Avanti Feeds and The Madness of Crowds

Avanti feeds is a shrimp feed manufacturer that nearly gained cult status among investors between 2016 and 2018 after having scripted one of the greatest success stories of the decade. From being an obscure feeds manufacturer to a dominant player in the Indian shrimp industry Avanti’s rise has been nothing short of phenomenal and our story today tries to piece together the puzzle that propelled the rise of the company’s stock price to near stratospheric highs and its eventual fall from grace. But before we do that, a brief on the company.

Avanti Feeds Limited

Avanti Feeds produces Shrimp food (Shrimp feed) and sells it to farmers cultivating shrimp in India. Once the harvest is complete, the company procures some of this raw shrimp, processes it and exports it to countries outside India. The Shrimp feed vertical contributes to about 83% of the company’s revenue and processed shrimp contributes to the other 17%. (The processing is done under a subsidiary — Avanti Frozen Foods Ltd where Avanti Feeds holds 60% of the company. The rest is owned by the Thai Union Group.)

But the real story isn’t in the numbers or the market share or the business operations, instead, it's deeply intertwined with the meteoric rise of the company. For observers of Avanti, its success had always been a foregone conclusion. The cause and effect sequence that led to the inexplicable change in fortunes was there for everyone to see —  at least that’s what the pundits claim. However, such lofty declarations deserve scepticism, especially considering the stock price was languishing at a mere Rs. 10 (adjusted for splits) back in 2012 when Avanti Feeds was still a fledgeling business. But experts continue to claim that Avanti’s rise was predicated on a sequence of predictable events. So do these stories deserve any merit? Can we study the historical sequence of events to predict the future?

The Narrative Fallacy

The trader-philosopher-statistician Nassim Taleb attributes the construction of such stories to what he calls the narrative fallacy. He points out that there is a deep biological basis to this problem. Humans have an innate desire to connect the dots and put things in order, to make sense of the world around us. To this end, we construct flimsy accounts of the past and create stories that can easily explain outcomes that might otherwise seem like chance events. This feature of storytelling forms the basis of our understanding of the world, even if the stories themselves are flawed and miss key details. The world would make very little sense without attributing a cause and effect chain to our knowledge of the past. However such stories rarely produce any valuable insights because most of what transpires in highly volatile environments are a product of chance events, and Avanti’s good fortune was predicated on just that.

Modest Beginnings

Selling shrimp feed has never been a glamorous business. For as long as the Indian Stock market has been in existence very few shrimp companies have managed to emerge from the confines of Dalal Street to stamp their authority as stellar performers and Avanti Feeds was no exception. It’s also noteworthy that companies that sell shrimp feed rise in tow with shrimp farming i.e. when farmers cultivate more shrimp and Indian farmers have always had trouble competing with the likes of China, Thailand and Vietnam until, in 2009, when the Indian shrimp industry witnessed the most fortuitous sequence of events.

A disease breakout in 2009 named the Early mortality syndrome (EMS) ruined the Black Tiger Shrimp farms all over China, Thailand and Vietnam who also happen to be the largest producers at the time. It was in the same year that the Indian Government allowed for the cultivation of a “new” variety of shrimp called the Vannamei (Pacific White Shrimp). These new shrimps were more disease resistant than their black tiger counterparts and could be cultivated using less feed, significantly easing the burden on the Indian shrimp farmers. This move prompted a nationwide shift in shrimp cultivation as more farmers got in on the act and Avanti Feeds saw a resurgence in its sales. With more shrimps to feed, Avanti was going to be the obvious benefactor but it did not stop at that. In 2012, EMS hit the leading producers once again, this time affecting the Vannamei farms in Thailand and Vietnam creating with it a sudden void in shrimp supply and the timing could not have been more propitious.

Lady Luck favours those who farm White Shrimp

Producers in India who were rapidly expanding production after having switched to the more productive Vannamei shrimps found themselves relatively unaffected by the disease which provided further impetus for Indian farmers to emerge and fill the supply void. The untapped potential in India and the large river systems that could accommodate all of this renewed cultivation provided the perfect launchpad for people to weave a compelling narrative about Avanti and its role in fulfilling India’s burgeoning need for Shrimp feed. The stage was set for Avanti to shine and shine it did.

During this time, growth rates for Avanti had reached record highs. So when the stock price reflected these changing fortunes, very few people doubted the rationality of the masses. The story was compelling enough for everyone in the market, both seasoned veterans and relative newbies to ride the wave, but there was one glaring issue. The narrative was incomplete and riddled with inconsistencies.

Loose ends

Firstly, shrimps are relatively primitive crustaceans with a rather simple immune system and the risk of disease outbreaks was always going to be high. Secondly, Indian farms cultivated shrimps in large volumes in localised regions and although these intense production techniques helped reduce costs they further aggravated the biological risks inherent in the farming business. India was extremely lucky to have survived both disease outbreaks that crippled much of the world’s supply. As it would happen, the Indian shrimp industry would remain relatively unfazed by these developments which prompted several investors to claim that the Avanti growth story was entirely predictable when in fact luck had played a major role in keeping the growth story alive

As Daniel Kahneman points out in his book, Thinking Fast and Slow, the ultimate test of an explanation is whether it would have made the event predictable in advance. No story of Avanti’s unlikely success will meet that test, because no story can include the myriad of events that would have caused a different outcome. The human mind does not deal well with nonevents. Because every critical decision turned out well, the record suggests almost flawless prescience — but bad luck could have disrupted any one of the successful steps, which is exactly what happened in 2018 when the world would witness a decline few could have predicted.

A Dangerous Game

The financial year 2018 would turn out to be a bumper year for Avanti. Shrimp prices had reached record highs, demand for feed was picking up as it had never done before, raw material prices were abnormally low and the financials were looking plush. It was then that news channels were constantly highlighting the new highs Avanti’s stock price was making as each day went by. This was a rather dangerous precedent at a time when people were already paying ridiculously high sums of money to purchase the stock (Trailing P/E levels had already hit 40’s by November 2017 when the 5-year average for the company stood at about 20) and as the stock price continued to climb it prompted further exuberant reactions bordering irrationality.

Irrational Exuberance

In 1996, Alan Greenspan, the Chair of the Federal Reserve Board (The US equivalent of the RBI), used the term irrational exuberance to describe the behaviour of stock market investors. In what was a rather unremarkable speech, these two words were reason enough for market investors across the globe to bail and within moments of him uttering these words, stocks markets world over had tumbled precipitously. The story stuck and was used as a telling example to describe the absurdity of the markets. However, there is much more to irrational exuberance that just Alan Greenspan and market euphoria.

Robert Schiller, the Nobel prize-winning economist calls Irrational exuberance the psychological basis of a speculative bubble. A speculative bubble is a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, and, in the process, amplifies stories that might justify the price increase and brings in a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement. These temporary rises are usually unsustainable because the contagion is premised on weak fundamentals and an abrupt decline in the company’s fortune or a calamitous event could bring down prices rather spectacularly. When the collective conscience of the market finally realised that current prices were unsustainable, Avanti’s price tumbled and there was a new narrative in tow to justify this decline.

What goes up must come down

Market participants were suddenly waking up to the realisation that Avanti’s growth might have been cyclical in nature and not linear/exponential. Cycles are characterized by ebbs and flows. They go up, peak, go down and then bottom. The disease hit industry had presented an opportunity for Indian shrimp farmers to fill the void, largely driven by the introduction of Vannamei. However, the allure of high prices had enticed farmers to ramp up production. But as farmers in Vietnam, Thailand and China began to recover from their predicament, a rebound in production was inevitable creating an environment where supply would eventually outstrip demand. Prices began to fall and many farmers started packing when shrimp farming suddenly turned unviable. Where do you sell your feed when there’s no one for the taking and Avanti’s growth rates started to decline.

Investors must bear in mind that Avanti’s numbers did not go for a toss. In fact, they continue to post respectable numbers. The problem is that most investors either failed to recognise that this market was cyclical or simply ignored the possibility entirely. On 4th June 2018, Avanti’s share price tumbled around 12% over and above the 40% fall since April. The company conducted a conference call post market hours especially to justify the fall in price — “The decline in price is only a temporary reaction and the consumption of shrimps in the US has come back to normalcy and the demand started picking up and would be restored to the normal level soon and even expected to go up, which is expected to trigger increase in prices. The Chinese imports are also expected to go up in months to come, Therefore, there is no need to panic about export demand for shrimps from India and its price.”

However, in subsequent interviews, Indra Kumar, the Managing director of Avanti Feeds did admit that FY 2018 was, in fact, an exceptional year as raw material prices were lower and the margins better than anyone had expected. He even pressed investors to moderate their expectation and use FY2017 as a base year as opposed to FY 2018 to measure future performance. However, the damage had already been done. Investors expected the anomaly to persist, they bid the price up to untenable levels in the hopes of finding everlasting riches and when their lofty expectations weren’t met, they bailed and the stock price tumbled.

We could see it coming

Now since the decline, multiple market gurus have been claiming they could see the Avanti story unfold aeons ago, that they knew the cycle was just about to go awry and it was going to end badly for everyone involved. As Daniel Kahneman notes — What is perverse about the use of "know" in this context is not that some individuals get credit for prescience that they do not deserve. It is that the language implies that the world is more knowable than it is. It helps perpetuate a pernicious illusion. While there have been experts who predicted that the shrimp industry does in fact move in cycles, very few got the timing right. A particular case in point is an industry report from 2013, that predicted the rise of India’s shrimp industry, the cyclical nature of the business and most of what would transpire for the next 5 years, except the timing of the events.

Off with their heads

This has also prompted a new wave of investors to call for the heads of analysts who predicted that the stock price would keep rising even when the evidence stood in stark contrast to their claims. Now we don’t like analysts anymore than you do and these are people who often claim credit for foresight they don’t deserve but in this case, we must put up a spirited defence for the analysts because there is no way they could have known that the cycle would end the way it did. As Kahneman states “When the outcomes are bad, clients often blame their advisors for not seeing the handwriting on the wall — forgetting that it was written in invisible ink that became legible only afterwards.” Actions that seemed prudent in foresight can look irresponsibly negligent in hindsight and we must take cognisance of this bias.

Finally, as the author of this piece, I would like to confess that this entire article has been premised on the benefit of hindsight and readers must harbour no illusions about the predictability of the stock market. We are in a dangerous game of cat and mouse and we must be fully cognizant of the untold perils of investing in the stock market. Where Avanti goes from here is anybody’s guess which is why we end every story with a call to you, fellow reader, asking you — “Where is your bet?”. That line is no gimmick, it isn’t a catchphrase, it is instead a very real enquiry about your subjective feeling on every story we write because you alone can decide where the price is headed, you alone can answer for the risks you are willing to take and you alone can bear responsibilities for your actions. You are the master of your own fate.

Fellow reader, I ask you again, Where is your bet?

. . .

Disclaimer: No content on this website should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. The author accepts no liability for any actual investments based on this article.

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Review & Analysis by Pawan, IIM Ahmedabad

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