Mahindra EPC irrigation- Greener pastures ahead?

When it comes to agriculture, the second thing that comes to my mind is the 'Government of India' (the first thing is, of course, good food!). Policies and subsidies announced by the Government from time-to-time have played a crucial factor in the emergence of our Agri economy. Whether these policies have been enough for the upliftment of the farming community is a debatable subject. Let us discuss one such scheme- Pradhan Mantri Krishi Sinchayee Yojana.


The PMKSY came into effect on 1st July 2015. It's been 5 full years since this scheme came into effect. The scheme has the following components:


Water Resources:

Source augmentation, distribution, groundwater development, lift irrigation, diversion of water from water plenty to water-scarce areas, supplementing rainwater harvesting beyond IWMP, MGNREGA, and repair, restoration, renovation of traditional water bodies.

Per Drop More Crop (Micro Irrigation):

Installation of Micro Irrigation Systems (Drip & Sprinkler) in fields, extension activities, coordination & management.

Watershed:

Ridge area treatment, drainage line treatment, soil and moisture conservation, water harvesting structure, livelihood support activities, and other watershed works.


The scheme has multiple objectives and micro-irrigation is just one of the components involved. The remaining part of this article shall speak in detail about micro-irrigation. Water resources and watershed management is beyond the scope of this article.


Micro-irrigation involves two different methods: drip irrigation and sprinkler irrigation. The drip method is a more targetted one. Below two images should help you understand my point better:


Drip irrigation
Sprinkler irrigation

The following image shows the percentage of assistance that the Central Government and State Government together provide for micro-irrigation:

Source: pmksy.gov.in

DPAP and DDP stand for Drought Prone Areas Programme and Desert Development Programme respectively.


The assistance provided is anywhere between 35% to 60% depending on the area in consideration and the category of beneficiary.


Let us start by taking a look at the area under agriculture as a % of total land area in India


Source: data.worldbank.org

Here's a corresponding chart for the world showing the % of agricultural land to total land:


Source: data.worldbank.org

And here's a chart showing the world population in billions.


Source: data.worldbank.org

The world population has more than doubled since the 1960s, whereas the % of the area under agriculture has increased by a few percentage points. Quite certainly, humanity has done well for itself by increasing the yield of food grains per hectare. Without getting into the details of specific crops, let me share with you the yield per hectare of the top 10 countries in the world:

Source: data.worldbank.org

The world average yield in kgs/hectare stands at 4074 and for India, the corresponding number is 3160 kgs/hectare. The top two numbers might look mind-boggling to you. I tried digging into the reason why the yield is so high for these two countries. I found out that these countries extensively deploy greenhouse intensive farming methods. This method of farming has its own advantages and disadvantages. Discussing those is outside the scope of this article. However, the key takeaway from the above table is that the yield per hectare in India is lesser than the world average. One of the reasons for the low yield is the relatively lesser penetration of micro-irrigation in India.


Benefits of micro-irrigation:



About the company:

The company was established as EPC industries in the 1980s by Mr. K. Khanna. He was part of the first batch of chemical engineering at IIT-Bombay. The company was acquired in the year 2011 by Mahindra & Mahindra Ltd. Both companies had operational synergies. M&M brought its expertise in marketing agricultural products and EPC brought to the table, the product portfolio in micro-irrigation. As on 31st Mar 2020, the promoter (M&M) holds 54.51%. The remaining shareholding is diversified and there is no major institutional holding.

Products & Services:

  • Micro-irrigation: Drip-irrigation & sprinkler-irrigation systems

  • Landscape irrigation

  • Pumps required for agriculture & domestic use

  • Irrigation automation products


Investment rationale

  • Almost 80% of the freshwater used in India is for agriculture. This clearly means that for saving water, the biggest consuming sector should have efficiency. India is home to only around 4% of global fresh-water reserves. Precision irrigation techniques such as drip irrigation and sprinkler irrigation help in reducing the consumption of water to a great extent.

  • Only 10% of the total potential area is currently under micro-irrigation. This clearly indicates under-penetration in the sector and leaves a huge scope for volume expansion.

  • The Government has been vocal about the need for increasing micro-irrigation and has been allocating close to Rs. 3000 crores towards the subsidy every year.

  • The promoter group Mahindra & Mahindra has businesses in the entire Agri value chain: ranging from seeds, crop care, and export of agri-produce. In such a diverse environment, Mahindra EPC is well-positioned to reap the benefits of existing relationships of other group companies.

  • COVID-19 has been a tough one to manage. Government finances are under pressure. In such a situation, the way to recovery is likely to be through rural India. Infrastructure, Agriculture are the two main sectors where employment can be generated at the ground level. It is highly likely that these two sectors will be high in the Government's pecking order.

Is there a moat?

  • Micro-irrigation requires financial investment from farmers. Despite a 50-60% Government assistance, the remaining contribution requires investment by the concerned farmer. The best way to sell such products is by engaging with the community at the ground level. Mahindra EPC has spent many years in such engagement activities. Such a rapport is not easy to build and provides a competitive advantage to the company. Below is an excerpt from the Q4 2020 analyst call transcript (Speaker: company management)

  • Mahindra EPC is a national player with its network in many states across the country. The irrigation business is partly cyclical in nature owing to the presence of monsoon at different times in different parts of the country. This cyclicality is a disadvantage for local small players, but it acts as an advantage for national players like Mahindra. When times are not good in a particular state, the deficit in business can be recovered in some other state. This advantage is not available to regional/ local players, who solely depend on a smaller geographical area for sustaining. This geographical diversification is an advantage when compared with local players.

  • Mahindra EPC is a zero-debt company with strong parentage. Debt + working capital challenges = Disaster (Jain irrigation). Mahindra EPC scores here and a strong balance sheet provides an edge in an industry where managing working capital is a challenging task.

Risks:

  • The irrigation business is subsidized by Government schemes. Any pressure on fiscal deficit or change in Government policies is likely to affect the business adversely.

  • Businesses that primarily depend on the Government subsidies for their revenues need prudent working capital management. Any major delay in collections will affect the return ratios and thereby investor sentiment.

  • The company conducts business in multiple states. Around 85% of the business comes from various state governments. The company has to liaison with various entities to collect the receivables.

  • The irrigation business is monsoon dependent. A drought in major markets for consecutive years would be a problem.

  • The micro-irrigation opportunity is a big one. In case there is a new player that emerges with strong political support and a higher working capital appetite, Mahindra EPC might lose its current edge. However, this is not an imminent risk and can be managed as time elapses.

  • There is some empirical evidence that the adoption of precise micro-irrigation reduces the requirements for fertilizers and other agri-chemicals. The fertilizer industry is cartelized and such cartels may not allow widespread usage of micro-irrigation.

Market potential:

The total area covered under micro-irrigation in India as on 31st March 2020 stands at 1.26 crore hectares. The potential area that can be covered under micro-irrigation stands at 6.95 crore hectares.

That is a massive 5.69 crore hectares, which is more than 4 times the total area covered as of today. The cost of covering 1 hectare of land under micro-irrigation is approximately Rs. 50,000. The total potential market comes to about Rs. 2.84 lac crores. (Please note that the potential area that can be covered under MI is an estimate by the Government under the PMKSY scheme. In case any readers think this number is too high or too low, we would love to hear more from you!)


Competition:

Netafim and Jain Irrigation are the major competitors for the company. Netafim is an Israeli company. It is a well-known fact that Israel is a leading country in agricultural research. Drip irrigation was invented by Simcha Blass. The rights to market the technology were purchased by Netafim.


As far as Jain Irrigation is concerned, Mahindra EPC is gaining market share due to the ongoing financial troubles at the former.


Government's focus:

The below table mentions the Government's budget allocation to micro-irrigation (per drop more crop scheme) under the PMKSY.


Source: Pocket book of Agricultural Statistics, published by Ministry of Agriculture & Farmers' welfare

The actual expenditure on micro-irrigation has been on the rise. However, every year, there has been a shortfall in the actual expenditure, when compared with the original allocation. This shortfall is not very uncommon in our budget. Many schemes have this kind of a shortfall when the actual numbers are out. However, a shortfall for many consecutive years may indicate some trouble for the industry.


Joint Venture

The company has entered into a joint venture with Top Greenhouses Ltd in the year 2019 and established a subsidiary Mahindra Top Greenhouses Pvt Ltd. If you can recollect, we said earlier that the yield per hectare in UAE is mind-boggling. The reason is that they use intensive protected farming methods. Mahindra Top Greenhouses has been established to focus on similar businesses in India. From my limited research on protected farming, the synergies click well as Mahindra EPC contributes by way of local market know-how, whereas Top Greenhouse brings technical expertise to the table. The protected farming business in India is at a very nascent stage. If the concept is likely to take-off well, Mahindra EPC will be one of the early professional players in India.


Raw material:

The company uses polymers for the manufacturing of various products in its portfolio. Polymer prices are linked with crude oil prices. Adverse fluctuations in crude prices are likely to affect margins. The company does not hedge its raw material costs, as mentioned in the annual report.


Operating Cashflows:

As mentioned earlier, receivables is a problem area, not just for the company, but for the entire micro-irrigation industry. The company has not generated positive cumulative operating cash flows over a period of the last 10 years (2011-2020). The net cash flow from operations stands at Rs. -4.01 crores. During the same period, the cumulative PAT stands at Rs. 80.99 crores.

The net cash used in operations is being financed by the promoter company.


Indebtedness & Solvency:

The company has no long term borrowings. Short term borrowings stood at Rs. 13 crores. The position is very comfortable.


Working Capital:

Receivable days for the company has increased from 103 in 2011 to 164 in 2020. During the same period, payables days have increased from 48 to 76. Inventory days have increased from 37 to 42.

Dividends:

The company has paid dividends in FY18 & FY19 and the dividend payout ratio stood at 28.14% and 28.3% respectively. While these numbers look decent, however considering the tight cash flow situation, the company may not be always in a position to pay regular dividends.


Growth rates:

The 10-year CAGR in Sales, EBITDA and PAT stood at 12.58%, 16.85%, and 32.08%


Margins:


Return Ratios:



Board of Directors:



Management remuneration:

The remuneration of all key managerial personnel put together adds to Rs. 2.68 crores. This comes out to less than 1% of the annual revenues for the company as per the latest reported financials. The numbers are comfortable.


Valuations:

The latest earnings per share reported by the company for the full year ended Mar 2020 stood at 8.38. As per the closing price on 13th July, the PE ratio stands at 21.


Conclusion

The irrigation industry is complex with tight linkages with the Government. Revenues are linked to Government spending. There are ample local manufacturers who have an upper hand in local markets.


On the positive side, valuations are favorable, and the sector is clearly under-owned. The Government's vision of doubling farmers' income will be difficult to achieve without increasing farm productivity. Mahindra EPC irrigation is a business started by visionary founders. The controlling stake now lies with one of the most respected and diversified conglomerates in the country.


The story in short:

Holding duration:

While the company is good and reputed, this may not be a buy and hold forever kind of a company. Growth will indeed be not as fast as some of the fastest-growing sectors. The presence of tailwinds is very important for staying invested during the most opportune times. The next few years look good for the sector with more focus on agriculture and allied activities.


Disclaimer: I am invested in Mahindra EPC Ltd and intend to keep adding gradually. I am planning to add in a staggered manner as Govt finances are under pressure. My views may be biased. Please do your due diligence before investing. If you have a contra-view, I would love to listen.



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