By AltG Innovation Centre On Behalf Of Taponeel Mukherjee And Poornima Vardhan
TATA's Acquisition Of Ching’s maker - Capital Foods Private Limited at the rumoured valuation of INR 5,500 Crore risk adjusted isn’t the best Capital Allocation decision for TATA.
TATA Consumer Pvt. Ltd. (TCPL) is focused on expanding its portfolio: From a failed bid to acquire the drinking water brand Bisleri to the rumoured $10 Billion interest in India's largest snack maker, Haldiram's. The latest news doing the rounds is TATA's potential interest in Ching's maker, Capital Foods Pvt Ltd., popular for offering Chinese food ingredients like masalas and sauces. The deal potentially values Ching's at an exorbitant INR 5500 Crores.
Capital Allocation is one of the most crucial elements of corporate strategy and one that TATA needs to pay close attention to. The key to a successful deal here is the price and potential value that TATA can create.
At the heart of this argument is the rumoured valuation of Capital Foods at INR 5,500 Crores, which, when scrutinised, presents several challenges for TCPL. To assess the viability of this investment, we must examine Capital Foods' current financials with projected annual revenues of INR 900 Crores and an assumed Earnings/Revenue ratio of 5% (generously higher than its 4-year average of 2.5%). The 5% here is the percentage of revenues Capital Foods has converted into earnings. A quick look over the last few years shows a volatile number, with a high of 10.31% for the year ending March 2021 and an average of 2.43%. Let's take the 5% as a base number for this year, giving the average earned a bump up and factoring in COVID-led disruptions over the last 3 years.
Assuming a 5% earnings on the projected INR 900 Crore gives us an INR 45 Crore in Revenue. At the rumoured INR 5500 Crore valuation, that's an implied P/E multiple of 122. High P/E multiples aren't a challenge if you can compensate via high growth in earnings. However, in this case, TCPL faces an uphill battle to generate significant returns on its capital investment, even with its expansive distribution network, brand-building expertise, and operational systems—the APEXX Formula Matrix below highlights the challenges. Let's look at a few scenarios based on the matrix.
Even if TCPL were to compound earnings for Capital Foods at an impressive rate of 25% annually for the next five years and mark the earnings at TCPL's current P/E ratio of 63.4, the resulting annual return would be a mere 9.62%. Even with the same 25% earnings growth, which is an exceptional scenario, but a compression in the P/E multiple of TCPL to say 50 sees the return from this investment dropping to a meagre 4.54%. In another scenario, should the annual earnings growth be only 15%, and TCPL have the same multiple in 5 years' time, the annualised return is less than 1%. Essentially, at INR 5,500 Crore, in spite TCPL's reach and distribution, this deal doesn't have enough margin of safety.
Note: AltG Analysis based on MCA and publicly available filings.
In a world increasingly seeing higher costs of capital, corporates allocating capital must seek higher rates of returns. TCPL must seek to allocate capital at a hurdle rate of at least 15% annual returns as the base case scenario. In this case, the best-case scenario is less than 10%.
So the question is what should TCPL pay for this asset of Capital Foods? Well, this depends on what hurdle rate and risk scenarios we consider. But even if we assume that the current P/E holds in 5 years' time (given the robust growth in India's consumer market, even with some volatility, we can see these multiples playing out) and that TCPL can grow earnings at 20% annually - For a 15% hurdle rate of return the value of the deal sits at INR 3500 Crore and for a 20% hurdle rate of return the value sits at INR 2850 Crore. Basically, given the risk-reward, the deal valuation looks very rich at INR 5500 Crore.
Considering these factors, it is clear that investing in Capital Foods at the rumoured valuation of INR 5,500 Crores is a suboptimal capital allocation decision for TCPL. The risks and uncertainties involved in achieving the desired returns at this valuation are too high. Instead, TCPL should focus on securing a lower valuation for this potential acquisition, ensuring that it aligns with its target hurdle rate.
Furthermore, TCPL should explore alternative avenues for growth and capital allocation. One such area is the Quick Service Restaurant (QSR) and packaged foods industry. Leveraging TCPL's strengths and resources in these segments could yield more promising returns and growth opportunities. India is at the cusp of a massive boom in consumption that will play out across the sectors. The APEXX Formula tells us that the plays in QSR chains, convenience stores, packaged foods, etc, have significant opportunities to allocate capital to compound capital at higher rates of return and enter businesses at lower valuations.
In conclusion, while Capital Foods and its product portfolio may hold promise, the rumored valuation of INR 5,500 Crores makes it risky for TCPL regarding capital allocation. To ensure meaningful returns, TCPL should consider negotiating a more favorable valuation or exploring other growth avenues in line with its financial goals. Smart capital allocation is essential for long-term success, and TCPL should pursue opportunities that align with its strategic objectives and investor expectations.
In conclusion, there are two rules in Investing: Rule number one: Purchase Price Matters! Rule number Two: Don't forget rule number one.
Disclaimer: Any views, comments or communication (above or in the past) should not be construed to be investment advice by Alternative Growth (hereafter referred to as “AltG”) in any form whatsoever. AltG does not make an offer to sell or solicit to buy any securities.