Prabhat Dairy IPO: Expensive valuations

While institutional business continues to be steady, ramping up retail business could weigh on margins

Prabhat Dairy’s integrated milk and dairy ingredients business, which has institutional clients such as Mondelez India Foods (Cadbury's), Britannia, Danone, Mother Dairy, Abbott Healthcare, Nestle, among others is enviable. But, the expensive IPO valuations are a dampener.

Prabhat provides dairy products such as skimmed milk sugar concentrate and milk powder, full cream milk powder, milk powder for baby food, sweetened condensed milk, among others to its institutional clients that form about three-fourths of its revenues. It also co-manufactures products such as curd, butter milk, ghee, ice-cream, etc., with leading players such as Heritage Foods, Britannia, Mother Dairy to name a few. Its retail business (one-fourth of revenues) houses its brand names such as Prabhat (milk, butter, etc.), Milk Magic (sweetened condensed milk) and Flava (flavoured milk) and is more regional in nature with presence in central and western India.

Going forward, the retail business will form half of its revenues and the company is looking to capture share from un-organised players (70 per cent of the overall market). However, competition from organised players, which remains intensive, will be a key monitorable. Among the new segments, Prabhat Dairy has recently commenced cheese manufacturing and has tied up with three-four leading quick service restaurants (Pizza, Burger segments). It is also actively ramping up its 1 kg cheese segments to meet the demand of hotels, restaurants and caterers. Continuous additions to its products portfolio and increasing capacity utilisation are other focus areas going ahead, and should add to topline growth.

Long-standing relationships with farmers for procurement of milk as well as with institutional clients are its key strengths. An integrated business, including direct procurement of milk from farmers, along with highly automation production operations are positives and provide support to margins.

Valuations: Of the Rs 516 crore IPO, about Rs 300 crore is being raised through fresh issue of shares (amount will go to the company) and Rs 216 crore is an offer for sale for partial exit by promoters and investors. Of the Rs 300 crore, Rs 185 crore will be deployed in part pre-payment of debt worth Rs 400 crore while rest will be used for capex and brand building purposes.

However, at the price band of Rs 140-Rs 147, even after assuming an optimistic growth of 40 per cent in FY16 net profit (profits have grown at a CAGR of 30 per cent during FY12-15), the issue is priced at 43.8 to 46.4 times earnings on a fully diluted basis. After applying Rs 5 discount for retail investors, this metric is still high at 42.2 times to 44.9 times. Notably, this does not consider the likelihood of margins seeing pressure given the company's strategy to increase brand awareness and improve retail mix.

While the IPO is valued at a discount to Hatsun Agro, which trades at 59 times FY16 estimated price/earnings, Hatsun’s annual revenues were nearly thrice of Prabhat Dairy's revenues in FY15. Hatsun’s return on net worth also stood at nearly 18 per cent, which for Prabhat was just 6.22 per cent in FY15. Heritage Foods, another peer with much higher revenues (about Rs 2,000 crore), currently trades at 17.5 times FY16 estimated earnings. Even as both these companies are largely retail-focussed and hence not strictly comparable, Prabhat’s valuations are expensive.