepared and distributed by Edelweiss Broking Limited ("Edelweiss") in the capacity of a Research
Analyst as per Regulation 22(1) of SEBI (Research Analysts) Regulations 2014 having SEBI Registration No.INH000000172.

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