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Unity Foods Limited (UNITY): Initiating Coverage with a BUY rating and TP of Rs35.2

• We initiate our coverage on Unity Foods Limited (UNITY) with a Dec-2021 Target Price of Rs35.2, offering a potential upside of 62.2%. We believe the company’s growth story is yet to be fully priced in, despite the fact that stock has provided exponential returns.
• Our liking for the stock stems from (1) an aggressive expansion plan, (2) addition of new product lines to transform the company from oil to food oriented company, (3) gradual shift towards high margin retail segment and (4) association with Wilmar which can take company’s identity to a new level as it has been seen in other subsidiaries/JVs of Wilmar in China, Vietnam and India.
• Aggressive expansion plan to drive volumetric growth: Though the company has already achieved sales of around Rs30bn in FY20, we believe this growth is likely to continue as we expect a 3-year FY20-23 sales CAGR of 38% due to addition of (1) a chemical refinery of 200 TPD, (2) a margarine facility of 60 TPD by FY23, (3) a new hydrogenation facility of 150 TPD by Jun-2021 and (4) flour mill of 370 TPD by Jun-2021. Similarly, we expect company to post 3-Year (FY20-23) profit CAGR of 143%.
• Addition of new products to transform from an Oil to a Food company: The company has a strong pipeline of new products that includes (1) margarine/shortening spread, (2) packaged rice, (3) flour for pizza and pasta baking and (4) soaps. The company also envisions to introduce pulses under the brand name of  Sunridge, in line with the business model of other Wilmar subsidiaries across the globe.
• Gradual shift towards retail segment to improve margins: The company’s current gross margins stand in the range of 6-8%, lower than peer companies (like Dalda, Punjab Oil) margins of 16-20% due to lower presence in retail consumer market. With the introduction oil brands and aggressive advertisement campaigns, we expect branded sales ratio of the company to improve to 18-25% in FY23 from 10-15% in FY20, which shall help in improving overall margins.
• Association with Wilmar to provide strategic direction: Taking cue from Wilmar JVs/subsidiaries across the globe, we believe UNITY is also on path to follow the same growth pattern by introducing a complete range of confectionary items. Adani Wilmar in India has a complete set of products ranging from edible oil to flour, rice and pulses amongst other food items. Similarly, Wilmar subsidiaries in Vietnam and China also offer same range of products. We believe this strategic direction will help UNITY to achieve a new milestone in branded market as Pakistan is amongst the top five wheat/rice producing nations in addition to a gateway to consumer market of 220mn people.

Key risks: Key risks to our thesis and valuation are (1) company’s inability to shift towards high margin retail business, (2) lower than expected margins on bulk business, (3) volatility in prices of international palm oil, (4) unfavorable changes in duty structure of finished products/raw materials, (5) high competition from peers, and (6) any changes in tax credit applicability.