Should you put Dalda in your portfolio?

On the surface, Dalda Foods looks like the kind of company that has characteristics investors would salivate over: the owner of a decades-old set of brands that are household names and hold a leading market share in a large category of consumer spending, rapid revenue growth fueled both by organic expansion as well as successful acquisitions, a management team with impressive credentials built up over decades at well-run multinationals, and an ownership structure that includes both the top management team as well as a hands-off financial sponsor. What is not to love?

But look carefully and you will notice that many of those favourable factors are backward-facing: they tell you more about the company’s past than its future. And if you are a prospective investor in Dalda’s stock, history is nice, but not what your money is meant to purchase. A stock, after all, is literally a claim to a share of the company’s future cash flows.

So that then begs the question: are Dalda’s best days behind it already? Or does the company still have a compelling growth story left to tell investors?

The timing of the initial public offering (IPO) of Dalda Foods’ shares is not yet certain since the company has decided to wait for a more favourable set of conditions in the equity markets, following the bearish sentiment that took hold over the Pakistan Stock Exchange in 2017. But while investors wait for the IPO book building process to resume, they have an extra few months to pore over the company’s financial statements and its position within the Pakistani economy and decide just how much they are willing to pay for the company’s stock.

At Profit, we decided to take the liberty of examining some of the questions investors should ask themselves before considering Dalda Foods as part of their equity portfolios.

The original banaspati ghee

It is hard for anyone alive to remember now, but before Dalda, there was no such thing as banaspati ghee. For most households in South Asia, cooking involved using coconut oil, or desi ghee (clarified butter), which was an expensive ingredient that had to be used sparingly. A Dutch company named Dada & Company started selling hydrogenated vegetable oil (banaspati ghee) to the South Asian market in the early part of the 20th century, and the product – cheaper than desi ghee – soon began to grow in popularity.

In the early 1930s, Lever Brothers (one of the predecessor firms of Unilever), was also looking to enter the banaspati ghee business, and had incorporated a subsidiary Hindustan Vanaspati Manufacturing Company for this purpose in 1931. That same year, rather than investing in building a brand from scratch, Lever Brothers decided to purchase the rights to manufacture and sell Dada ghee in British India.

Dada agreed to sell those rights, on one condition: that the name Dada be retained. Lever Brothers, however, wanted to give the brand its own touch and decided to put the L from Lever Brothers in the middle of the name, making it Dalda. The company started manufacturing and selling the product in 1937.

But of course, it is not enough to simply start manufacturing the product. For a new category of products like banaspati ghee, consumers have to be convinced to try the product. “The challenge for Dalda in the initial years was to drive home the point that it tasted just like desi ghee, had deep-frying properties like it, but unlike ghee, it wouldn’t feel heavy either on the pocket or the palate,” said Sagar Boke, head of marketing at Bunge India (the current owners of Dalda in India) in a 2015 interview with Indian financial newspaper Business Standard.

To get around that problem, Lever Brothers began what is believed to be one of the first multimedia advertising campaigns in South Asia. “In cities, roadside stalls had men preparing tasty snacks using Dalda and offering them to the passers-by. Short films were screened in theatres. An intriguing, round-tin-shaped van roamed the streets. Attractive leaflets were handed out and small tins of banaspati sold. People were encouraged to smell, touch and taste the product. In villages, wandering storytellers were roped in to talk about Dalda. Different customers were targeted using different pack sizes – hotels and restaurants were offered large, square tins and individual consumers small, round tins,” writes Malathy Sriram, in the Indian business publication, BusinessLine.

The marketing campaign, designed by the firm Lindas, worked, and Dalda became a household name throughout South Asia, and largely remains so today.

Unilever sells off Dalda

In 2003, Unilever made the strategic decision to sell of the Dalda brand in both India and Pakistan. At the time, Dalda accounted for just under 19% of Unilever Pakistan’s revenues, so the sale meant a significant reduction in the size of the company’s business in the country. Nonetheless, Unilever was determined and retained HSBC as their investment bankers to manage the transaction.

Needless to say, the chance to acquire the biggest brand of edible oils in the country was not something that went unnoticed in Pakistan’s business community. No fewer than 19 entities bid for Dalda Pakistan, a list that included some of the biggest names in the food and consumer goods business in Pakistan, including Saffola Group, Candy Land, Habib Oil Mills, Lakson Group, Avon, Fauji Foundation, and Zulfiqar Industries.

The winning bidder, however, was none of these. The bid that won the auction came from Westbury Group, which, while well-known in Karachi’s trading and financial community, was not known to be a manufacturing or consumer goods powerhouse.

The group is owned by two brothers from Karachi, Bashir Janmohammed and Rasheed Janmohammed. Prior to acquiring Dalda, Westbury was primarily a commodities trading business based in Karachi, which also – at the time – owned a brokerage licence on the Karachi Stock Exchange. While they traded in many commodities, their biggest businesses was palm oil, the main raw ingredient for banaspati ghee. Indeed, at the time of the acquisition, Westbury was the largest importer of palm oil into Pakistan.

Before the acquisition, analysts had been expecting the winning bid to be between Rs900 million and Rs1 billion. Westbury’s winning bid was Rs1.33 billion. The transaction closed in July 2004. (Incidentally, Dalda India was sold to Bunge, a US agribusiness company, for INR 1 billion, which was approximately equal to PKR 1.6 billion at the time.)

The deal included the rights to the Dalda brand name and almost all of the edible oils and fats business of Unilever Pakistan, except Blue Band margarine. However, while the newly incorporated, Westbury Group-owned Dalda Foods would not own the Blue Band brand name, it would continue to manufacture the margarine as an outsourced manufacturer for Unilever Pakistan.

It was not just Wesbury’s willingness to bid higher that won them the auction. Indeed, Habib Oil Mills actually had a slightly higher bid at Rs1.35 billion. However, unlike the other bidders, Westbury allied itself with the Dalda management team at Unilever Pakistan and included them as shareholders in their bid.

(Note: In a sellside auction process, there are often bidders who put in a high bid, but may not have the intention or ability to close the transaction, so the seller often prioritises other factors and may end up selling a company to a buyer who had a slightly lower bid, but can demonstrate keen interest in actually closing the transaction, such as having the current management team as shareholders.)

The Westbury approach

The Janmohammed brothers have a business philosophy that is still somewhat unusual in Pakistan: they are smart enough to know what they do not know, and confident enough to trust the people they hire to do the job. While they had been in the commodity business for decades and knew it inside out, they were less familiar with the business of manufacturing and selling a direct-to-consumer product. So they made sure to retain the Unilever management team that had been running Dalda before the 2004 transaction.

That bet appeared to have mostly paid off: Dalda’s revenues have grown from Rs4 billion for the financial year that ended June 30, 2005, the first full year after the Westbury acquisition, to Rs33 billion in fiscal 2017, an annualized rate of 19.1% per year. Inflation during that time has averaged 9.1% per year.

People familiar with the company’s affairs say that, when it comes to day-to-day affairs, the Janmohammed brothers let the management run the show. And they have made it a point to retain almost the entirety of the senior Unilever team, trusting not just in the team that knew the brand before Westbury bought it, but also in the generally higher quality of human capital found at the local subsidiaries of Western multinational companies.

Every single one of the executive directors of Dalda Foods is an ex-Unilever employee. This includes not only the CEO, Perwaiz Hasan Khan, but also the directors for finance and information technology, sales and distribution, human resources, marketing, and technical operations. Small wonder, then, that the management is able to claim that the Dalda corporate culture is similar to that of Unilever Pakistan.

“Our organizational values are our very own, but perhaps not very dissimilar from Unilever Pakistan,” said Perwaiz Khan, in an interview with Profit. “The culture change, if any, has not been stressful.”

Growing the business

Soon after the acquisition, the newly incentivized management team (the top management are all shareholders in the company) began an aggressive expansion plan that relied. “The company’s growth trajectory has combined organic growth as well as growing through acquisitions and diversification,” said the CEO.

The first initiative was to try to sell more of Dalda’s products to the large expatriate Pakistani population in the United Kingdom, Canada, and the United States, which the company was successfully able to do starting in 2005. Dalda management is particularly proud of this achievement since it meant being able to meet the relatively high food quality standards of the European Union, no mean feat for a company that was used to catering to Pakistani consumers.

The second initiative was the launch of another brand of cooking oil named Manpasand. The Dalda Foods management felt that Dalda itself was a brand that largely catered to the needs of the upper middle-class, and that the company was missing out on the growing market below that income level. “We launched Manpasand in 2006 to cater to the needs of the large middle segment of the market,” said Perwaiz Khan.

The next major phase of growth came through the acquisition of a controlling stake in Wazir Ali Industries in 2007, a struggling publicly listed manufacturer of edible oils that owned the brand name Tullo, which added another household brand to the Dalda Foods portfolio. “Tullo has been fully nurtured back to health and has made a successful and dramatic turnaround to become one of the fastest growing brands in the edible oils category,” said the CEO.

The year 2007 was the peak of the economic boom under the Musharraf Administration, and middle-class incomes were rising rapidly, and Pakistan was finally beginning to have a sizeable upper middle class that could truly be counted as part of the global middle class. This income strata was not satisfied with Dalda’s existing brand offerings, and so Dalda Foods launched it olive oil business, branded as Dalda Olive Oil, and imported from Spain.

It was not just brands and acquisitions, however. The company also invested in the less glamorous, but nonetheless highly important, areas of manufacturing capacity. In 2011, Dalda Foods completed work on a new edible oil processing plant in Karachi, which increased the company’s manufacturing capacity by another 300 tons a day. And in 2012, Dalda added a new edible oil neutralization and bleaching plant, with a capacity of 100 tons per day. “This further improved the company’s ability to use indigenous sunflower seeds,” said Perwaiz Khan.

In short, the first eight years after the acquisition from Unilever were a flurry of activity geared towards growing the business, and one that yielded results. Between 2005 and 2012, Dalda Foods’ revenue grew by an average of 28.1% per year, a period during which inflation averaged 11.8% per year, and hit Rs22.6 billion in 2012.

Running out of steam

After 2012, however, the company began to lose steam. Revenues continued to grow, but at a much more tepid pace. Between 2012 and 2017, the company’s revenues have grown by 7.6% per year. Inflation averaged 5.5% per year during that same period.

It is not as though Dalda Foods has stopped trying to grow its business. In 2013, the company commissioned a new edible oil seed extraction factory in Port Qasim, which has a capacity of 300 tons per day.

The problem, however, is that the edible oil business itself stopped growing. Dalda management relies on estimates published in Dawn that suggest that the edible oil market may be worth as much as Rs500 billion a year, and growing at approximately 7% per year. Interestingly Bashir Janmohammed gives a much lower figure. “With growing population, edible oil consumption is expected to rise by 3 to 5% on yearly basis making it an even more attractive market”. Perwaiz Khan says that they estimate that a little over 60% of that market is domestic consumers, with the remainder taken up by industrial consumers.

If Perwaiz Khan is correct, that would imply that the consumer market is worth just over Rs300 billion a year. However, we at Profit utilized data from the Pakistan Bureau of Statistics to calculate the size of the consumer market for edible oil and came up with a larger figure of Rs403 billion in 2017. Assuming the 60-40 split between consumer and industrial is correct, the total size of the edible oil market should be around Rs671 billion.

Our estimates for the market’s growth between 2002 and 2017 were an average rate of 11.1% per year. However, that number masks a more disturbing reality for edible oil manufacturers. Between 2002 and 2012, the domestic consumer edible oil market grew at an average of 17% per year, but between 2012 and 2017, it only grew by 0.2% per year. Put differently, in inflation adjusted terms, the average Pakistani household is spending less on edible oils than they were five years ago.

We suspect that the industrial market for edible oil is probably operating differently than the consumer market. Nonetheless, given the dominance of the consumer market, it does not bode well for the industry to see ordinary households using less of their product on a per-capita basis.

Diversification versus dividends

At some level, it appears that the management is well aware of the slowdown in the market for their core product and have begun to diversify away from edible oils. In 2015, for instance, Dalda Foods completed work on a factory to produce Cup Shup, a new brand of tea whitener, an important food category in a country obsessed with tea. And in 2017, the company launched a brand of snack foods called Knock Out.

And at some level, the market expects Dalda to succeed at its diversification strategy. When it launched its tea whitener brand, for instance, the current market leader in that category, Engro Foods, was forced to respond by dramatically increasing its marketing spending on television commercials for its Tarang brand of tea whiteners.

At the time, analysts had high hopes for Dalda’s foray into this space. “We believe, given relatively deep pockets of Westbury and Dalda Foods to invest in the brand, ‘CupShup’ is expected to test Tarang’s dominance in the tea whitening segment,” wrote Muhammad Ibadur Rahman, a research analyst at Elixir Securities, an investment bank, in a note issued to clients on September 29, 2015.

Dalda does not yet break out its revenues by category of products its sells, so it is hard to judge the success of this venture. But judging by the fact that revenue growth has yet to pick up, at the very least, it may be too early to tell how much success the company is likely to have in moving away from its core business of edible oils.

However, beyond the challenges of a slowing market in its core products, Dalda’s ability to grow is being hamstrung by a decision that is very much within the purview of its board of directors: the decision on how much to pay out in dividends.

Between 2012 and 2017, Dalda Foods has paid out an average of 80.4% of its net income in dividends to its existing shareholders. And the dividend payout ratio only appears to keep growing over time. For each of the last three years, the company has paid out over 95% of its net income in dividends. In fiscal 2016, the company actually paid out a dividend an astonishing nine times in just one year.

That kind of behaviour on the part of a company’s board – dominated as it is by the management and its financial sponsors, all of whom has significant shares in Dalda Foods – suggests that both the management and financial sponsor are done with trying to grow the business and are now cashing out, and indeed, using the company’s cash flows as their ATM for their monthly expenses. Such a policy may be acceptable in the case of a private company, but is unlikely to be welcomed by public company shareholders.

Caveat emptor: sponsors and management cashing out

And, judging by the structure of the offering, the management and the Westbury Group are not done cashing out. If the IPO goes through as it is currently structured, over 63.6% of the cash generated from the stock offering will flow not into the company to fund its expansion plans, but to existing shareholders of Dalda Foods’ holding company, which is primarily the Westbury Group, but also the current management team. That existing set of shareholders would be selling 19.4% of their current shares in the business.

At the current floor price of Rs85 per share (likely to go up if there is sufficient investor demand), Rs2.55 billion (of at least Rs7 billion to be raised) would go to the company to provide most of the funds for its Rs3 billion project to expand its seed extraction plant and increasing its seed crushing capacity by an additional 500 tons per day. This would allow the company to reduce its costs and increase profit margins (the company does not disclose by how much).

When asked to comment on what the transaction structure reflects about the management and sponsors’ views of the company’s future, CEO Perwaiz Khan said,”the company has been doing well, is doing well, and Insha Allah will continue to do well. The company is in robust financial health and growing at a fast and steady pace. Our pipeline of future projects is good and sensible. The investment needs of those projects are quite adequately fulfilled by the proposed IPO structure.”

At Rs85 per share, the company is valuing itself at 12.6 times its 2017 earnings. The median valuation for the publicly listed food companies Dalda identifies as its peers is 24.4 times trailing twelve months’ earnings. Almost none of those companies, however, offers as high a dividend payout ratio as Dalda is offering, and most have higher revenue and profitability growth. Meanwhile, the overall stock market trades at a multiple of 10.1 times trailing twelve months’ earnings.

So, in a nutshell, Dalda Foods is asking investors to value it like a high-growth food and consumer goods company even though, for the last five years, its management has been plowing most of its profits into dividends rather than reinvesting that cash into its business. Meanwhile, most of the management team is already quite senior and some key personnel are likely to be close to retirement and will be getting a large cash payout as a result of the structure of the offering.

Of course, there is absolutely nothing wrong with sponsors selling their shares in a company at the time of an IPO. But when they do that, they must present to the investing public a clear plan for succession of key management personnel, and for how the company plans to continue growing its business after its existing sponsors cash out part of their stake in the company. Dalda’s prospectus leaves much to be desired on that front.

Nobody would begrudge the current Dalda management team any possible retirement plans (none have yet been announced), nor should anyone suggest that they and the current shareholders do not deserve the cash that is coming their way. They have certainly worked hard to earn it and deserve congratulations on the successful business they have built.

But the last five years suggest that Dalda has struggled to grow its business, and that a lot of work needs to be done in order to ensure that the business remains as vibrant as it was in the years immediately following the acquisition from Unilever. Who will do that work, and what work will they undertake are details the company should offer with greater clarity if it expects investors to clamour for its shares on the stock exchange.

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Editors Note: Dalda goes public