Ease in margins seen from Q4 for dairy cos; stay stock selective: Analysts

Dairy stocks: Analysts see the benefits of price hikes to begin accruing from the March quarter onwards, while the financial year 2023-24 (FY24) will be a steady year for the industry's margins

Shares of dairy companies have staged a steady turnaround in the last few months as related companies announced price hikes to fight rising costs of milk procurement and fodder.

Scrips of Dodla Dairy, Heritage Foods, Parag Milk Foods and Vadilal Industries have risen 13-94 per cent so far in the financial year 2022-23 (FY23). By comparison, the benchmark Sensex and Nifty50 indices are up around 5 per cent each. 

Analysts see the benefits of price hikes to begin accruing from the March quarter onwards, while the financial year 2023-24 (FY24) will be a steady year for the industry's margins.

"Companies have taken price hikes with some lag, the positive impact of which will be likely seen starting Q4FY23 while FY24 is expected to be a normal year in terms of margins and raw milk supply," said Vinit Bolinjkar, Head of Research, Ventura Securities.

The dairy industry has taken consistent price hikes in the last ten months, taking the price of wholesale milk up by 10 per cent year-on-year (YoY) to around Rs 52 per litre till mid-December.

The decision to hike prices comes after the industry delivered weak profit margins this (financial) year, impacted by higher wholesale prices of milk due to a sharp rise in cattle feed prices, logistics and packaging costs and the lumpy virus disease.

The operating margins of Heritage Foods and Dodla Dairy, for instance, declined 482 and 230 basis points YoY, respectively, in the September quarter despite firm revenues.

"Post Covid-19, the dairy sector has faced unprecedented inflationary pressure as raw milk prices and packaging costs rose sharply led by an increase in prices of fodder that were passed on by the farmers amid high demand. The lumpy virus also took out 7-8 per cent of the milk supply. All of this pressured the sector’s gross margins in FY23, which fell from 25 per cent plus level to below 18 per cent," said  Bolinjkar of  Ventura Securities.

Experts foresee cattle feed prices to remain high in the near term, which cements the need for companies to continue price hikes in the second half of FY23.

"We continue to factor contraction in dairy companies’ EBITDA margin by 50-100 bps in H2FY23. Companies will need to raise prices again in the second half, and focus on increasing the share of value-added products to protect their profitability", analysts at ICICI Securities said in a note.  

On the other hand, the revenue growth is expected to remain strong due to better volumes and higher sales to the hotels, restaurants and catering (HoReCa) segment, they add.

The dairy industry, which is still primarily catered to by the unorganised sector, leaves a huge opportunity for the formal sector. As organised companies expand their presence in milk-producing states via processing centres, their market share gains in the unorganised segment will also accelerate, experts say.

From an investment viewpoint, Boljinjkar of Ventura Securities prefers Parag Milk Foods and Heritage Foods, which are currently valued at 8.7x and 9.9x their FY25 EV/EBITDA, respectively.

Another analyst at a local brokerage, who didn't wish to be named, picked Hatsun Agro Product as his investment bet, which has a significant product line in the VAP category. He also likes Dodla Dairy and Heritage Foods.