Description

Prataap Snacks is a growing snack food company in India with a long runway ahead of it.  The company is taking market share in a relatively fragmented market, has a strong management team and is backed by Sequoia, arguably the world’s most successful investment firm.  The company is small ($371 million market cap) and the float is even smaller given over ½ of the company is owned by Sequoia and other long-term holders, but we have found that there is liquidity available if you are patient.    

Prataap is investing heavily to continue to take share, launch new products and expand its distribution reach throughout India – as a result we believe the company is underearning and will see margins expand significantly in the coming years.  If we’re correct about the growth path and margin expansion, the current valuation (54x this year's earnings, 33x next year's) will appear cheap in hindsight. The stock is down this year due to a broad selloff in Indian small caps and because of an increase in potato prices that have decreased Prataap’s margins.  We believe these issues are short term in nature and also think that Prataap will be an attractive acquisition candidate in the next few years when Sequoia looks to exit their large stake (48%) in the company.

Overview

Prataap was launched in 2004 - the three founders still run it and own 23% of the company.  In 2011 Sequoia invested $30 million into the business which helped fuel its growth – Sequoia got two board seats which they still hold today.  Prataap today sells potato chips and other snack foods throughout India under the popular Yellow Diamond brand name. They sell a variety of snacks in different sizes but the consistent theme is that they are sold at attractive price points relative to the competition (20-30% cheaper):

The table below is a good synopsis of our thesis – Prataap is currently underearning relative to larger consumer staples companies in India due to its smaller size, but it is rapidly gaining share and we expect the monetization gap to gradually close over time.  The management team has executed extremely well thus far – between their history and Sequoia’s heavy involvement we think the company has a reasonable chance to compound revenue and earnings at a high rate for decades to come:

Growing Share of a Growing Pie

Branded consumer companies in India can be fantastic businesses as seen by the high multiples awarded to them in the table above.  Given strong population and economic growth in India, the organized snack food market is expected to grow in the mid-teens per annum looking forward:

While the market has priced a lot of this growth in, particularly for the large incumbents, we believe Prataap has an opportunity to grow into a similar position over time.  The food sector in India is relatively fragmented with just 27% controlled by the top three players. Prataap has been steadily gaining share due to it’s value proposition, continued investments into its brand, new product launches and expanded distribution:

Prataap’s investment spending and market share growth have lead to significantly lower margins than its peers, but we believe this is rational and that the capital is being spent with high expected returns.  As one example Prataap’s logistics costs as a % of sales are in the high single digits as a % of revenue versus low to mid-single digits for larger consumer companies. This will gradually improve as they continue to grow and is one of many reasons why Prataap is also an attractive acquisition candidate for its larger peers.

Sequoia

Sequoia first invested in 2011 and owns 48% of the company today.  Given its fund life and based on the language below from the prospectus, Sequoia will have to exit their stake in the next 2-4 years.  They own too much to sell in the public market which makes a strategic sale quite likely in our opinion. Plugging Prataap’s popular brands into a larger, more efficient distribution system would be highly accretive to the larger players and they could afford to pay a nice premium given the large discrepancy in valuations.  Britannia, ITC, Haldiram, Pepsico and Lotte are all possibilities. To be clear we don’t think anything is imminent and believe that both the company and Sequoia’s plan is to grow and improve its margins for a couple more years to maximize the price it can get, but if and when they do want to sell we think there will be plenty of interest.

“Further, the conclusion of the initial fund life of the Sequoia entities shall commence earliest in mid-2018 post which Sequoia entities expect to dispose-off assets / investments and wind down within a period of two to three years, subject to any regulatory changes or approval. Accordingly, the latest period by which the Sequoia entities shall liquidate their shareholding in our Company is as follows”

Summary

If Prataap’s management continues to execute we think they can realistically grow their top line at 15% for several decades to come and even faster (~20%) in the next few years.  As they grow they should see benefits from scale that will significantly improve margins as well, making the current valuation appear low in hindsight. While we’d be happy to own this for a long time, we also think the odds of a strategic sale over the next 2-4 years are high given Sequoia’s large stake.  While there are short-term risks, including margin pressure from rising input costs (as seen recently with potato prices), we’ve been impressed with the company’s ability to manage around that and think the risk/return here is attractive.

Catalyst

• Continued market share gains
• Margin improvement
• Strategic sale to larger player