Faisal Hussain is the founding CEO and sponsor of The Organic Meat Company Limited, an export-oriented project with an upcoming IPO on the PSX slated for next month. Faisal is a fourth-generation business leader belonging to a family run enterprise that has operated in the livestock processing industry for over 80 years, with industrial units in Karachi, Lahore, and Multan.

Before founding TOMCL, Faisal was associated with the family run sheep casings (Offal processing) export business for over two decades. He holds an MBA from Institute of Business Administration (IBA), and an MBA (Finance) from Cardiff Business School, University of Wales, UK.

He entered the meat processing and export business in 2009 with a vision to introduce innovations into an extremely traditional business category. A year later, TOMCL was incorporated, which has since grown into an annual $20 million exporting company, with a focus on the value-adding meat products.

In this interview, BR Research picks Faisal’s brains on the upcoming IPO, industry fundamentals, risks to thesis, TOMCL’s value proposition, regulatory environment, and global meat market prospects in the aftermath of Covid-19. Below is the edited transcript of the conversation.

BR Research: The global meat market offers a rich premium for organically raised animals. Your company is called ‘The Organic Meat Company’. Curiously, the Prospectus does not lay any emphasis on whether the livestock procured is organically raised.

Faisal Hussain: Most of Pakistan’s livestock husbandry takes place in rural areas, where animals are raised on free-range grazing. The trend of fattening farms has only picked up recently, and so far, has a tiny share in domestic meat universe. TOMCL does not procure cattle from fattening farms; therefore, our products are sourced from ethically raised livestock.

However, the globally recognized ‘farm to fork’ concept dictates that in absence of complete back traceability, meat processors that procure animals raised on free-range grazing cannot technically claim to sell ‘organic’ product(s).

Until last year, Pakistan had no regulatory authority with links to international ‘organic meat’ certification bodies. Only this year, a new authority has been created in Pakistan that has engaged a French body to seek certification of ‘organic’ label for locally sourced meat.

That said, the name represents our commitment to procure ethically raised livestock, and eventual goal is to seek “organic” certification once the regulatory mechanism is in place.

BRR: Does lack of organic certification hinder access to EU and other western markets?

FH: EU has a rigorous screening system for Mad Cow disease. Pakistan is part of ‘Category B’ list, which includes countries that have never faced a Mad Cow outbreak. These countries are required by EU to submit dossiers for a period of seven consecutive years, showing evidence that Pakistan is disease-free. The seven-year requirement reflects the natural lifecycle of cattle, after which it would be safe to conclude that local breeds are free of this inherited deformity. The moratorium was to be lifted in March 2019; however, the process has faced delay due to reassignment of concerned officials in the MNFS&R.

While other countries have had to take drastic actions such as mass culling to eradicate Mad Cow, Pakistan has another advantage: the slaughtering of 3 million cattle that takes place nationally every year at the time of Eid-ul-Adha.

We are confident that once the dossier requirement is met and the organic certification authority also becomes functional, the EU market will be open to Pakistani meat exporters.

BRR: Does the company plan on entering domestic retail to ride out export cyclicality?

FH: TOMCL is a wholly export-oriented company, and domestic sales are limited to the extent of by-products such as red offal and animal skin. The brick and mortar model of domestic retail has very high overhead costs, while it offers very thin margins due to intense competition from informal sector. So far, the management has no plans to enter that segment.

However, we are now exploring e-commerce for domestic sales. We recently launched an online portal, called ‘Meat Master’, that will offer Qurbani services for Eid later this month. However, this is planned to be a one-time event only for Eid this year, taking in to account SOPs for social distancing and public’s hesitation to physically visit mandis.

BRR: The Prospectus lists slaughtering capacity at 60 heads for cattle, and 120 heads for goat/sheep per hour, respectively. What is the utilization level?

FH: Islamic traditions prescribe that blood be drained from the animal after slaughtering, before hooking it on the line for processing. While this may slow down the process, it is an integral part of our values as a Shariah compliant, Halal Meat business.

Nevertheless, estimating operational efficiency from slaughtering capacity utilization is misleading. TOMCL’s value proposition is its Fresh Chilled meat portfolio. It is more important to evaluate the chilling and freezing capacity utilization, which stands at 75 tons per day for chilling, and 250 tons per day for freezing.

Remember, products in the Fresh Chilled category must be transported within 24 hours of processing. Businesses that export via air can thus process smaller orders four days a week, while those with access to shipments via sea can plan large orders around sea-liner schedules. The key is frequency and size of export order bookings.

BRR: Various local competitors such as Al-Shaheer (ASC) and Tata claim to operate in value-adding meat exporting segment including Offal exports. However, the Prospectus claims that TOMCL is the only Pakistani value-added meat exporter. What sets it apart?

FH: ASC and others only process Red Offal, which includes liver, kidney, and similar organ meat that are highly commoditized products. TOMCL’s expertise is in White Offal segment, which include organs such as tripe, honeycomb, intestine, omasum, pizzle, testicles, and other delicacies (HS code: 0206.90). It is a very specialized business that has very high technical barriers to entry. Our expertise has been honed over past eight decades through inter-generational experience. This is something where we edge out our competitors who do not have access to the same skilled labour and entrepreneurial experience as we do.

We believe butchery is an art; not every butcher can dress the flesh such that every organ of the slaughtered ruminant is in its optimal usable form. All over the world, the best butchers come from families that have been in the profession for generations. These are artisans-in-training for life, which are not only skilled in handling/processing of delicate organs, but also have the endurance to withstand the stink. Others often find it odious and dispose of White Offal as a by-product.

The sponsor-led management has been in White Offal processing and export for four generations. This gives us an unparalleled advantage over the rest – the institutional memory of a family-run business. For instance, having an appreciation for the subtle differences between the various grades of intestine; identifying the right breed for Offal sourcing based on customer-specific preferences; or knowing where to find the right buyer for Offal of various types, grades, and quality.

BRR: Within existing export destinations, which competing countries pose greatest threat to Pakistan-based meat suppliers?

FH: As far as exports to Middle East is concerned, Pakistani suppliers are a threat to themselves. For more than three decades, Pakistani exporters have supplied Fresh Chilled meat to the region by air. Although the market size is growing, it is not growing exponentially. New entrants from Pakistan have traditionally competed on pricing, instead of product innovation.

When it comes to value-addition, de-boning, grading and classification, or preparing prime cuts such as tenderloin, striploin, eye-round, and T-bone etc makes it easier for the distributor to cater to bespoke preferences of his customers in the restaurant, food processing, or household industry. If the distributor can charge a premium, so can the exporter.

TOMCL is among the first Pakistani exporters trying to carve out a space for itself in a competitive value-added segment. However, other Pakistan-based exporters have struggled to break into this market due to intense competition, even though Pakistan’s beef breed is qualitatively far superior. But pricing often plays a far more crucial role. Brazil, for example, produces world’s cheapest beef, which has allowed it to become a global leader.

BRR: Conventional exporting sectors such as textile claims that substantial and sudden devaluation of currency often impacts pricing power adversely, as buyers demand contract renegotiation due to change in price competitiveness. Is that true for meat exports as well?

FH: Unlike Pakistan’s textile, the domestic meat processing sector has a very insignificant global footprint. Pakistan is 27th on the list of world’s top beef exporting countries, despite featuring among top 5 in terms of livestock population. Top 10 exporters dominate 82 percent of global trade. Thus, our ability to influence pricing setting is very low. As a rule of thumb, if we are price competitive with export leaders such as Brazil, the domestic industry will have sufficient orders to operate on full utilization. For the rest of the world, we are so small that devaluation makes little difference to our overall competitiveness.

The challenge posed by devaluation within meat industry is of a different nature. Historically, meat exporters from Pakistan have been content with exporting their produce to countries in familiar markets such as the Middle East. Even in these markets, Pakistani exporters undercut each other, by lowering prices to capture each other’s business, instead of taking full advantage of currency devaluation.

BRR: Most local players use air cargo to transport Fresh Chilled products, which is advantageous considering the short shelf life of the category. However, the prospectus claims that TOMCL is the only company with the permission to export meat to KSA via sea. Why is a slower mode of transport for a highly perishable category an advantage?

FH: For the product to maintain its composition, it must be stored at a temperature below 4C. Airports in Pakistan KSA, and UAE cannot guarantee the recommended temperature during the onloading and offloading process. This means the product experiences heat shocks upon exposure to atmosphere, allowing for bacterial growth that changes the appearance, smell, and overall composition of the meat.

It is true that transit time by sea takes much longer: it takes 72 hours to cargo meat to UAE by sea as opposed to 2 hours by air. However, transport by sea ensures that there is no change in the quality of the product since it remains refrigerated from the time that it exits our factory up until it reaches the customer. As a result of our investment in cold chain, the regulatory bodies in KSA have permitted TOMCL’s request to raise rated shelf life of Fresh Chilled products from 14 to 21 days. This has conferred a significant price advantage, as export via sea costs only one third of air freight cost.

BRR: What is the status of export plans to China?

FH: The first 6 items in the revised FTA with China are all meat related. Over the past two years, TOMCL prepared research reports showing that Pakistan’s meat shipments to Vietnam are predominantly re-exported to Chinese market. Our efforts finally bore fruit last year with the kind assistance of President FPCCI, Zubair Tufail.

China is the world’s largest meat importer. After the elimination of regulatory duties, Pakistani exports are naturally cheaper than rest of the world which faces RD of 20 percent. Government to government protocols, such as mechanism for disease-free certifications, still need to be established. This may take another year. We expect that TOMCL will be among the first few companies to be granted license to export meat products into China.

BRR: Industry insiders claim that other players enjoy much more competitive pricing on shipments by air. Is that a fair representation?

FH: Some of our competitors enjoyed first movers’ advantage in the Fresh Chilled category, to the extent of shipment contracts with airliners are concerned.

On average, Emirates flies up to four Boeing 777 every day to Dubai, which has cargo space of 22 tons. Early entrants were able to secure the 10tons empty space in cargo from airlines by negotiating long term contracts. Because air cargo space is available in finite volume, entry of new players into Fresh Chilled drove its price upwards.

As a result, TOMCL decided that it will not get into an unnecessary price war to outbid its competitors, which will result in thinning of margins across the industry. Instead, we decided to invest in and cultivate exports via sea, which are now finally bearing fruits, especially during lockdown when other modes of transport have either been shut down or have become prohibitively expensive.

BRR: The Prospectus does not share any projections or earnings guidance, which usually play a crucial role in investor decision making, especially for institutional investors. Are there any plans to share forecasts before IPO?

FH: The Consultant to the Issue are bound by the prescribed Prospectus format in line with the Public Offering Regulations, 2017 and cannot deviate from those. The Prospectus is in line with the applicable relevant regulations and has been cleared by SECP and PSX. As per legal advice, earnings forecasts are no longer part of the prescribed Prospectus format.

BRR: Between FY17 and FY18, fixed assets grew by 2.30 times. Does this represent any major project expansion; or accounting for revaluation of fixed assets, which also increased by a similar amount during the same period (est. Rs700mn)?

FH: During FY18, the company undertook expansion for vacuum packaging facility. Moreover, the company took revaluation of fixed assets for the first time since its inception to incorporate the factual position of its asset base. This was done based on auditor recommendation. Accounting standards permit PLCs to take fixed asset revaluation every three years. The treatment is not unique to TOMCL; it is an established industry practice.

It must be highlighted that the external auditor, Grant Thornton - an SBP Category A firm – has issued unqualified opinion for company’s financials for the past 4 years since its appointment.

BRR: Does the company hold any inventory of biological assets?

FH: Currently, the company does not hold livestock inventory for more than seven days, as animal husbandry is a major expenditure.

BRR: The business appears to have a high degree of reliance on ST debt instead of market credit. Can you explain supply side dynamics?

FH: The meat processing industry mainly procures livestock from suppliers in the unorganized sector. No market credit is offered by livestock suppliers; in fact, payment terms often include partial advance payment, while remainder is settled on delivery.

Other than the Fresh Chilled segment, all other exports such as Offal, Frozen meat, and Vacuum Packaged products are classified as value-added activities. As the company has shown value added export performance of Rs 1.2billion in the past 12 months, it has become eligible to convert ST borrowing into export refinance. The process has been delayed until now because commercial banks’ refinance lending limits are maxed out.

BRR: Does outstanding debt mainly consist of overdraft facilities?

FH: As on June 30th, the company only has ST debt outstanding on its books. Most of these consist of trade finance loans/Murabaha facilities, taken from Islamic banks as post shipment loans. It must be highlighted that the company is Shariah compliant, both in terms of operations and capital structure.

BRR: Why has the company not availed bill discounting facility against its exports and used those proceeds to finance working capital cycle?

FH: Fresh Chilled exports by air are made on open-credit basis. A regular invoice cycle usually involves receipt of 30 percent advance payment. This is followed by procurement of livestock, immediate processing, and shipment. Once the shipment reaches destination, the company receives remainder payment against the invoice, upon which it issues release order for Bill of Lading. These are generalized terms, however, and may vary depending upon product category.

Given the current way of doing business in the industry, issuing an LC or bank contract especially for by air shipments will only drive buyers away by inflating costs. However, now that shipments via sea are open, the status quo has already been shaken up.

BRR: The company has a healthy solvency position; debt to equity (even net of revaluation) is at just 0.60 times, with NIL long-term borrowing. Why has it not sought LT financing for expansion plans, instead of taking the issue public?

FH: Based on its healthy financials, the company can choose to leverage if it so wishes – even after accounting for requirements of Shariah compliance. However, businesses do not draw expansion plans based on monetary policy cycle.

The company should not take on more debt just because it is cheaper to do so right now. The IPO has been in the works for the last one year. TOMCL will finance the planned expansion through IPO proceeds as per the original plan.

If a need is felt to raise debt for another round of expansion later, the decision can be taken at that time. Especially since TOMCL’s financial position post-IPO will improve tremendously, allowing room to leverage if need be.

BRR: As per the Prospectus, two-thirds of IPO proceeds will be utilized towards working capital. Will that lead to restructuring of balance sheet or sales expansion?

FH: This is in fact a positive for prospective equity investors, as utilization of funds towards working capital will help increase turnover efficiency, grow sales, and augment earnings growth. Had the funds been earmarked primarily for fixed asset expansion, the payback period would be longer.

BRR: Does that mean TOMCL will not use IPO proceeds to repay any debt component?

FH: The company is legally required to utilize IPO proceeds strictly in compliance with the purpose stated in the Prospectus. Thus, the funds raised will be utilized only to set up Offal processing facilities at Korangi and EPZ, while the remainder utilization would be towards working capital and enhancement of the company’s existing product offering.

In case the company receives additional funds, these would be utilized towards repaying debts with financial institutions. However, any loan repayment will be restricted to financial institutions only, and not of the sponsor loans that will remain invested in the business for the foreseeable future.

BRR: The company also plans on setting up a plant in EPZ Karachi for re-exports of Offal using IPO proceeds. Is the plan premature in absence of firm agreements for imported Offal procurement?

FH: Our family has been into offal exports since 1932 and has received 16 consecutive export performance awards from the FPCCI, hence our credentials and ambitions on the offal trade are based on experience and existing business network. Furthermore, the family business is already importing sheep offal through abattoirs in Europe for past 16 years.

The European counterparts are some of the largest abattoirs in the European markets and deal in halal meat of various kinds; therefore, acquiring beef offal from the same suppliers will not pose a challenge. However, we have not entered a formal contract because having a processing facility is a pre-requisite. The planned lead time on this project is 18 months.

More importantly, the raw material is currently being utilized for pet food industry in EU and sells for pennies. As a commercial decision, if we can offer slightly better pricing - since we are adding value to the product and re-selling it at a higher price - the supply from European side will be easily diverted to us.

BRR: The Prospectus discloses that the company only has a single long-term buyer with only marginal share in total sales. Do buyers in target markets offer longer term contracts to your competitors, whether from within Pakistan or from other countries such as Brazil and India?

FH: The company has made a strategic decision to have minimal sales concentration by diversifying its customer base. This not only ensures that our product is exported to many destinations but also serves as a risk management tool, whereby no one customer is extended unmanageable levels of credit.

Majority of sales in the Fresh & Chilled category are made on open-credit basis, therefore the need to adopt prudential credit risk management strategy is very high. In contrast, most of the competitors carry severe single-destination, single-client risk.

BRR: The Prospectus claims that via sea exports have helped improve sales since the onset of Covid-19. But if the global economy faces an extended downturn along with job losses in primary markets such as Middle East, how is it expected to impact meat consumption in the region?

FH: The still unfolding pandemic has no timeline to it. Nevertheless, meat is a staple food for many countries; and although demand must face some income elasticity, as a staple it cannot suffer too much. Products exported via sea are primarily for household consumption, a segment which has grown during the current crisis. Once flights were suspended, meat processors from northern parts of Pakistan were unable to export allowing TOMCL to gain new customers.

The new clientele shall continue to remain with us even once air transport resumes because the buyers are getting better quality meat at a cheaper price. The returns from our new customer base will start reflecting in our financial performance for FY20. We are hopeful that the growth trajectory will continues as the world recovers from the impact of COVID-19.

BRR: It has been observed in the past that commodity exporters set up intermediary firms abroad, selling bulk of their output to these sister concerns. In the process, minority shareholders lose out on profit margins. Does the company sell or plans to make sales to related parties in future?

FH: The only related party sales are to a family business concern which was set up at the Export Processing Zone, Port Qasim called MSMH (Pvt) Limited. Other than that, neither TOMCL nor the sponsors or any related persons make any transactions to any intermediary firm. It must be pointed out that the sponsors of the company do not hold any directorial/management positions, or commercial interest in any private limited firm other than TOMCL.

BRR: How many independent directors does the company plans on installing on the BoD post IPO? What is the progress on adoption of Code of Corporate Governance to ensure greater transparency?

FH: Excluding myself and Ali Hussain (sponsors), and Rizwan Punjwani, all directors are independent with only qualifying shares in the company. The composition of the Board will remain the same, since we are already fully compliant with the Code of Corporate Governance and all our directors have undertaken a director’s course conducted by the ICMAP. Even though the regulations allow us time to become compliant to this requirement, we decided that we must be fully compliant before the IPO.

BRR: Has the company sought or been supported by any private investors during its growth phase?

FH: This is disclosed in the prospectus document. Rizwan Punjwani, a private equity investor, acquired around one percent shares of the company at a price of Rs18 per share. This is the same price as the floor price for our offering.