Parag Milk Foods: PCG Research
Parag Milk Foods: PCG Research
Parag Milk Foods: PCG Research
PCG RESEARCH
Parag Milk Foods
Industry CMP Recommendation Buying Range Target Time Horizon
BUY at CMP and add on
Packaged Foods Rs. 263 Rs. 263 233 Rs. 308 370 3-4 Quarters
Declines
Kushal Rughani
kushal.rughani@hdfcsec.com
Opportunity size in Dairy is huge and in turn offers strong growth visibility for branded players. Parag Milk,
with its strengths on procurement, distribution, innovation and management bandwidth is best placed among
its peers. While most of the listed Dairy players are either regional in nature or have dominant B2B
positioning, Parag offers a pan-national branded dairy play with large B2C focus. This, coupled with
expanding product portfolio augurs well from overall growth perspective. The stock trades at 22x/16x of our
FY18E/FY19E earnings while it is available at FY18/FY19 EV/EBITDA of 11.4x/8.7x. The stock is slightly
expensive to some peers but the higher valuation is justified by lower share of institutional sales, stronger
brands, distribution reach, and strong execution history. Moreover, given the focus on innovation an
increasing distribution network, PMF is set to post revenue CAGR of 14.3%, led by 17% CAGR for value-
added products during FY16-19E. Additionally, recent IPO proceeds would not only reduce leverage but also
help meet capex requirement, thereby accelerating profitability and improvement in return ratios. We
forecast 130bps margin expansion over the same period led by operating leverage and change in products
mix. We expect company to post robust PAT cagr of 41% led by improvement in operational performance
and lower interest out go over FY16-19E; we forecast Rs16.3 EPS for FY19. PMF trades at 16x FY19E P/E,
valuations do not adequately factor in the strong long term growth prospects (EPS CAGR 41% over FY16-
19E). We recommend BUY on Parag Milk Foods (PMF) at CMP and add on dips to Rs 233 with sequential price
targets of Rs 308 and Rs 370 (based on ~23x FY19E earnings) over the next 3-4 quarters.
Investment Rationale
Parag Milk (PMF) is a branded play on the attractive dairy industry in India. The companys large B2C mix,
well segmented brands, expanding value-added product portfolio and increasing distribution presence should
ensure 14% revenue CAGR in FY16-19E in the value-added products segment. Investments in procurement,
manufacturing, supply chain, people and branding are being front ended. This, we believe, will lay the
foundation for strong long-term profitable growth. Further, improving cash flows and the recent funding
through an IPO will ensure lower interest costs, thereby accelerating profit growth.
The India dairy industry has been represented in the listed space through a host of business models. Some
are focused on the institutional business with a low share of branded sales, while some market liquid milk
with a low share of value-added products. Further, some are plain marketers of value added products with no
back-end in place. We believe that the best model is one with strong procurement/manufacturing base at the
back-end and consumer-centric brand focused business at the front-end. Such a model brings with it the dual
advantage of cost efficiency and pricing power. PMF, with its procurement/manufacturing capabilities and
major skew to the B2C space, is the closest in the listed space to an ideal business mix.
IPO Highlights
In May-2016, Parag Milk came out with an IPO of total 3.4 cr equity shares at Rs 215 per share which was
oversubscribed ~2x. From the IPO, PMF raised Rs 300cr through fresh equity and Rs 470cr of offer for sale
(OFS) gave partial exit to (1) two PE investors Motilal Oswal and IDFC, and (2) the promoter family. The IPO
proceeds would be used to augment its milk processing capacity at both the plants and increase production
capacity of valueadded products such as cheese, paneer, flavoured milk and whey Product. Moreover, PMF
will also set up an R&D facility and some of the funds for marketing activities. Company utilized Rs 100cr to
pay down working capital loans. Stock currently quotes at 20% premium to its IPO Price and 26% below its
all-time high price touched in July-2016. Post IPO, promoters holding came down from 62% to 48%.
Parag is one of the largest manufacturers of cheese in the country with a share of over 32% in the cheese
market (largely institutional hotels, restaurants and caterers (HoReCa). Cheese accounted for 18% of its
top-line and has grown at CAGR of 22% in FY14-16. Parags cheese plant at Manchar (Pune) currently has a
capacity of 40mt/day, which will be increased to 60mt/day in the current fiscal year funded by proceeds from
the IPO. The plant is capable to producing cheese in 75 stock-keeping units under a wide range, including
cheddar, mozzarella, processed and gourmet cheese. The cheese facility runs at 80-85% capacity. Expansion
in cheese is in line with its strategy of focusing on value added and higher margin products. While Parag has
a strong presence in the institutional segment (HoReCa) wherein it supplies to McCain Foods, Jubilant
Foodworks, Sams Pizza, Mother Dairy, etc, the network expansion and increase in advertisement and
promotional expense should improve retail share of cheese products as well. The cheese market is
completely organized due to the product being highly capital intensive, and is currently an Rs2200cr market
in India, growing at a CAGR of ~20%. The cheese market in India is expected to grow at a similar pace for
the next three years also driven by increase of cheese usage in traditional food dishes, penetration &
premiumisation of the category and growth in the consumption of western dishes where cheese is among the
main ingredients. We expect Parags cheese revenue to grow at 17% CAGR over FY16-FY19 to Rs 440cr.
Ghee (clarified butter) is the largest consumed dairy product in India after liquid milk and curd. It is a key
ingredient in Indian recipes. As of 2016, the ghee market stood at Rs 81,100cr, growing at CAGR of 14%,
and is currently large pie is occupied by unorganized players. Amul is the largest player in the organized
ghee market. Retail accounts for 55% of the total organized market. Parag is the largest cow ghee brand in
India and is also known as the category creator. The market for ghee is expected to grow at CAGR of 14% to
Rs 1,37,500 cr by 2020. ~22% of the Ghee market is covered by organized players. We expect Parags ghee
revenue to grow at 12% CAGR over FY16-FY19E to Rs 500cr.
Whey is a by-product of cheese which needs to be processed and refined further to be sold as a branded
product. Currently Parag sells whey only to institutional customers, (leading supplier to Nestle and UTH
Beverage Factory) but is now setting up a processing and refining facility which will cater to retail consumers.
Whey as a category is not developed in India vs. developed markets; it is currently ~Rs 350cr category and
is expected to scale up to Rs 1200cr 2020. Whey protein contributed only 3.5% of Parags total business in
FY16; however, it entails superior margins. We expect Parags whey protein revenue to grow at 58% cagr
over FY16-FY19E to Rs 230cr.
Dairy Farming - In 2005, Parag set up Bhagyalaxmi Dairy Farms at Manchar (Pune) to educate farmers about
best practices of breeding, feeding, animal management and improving productivity. The farm houses >
2,000 Holstein breed cows, as well as a fully automated rotary milking parlor to milk cows without human
intervention and ensure that milk is not exposed to any impurities in the environment. The cows at the farm
have an average milk yield of 25-30 litres/day compared to the Indian average of 6-7 liters. The premium
fresh milk produced by the farm is sold to around 20,000 customers in Mumbai and Pune under the Pride of
Cows brand.
Parag currently meets a significant portion of its milk requirement (~85%) directly from farmers in 29
districts across Maharashtra, Andhra Pradesh, Karnataka and Tamil Nadu. The company procures ~1mn liters
of milk per day currently through 4,300 village level collection centers reaching 2.5 lakh+ farmers across its
catchment areas. It currently has 114 chilling centers and bulk coolers across both its Manchar and
Palamaner processing plants and plans to add 75 new bulk milk coolers and 100 automated milk collection
systems, which will be installed at under-penetrated villages and will thus expand the milk procurement
base.
Youth and
travellers as a
Flavoured milk in various
source of instant
Flavours
nourishment
Farm-to-home concept
targeted at household
Premium Cow Milk consumers seeking
premium quality cows
milk
Q2 FY17 Update
Parag Milk Foods net sales were up 0.7% to Rs 470cr. Revenue growth was muted as Skimmed Milk Powder
(SMP) sales declined by 31% to Rs 440mn. Excluding SMP business, net sales increased by 6% as Fresh milk
sales increased by 13% to Rs 97cr aided by 6-7% price hike while Milk product sales were up by 5% to Rs
326cr largely impacted by weakness in rural markets (25-30% of sales). While cheese business continues to
grow ahead of market growth of 16-18%, Ghee sales were impacted due to price hike and subdued demand
in rural markets. In terms of regions, demand was impacted by drought in Maharashtra and Tamil Nadu while
heavy rains impacted the sales in North eastern markets.
Gross margins were up by 370bps (60bps QoQ) at 30.5% aided by continued decline in low margin SMP sales
and increase in share of value added products. Moreover, company had taken price hike of 8% in Cow ghee
in the middle of the quarter, ahead of market, in order to offset the impact of increase in raw milk prices.
Employee cost increased by 10%. Other expenses increased by 31% largely on account of a) increased A&P
expense behind core brands by 100bps and b) higher milk handling cost due to lower buying of semi-finished
goods. The management has stated that A&P spends were higher in the quarter due to pre festive branding
exercise; however, overall FY17 spends will not be at the same run rate as Q2. Resultant EBITDA was down
by 9.0% with margin decline of 80bps to 8.0%.
Overall impact on procurement for the organised dairy sector was minimal as payments are largely executed
through banking channel. PMF makes digital payment to the chilling centres; majority of its farmer network
gets payment from village collection centres, which are also completely through banking channel.
The distributor channel was impacted for initial 8-10 days due to delayed payment from retailers. While the
retail off take in urban areas (~80% of B2C sales for PMF) is returning to normalcy, the inventory levels at
the retailer end have already started reducing. Company has extended credit period to the distributors on
selective basis and things are gradually improving.
Intends to open > 100 Gowardhan shopees over the next 12 months
Parag Milk Foods plans to open 120 to 150 Gowardhan shopees in 2017 and has started its pilot
in Hyderabad.
Parag has second largest share of India's cheese market, is present in both packaged milk and milk
products. The company plans to convert its existing shops in Maharashtra to the uniform format to be
designed under Gowardhan Shopee. Company intends to develop these shopees on franchise basis.
The company has also plans to expand the number of brands it owns from existing four to total of
seven by the end of next year. 'Milk Rich' will be the fifth brand of the company in dairy whitener
category. It will not be just re-branding of the existing Gowardhan dairy whitener.
Parag will be launching its sixth brand in the category of whey products. Company has set up separate
factory for whey consumer products like protein mix powder which would drive revenues from FY18
onwards.
In 2014, Indias dairy industry was worth ~Rs 4,061 billion, posted CAGR of 15.4% during 2010 to 2014.
Total production of milk and dairy products in India is expected to increase from 147 Million Metric Tonne
(MMT) in 2015 to 189 MMT in 2021, and total consumption of milk and dairy products is expected to increase
from 138 MMT in 2015 to 192 MMT in 2021. Indias dairy industry is expected to maintain growth at CAGR of
approximately 14.9% between 2015 to 2020, to reach value of Rs 9,397 billion by 2020. In India, milk
consumption mainly consists of buffalo milk at 49% followed by cow milk at 48% as on financial year 2014.
However, cow milk is growing at a faster pace than buffalo milk and is expected to account for the majority
of the total milk consumed in line with the developed markets. On a state level, Uttar Pradesh, Rajasthan and
Andhra Pradesh were the largest milk producers accounted for 17.7%, 10.5% and 9.8% of total milk
production in 2014, respectively. Further, of the 35 states and union territories in India, cow milk is dominant
in 24 states and union territories. The top five cow milk producing states in India currently are Tamil Nadu,
Uttar Pradesh, Rajasthan, Maharashtra and West Bengal.
During 2010 to 2014, the organised segment recorded at a CAGR 20.7% whilst the unorganised segment
grew at 14.2% CAGR during the same period. However, the unorganised segment still dominates the Indian
dairy industry at 80% compared to the organised segment at 20% by value in 2014. The organised segment
is expected to post CAGR of 19.5% between 2015 and 2020 and would account for approximately 25.5% of
the Indian dairy industry by 2020. The unorganised segment is expected to post CAGR of 13.2% during the
same period and is expected to account for 74.5% of the total Indian dairy industry by 2020.
Branded value-added dairy products category is the most attractive category in the dairy market. This
category is not only growing at a faster pace than overall category (1.5x growth), but is also far more
profitable. PMF has a strong value-added portfolio across categories (cheese, UHT milk, yogurt, fresh cream,
dairy whitener and milk based beverages). Two thirds of PMFs FY16 revenues came in from value-added
products. We expect PMFs valuation discount versus F&B peers to narrow. Opportunity size in Dairy is huge
and in turn offers strong growth visibility for branded players. Parag, with its strengths on procurement,
distribution, innovation and management bandwidth is best placed among its peers. While most of the listed
Dairy players are either regional in nature or have dominant B2B positioning, Parag offers pan-national
branded dairy play with large B2C focus.
The stock trades at 22x/16x our FY18/FY19 earnings estimates and at FY18/FY19 expected EV/EBITDA of
11x/8.7x. The stock is slightly expensive to some peers but the higher valuation is justified due to lower
share of institutional sales, stronger brands, distribution reach, and strong execution history. Moreover, given
the focus on innovation an increasing distribution network, PMF is set to post revenue CAGR of 14.3%, led by
17% CAGR for value-added products during FY16-19E. Additionally, recent IPO proceeds should not only
reduce leverage but also help meet capex requirement, thereby accelerating profits and improving return
ratios. We forecast 170bps margin expansion over the same period led by operating leverage and change in
products mix. We expect company to post robust PAT cagr of 41% led by improvement in operational
performance and lower interest out go over FY16-19E; we forecast Rs16.3 EPS for FY19. PMF trades at 16x
FY19E P/E, valuations do not adequately factor in the strong long-term growth prospects (EPS CAGR of 41%
during FY16-19E). We recommend BUY on Parag Milk Foods (PMF) at CMP and add on dips to Rs 233 with
sequential price targets of Rs 308 and Rs370 (based on ~23x FY19E earnings) over the next 3-4 quarters.
We believe stock has potential to give consistent returns over the next 5-7 years.
Parags manufacturing operations are largely dependent on the supply of cow milk, which is the
primary raw material for all the dairy products. Given the seasonal nature of the dairy industry, cattle
farming patterns and no formal agreements with the farmers, availability of raw milk keeps on
fluctuating which thereby could adversely impact the running of its operations.
Business operations are dependent on supply of large amounts of raw milk, and an inability to procure
adequate amounts of quality raw milk at competitive prices could adversely affect results of
operations. Also, volatility in milk prices can impact margins which in turn could hurt profitability.
Working capital of the company is stretched given the high debtor days given to distributors and the
high processing time in some of the value added products like cheese.
Competitive intensity is high in the category with some strong regional players and few pan India
players like (Amul & Mother dairy), which may impact pricing and margins of the company. Moreover,
large market size of unorganized segment also remains key concern.
Presence
Dominant in Value
Divesrsified Position Added Multi Region
Company Product Portfolio in B2C Products Presence
Hatsun Yes Yes Yes No
Britannia No Yes Yes Yes
Parag Milk Yes Yes Yes Yes
Heritage Yes Yes Yes No
Kwality No No Yes Yes
Prabhat Yes No Yes No
Source: HDFC sec Research
Valuations
Milk Products Rev to witness 17% cagr over FY16-19E EBITDA and PAT to witness strong growth momentum
80 300
2100
1900 70
1700 250
60
1500
1300 50 200
1100
40
900 150
700 30
500 100
20
300
100 10 50
FY13 FY14 FY15 FY16 FY17E FY18E FY19E
15
% 13 %
18 16
Source: Company, HDFC sec Research Source: Company, HDFC sec Research
Confectionary &
Others
27 30
Source: Company, HDFC sec Research Source: Company, HDFC sec Research
Indian Dairy Industry Market Size (Rs Bn) Indian Cheese Market (Rs Bn)
8000 70
7000 59
60
6000
50 47
5000
4000 40 35
29
3000 30
22
2000 17
20
1000 12
10
0
2014 2015 2016 2017E 2018E 2019E 2020E
0
Unorganized Organized 2014 2015 2016 2017E 2018E 2019E 2020E
Source: Company, HDFC sec Research Source: Company, HDFC sec Research
Price Chart
400
350
300
250
200
150
100
50
Sep-16
May-16
Nov-16
Jul-16
Jun-16
Oct-16
Dec-16
Aug-16
Rating Definition:
Rating Chart
R HIGH
E
T
MEDIUM
U
R
N LOW
LOW MEDIUM HIGH
RISK
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