cover story analysIs

Cold chain: Finally warming up to India?

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Indias agricultural infrastructure, and in particular its fledgling cold chain industry, may have caught investor attention, particularly after news of farm produce rotting because of lack of suitable storage infrastructure. Yet the governments theoretical emphasison cold storage infrastructure is not new at all, say Aneesh Matapurkar and Arnav Sinha, in their analysis of this in-the-limelight segment.
the chain in relation to fruits and vegetables, but the network does not differ significantly even in relation to other products like milk, poultry, meat and medicines. The Cold ChaIn proCess There are two main elements of the cold chain logistics system: (a) Surface storage: Refrigerated warehouses for storage of the perishable product in consideration (b) Refrigerated transportation: Reefer trucks, containers, ships, trains for transport of perishable products A cold chain logistics player could be solely a cold storage owner or owner of a fleet of reefer trucks or, as is becoming increasingly common, an integrated 3PL firm that owns the entire network right from procurement to the final destination of the product.This is what a typical cold chain network would broadly be like. i) The first stage is, of course, the production zonethe field where the fruits and vegetables are grown and then procured by the retailer or a third party agency. ii) The food products are frequently brought to a pre-cooling centre, which is located not too far from the production zone. Pre-cooling, carried out within a short period after procurement, prepares the fruit or vegetable for transportation over long distances. iii) Refrigerated or reefer trucks are used to transport these food products at controlled temperatures from the pre-cooling centre to the cold storages. The size of these trucks could vary from one tonne to more than 15 tonne. iv) Cold storages are generally centrally located warehouses built to cater to multiple production zones and pre-cooling centres. Imagine the typical huband-spoke model in logistics. Here, depending on factors like how long the product needs to be stored and what use it is going to be put to, the product is stored at a sub-zero temperature using methods like chilled storage, deep freezer storage, controlled atmosphere storage, gas controlled cold storage, etc. All these essentially slow down the ripening process of the food product and enhance its shelf life. v) From here, the food product can be taken to a processing plant, where it can be converted into jams, jellies, pickles or juices. Many processing plants use fruits and vegetables directly from the production zone or pre-cooling centre too. vi) The other likely destination for the food product would be to a wholesaler or retailer. This transportation is again done in reefer trucks. At the retail store, these food products would again be stored at low temperatures in large refrigeration units, to delay the advent of decay. vii) Another end-use could be export of the food product, which would be
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ith cold storage chains being given infrastructure status in Budget 2011-12 recently, the cold chain sector is in focus once again. This has become an annual ritual now, with additional budget sops reminding us every year how important the entire cold chain sector is, and why it needs to be nurtured if we aim to feed our millions in the coming years without having to resort to large scale import of food products. Whether this focus has translated into actual growth on the ground is a different story altogether, and one worth examining. In this article, we will analyse key aspects of the cold chain industry, in its infancy, but by no means nascent in its energy, the effect it has on many other important sectors, and how its development is expected to pan out in the next few years. A cold chain is a temperature-controlled supply chain network, with storage and distribution activities carried out in a manner such that the temperature of a product is maintained in a specified range, needed to keep it fresh and edible for a much longer period than in normal ambient conditions. This system facilitates longdistance transport of various products as well as makes seasonal products available over the entire year. Before we get down to identifying the drivers and challenges for the cold chain industry in India, there might be some merit in understanding what a typical cold chain network looks like. We will discuss
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ComponenTs oF Cold ChaIn loGIsTICs

massive investments in cold storage for a long time, until organised retail started picking up recently. India has a total of roughly 5,300 cold storages with a capacity of 23 million metric tonne, over 90 per cent of which are suitable to store potato products only and are fairly archaic. The cold chain capacity situation is even worse at just over 60,000 metric tonne only. GovernmenT InCenTIves The Government of India has been cognisant of the need to nurture the cold chain industry and has introduced several incentives over the years to achieve that aim. Some of these incentives are: i) Budget 2011-2012 provided infrastructure status to the cold chain sector. This opens up the sector for perks like viability gap funding. The Budget also exempted air-conditioning equipment and refrigeration panels used in cold chain infrastructure, including conveyor belts, from excise duty. It also extended excise duty exemption to conveyor belts and equipment used in cold storages, mandis and warehouses. ii) Budget 2010-2011 proposed a concessional import duty of five per cent with full exemption from service tax to set up and expand cold chains to preserve farm produce as well as milk, meat and poultry products. The proposal also included duty-free import of refrigeration unit, which is required to make refrigerated vans or trucks. It also exempted trailers and semi-trailers used in agriculture from excise duty. iii) As part of Budget 2009-2010, Government of India introduced tax benefits for companies making investments in setting up cold chain facilities. iv) Other past incentives include access to external commercial borrowings, 100 per cent FDI and provision of up to 25 per cent project costs involved in setting up cold storage facilities provided by the Government under the Capital Investment Subsidy Scheme. v) The Government of India has also revised its Scheme of Food Parks under the 10th Five Year Plan into the Mega Food Park Scheme (MFPS) under the 11th Five Year Plan, which envisages a
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typically done in refrigerated containers in ships. Once the ship reaches its destination, the process would be similar to (vi) above. CurrenT sTaTe oF The IndIan Cold ChaIn seCTor The key industries served by the cold chain industry are fruits and vegetables, ice cream, processed meat and poultry, marine products, preventive medicine (mainly vaccines) and chemicals. A strong cold chain industry ensures improved availability of food products as well as prevents spoilage of medicines, and therefore has a critical role to play in a country like India. The following statistics help in understanding the current state of the cold chain sector in the country, and also make amply clear the fairly long way we need to cover in its development: Close to two-third of Indias population is dependent on agriculture for its livelihood. The Indian food market is estimated at over $182 billion, and accounts for about 20 per cent of the total Indian retail market. According to a 2005 report by the US Department of Agriculture, the Indian food market is set to almost double by
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2025, to reach $344 billion at a CAGR of over four per cent. India is the 2nd largest producer of fruits and vegetables in the world, with annual vegetable produce of around 85 million tonne (9.1 per cent of global produce) and annual fruit produce of around 45 million tonne (8.4 per cent of global produce). Despite the high production, our contribution to the world market is under one per cent, in particularly sharp contrast to China, which accounts for over 20 per cent of the exports to the world market. Out of the roughly 130 million tonnes of fruit and vegetable produce, nearly 40 per cent gets wastedenough to feed countries like Brazil and Vietnam. India is the largest producer of milk in the world, producing close to 100 million tonne, and accounting for nearly 17 per cent of the global production. About 35 per cent of this produced milk is processed. More than 10 per cent of the annual milk production is lost because of inadequate storage facilities. Indias cold storage infrastructure was built in the 1960s, mainly for potatoes and potato seeds, and there were no

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growth in Indias share in global food trade from 1.5 per cent to three per cent by the year 2015. This would be achieved through promotion of both processing and cold storage facilities in India. These initiatives from the Government have been very encouraging for the industry as a whole and have complemented the efforts of the private sector in strengthening Indias cold chain infrastructure. The results have not been dramatic, and so have not been very noticeable. But we feel that in the medium term these measures will certainly help small logistics players grow to a level where they can provide integrated pan-India services to their clients, which include retail giants, pharmaceutical majors and major F&B players. GrowTh drIvers The key drivers for growth of the cold chain sector in India are: Growth in organised retail: With the growing demand for fruits and vegetables all year long, acceptance of frozen food products and increase in income levels that makes people accept a premium for fresh food products, organised retail is the strongest driver for the development of cold chain in India. Large players like Bharti-Walmart and Aditya Birla are investing heavily in devpromInenT deals In The seCTor

eloping a strong back-up infrastructure that ensures preservation of produce over long periods of time. Growth in processed food sector: There has been a marked improvement in consumer preferences for processed foods, and the Government has reciprocated by announcing intent to establish several Mega Food Parks. This augurs well for the development of the cold chain sector in the country. Government initiatives: The various measures taken by the Government, as discussed earlier in this article, are expected to go a long way in incentivising investment into the development of cold chain infrastructure. Shift towards horticultural crops: Due to increasing risks and investments in grain crops, farmers are moving towards cultivation of horticultural crops. These crops need refrigerated storage, and hence are expected to encourage the development of cold storages. Demand from the pharmaceutical sector: The Indian vaccine market is somewhere in the range of Rs 1,000 crore, and is growing at 25-30 per cent year-onyear (y-o-y). These vaccines require temperature control right from the manufacturing point to the consumption point, which makes cold-chain management imperative.

Date

Target

Investor/Buyer

Stake

Feb 2011 Milk Mantra Dairy

Dec 2010 Dec 2010 Mar 2010 Aug 2009 Jul 2009 Aug 2007 Nov 2006

Aavishkaar Venture Management Swastik Roadlines India Equity Partners RR Enterprises Kuehne+Nagel Global Agrisystems Nine Rivers Capital Snowman Frozen IFC Foods Future Supply Fung Capital Chain Solutions Kausar India Gati Snowman Frozen Gateway Foods Distriparks

Deal size (Rs mn) NA 225

Deal type PE

NA 100 per cent NA NA 26 per cent 53 per cent 51 per cent

450 100 315 250 1,350 NA NA

PE M&A PE PE PE M&A M&A

IndusTry ChallenGes On the other hand, the key challenges to the growth of the sector are: High energy costs: Operating costs for the cold storage business in India are approximately Rs 80-90 per cu ft per year as compared to Rs 40 per cu ft per year in the West. Energy expenses alone make up about 30 per cent of the total expenses for the cold storage industry in India, compared to 10 per cent in the West. These factors make the business of setting up of cold storages one of high entry barrier. Additionally, Indias peak power deficit hovers around 17-18 per cent, which makes things even more difficult for an energyintensive sector like cold-chain. Investment in back-up systems, on the other hand, increases capital investment costs, making it even more unviable for a small player. Rising real estate costs: An even bigger struggle for new entrants in the present day context is the increasing real estate price. Typically, a fully integrated, international class cold storage facility with one million cu ft of storage space will require an area of an acre to build, which could cost anything between Rs 1 crore and 1.5 crore, constituting 10-12 per cent of the project cost. Cooling units are not mobile units, and so location becomes a key factor, and with Indias small land holdings, getting a sufficiently large tract of land to build a cold storage unit becomes a major additional constraint. Lack of logistical support: The cold chain industry in India currently is very fragmented, with players not having the cash strength to invest in the technology needed to build high quality cold storage infrastructure or even be able to cover the entire value chain from procurement at farflung farms through transportation in reefer trucks to delivery at retail centres in cities. Currently, fresh produce is left near the fields till a truck-load is accumulated for drop at the local market. To add to the problem, pre-cooling in most parts of India is unheard of, and the transportation is done in open body trucks. Uneven Distribution of capacity: A majority of investment into setting up cold storages in India has been in states like Uttar Pradesh, Uttaranchal, Maharashtra, Gujarat, Punjab and West Bengal. This
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expeCTed near-Term GrowTh In The Cold ChaIn seCTor

Source: Business Today, IndiaInfraGuru.com, o3 Capital Research

needs to be more geographically diverse, and reflective of the production levels of fruits and vegetables in various parts of the country. Secondly, the cold storages that have been traditionally set up can cater to single commodities only. Different commodities require different ambient conditions for storage and the current technology in use at most Indian cold storages prevents that, resulting in poor capacity utilisation and low financial viability because of the expected seasonality of food products. FDI restrictions in retail: That large investments are needed to develop cold chain infrastructure in India, and to a significant extent from the private sector, is a theory with wide backing. There are not too many third party logistics players who have the balance sheet strength to make such investments. The other source of investments are large business groups that have a presence in the retail sector and need to set up a cold chain back-up to support their retail front that involves delivery of fresh farm products to all parts of the country. Even though business groups like the Birlas, the Future Group, the Reliance Group and the Bhartis have been investing in cold chain, easing restrictions on FDI in retail could open up the channels for further fund infusion from new foreign entrants into the retail business. Food chains, especially McDonalds, have also played an important role in development of cold chain infrastructure in the country. McDonalds has spent
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substantial resources in ensuring that the quality of potatoes used at its restaurants in India matches its international standards, and has invested not only at the farm level, but also in the transportation from the farm to its outlets. prIvaTe InvesTor InTeresT Cold chain has been one of the prime areas of interest for private equity funds for the last few years now. Despite this sustained interest, we have not seen too many deal announcements in the sector because there are only a handful of players with any reasonable degree of scale. Unless a cold chain player reaches a threshold annual turnover of Rs 40-50 crore, the valuation and promoter stake dilution dynamics do not work out to merit a private equity investment. An interesting example here would be that of Tuscan Ventures, a leading logisticsfocused private equity fund, which had been looking to participate in the cold chain story, but evidently did not see a sizeable investment opportunity in the sector. They went on to incubate their own in-house third party cold chain business instead, investing in both surface and transport infrastructure. Most of the other major players are part of larger logistics outfits like Gateway Distriparks, TCI, Container Corporation of India and Gati, and have been steadily growing in scale. way Forward Despite the under-developed conditions

prevailing currently, we remain optimistic about the industry. With the average capacity utilisation in the industry ranging between a dismal 30 per cent, to a profitable 75 per cent, the unit revenue potential of a cold storage facility is governed largely by its investment in technology and overall service standards. Of course, it ends up being a chicken-and-egg situation with a small logistics player not having the ability to invest in technology, and unless he invests in technology his margins remain abysmal. In a situation like this, sops from the Government do go a long way in creating the right atmosphere for investment and growth. But government incentives, including the ones in the recent budget, will not exactly open the floodgates for investment into the sector. There is still some time before the trickle develops into a steady stream of cash inflow, but we are getting there. We also foresee greater degree of public private partnerships in the sector as well as greater involvement of railways and airports in strengthening the cold chain infrastructure. Additional measures that the government should take to help the sector are: i) Aid in acquisition of land to set up facilities for cold storage, food processing, etc. ii) Examine reducing FDI restrictions in retail iii) Speed up the introduction of GST, which will generally help the development of large centrally-located warehouses The key factor that will decide how the cold chain sector grows over the next few years would be how strong, and how sustainable, the investment flow into the sector is. Increasing investments from large business houses to create a backup for their interests in the retail sector, as well as increasing willingness on the part of consumers to pay a premium for higher quality of food products, and thus helping in equitable distribution of the cost of a strong cold chain infrastructure, will drive the growth of the industry. IT
Matapurkar (left) is a Director and Sinha is an Associate at o3 Capital Global Advisory.
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