Dairy companies: Winners and losers amid rising milk procurement costs

Hatsun Agro, Heritage Foods better placed than Parag, Prabhat

Rising costs of milk procurement is likely to pull down the Ebitda margins of leading dairy companies such as Parag Milk Foods (Parag), Prabhat Dairy (Prabhat) in the March 2017 quarter (Q4) even as the impact will be relatively less for names like Heritage Foods (Heritage) and Hatsun Agro (Hatsun; already announced its Q4 financials). 

Milk procurement costs have increased 15 to 20 per cent in the quarter on a year-on-year basis. However, there are two to three main factors determining the extent of margin impact for these companies.

Sourcing model followed by a dairy company

Dairy companies source milk either directly from farmers or via agents/contractors or via a combination of these two. Companies having higher sourcing directly from farmers obviously are better placed in terms of steady milk supply, consistent milk quality and relatively lower milk procurement costs. Among the listed dairy companies, while Hatsun and Heritage source 99 per cent and over 90 per cent of milk directly from farmers, this number stands at 85 per cent for Parag and 65 per cent for Prabhat. 

Ability/ease with which companies pass on higher input costs

Companies having higher revenues from the business to business (B2B) segment can pass on the higher costs conveniently. For instance, Prabhat derives 73 per cent of its revenues from B2B segment and over 60 per cent of its revenues are on a cost plus model. The other three companies are focused on the business to consumer (B2C) channel, which forms anywhere between 66 to 96 per cent of their revenues. Companies having higher revenues from the pouch milk segment, too, can pass on the higher costs relatively easily with lesser time lag, thus limiting the impact of higher costs on their margins. Hatsun and Heritage fall in this category while Parag and Prabhat are focusing more on the value-added products such as ghee, cheese, paneer, etc.

“Parag and Prabhat, which are less dependent on pouch milk and partly rely on agents to source milk, are most at risk of margin erosion despite the 6-8 per cent price hike in January,” says Ritesh Vaidya, consumer analyst at Ambit Capital.

Overall, analysts believe Heritage is likely to witness least impact on its Ebitda margin in the quarter (on a year-on-year) basis, followed by Prabhat and then Parag (see table). In fact, Parag had started feeling the heat of higher procurement costs in the December quarter itself. 

Rising input costs coupled with higher promotional and ad spends had led to the company reporting an Ebitda loss in the previous (December) quarter. While margin might look slightly better sequentially for Parag, the pressures are likely to last a few more quarters, believe analysts.

Though Parag is expected to take another 4-5 per cent price hike, it may not completely offset the increase in procurement cost. "Higher competitive intensity in B2C segment will limit price hikes and keep margins under pressure in the interim,” wrote Dhaval Mehta, analyst at Emkay Global in a recent report on the company.

Going forward, analysts believe procurement costs could rise another 7-8 per cent as overall milk supply reduces in summer.

At current levels, Hatsun trades at 45 times FY18 estimated earnings which is on the higher side and seems to bake in the positives adequately. The company posted its results last Monday and registered a healthy expansion of 108 basis points in its Ebitda Margin to 9.6 per cent compared to the year-ago quarter. Its revenues grew 36 per cent to Rs 1,215 crore while net profit came in at Rs 43 crore as against a net loss of Rs 17 crore in the base quarter. Company's plans to raise upto Rs 500 crore via a QIP will keep the stock buoyant. The other three companies are trading anywhere between 21 to 29 times FY18 estimated price to earnings ratio and are fairly valued for now.