Market Dairy Edelweiss 12.12.17

India Dairy
Crème de la crème: Milking the value chain

December 1, 2017
Shradha Sheth Sanyam Jain

+91 22 6623 3308 +91 22 4040 7412 Edelweiss Securities Limited
[email protected] [email protected]
Dairy
Executive Summary

India’s dairy sector is a very white, bright and freely flowing
opportunity. It’s got size (INR5.4trn), leadership (largest milk
producer globally, 160mmt) and growth – 15% CAGR over
2016‐20E. We believe this scale and underlying momentum
will throw up even more possibilities, and the organised

(Click here for market will grow even more rapidly at 20% p.a, doubling into
video clip) a INR2.5trn market by 2020. This should be driven by a mix of
underlying structural trends led by: a) A huge unorganised
market (~78%) led by fresh dairy products; b) A consumption and market shift
to high‐margin emerging VADP; 2.5x over FY16‐20E and; c) Large vegetarian
population (31%), which has sub‐standard protein consumption. This mix
has been the backbone of India’s dairy market growth over the years, and it’s
set to accelerate.

Not surprisingly, India’s dairy sector is throwing up big investment
opportunities; a mix of growth, rising consumer maturity and the shift to more
value‐added products. But, the key differentiators that will enable businesses
to leverage these opportunities will lie in: a) Milk sourcing capabilities ‐ The
infrastructure, ability to diversify and scale; b) Product mix ‐ A combination of
milk and VADP; c) Channel mix ‐ B2C franchises and strong distribution
networks; d) Brands ‐ Ability to build, execute and provide pricing power; and
e) Capital efficiency ‐ Ability to manage and improve. It’s a huge market – but it
is competitive, and businesses will need strong models and scalability to
thrive. We believe Parag’s strength lies in its well‐entrenched VADP portfolio;
Heritage Foods boasts of a strong procurement infrastructure and product mix;
and Prabhat Dairy is shifting focus to VADP and B2C segment.

The dairy sector should drive high growth and profitability for the leaders ‐
the sector is poised for healthy ~20% plus earnings CAGR and average ~25%
plus RoCE. We see meaningful stock returns for investors, and our pecking
order is: 1) Parag (initiate with ‘BUY’) has a robust VADP portfolio (~64% of
sales); 2) Heritage (initiate with ‘BUY’) is straddling high RoCE (milk) and
margin (curd) segments to emerge a pan‐India VADP player; and 3) We
maintain our positive stance on Prabhat Dairy (‘BUY’) as its at the cusp of
transitioning to a B2C VADP player.

Structural levers to script multi‐year growth story
We envisage the domestic dairy industry to embark on the growth super highway —value
CAGR of 15% over FY16‐20. We believe structural growth levers are in place to fuel this
spurt: wherein: a) Mere 22% (INR1.19tn) organised pie is set to catapult ~2x, primarily
driven by fresh dairy products (milk, curd, paneer, etc) clocking 20% CAGR over FY16‐20E; b)
Urbanisation is driving strong 2.5x surge in VADP, spearheaded by high‐margin emerging
categories like cheese, whey, UHT and flavoured milk logging ~25% CAGR versus liquid milk’s
15% CAGR over FY16‐20E; and c) There’s a large vegetarian population (31%) with rising
income levels and sub‐standard protein consumption.
1 1 Edelweiss Securities Limited
Edelweiss Securities Limited
Dairy
Fig. 1: Huge unorganised market augurs well for fresh dairy products
FY20: INR654bn
Organised: 4%
FY20: INR493bn
Organised: 7%
FY20: INR382bn
Organised: 16%
Paneer
Higher unorganised
FY16: INR386bn FY20: INR1,367bn
Organised: 21%
Curd Organised: 3%
Butter FY16: INR288bn FY20: INR6,068bn

Organised: 6% Organised: 26%
FY16: INR222bn
Organised: 14% Ghee
FY16: INR811bn
Organised: 19% Milk
FY16: INR3,483bn
Organised: 22%
Larger market size

Fig. 2: Emerging VADP to grow 2.5x – Product‐wise growth rate
FY20 FY20
INR59bn INR12bn
FY20
FY20
INR104bn Cheese Yogurt
INR48bn
Flavoured UHT milk
FY20
INR24.5bn milk
Whey
13% 24% 25% 32% 32%

FY16 FY16 FY16 FY16 FY16
INR15bn INR20bn INR42bn INR20bn INR4bn

Source: IMARC

Competitive landscape
Factors crucial for success in the domestic dairy industry include:

1) Procurement infrastructure: Companies with infrastructure for direct milk
procurement from farmers enjoy huge competitive edge as it assures steady milk
supply and consistency in milk quality. We have ranked companies based on share of
direct procurement, diversification and growth. Heritage scores high in terms of direct
procurement (95%) and diversification.

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Dairy
2) Right product mix ‐ VADP + fresh dairy: Right mix of milk and VADP is vital to maximise
growth, margins and return ratios. We have evaluated companies and ranked them on
the basis of right mix of high‐RoCE milk & fresh dairy products and high‐margin & high‐
growth VADP. Parag is strongest in VADP, deriving ~64% sales from the segment, with
the high‐margin emerging VADP contributing ~27% to sales (majorly driven by cheese).
Heritage derives 65% sales from the high‐RoCE milk segment and is further increasing
sales in high‐margin fresh dairy VADP like curd, which will sustain high RoCE. Prabhat,
from being a specialty ingredients B2B player, targets to become a 50% B2C player by
2020 (~30% currently) by enhancing VADP sales to 45% in FY20 from ~26% in FY17.

3) Channel mix: Companies with strong distribution networks in their respective
territories have established robust B2C franchisees. Rising consumption of VADP has
resulted in players expanding their B2C mix too. We have ranked companies based on
their mix of B2C and B2B. Heritage has a strong B2C franchisee (>90% of sales),
reflected in higher return ratios ‐ ~40% pre‐tax RoCE. Parag is strong in VADP pan India,
led by strong brand building with B2C sales at 67% of mix. Prabhat is targeting ~50%
sales from the B2C segment from ~30% currently.

4) Branding: As companies move up the curve into VADP, it becomes important to engage
in brand building as it imparts pricing power. We have ranked companies based on
brand strength, distribution network and ad spends. Parag, with its strong brands like
Go in cheese, expends 3.0% of sales towards ad & marketing.

5) Capital efficiency: Right product mix drives capital efficiency as milk and fresh dairy
products are high‐RoCE businesses, while VADP, particularly emerging categories, are
capital intensive and currently in investment mode with returns anticipated to improve
with rising utilisation. Heritage ranks the highest on capital efficiency metric.

Table 1: Competitive advantage framework
Company Procurement Product mix Channel Mix Branding Capital
network Efficiency Remarks
Parag leads with 64% share of VADP and 27%
Parag Milk Foods 2 1 2 1 3 share of emerging VADP and established
leading brands Gowardhan and Go.
Heritage is strong end to end with 95% direct
Heritage Foods 1 2 1 2 1 procurement and 100% B2C sales with 83%
revenue share of high RoCE milk and curd.
Specialty ingredients supplier shifting
Prabhat Dairy 2 2 3 2 3 towards higher share of VADP and B2C sales
(50% by FY20 from 30% currently).
Established brands Arokya, Arun, Hatsun and
Ibaco with differentiated strategies to
Hatsun Agro Product 1 2 1 2 2
establish near 100% direct procurement and
retail sales.
Largest private dairy leveraging scale to
Kwality 4 3 3 3 2 establish direct procuremetn network and
brand Kwality to enhance B2C sales.
Source: Edelweiss research
Note: Ranking is 1‐5, based on 1 being the best

Dairy
Valuation: Rerating to trend in line with global & domestic listed peers
Strongest domestic listed dairy player (based on the above‐mentioned parameters) Hatsun
quotes at ~30% premium to the other well managed and superior RoCE company, Heritage,
due to superior procurement network. It is in‐line with the FMCG median. Further, in terms
of valuation, it quotes at 2x to emerging VADP players like Parag.

Fresh dairy products players can trend in‐line with FMCG players which command strong
brands, RoCE and have significant scope for growth led by demand shift to organised
segment. Hence, we value Heritage at 30x, a mere 10% discount to the Indian FMCG median.
Further, we perceive rerating potential for under‐penetrated emerging VADP‐oriented
companies as they follow the footsteps of global VADP dairy players, which trade in line
with their FMCG peers. However, led by capital intensity of VADP segment, we value Parag
at 28% discount to the domestic FMCG median and 20% discount to Heritage. With huge
growth prospects in the underpenetrated and high‐margin emerging VADP, we believe the
discount will narrow as the company scales up its RoCE. We value Prabhat at 22x FY20E P/E,
at 34% discount to domestic FMCG median, 27% discount to Heritage and 8% discount to
Parag due to higher B2B sales. With shifting focus to value‐added products and B2C
segment, the discount will narrow, in our view.

We believe the discount in valuations of fresh dairy player, Heritage and VADP players,
Parag and Prabhat, will narrow to Hatsun and FMCG universe median.

Risks and concerns: Challenges in scaling up to VADP
The Indian dairy industry’s long‐term structural growth is undeniable and demand shift to
organised players is also inevitable with transition to VADP. However, the risks are: a) Milk
price volatility can impact short‐term profitability, but the structural drivers are intact; b)
Capital intensive nature of VADP can impact short‐term RoCE, but it will reduce margin
volatility due to vagaries of milk cycle; c) Rising aggression among large cooperatives like
Amul in the VADP space could cap the sector’s growth potential in short term, but the long‐
term VADP transition‐led growth remains intact.
Stocks: Our preferred picks
Parag’s strong focus on emerging VADP with well‐established brands and capex already
undertaken are estimated to spur PAT CAGR of 49% over FY17‐20, with pre‐tax RoCE spiking
1,064bps to 19.0%. The company has higher proportion of emerging VADP (~27% of sales in
FY17), where capital intensity is higher versus the high‐RoCE traditional dairy companies.
Hence, we have valued Parag at 24x FY20E EPS (34x FY19E EPS), at 28% discount to FMCG
median and 20% discount to Heritage’s target FY20E P/E. However, global dairy VADP
players trade in line with their FMCG peers, which we anticipate Parag to gradually follow.
We initiate coverage on Parag with ‘BUY’ and target price of INR340, implying ~40% upside
from current levels. At CMP, the stock trades at 17.1x FY20E.

We envisage Heritage to benefit from the structural shift in demand to the organised
segment in fresh dairy products even as the company transitions to a VADP dairy player. We
estimate robust 23% sales and 21% EBIT CAGR over FY17‐20 and adjusted RoCE at 42%, a
rare combination in the dairy sector. We value the stock at P/E of 30x FY20E EPS (41x FY19E
EPS), at ~10% discount to domestic FMCG players and add the market value of investment in
Future Retail with 20% holding company discount. We initiate coverage with ‘BUY’ and
Dairy
target price of INR976, implying 29% upside from current levels. At CMP, the stock trades at
25.9x FY20E.

With Prabhat shifting focus to value‐added products and B2C segment, we estimate sales,
EBITDA and PAT CAGR of 15%, 19% and 39%, respectively, over FY17‐20. We value Prabhat
at 22x FY20E P/E (30x FY19E EPS), which is at 34% discount to domestic FMCG median, 27%
discount to Heritage’s target FY20E P/E, and 8% discount to Parag’s target FY20E P/E, due to
higher B2B sales. With shifting focus to value‐added products and B2C segment the discount
will narrow. We maintain ‘BUY’ with TP of INR211, implying 30% upside from current levels.
At CMP, the stock trades at 17.0x FY20E EPS.

Table 2: Valuation snapshot
FY17
FY17‐20E FY17‐20E EBITDA
Company Name Currency M Cap Sales CAGR PAT CAGR margin P/E (x) EV/EBITDA (x) EV/Sales (x) RoCE (%)
(%) (%) (%) FY19E FY20E FY19E FY20E FY19E FY20E FY19E FY20E
India Dairy
Heritage Foods* INR 35,188 22.9 18.4 7.7 35.2 25.9 17.5 13.4 1.2 1.0 38.8 41.7
Hatsun Agro INR 133,939 18.8 43.4 9.1 61.2 33.9 24.6 17.1 2.5 2.0 32.1 37.7
Kwality INR 23,939 10.3 19.1 6.6 8.7 NA 6.0 NA 0.5 NA 24.5 NA
Parag INR 20,339 14.1 48.9 6.2 24.0 17.1 10.8 8.5 1.0 0.8 15.2 19.0
Prabhat INR 15,911 14.8 38.9 9.0 23.4 17.0 10.3 8.3 1.0 0.8 11.7 14.4
Mean 16.2 33.7 7.7 30.5 23.5 13.9 11.8 1.2 1.2 19.9 26.1
Median 14.8 38.9 7.7 24.0 21.5 10.8 11.0 1.0 0.9 17.7 21.2
Source: Bloomberg, Edelweiss research
Note: Kwality's CAGR calculation is for FY17‐19. RoCE is pre‐tax.
Note: Heritage's RoCE is adjusted for discontinued segments and investment in Future Retail

Dairy
Contents
Executive summary .................................................................................................................. 1
Indian Dairy: Largest market, fastest growth ........................................................................... 8
Key Structural Trends & Drivers ............................................................................................. 11
Competitive edge of players .................................................................................................. 18
1) Milk procurement ‐ Driven by direct sourcing and diversification ............................. 19
2) Right product mix of milk and high growth and high margin VADP ........................... 22
3) Channel Mix: Strong branding leading to higher B2C sales ....................................... 27
4) Branding: Ramping up the value proposition ........................................................... 28
Company‐wise dynamics ........................................................................................................ 29
Outlook & Valuations ............................................................................................................. 33
Annexure ................................................................................................................................ 36

Initiating Coverage
Parag Milk Foods ................................................................................................................... 39
Heritage Foods ....................................................................................................................... 75

Company Update
Prabhat Dairy ....................................................................................................................... 107

Profiles
Amul ..................................................................................................................................... 115
Hatsun Agro Product ............................................................................................................ 121
Kwality ................................................................................................................................. 129

Dairy
Indian Dairy: Largest market, fastest growth

 India India has come a long way from being in deficit from 20mn MT IN 1970 to

being the world’s largest milk producing country at 160mn MT—accounting for a
huge 18.5% of world production.
 In last 35 years, India’s milk production outstripped with 4.5% CAGR as against
mere ~1.6% CAGR posted by global milk production.
 Going ahead, India’s milk production is expected to outperform global production
and grow at similar 4.2% CAGR going ahead to 185mn MT per annum/507mn litres
per day and surpass EU to emerge the largest dairy producer by 2020 and improve
in value terms at ~15% CAGR to INR9.4tn over FY16‐20.

India has come a long way from being in deficit days to being well embarked to emerge as
the world’s largest producer and consumer of milk. Globally, the EU, India and the United
States are the largest milk and dairy products producers and consumers accounted for
India is the world’s largest milk 20.3%, 18.4% and 11.9% shares, respectively, in global dairy production in 2014.
producing and fastest growing
country Chart 1: Share of global production in 2014 ‐ EU, India, US majors
EU
Others
20%
24%
Argentina
Turkey 2%
2%
New Zealand
India
3%
Russian 18%
Federation
4% Brazil
4%
Pakistan China USA
5% 6% 12%
Source: Parag RHP

Interestingly, in last 35 years, India’s milk production grew at 4.5% CAGR as against mere
~1.6% CAGR posted by global milk production. India’s milk production growth was driven by:
1) Rising productivity of animals by ~70% (2.5% CAGR); 2) Cattle population growing by 30%
At 4.5% CAGR over past 3.5 (1.7% CAGR); and 3) Entry of private players as well as NDDB (National Dairy Development
decades, India has outstripped Board) which has provided farmers with better cattle fodder and artificial insemination
global milk production CAGR of services. Ergo, going forward while other top milk producing geographies like EU, USA,
mere 1.6% China, Pakistan are expected to grow their production volumes at <2% CAGR over 2020,
India is set to clock 4.2% CAGR in volumes over 2016‐20 and overtake the EU to become the
largest milk and dairy products producer by 2020.

Dairy
Chart 2: India outpaced global milk production at 4.5% CAGR Global production grew at mere 1.6% CAGR in past 35 years
175 1,000
140 800
105 600
(M MT)
(M MT)
70 400
35 200
0 0
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
Source: FAO

While Amul’s Operation Flood from 1970‐1996, augmented India’s milk production at 4%
CAGR over over the period making India self reliant, de‐licensing of the dairy sector in 1991‐
92, led to the entry of several private players like Hatsun Agro, Heritage Foods, Parag Milk
Foods, Prabhat Dairy, etc helping strong 4% production CAGR during 1992‐2015. But, India’s
milk consumption grew at relatively higher 5% CAGR during the period. We believe
continuous increase in productivity will help bridge this gap.
India is expected to surpass EU to
emerge the largest dairy producer
India to emerge largest dairy producer by 2020
by 2020 and improve in value
terms at ~15% CAGR to INR9.4tn The Union Government implemented the Central Scheme National Dairy Plan ‐ Phase 1
over FY16‐20 during 2012‐17 to improve productivity of dairy cooperatives through several input
activities. Investments by private players in the domestic dairy sector is also expected to
further augment milk productivity. Going ahead, India’s milk production is expected to
outperform global production and grow at similar 4.2% CAGR going ahead to 185mn MT per
annum/507mn litres per day and surpass EU to emerge the largest dairy producer by 2020.

Table 3: Top milk producers’ growth – India pacing ahead to emerge largest producer by 2020 (mn MT)
CAGR
Countries 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E 16‐20E (%)
EU 156 157 161 163 166 169 172 175 177 1.6
India 134 138 145 151 157 164 170 178 185 4.2
USA 91 91 94 96 97 99 100 102 104 1.7
China 45 45 45 45 46 46 46 46 47 0.5
Pakistan 38 39 39 39 40 40 41 41 42 1.2
Brazil 33 33 34 35 36 37 37 38 39 2.0
Others 270 270 274 281 287 293 298 303 308 1.8
Total 766 773 792 810 829 847 865 883 901 2.1
Source: IMARC report

India‘s dairy industry is worth ~INR5.4tn by value, having grown at 15% CAGR during 2010‐
16. Going ahead, the dairy industry is expected to maintain ~15% CAGR over 2016‐20, and
attain value of INR9.4tn on rising consumerism.
Dairy
Chart 3: Domestic dairy industry recorded 4.2% volume CAGR... Chart 4: ...with 15% value CAGR during FY10‐16
600
10,000
480 8,000
(mn litre per day)
(INR bn)
360 6,000
240 4,000
120 2,000
0 0
2010 2016 2020E 2010 2016 2020E
Source: Industry, Edelweiss research

Dairy
Key Structural Trends & Drivers
Domestic processed dairy set to
become INR9.4tn industry by 2020

 Increasing per capita: India’s per capita milk consumption has been increasing at
3% CAGR versus 1% CAGR globally. Further, at 97 litres per year it significantly
trails its global peers. We believe there exists humungous scope for India’s per
capita milk consumption to spurt led by growth in value‐added products (VADP),
which is at 34% of industry versus 86% for the global mature markets like EU.
 Vast vegetarian population: Given rising income levels and sub‐standard protein
consumption, we believe latent growth potential for India’s dairy industry is
huge.
 Rising share of organised sector: Led by rising disposable income, and growing

consumer preference for branded and value‐added milk & milk products,
investments by organised players in the sector has been on the rise. The
organised players are set to grow at 20% CAGR over 2016‐20 outpacing industry
growth of 15% CAGR, and enhance share in the Indian dairy industry to 26% from
22% in 2016.
 Value‐added products to grow at faster clip: VADP has been gaining importance
with increasing changes in India’s demographic and dietary patterns. In medium
term, while demand for branded milk is expected to grow by ~15% CAGR, VADP
would grow even stronger by ~20% plus CAGR driven by increasing share of
organised sector within traditional VADP and rising penetration of high‐growth
emerging VADP.

Catalyst 1: Rising per capita income
India is the world’s largest consumer of dairy products, consuming almost 100% of its own
Per capita availability of milk in
milk production. Despite being the world’s largest consumer, per capita milk consumption
India is among the lowest at 97
(PCC) in India is 97 litres/year, significantly trailing USA, EU27, Russia Federation and Brazil.
litres / year
Chart 5: Per caita dairy consumption across regions
300
240
(litres per year)
180
285 281
120
220
156
60
97
24
0
United States EU27 Russian Federation Brazil India China
Source: IMARC Report
Dairy
India‘s dairy industry per capita milk consumption grew at healthy 3.1% CAGR during FY04‐
India’s per capita milk 14. This was unlike the trend seen in developed countries, where per capita is already very
consumption is clocking 3.1% high leading to world per capita growth of mere 0.9% CAGR in past 10 years.
CAGR at ~3x global average of
0.9% CAGR, where per capita We believe there exists huge scope for per capita milk consumption led by growth in value‐
consumption is already high and added products, which stands at 34% of industry as compared to 86% for global mature
hence stagnating markets like EU.

Chart 6: India’s per capita milk consumption grew at healthy 3% CAGR, while globally it grew at mere 0.9% CAGR
125 115
100 110
75 105
(kg)
(kg)
50 100
25 95
0
90
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2004 2009 2010 2011 2012 2014

Per capita consumption Per capita consumption

Source: World Dairy Situation

With unorganised segment accounting for substantial share of big categories like ghee,
curd, and paneer and strong scope within high‐margin yet underpenetrated categories
like cheese, whey, UHT milk, there is huge scope for penetration of value added
products.
With 31% of India’s
population being vegetarian, Catalyst 2: Vast and growing vegetarian population
overall protein consumption
India’s large vegetarian population is a key driver for the dairy industry with animal‐based
is extremely low
proteins being one of the lowest here. Even as the vegetarian population comprises a high
~31% of the total population, overall protein consumption in India is significantly lower
90% of the daily calorie intake than other countries, and at mere <10% of total calories consumed. Further, animal‐based
from animal‐based sources in protein consumption is lowest in India at <15 grams per day and ~90% of the daily
India is accounted by dairy calorie intake from animal‐based sources is accounted by dairy. Given the strong linkage to
income and current sub‐standard protein consumption in India, we believe India’s dairy
industry holds immense potential.

Dairy
Chart 7: Dismal protein consumption, as a proportion of total calories consumed
50.0
40.0
Overall, India’s protein 30.0
(%)
consumption is significantly
lower than other countries at 20.0
<10% of total calories consumed
10.0
0.0
Indonesia
China
Vietnam
Sri lanka
Malaysia
India
Japan
Europe
Russia
Brazil
USA
Thailand

Chart 8: Low consumption of animal‐based protein
75
60
(grams/day)
Animal‐based protein 45
consumption lowest in India at
<15 grams per day 30
15
0
India Thailand China Brazil Japan Russia United USA
Kingdom

Source: FAO, Edelweiss research

Catalyst 3: Rising share of organised players – to grow to 26% share
On account of rising disposable income, rising consumer preference for branded and value‐
added milk and milk products, investments are being made by organised sector players. As
such, the share of organised segment has gradually inched up from 16.7% in FY10 to 22% in
FY16.

The organised segment comprises ‘cooperatives’ and ‘private dairy companies’.
Unorganised segment has the ‘local vendors’ and ‘self‐consumption’ which command huge
~80% share in value terms.

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Fig. 3: By volume, organised dairy contributes mere 14%

Total Milk
Production
Self Marketable
Consumption Milk
54% 46%
Unorganised Organised
32% 14%
Co‐operatives Private Players
8% 6%

Source: Parag RHP, Edelweiss research

Chart 9: Processed dairy growing at 15% CAGR with organised growing faster at 20% CAGR
10,000 25.0
CAGR
8,000 22.0
6,000
(INR bn)
19.0
(%)
4,000
16.0
20.7 20.0
2,000
13.0
0 14.1 13.4
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
10.0
2010‐16 2016‐2020E
Organised Unorganised Unorganised Organised
Source: IMARC Report, Edelweiss research

With organised segment estimated The organized segment is expected to grow at a CAGR of 20% over 2016‐20 outpacing the
to grow at faster clip of 20% value overall industry (growing at 15%), and enhancing its share in the Indian dairy industry to
CAGR over 2016‐20E versus overall 26% from ~22% currently. We expect private players and cooperatives with increasing
industry’s 15%, we expect investments will be able to gain share from unorganised players.
organised segment’s contribution
to expand to 26% from 22% Rising consumerism, increasing nuclearisation of families, growing urbanisation, and
currently preference for packaged branded products will act as key growth levers for this trend.

Dairy
Catalyst 4: Rising urbanisation propelling VADP
Increasing preference for VADP in India: In recent times, value‐added products (VADP) have
been gaining preference among customers due to apparent changes in demographic and
dietary patterns. The share of VADP has gradually increased and now stands at 34% of total
industry. However, contribution of milk and skimmed milk powder (SMP) combined stands
at ~66% of industry sales.

Chart 10: Indian dairy industry split (2016) – VADP comprises just 34% of share
UHT milk Cheese
Significant scope to increase SMP 1% 1% Others
VADP contribution in India which 1% 2%
Butter
stands at 34% of industry versus 4%
Curd
86% in global markets like EU
5%
Paneer
7%
Ghee
15%
Liquid milk
64%

Source: Parag DRHP, Edelweiss Research

VADP accounts for lion’s share of EU market: Comparatively, in EU drinking milk share
is just 11%, SMP a low 3% with the balance used to manufacture VADP leading to its
contribution being at a high 86%. Cheese accounts for lion’s share of EU’s dairy market
In India, less than 1% of milk with 36% share, followed by butter at 30%. This exemplifies the limited penetration of
procured is utilised for cheese VADP in the Indian market and humungous scope for growth.
production compared to 36% in
Europe Chart 11: EU dairy industry split (2015) – VADP accounts for high 86% of share
Milk Powder Other Products
3% 3%
Acidified Milk
4%
Cheese
Drinking Milk 36%
11%
Cream
13%
Butter
30%
Source: Eurostat, Edelweiss research
* Excluded milk powder and drinking milk in value‐added products
Dairy
Indian dairy industry can be classified into commodity dairy products like: 1) Raw milk; 2)
Skimmed milk powders (SMP); and 3) Dairy whiteners (DW) which are low margin products.
Further, milk products like curd, buttermilk, ghee, butter, ice cream and paneer can be
classified as traditional VADPs which have a huge unorganised market and driven by
increasing nuclearisation of families.

With improving macroeconomic trends like rising consumerism, India is witnessing
increasing consumption of emerging VADP like UHT milk, cheese, flavoured milk, yogurt,
lassi, whey, etc. These are hugely underpenetrated categories.

Fig. 4: Evolution of key categories ‐ Consumption of VADP on the rise
Commodity Traditional Emerging

Products: VADP VADP
 Curd  Cheese
 Liquid milk  Whey
 Paneer
 Milk powder  UHT/
 Ghee
 Butter Flavoured milk
 Yogurt
65.6% share 32.6% share 1.9% share

Segment Segment Segment
growth: 15% growth: 16% growth: 25%

Currently, due to conventional culture, commodity dairy products like liquid milk and
We estimate organised players to SMP contribute ~66% of total dairy industry, followed by traditional dairy products
clock 20% CAGR in commodity (ghee, paneer, curd, buttermilk, butter and ice‐cream) forming ~32%, and emerging
and traditional dairy products led VADP (cheese, whey, UHT, flavoured milk, yogurt) accounting for mere ~2% of market.
by sizeable unorganised market
and 26% CAGR in emerging VADP Ergo, there is humungous growth opportunity in traditional milk products like ghee,
led by under penetration curd and paneer due to large industry size and unorganised presence, which we expect
will lead to strong 20% CAGR in organised players in these segments over 2016‐20E.
Emerging VADP like UHT milk, flavoured milk, cheese and whey have highly organised
market presence, but are hugely underpenetrated (small market size) which we believe
will lead to strong 25% CAGR in growth for these segments over 2016‐20E.

Dairy
Table 4: Humungous opportunity for organised segment led by high market growth, low penetration of VADP
Organized 2016 Share of 2020 Sales of 2020 Share of Total Market Organized
Category 2016 Sales sector sales organized 2020 Sales the organized the organized CAGR 2016‐ Market CAGR
(INR mn) (INR mn) sector (%) (INR mn) Sector (INR mn) Sector (%) 2020 (%) 2016‐2020 (%)
Commodity Products 15 17
Liquid milk 3,483,000 760,000 22 6,068,000 1,593,000 26 15 20

SMP 66,000 66,000 100 112,773 112,773 100 14 14
Traditional VADP 16 19
Ghee 811,000 154,000 19 1,367,212 288,912 21 14 17

Curd 288,000 17,000 6 492,690 35,421 7 14 20
Paneer 386,000 11,000 3 653,576 22,684 3 14 20
Cream 17,000 17,000 100 29,704 29,704 100 15 15
Butter 221,701 30,183 14 382,238 61,326 16 15 19
Buttermilk 21,000 21,000 100 43,092 43,092 100 20 20
Lassi 19,000 19,000 100 39,298 39,298 100 20 20
Emerging VADP 25 26
Whey (powder) 15,000 7,000 47 24,457 12,229 50 13 15

Flavoured milk 20,000 20,000 100 47,828 47,828 100 24 24
UHT milk 42,000 42,000 100 103,778 103,778 100 25 25
Yogurt 4,000 4,000 100 12,075 12,075 100 32 32
Cheese 20,000 20,000 100 59,388 59,388 100 32 32
Total 5,413,701 1,188,183 22 9,436,109 2,461,508 26 15 20
Source: Industry, IMARC report, Euromonitor
Note: Industry numbers for whey are from Euromonitor report and industry input; all other product information is from IMARC report

Pertinently, as one moves up the VADP curve profitability too ramps up over the basic
dairy products.

Dairy
Competitive edge of players

 Strong procurement infrastructure, key to success: Companies with infrastructure
for direct milk procurement from farmers enjoy huge competitive edge as it
assures steady milk supply and consistency in milk quality at relatively lower
prices. Heritage at ~95%, Hatsun ~100%, Parag ~80% and Amul at 100% score high
in terms of direct procurement and diversifying over the years.
 Right product mix of milk and high‐growth VADP: A right mix of milk ‐ VADP
helps maximise growth, margins and return ratios. Companies with high milk
sales (Heritage and Hatsun at 65‐70% of sales) have seen their direct
procurement network scale up resulting in higher RoCE. It is these players that
have been leveraging their established milk brands to expand their VADP share.
VADP is an attractive opportunity as: i) These products are poised to grow at
higher rate; and ii) Command ~1.5‐2x higher EBITDA margins.
 For Heritage, while VADP currently contributes 24% of sales it is well on way to
touch 28% levels over FY17‐20E. While Heritage has the best product portfolio
with majority of its sales from high‐RoCE fresh dairy products, it is prudently
increasing sales of high‐margin VADP. Parag derives ~64% of its sales from VADP,
which is expected to go to 70% over FY17‐20. Emerging VADP contributes ~27%
of sales, however it has been ahead of the curve in these high margin emerging
VADP with strong capex already incurred. Ergo, we believe Parag is best placed
to capture the advantages of high‐growth emerging VADP, which would offset
the initial drag of lower RoCE of VADP like cheese.
 Channel mix ‐ Strong branding and higher B2C sales: Heritage and Hatsun have
a strong procurement & distribution network which has led to creation of a
strong B2C franchise (>90% of sales) for them. Rising consumption of VADP is
seeing players expand their B2C mix. However, there are certain VADP like
cheese which is consumed ~50% out of home. Also, categories like butter,
paneer and SMP are institutional in nature. Parag is strong in VADP due to its
prowess in brand building in VADP and B2C sales account for ~67% of its mix.
 Strong branding to scale the value curve: As competition intensifies and
companies move up the value curve to VADP, it has become extremely
critical to spruce up brand building activities. Examples being national brands
like Gowardhan ghee ‐ fetches better realisations and commands brand
premium. Parag offers an entire range of cheese products and variants
leveraging strength of its core Go cheese brand, while also devising a
premiumisation strategy.

Dairy
1. Milk procurement ‐ Driven by direct sourcing and diversification
Raw milk procurement is one most critical requirement in the dairy eco‐system. Steady milk
supply is an important attribute of a dairy company’s supply chain. Consistency in milk
quality is also important to manufacture VADP to maintain similar taste. So, it becomes
imperative for VADP manufacturing companies to have or develop a direct milk
procurement supply chain. As dairy companies are increasingly focusing on B2C segment, an
integrated milk supply chain with strong direct procurement becomes imperative to procure
quality milk and gain sustainable competitive advantage.

 We have evaluated companies on their procurement trend.
 We have evaluated the proportion of direct milk procurement as it ensures availability
of good quality milk and lesser volatility in difficult times.
 Diversification of procurement base is evaluated to see scalability over the years
beyond home states.
 Companies equipped with infrastructure to procure milk directly from the farmers
enjoy huge competitive advantage as it assures steady milk supply and consistency in
milk quality at relatively lower prices.

Table 5: Procurement trend – Hatsun’s procurement has grown the most rapidly
Parag, Hatsun and Amul are ahead 4 year %
with ~9‐14% procurement CAGR in FY13 FY14 FY15 FY16 FY17 CAGR
past 4‐5 years Parag 0.9 0.8 1.0 1.0 1.2 8.8%
Heritage Foods 0.9 0.8 1.0 1.1 1.0 3.4%
Prabhat 0.6 0.8 0.9 1.0 0.8 7.1%
Hatsun Agro products 1.6 NA NA NA 2.7 14.0%
Amul 13.1 13.6 15.3 16.0 18.2 8.5%
Heritage has expanded
procurement from 20,000LPD in
1993 to 1.04mn LPD in FY17,
clocking 18% CAGR As seen from the above table, Parag, Hatsun and Amul are ahead with ~9‐14% procurement
CAGR in past 4‐5 years. For Heritage, however, procurement increased at lower CAGR of 3‐
4% primarily due to lower procurement from states outside its home states – the company
decreased its procurement in Rajasthan in FY17 as it hired out a plant for conversion of milk
into SMP in FY16. However, if we take growth till FY16, Heritage’s procurement grew at 5%
CAGR. Going ahead, with the availability of Reliance Dairy’s network, procurement is
expected to spurt by ~20% CAGR over FY17‐20E.

Over long term (past 24 years), Heritage expanded its procurement from 20,000LPD in 1993
to 1.04mn LPD in FY17, growing at 18% CAGR. Going ahead, Heritage has set itself a stiff
target of more than doubling its procurement to ~2.8mn litres/day by FY22.

Dairy
Table 6: Direct procurement and diversification
Milk
Direct procurement
Procurement per day (mn
Company mix (%) liters per day) Diversification of procurement base
Parag ~80% 1.2 85% Maharashtra, non‐Maharashtra
proportion reduced from 24% in FY13 to
15% in FY15
Heritage ~95% 1.3 60‐65% from Andhra Pradesh; 35‐40%
from 5 other states
Prabhat ~70% 0.8 100% Maharashtra
Kwality ~25% 3.3 Sources from 3 states ‐ UP, Rajasthan,
Haryana
Hatsun ~100% 2.7 70‐75% from Tamil Nadu; 25‐30% from
4 other states
Vadilal ~35‐40% 0.4
Amul 100% 18.2 Mainly Gujarat (85%) and Maharashtra

As evident from above table, Parag, Heritage Foods, Hatsun, directly procure ~80‐100% of
their milk requirements from farmers and have also diversified outside their home states.

Procuring consistent quality milk Direct procurement infrastructure key
involves measures to distribute Setting up a direct milk procurement network entails significant capex (refer chart below).
quality testing equipment to
The farmers provide milk to Village Level Collection Centres (VLCC) twice daily where milk
village centers and capital
analysers are installed which checks the milk quality for fat & SNF parameters. Then, the
investment in procurement
VLCC tested milk is transported to Bulk milk coolers (BMC) and then to Milk Chilling Centre
infrastructure
(MCC) where it is further tested for quality. Thereon, further samples are taken for
advanced testing which once approved are transported in specialised milk tanker vehicles to
the dairy processing plants for manufacturing the products. Typically, in this model, the
companies own the VLCC, MCC and processing plants. This is the most favoured method as
it ensures that the quality of milk is maintained with testing done at each stage at the VLCC,
BMC, MCC and processing plant.

Fig. 5: Procurement chain of Indian dairy industry
Village level
Bulk Milk Coolers Milk Chilling Centre Dairy Processing
collection centre
(BMC) (MCC) Plant
(VLC)
• Handling Capacity: • Handling Capacity: • Handling Capacity: • Handling Capacity:
500‐2000 litres 10,000‐15,000 litres 20,000‐50,000 litres 0.5‐1mn litres per
• Capex: INR0.2‐ • Capex: INR1.5‐2mn • Capex: INR15‐40mn day
0.3mn • Capex: INR1bn

Dairy
Table 7: Strong procurement network across companies
Milk Collection Milk Chilling
Centres/VLC Bulk Milk Coolers Plant/Centre
Prabhat Dairy 481 115 20
Parag 3,400 NA NA
Heritage 12,774 106 89
Hatsun 10,000 400+ NA
Kwality NA NA 29

 Heritage procures a high 1.34 mn litres per day aided by 195 bulk coolers and chilling
centers, which were fortified with Reliance’s network in the North.
 Prabhat has an established network of 481 milk collection centres (VLCC), 115 bulk milk
Organised has been expanding coolers (located across 600 villages) and 20 chilling centers. The company is looking at
versus unorganised sector by widening its milk collection and chilling network by 80% over next 3 years.
virtue of introducing
standardisation and transparency  Parag has a strong procurement network spread across 29 districts of Maharashtra,
in milk payments. Moreover, Andhra Pradesh, Karnataka, Tamil Nadu having tie‐ups with 3,400 VLCCs.
educating farmers on best dairy
and animal husbandry practices is The organised sector has been expanding market versus unorganised sector by virtue of
further bolstering their introducing standardisation in milk quality testing and transparency in computing the
procurement share
consideration paid to farmers, and the farmers being paid on time without delays for their
milk. Further, educating farmers on best dairy and animal husbandry practices with services
like artificial insemination, cattle feed and fodder at subsidised rates is also helping private
players like Heritage gain further market share.

The above is despite the strength of cooperatives in the respective states. For instance, the
Karnataka state government gives subsidy to farmers for supplying milk to the cooperatives.
This makes it difficult for private players to procure milk from Karnataka.

Table 8: Share of cooperatives’ procurement across states (mn litres)
Co‐operative milk Share of Co‐
State Production procurement operative (%)
Gujarat 12,262 6,381 52
Goa 54 24 45
Karnataka 6,344 2,365 37
Puducherry 48 16 33
Tamil Nadu 7,244 1,110 15
Sikkim 67 10 15
Kerala 2,650 401 15
Maharashtra 10,153 1,330 13
Orissa 1,930 192 10
Bihar 8,288 630 8
Telangana 4,442 260 6
Andhra Pradesh 10,817 486 4
Source: NDDB, Dept of Agriculture

Dairy
2. Right product mix of milk and high growth and high margin VADP
Given one of the lowest average per capita consumption vis‐a‐vis other countries with a
high unorganised market and low VADP penetration, we believe India’s dairy industry is well
poised to grow at ~15‐30% CAGR across categories over FY16‐20E.

It is important to have the right mix of high RoCE milk business along with high growth and
margin VADP to minimise working capital and maximise growth, margins and return ratios.
To illustrate, companies with higher milk sales like Heritage and Hatsun have scaled up
well in terms of establishing a strong direct milk procurement network, clocking higher
RoCE with negligible working capital. These players are also leveraging their established
VADP presents an attractive brands in milk business to expand their VADP share. VADP have been gaining importance
opportunity as: i) These products due to increasing changes in demographic and dietary patterns.
are poised to grow at higher rate;
and ii) They fetch ~1.5‐2x higher We believe VADP presents an attractive opportunity as: i) These products are poised to
EBITDA margins grow at higher rate; and ii) Fetch ~1.5‐2x higher EBITDA margins. We believe Parag is best
placed to capture these advantages with VADP at 64% of sales and expected to catapult to
70% of sales in FY20, which would outweigh the initial drag of lower RoCE of VADP like
cheese. Over FY17‐20, we expect Parag’s RoCE to expand by 1064bps to 19.0 (from 8.4% in
FY17).

Table 9: Industry dynamics
Traditional Value Added Emerging Value Added
Liquid Milk & Milk Powders Products Products
Products Pouch Milk, Skimmed Milk Curd, Paneer, Ghee, Butter, Cheese, Whey Protein, UHT
Powder, Whole Milk Powder, Ice‐cream, Buttermilk Milk, Flavoured Milk, Yogurt
Dairy Whitener
Penetration High Medium Low
Margin
RoCE
Share of Dairy Industry (%) 65.6 32.6 1.9
Key Players (Revenue Share) Heritage (Milk: 65%) Heritage (Curd: 18%) Parag (Cheese+Whey: 22%)
Hatsun (Milk: 68%) Parag (Butter+Ghee: 27%)
Prabhat (Milk Powders: 44%) Prabhat (Ghee: 20%)
Vadilal (Ice‐cream 90%)

Milk, traditional VADP high RoCE; emerging VADP at investment phase
Pouch milk fetches highest RoCE Pouch milk offers highest RoCE (due to negligible capital requirement), asset turn of ~10‐12x,
(due to negligible capital and negative working capital cycle due to low shelf life, despite lower gross margins of ~15%.
requirement), turn of ~10‐12x and Inventory is also negligible as milk procured reaches the consumers in 30 hours and
short working capital cycle receivable days are low as distributors pay within a week of purchasing the milk, while
companies have to pay the farmers once in ~10 days for their raw milk purchase. As a result,
players like Heritage which have revenues of ~65% from fresh milk generate average RoCEs
of ~40%.

Pouch milk: Highest RoCE, basic building block
Direct milk procurement is essential for liquid milk business. Following steady scale up in the
direct procurement network and given perishable nature of liquid milk, the segment is
dominated by regional private dairies or cooperative dairy companies and faces lesser
Dairy
threat from national players even with pan‐India distribution. Further, consumers don’t
easily switch pouch milk brands. Hence, with consumers’ trust reposed on the brands, milk
companies like Heritage and Hatsun are leveraging their brands to expand into VADP.

Table 10: Highest RoCE in milk on high asset turn
Particulars INR/litre Particulars INR mn
Company Realisation (A) 33 WC Cycle (days) 5
Milk Requirement (litre) 1 Production (mn kgs) 300

Milk Price 28 Annual Revenue 9,913
Total Cost (B) 28
Capex 700
Gross Profit (C) (A‐B) 5 WC 136
Gross Margin (%) 15 Total Capital Requirement 836
Less: Operating Expenses @ 11% 4 EBITDA 423

Deprecitaion 56
EBITDA 1 EBIT 367
EBITDA Margin (%) 4
RoCE 44%

Traditional VADP
 Fresh products: High margins with low working capital
Fresh products like curd and Companies are moving up the curve into traditional VADP to include fresh dairy
paneer are highly profitable and products like curd, paneer and buttermilk as it’s a natural extension since: 1) They are
also generate higher return ratios leveraging the same pouch milk supply chain; and 2) Allows players to utilise the unsold
considering limited working capital pouch milk to produce fresh dairy products like curd and paneer.
requirement
Products like curd and paneer are highly profitable and also generate higher return
ratios considering limited working capital. For instance, curd involves lower working
capital (as it has shelf life of 3‐15 days depending on the pouch quality or whether it is
set curd), but fetches higher margins (gross margins of ~30‐33% and EBIDTA margins of
~18‐22%), leading to higher RoCE. Companies like Heritage have 18% of sales coming
from curd, leading to better margins with high RoCE.

Curd contributes 18% to Heritage’s On account of limited shelf life, these products can be sold only via direct distribution
sales, leading to better margin to retailers. Hence, companies engaged in pouch milk business are better placed to
with high RoCE grow in packaged curd as they can leverage their regional processing and supply chain
set up to produce curd.

Dairy
Table 11: Pouch curd fetches high margins, return ratios
Particulars INR/litre Particulars INR mn
Company Realisation (A) 46 WC Cycle (days) 10
Milk Requirement (litre) 1 Production (mn kgs) 100

Milk Price 32 Annual Revenue 4,600
Total Cost (B) 32
Capex 2200
Gross Profit (A‐B) 14 WC 126
Gross Margin (%) 30 Total Capital Requirement 2,326
Less: Operating Expenses 6 EBITDA 848

Deprecitaion 176
EBITDA 8 EBIT 672
EBITDA Margin (%) 18
RoCE 29%
Note: We have calculated for buffalo milk, taking cue from Heritage

 Ghee and SMP: More capital intensive
Whenever any milk player receives excess supply of milk from the farmers, they
have to accept it. If the demand for fresh products, such as, milk and dahi (curd) is
limited, the company converts the excess milk into longer shelf‐life products like
skimmed milk powder and milk fats. Thus, the milk business can provide raw
material for other sub‐segments. A litre of cow’s milk has 3 components ‐ 3.5% fat,
7.5% SNF (solid not fat, which includes protein, calcium and other minerals), and
Parag’s leading ghee brand, water. When any company sells standard milk, it sells milk with 3‐4% fat and saves
Gowardhan, contributes 22% to some fat for the manufacture of products such as ghee and butter. Ghee can be
sales and has ~10‐15% EBITDA sold in bulk at ~5% margins.
margin
Parag has strong ghee brands in Gowardhan, which contributes 22% of sales,
realizes ~24‐28% gross margin and registers 10‐15% EBITDA margin. SMP is sold
through bulk and wholesale channels.

Dairy
Table 12: Ghee (B2C) generates 15‐20% RoCE
Particulars INR/kg Particulars INR mn
Ghee WC Cycle 95
Production (kgs) 1
Company Realisation 417 Ghee Production (mn kgs) 25
SMP Production (mn kgs) 40
SNF generated (kgs) 2.5
Realisation (INR/kg) 160
Company Realisation 400 Annual Revenue 26,417
Total Revenue 817 Capex 5000

WC 6,876
Milk Requirement (litre) 20 Total Capital Requirement 11,876
Milk Price 28
Milk Cost 560 EBITDA 2,663
Packaging and Other Costs 60 Deprecitaion 400
Total Costs 620 EBIT 2,263
RoCE 19%
Gross Profit 197
Gross Margin (%) 24
Less: Operating Expenses @ 14% 114
EBITDA 82
EBITDA Margin (%) 10
Emerging VADP at investment phase; rising B2C, whey consumer to improve RoCE
Going ahead, growth in most emerging VADP categories is expected to be strong given the
current landscape (mentioned earlier). Even though emerging VADP like cheese are capital
Even though emerging VADP,
cheese, is capital intensive with intensive with lower asset turn (1.5x) and higher working capital cycle (cheese needs to be
lower asset turn, it offers high cured and has high inventory of 2 months), leading to relatively lower RoCE than milk and
growth and margins traditional VADP. But, it offers highest growth and margins. Further, around 50% of cheese
is sold in institutional and HORECA segments, due to which blended realisations are lower
than pure B2C sales.
We believe improving brand awareness and rising B2C sales will lower debtor days and lead
to gradual improvement in RoCE for bigger emerging VADP’s like cheese, which currently
enjoy high share (~50%) of B2B in their mix.
Players, which have achieved scale
in VADP like cheese, can venture Players that have achieved scale in VADP like cheese can venture out to explore whey
into whey consumer—a high gross consumer, a high gross margin product (45%), much higher than the entire VADP pack.
margin product (45%), entailing However, it entails significant capital investment. For instance, Parag has invested way
higher blended RoCE than pure ahead of the curve and attained substantial scale in cheese to venture into whey consumer.
cheese Hence, we believe investment in emerging VADP like cheese will yield higher for players like
Parag (~20% of sales) who have invested in VADP like cheese much ahead of the value curve
and ventured into high‐margin whey consumer thereby providing a higher blended ROCE
than pure cheese players.

Dairy
However, with the sector at investment phase, return ratios are depressed ‐ Parag has
generated average 12% pre‐tax RoCE in past 5 years, which we expect will improve to 18%
by FY20. Globally, companies well‐entrenched in VADP like Glanbia, a leader in whey
consumer and Kraft in cheese generate double digit EBIDTA margins of ~16%. Glanbia
generates 18% RoCE in performance nutrition division (whey consumer).

Table 13: Cheese (blend of B2B and B2C), whey consumer have potential to generate pre‐tax RoCE of 25%
Revenue (for 10l of milk) INR Cost (for 10l of milk) INR INR mn
Cheese Milk Cash Conversion Cycle (days) 90
Production (kgs) 1 Milk Required (litres) 10
Realisation (INR/kg) 310 Price of Milk 28 Annual Volume
Total Milk Cost 280 Cheese (mn kgs) 18
Institutional Whey Add: Packing and other cost 230 Institutional Whey (mn kgs) 5
Production (kgs) 0.3 Total Costs 510 Whey Consumer (mn kgs) 1
Realisation 163
Net Revenue (INR) 49 Gross Profit (B) 282 Annual Revenue
Gross Margin (%) 36% Cheese 5431
Consumer Whey Institutional Whey 791
Production (kgs) 0.2 Operating Costs Whey Consumer 2529
Realisation 2165 Ad Spends @ 6% 48 8751
Net Revenue (INR) 433 Other Op Exp @ 10% 79
Total ( C) 127 Working Capital 2158
Total Revenue (A) 792 Capex 3500
EBITDA (B‐C) 155 Total 5658
EBITDA Margin (%) 20%
OP 1715
Less: Depreciation 280
EBIT 1435

RoCE 25%
Note: Above RoCE of cheese is assuming 55:45 B2C:B2B mix, taking cue from Parag. With
Heritage commands highest RoCE improving mix towards B2C, RoCE can further improve. We have assumed 80% capacity
in the entire dairy pack with milk utilization for cheese and whey consumer.
contributing 65% to revenue.
Further, its increasing scale in
traditional and fresh VADP from Product mix of Indian dairy companies
24% to ~30% of sales is aiding A mix of high‐RoCE milk segment, and leveraging established milk brands for high growth
sustain high RoCE and margin VADP is a theme prevailing across all Indian dairy companies, who have set their
eyes on continuously increasing the share of higher‐margin VADP. These companies include
Heritage and Hatsun who derive highest proportion of their revenues from milk (65‐68%),

while for others majority of their revenue comes from non‐milk products. Heritage

commands highest RoCE in the entire dairy pack.

Parag has the best scale in VADP at
64% of sales along with strong But, milk entails lower margins and scalability hinges on enhancing procurement reach,
branding and product mix which takes time to develop. Competition from cooperatives is also getting fiercer. To
succeed it has become imperative for players to leverage their procurement to extend into
other VADP.

Dairy
Penetration of organised players in VADP categories is comparatively lower than in liquid
milk, with many of these categories in low‐single digit penetration. However, over next 3
years, led by rising income levels, increasing urbanisation and improving dietary habits,
emerging (organised) VADP categories are estimated to grow at 25% CAGR.

In the long run, we believe companies with higher share of VADP, strong branding,
differentiated products and distribution network for B2C channel will earn higher margins,
record higher growth and survive the cooperatives. In our view, Parag has the best scale in
VADP at 64% of sales along with strong branding and product mix. Heritage and Hatsun are
also moving into traditional VADP, which will lead to better margins and sustain high RoCE.

Table 14: Revenue mix of Indian dairy players – Heritage, Hatsun strong in fresh milk, Parag best‐in‐class in VADP
Product mix (%) Prabhat Parag Heritage Kwality Hatsun Vadilal Amul
Commodity Products 70 34 66 68 68 0 66
Liq Milk 14 22 65 41 68 55
Milk Powder 44 13 1 27 11
Sweetened Condensed Milk 12
Value Added products 26 64 30 25 28 90 34
Curd 1 5 18 7 7 1
Paneer 1 2 1 0
Cheese+Whey 2 22 0 3
Others 2 1 13
Butter 0 5 7 18 10
Ghee 20 22 8
Icecreams 1 2 8 90
UHT/Flavored milk 1 6 1 11
Others
Processed foods 9
Others 4 3 4 7 4 1

3. Channel Mix: Strong branding leading to higher B2C sales
Heritage and Hatsun have strong India’s favourable demographics have seen increasing consumerism and rapid urbanisation.
B2C franchisees in milk ‐ >80% of As a result, rising consumption of VADP and variants of milk has seen players expanding
sales their B2C mix. Heritage and Hatsun have a strong distribution network in their respective
territories which has led to creation of strong B2C franchise and >90% of sales are through
this segment. However, there are certain VADP like cheese, which are consumed ~50% out
of home. Also, categories like butter, paneer and SMP are institutional in nature. Parag is
Parag is strong in VADP due to strong in VADP due to strong brand building. But, its B2B sales only include cheese. Hence,
strong brand building with B2C mix overall B2C and B2B mix stands at 70:30, respectively.
at 67%, though diluted by out‐of‐
home consumption of cheese
Table 15: Fresh dairy players lead in retail sales
Channel mix Heritage Hatsun Vadilal Parag Kwality Prabhat
Retail 100 100 100 67 40 27
Institutional 0 0 0 33 60 73

Dairy
4. Branding: Ramping up the value proposition
As companies move up the curve into VADP it becomes critical to engage in brand building.
Branding offers multiple advantages viz: 1) Better realisations ‐ National brands like
Gowardhan ghee enjoy better realisations; 2) Easier to build product portfolio around an
established core brand ‐ Parag has been able to offer a full portfolio of cheese products and
variants around its core Go cheese brand.

Table 16: Investment in brand‐building – ad spends as a % of sales
Hatsun Agro Products Ltd. 1.52 2.02 2.20 2.31 2.60
Parag and Hatsun spend the Parag Milk Foods Ltd. 1.87 1.19 1.71 2.32 2.98
highest in brand building at ~2.5‐ Prabhat Dairy Ltd. 0.30 0.48 0.80 0.80 1.22
3% of sales Kwality Ltd. 0.09 0.13 0.34 0.07 0.30
Heritage Foods Ltd. 0.10 0.13 0.13 0.20 0.19

Table 17: Pricing premium of brands – Gowardhan and Go command 4‐5% premium
Premium/
Brand Description Size MRP Discount (%)
Ghee
Gowardhan Premium Cow Ghee (Jar) 1lt 565
Amul Pure Ghee (Tin) 1lt 505 11.9
Prabhat Pure Cow Ghee (Jar) 1lt 550 2.7
Dynamix Cow Ghee (Jar) 1lt 565 0.0
Cheese
Go Cheese slices 200gms 135
Amul Cheese slices 200gms 118 14.4
Mother Dairy Cheese slices 200gms 130 3.8
Britannia Processed cheddar slices 200gms 145 ‐6.9

Dairy
Company‐wise dynamics

Margins
Heritage is predominantly into pouch milk and hence registers low profitability. Parag owing
to its higher VADP share enjoys higher gross margins than peers at 27% (22% for Heritage).
Hatsun and Vadilal too records higher gross margins due to presence in higher gross margin
ice creams, which accounts for larger proportion of VADP sales. While Heritage had ~8%
EBIDTA margins, we believe with the higher investments in brand building the margins will
remain range bound. With investments required in A&P spends for B2C business, Parag’s
EBIDTA margin is only in high single digits (average of 8% in past 7 years). But, with VADP
gaining ground we expect Parag’s gross margins to improve and impel EBIDTA margins to
9.6% in FY20. Comparatively, Prabhat records higher EBIDTA margins due to proximity to
sourcing and customers, which keeps logistics costs low.

Table 18: Product‐wise– Whey (consumer), ice‐cream fetch highest gross margins
Product Gross Margin (%)
Vadilal leads the pack with gross Milk 15‐18
margins at 57%. Higher margin ice‐ Milk Powders 5‐8
cream business also aids Hatsun’s Curd 30‐33
high gross margin at 27%, followed
Paneer 25‐30
by Parag with higher VADP
Ghee 24‐28
Butter 15‐18
Ice‐cream 45‐50
Cheese 30‐34
Whey (consumer) 40‐50
Flavoured Milk 25‐30
Source: Industry

Table 19: Company‐wise gross margins: Vadilal leads followed by Parag and Hatsun
Company (%) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Vadilal 40 56 57 58 52 57 57 NA NA NA
Hatsun 25 25 24 26 26 28 27 NA NA NA
Parag 22 22 25 23 26 27 27 29 30 30
Heritage 20 20 23 22 19 21 22 21 22 22
Prabhat Dairy NA 21 21 21 23 20 19 22 22 23
Kwality 9 9 8 8 9 8 10 NA NA NA

Dairy
Table 20: Product‐wise EBIDTA margin – VADP generate higher EBITDA margins
Vadilal leads the pack in EBITDA Product EBITDA Margin (%)
margin at ~12%, followed by Milk 3‐5
Prabhat at ~9‐10% due to Milk Powders 0‐2
proximity to sourcing and Curd 18‐22
customers; Heritage and Hatsun Paneer 18‐22
clock ~7‐9% Ghee 10‐15
Butter 5‐8
With VADP gaining ground, we Ice‐cream 15‐18
expect Parag’s EBIDTA margin to Cheese 14‐18
jump to 9.6% in FY20 from
historical average of 8%

Table 21: Company‐wise EBIDTA margin – Vadilal and Prabhat lead with Parag to follow
Company (%) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Vadilal 10 13 11 11 10 13 12 NA NA NA
Prabhat Dairy NA 10 11 10 10 10 9 9 9 10
Parag 8 9 9 8 7 9 6 9 9 10
Hatsun 7 7 7 7 7 9 9 NA NA NA
Heritage 7 7 10 9 6 8 8 6 7 8
Kwality 6 7 6 6 6 6 7 NA NA NA

Cash Conversion Cycle and Asset Turns
Heritage and Hatsun have healthy/shorter cash conversion of 14‐23 days. Hence, their
average CFO/EBIDTA is 80% and 95%, respectively, due to significantly higher presence in
pouch milk which entails very short working capital cycle. As companies shift to higher VADP
in B2C channel, working capital needs rise as they have to offer higher credit periods to the
channel. Further, in VADP like cheese, inventory days are higher at 3‐6 months as curing
depends on the type of cheese. Hence, for Parag cash conversion takes longer time at 80
days. For Prabhat working capital towards B2B business is high due to higher debtor days,
which leads to stretched cash conversion cycle.

Table 22: Product‐wise cash conversion cycle – Milk has the fastest operating
turnover
Cash Conversion Cycle
Product
(days)
Milk 5‐7
Milk Powders 20‐25
Curd 10‐15
Paneer 15‐20
Ghee 90‐95
Butter 10‐20
Ice‐cream 30‐40
Cheese 90‐95
Source: Industry, Edelweiss resarch

Dairy
Table 23: Player‐wise cash conversion cycle: Heritage, Hatsun most favourable cash conversion due to higher milk
Company (days) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Heritage Foods 12 12 11 12 15 16 14 14 12 12
Hatsun Agro products 13 18 16 7 14 28 23 NA NA NA
Vadilal 122 118 106 111 93 66 64 NA NA NA
Parag 71 79 77 57 64 80 81 82 80
Prabhat 29 38 53 67 75 83 93 96 96
Kwality 105 91 82 87 91 97 97 NA NA NA

Table 24: Product‐wise asset turn – Milk generates the highest asset turn
Heritage leads the pack in cash Product Asset Turn (x)
conversion cycle due to high Milk 12.0
presence in milk, which entails Curd 2.0
very short working capital cycle Ghee 2.5
Cheese 1.6

Table 25: Player‐wise asset turn – Heritage clocks highest
Company (x) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Heritage 5.9 7.6 8.7 7.7 7.8 8.2 7.2 4.7 4.8 4.9
Hatsun Agro 3.3 3.6 4.2 4.0 3.7 3.8 3.7 NA NA NA
Kwality 3.1 3.5 3.8 3.6 3.4 3.0 2.7 NA NA NA
Parag 1.8 2.1 1.7 1.7 2.1 2.2 2.0 2.0 2.2 2.5
Prabhat Dairy 1.1 1.3 1.5 1.4 1.5 1.5 1.5 1.6 1.7
Vadilal 1.2 1.0 1.0 1.0 1.1 1.3 1.3 NA NA NA

RoCE
Heritage scores high on RoCE due to milk and increasing VADP sales: Heritage has higher
Players in VADP pack have higher
asset turn due to higher share of milk business and lower working capital resulting in highest
working capital needs as they have
to offer higher credit periods RoCE among peers. Leveraging its fresh milk brand, it has now moved into high‐margin
VADP like curd, which has helped perk up margins. We are enthused by Heritage’s strategy
of enhancing milk sales and procurement geographically, and extending VADP sales with
focus on maintaining their already high RoCE. As for Hatsun, despite having higher milk
business, RoCE is at ~22% (versus 40% for Heritage) due to high investments made for
increasing procurement beyond the home state, leading to high capital costs.

Investing in high‐growth emerging VADP ahead of time to increase RoCE: Parag has low
RoCE due to high investment of INR3.5bn in past 8 years in high growth and margin VADP
categories like cheese and whey consumer in turn creating significant entry barriers for
other prospective players. As Parag scales up its VADP (cheese and whey) sales, we expect
RoCE expansion by 1064bps to ~19% over FY17‐20.

Dairy
Table 26: Product‐wise RoCE – Milk generates the highest RoCE
Milk has highest RoCE, followed by Product RoCE (%)
curd Milk 44‐48
Curd 30‐32
Ghee 15‐20
Butter 5‐10
Cheese 20‐22

Table 27: Player‐wise RoCE – Heritage scores highest
RoCE‐Dairy (%) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Heritage Foods* 21.4 36.5 66.8 52.0 31.4 52.0 39.4 32.3 38.8 41.7
Vadilal Intl 15.1 16.9 20.7 20.4 14.7 23.3 22.1 NA NA NA
Hatsun Agro 15.1 16.9 20.7 20.4 14.7 23.3 22.1 NA NA NA
Kwality 18.9 23.3 20.4 20.5 19.6 18.3 17.3 NA NA NA
Parag 14.5 11.4 9.1 12.3 16.4 8.4 13.7 15.2 19.0
Prabhat Dairy 0.0 11.6 11.0 11.2 10.8 9.9 9.5 11.7 14.4
*Adjusted RoCE – Adjusted for demerged segments and Future Retail investment

Heritage leads the pack in RoCE
due to milk business with high
asset turn

Parag lags in RoCE; however, with
high investments over the years,
we estimate RoCE to catapult
1064bps to ~19% over FY17‐20
Dairy
Outlook and Valuation

 In the domestic dairy industry, we perceive rerating potential for the under‐
penetrated but emerging VADP players. Accordingly, we initiate coverage on Parag
with a ‘BUY’ and target price of INR340, based on P/E of 24x FY20E, which is
~28%/20% discount to FMCG median and fresh dairy players like Heritage,
respectively, and implies 40% upside. We believe the discount will narrow, with
improving margins and ROCE, and move inline with global trend of VADP players
trading in line with FMCG peers.
 We believe fresh dairy products players are comparable to the Indian FMCG
players ‐ the latter command strong brands, superior RoCE, and have significant
scope for growth led by the shift to organised segment. Accordingly, we initiate
coverage on Heritage with a ‘BUY’ and target price of INR976, based on P/E of 30x
FY20E, which is at ~10% discount to our FMCG universe and implies ~29% upside.
 We value Prabhat at 22x FY20E P/E, which is at 34% discount to domestic FMCG
players, 27%/8% discount to Heritage/Parag due to higher B2B sales. However, with
shifting focus to value‐added products and B2C segment we believe the discount
will narrow.

Globally VADP companies trade in line with their FMCG peers
India has strong potential of ~15‐30% plus CAGR in VADP over next few years. We perceive
Globally, value‐added dairy rerating potential for under‐penetrated emerging VADP‐oriented (cheese, whey, UHT milk etc)
companies trade in line with their
companies like Parag due to their growth prospects. They are likely to follow the footsteps of
FMCG peers
global VADP dairy players, which trade in line with their FMCG peers. However, in the interim

as the emerging VADP (~27% of sales in FY17), is capital intensive versus traditional dairy
companies, we have valued Parag at 24x FY20E EPS and 28%/20% discount to FMCG players
and Heritage’s target FY20E P/E of 20x FY20E, respectively. Going ahead, we believe this
discount to FMCG peers will gradually reduce with improving return ratios and margins.

Drawing comparisons with Indian FMCG peers

We believe fresh dairy products companies are comparable to the Indian FMCG players, which
command strong brands, growth and superior RoCEs, and hence available at median P/E of
33x FY20E. Comparatively, Heritage derives ~83% of sales from fresh dairy products and has
strong regional moat, leading to healthy return ratio of ~42%. In fresh dairy segments where
Heritage is a major player, the shift from unorganised to organised is huge. Hence, we assign
mere 10% discount to Heritage versus its Indian FMCG peers.

Parag: Redefining categories
We believe Parag is well placed to capture the dairy opportunity in India as it metamorphoses
We have valued Parag at 24x FY20E to a branded dairy consumer player through significant investments in VADP (currently at
P/E, which is at 28% discount to strong ~64% of sales and set to grow to 70%), dedicating capex much ahead of the curve
domestic FMCG players due to
and incurring high ad spends. This will help it grow EBIDTA ~2.3x and register 49% CAGR in
capital‐intensive emerging VADP;
going ahead, we believe, this net profit over FY17‐20E with 1064bps expansion in pre‐tax RoCE to 19%. We initiate
discount will narrow with improving coverage on Parag with a ‘BUY’ and target price of INR340, implying 40% upside from current
return ratios and margins levels, based on P/E of 24x FY20E (at ~28% discount to our FMCG universe and 20% discount
to fresh dairy product company, Heritage). At CMP, Parag is available at 24.0x FY19E and
17.1x FY20E P/E.

Dairy
Heritage: Leveraging moat to take the right stride
We have valued Heritage at 30x We like Heritage Foods as: 1) It is a strong franchisee in the high‐RoCE milk business in the
FY20E P/E, mere ~10% discount to South; and 2) It targets to be a pan‐India VADP player, straddling high‐RoCE and margins
domestic FMCG players, led by curd, yogurt and ice‐cream segments. We estimate 21% EBIT CAGR and highest pre‐tax RoCE
strong regional moat yielding at ~42% to sustain over FY17‐20. We initiate coverage on Heritage with a ‘BUY’ and target
healthy return ratio at ~40% and price of INR976, implying ~29% upside from current levels, based on P/E of 30x FY20E (which is
scope of shift in the huge fresh at ~10% discount to our FMCG universe). At CMP, the stock is available at 35.2x FY19E and
dairy segments that Heritage deals 25.9x FY20E P/E.
in

Prabhat: Metamorphosing into value‐added B2C player
With Prabhat shifting focus to value‐added products and B2C segment, we estimate sales,

We value Prabhat at 22x FY20E P/E, EBITDA and PAT CAGR of 15%, 19% and 39%, respectively, over FY17‐20. We maintain ‘BUY’
which is at 34% discount to with TP of INR211, 22x FY20E EPS (34% discount to FMCG players, 27%/8% discount to
domestic FMCG players due to Heritage/Parag), implying 30% upside from current levels. At CMP, the stock trades at 23.4x
higher B2B sales; with shifting FY19E and 17.0x FY20E EPS.
focus to value‐added products and
B2C segment we believe the We believe Parag, Heritage and Prabhat are well placed to capture the organised milk
discount will narrow
consumption and increasing VADP uptick in India’s dairy space. This, we believe, will enable
them to register a sustainable run over competition.


Table 28: Valuation snapshot
FY17
FY17‐20E FY17‐20E
Company Name Currency M Cap EBITDA P/E (x) EV/EBITDA (x) EV/Sales (x) RoE (%)
Sales CAGR PAT CAGR
margin
Dairy
(%) (%) (%) FY17 FY18E FY19E FY20E FY17 FY18E FY19E FY20E FY17 FY18E FY19E FY20E FY17 FY18E FY19E FY20E
Global Dairy
Dean Foods USD 1,016 (1.1) (18.6) 5.9 7.1 14.0 13.3 12.8 4.3 5.5 5.4 5.5 0.3 0.2 0.3 0.3 20.7 11.7 10.3 10.1
Fonterra NZD 10,345 6.7 11.4 8.6 13.9 12.1 10.9 10.1 9.9 8.6 8.1 7.6 0.8 0.8 0.7 0.7 10.5 11.7 12.6 13.1
China Mengniu Dairy Co HKD 78,466 9.2 24.6 7.5 32.4 27.1 19.8 16.9 17.7 14.0 11.7 10.3 1.3 1.2 1.1 1.0 (3.5) 10.7 13.4 14.3
Parmalat EUR 5,844 4.3 15.0 8.6 39.4 38.4 26.3 22.5 10.4 12.2 10.5 9.6 0.9 0.9 0.8 0.8 2.5 4.0 6.5 7.0
Mean 4.8 8.1 7.6 23.2 22.9 17.6 15.6 10.6 10.1 8.9 8.3 0.8 0.8 0.7 0.7 7.6 9.5 10.7 11.1
Median 5.5 13.2 8.0 23.1 20.5 16.5 14.9 10.1 10.4 9.3 8.6 0.9 0.8 0.8 0.7 6.5 11.2 11.5 11.6
Global VADP Companies

Nestle SA CHF 26,511 2.9 6.8 18.8 24.8 24.2 22.1 20.0 16.9 16.4 15.3 14.2 3.2 3.1 3.0 2.9 13.4 16.0 17.1 18.9
Danone EUR 47,138 7.3 11.7 17.8 22.7 20.6 18.5 16.7 16.8 14.9 13.6 12.6 3.0 2.6 2.5 2.4 13.4 15.1 16.0 16.4
34
Glanbia EUR 4,574 (3.6) 8.2 10.7 20.0 17.5 16.6 15.3 17.7 16.2 15.7 14.8 1.9 2.3 2.2 2.1 18.7 17.7 16.4 15.6
Almarai SAR 55,560 4.5 7.3 29.5 26.7 25.0 24.2 21.6 15.5 16.2 15.5 14.7 4.6 4.6 4.3 4.0 16.1 15.4 16.1 16.6
Vietnam Dairy Products VND 284,455,700 13.0 11.6 25.1 33.6 28.8 25.4 22.7 23.4 20.4 17.9 16.3 5.9 5.3 4.7 4.1 39.3 46.6 48.1 47.8
Mean 4.8 9.1 20.4 25.6 23.2 21.3 19.3 18.1 16.8 15.6 14.5 3.7 3.6 3.4 3.1 20.2 22.2 22.7 23.1
Median 4.5 8.2 18.8 24.8 24.2 22.1 20.0 16.9 16.2 15.5 14.7 3.2 3.1 3.0 2.9 16.1 16.0 16.4 16.6
Global FMCG
Unilever Plc EUR 140,735 2.7 10.2 18.0 25.5 21.8 20.0 17.8 16.3 14.4 13.7 12.7 2.9 2.9 2.8 2.7 32.6 35.2 45.7 53.0
Procter & Gamble Co/The USD 228,300 3.1 4.9 26.4 23.0 21.6 20.3 19.0 14.4 14.0 13.4 12.9 3.8 3.7 3.6 3.5 27.8 19.3 20.2 23.4
Reckitt Benckiser Group Plc GBP 45,478 11.5 9.1 29.9 21.7 19.7 17.9 16.6 20.3 17.7 15.7 14.8 6.1 5.2 4.5 4.4 23.9 24.4 23.4 22.6
Colgate‐Palmolive Co USD 63,619 3.0 4.6 29.1 25.8 25.2 23.6 21.8 62.2 62.6 59.2 56.1 18.1 17.8 17.2 16.6 NA NA NA NA
Mean 5.1 7.2 25.9 24.0 22.1 20.4 18.8 28.3 27.1 25.5 24.1 7.7 7.4 7.0 6.8 28.1 26.3 29.8 33.0
Median 3.1 7.0 27.8 24.2 21.7 20.1 18.4 18.3 16.0 14.7 13.8 5.0 4.4 4.1 3.9 27.8 24.4 23.4 23.4
India FMCG
Nestle India INR 742,059 9.3 23.2 18.8 79.4 62.4 50.8 42.4 41.8 38.1 31.7 26.9 7.9 7.4 6.8 6.0 31.8 38.6 45.4 51.8
Dabur INR 600,238 10.5 13.0 19.6 47.0 43.0 37.4 32.6 39.6 36.9 32.2 28.2 7.8 7.3 6.5 5.8 28.3 26.6 26.4 26.7
Britannia INR 576,998 14.0 19.3 14.3 65.2 56.8 46.8 38.4 44.6 38.3 31.8 26.4 6.4 5.7 5.0 4.3 37.0 33.0 32.3 32.5
Marico INR 400,655 12.9 13.9 19.6 50.0 46.1 38.8 33.4 33.7 32.3 27.3 23.6 6.6 6.0 5.2 4.6 36.8 34.7 36.8 39.1
GSK Consumer INR 255,786 12.4 11.5 22.1 39.0 36.6 32.0 28.1 26.8 26.7 23.1 20.2 5.9 5.2 4.7 4.2 22.2 21.5 22.3 22.7
Mean 11.8 16.2 18.9 56.1 49.0 41.1 35.0 37.3 34.5 29.2 25.0 6.9 6.3 5.6 5.0 31.2 30.9 32.6 34.5
Median 12.4 13.9 19.6 50.0 46.1 38.8 33.4 39.6 36.9 31.7 26.4 6.6 6.0 5.2 4.6 31.8 33.0 32.3 32.5
India Dairy
Heritage Foods INR 35,188 22.9 18.4 7.7 43.1 54.7 35.2 25.9 24.6 25.1 17.5 13.4 1.3 1.4 1.2 1.0 30.2 19.9 26.0 28.5
Hatsun Agro INR 133,939 18.8 43.4 9.1 100.0 81.7 61.2 33.9 37.2 30.3 24.6 17.1 3.4 2.9 2.5 2.0 46.4 35.3 34.8 49.5
Kwality INR 23,939 10.3 19.1 6.6 12.3 11.0 8.7 NA 8.5 7.1 6.0 NA 0.6 0.5 0.5 NA 19.7 16.7 17.7 NA
Parag INR 20,339 14.1 48.9 6.2 56.4 27.8 24.0 17.1 20.3 12.9 10.8 8.5 1.3 1.2 1.0 0.8 7.1 10.6 11.0 13.8
Prabhat INR 15,911 14.8 38.9 9.0 45.5 37.1 23.4 17.0 14.1 12.8 10.3 8.3 1.3 1.1 1.0 0.8 5.8 6.7 9.9 12.4
Mean 16.2 33.7 7.7 51.4 42.5 30.5 23.5 21.0 17.6 13.9 11.8 1.6 1.4 1.2 1.2 21.8 17.8 19.9 26.1
Median 14.8 38.9 7.7 45.5 37.1 24.0 21.5 20.3 12.9 10.8 11.0 1.3 1.2 1.0 0.9 19.7 16.7 17.7 21.2
Note: Parmalat has 93% sales from dairy, Nestle SA 16%, Danone 49%, Almarai 76% and Glanbia has 35% sales from Global performance nutrition.
Note: Kwality's CAGR calculation is for FY17‐19
Dairy
Annexure

Milk Prices

Chart 1: Milk price in Delhi
48 40
41 31
(INR/litre)
35 22
(%)
28 12
22 3
15 ‐6
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Milk Price % Change


Chart 2: Milk price in Gujarat
50 19
46 15
(INR/litre)
42 10
(%)
38 6
34 1
30 ‐3
Milk Price % change

Source: Amul, Edelweiss research

Dairy
Chart 3: Milk price in Andhra Pradesh
35 20
32 15
(INR/litre)
29 10
(%)
26 6
23 1
20 ‐4
Milk Price % Change

Source: Heritage, Edelweiss research

Chart 4: Milk price in Maharashtra
32 40
29 30
(INR/litre)
25 20
(%)
22 10
18 ‐
15 ‐10
Milk Price % Change

Source: Prabhat, Edelweiss research

Dairy
Table 1: State wise milk production – national share and 3 year CAGR
FY16 (mn litres) Share (%) CAGR (%)
Uttar Pradesh 26,387 17.0 4.2
Rajasthan 18,500 11.9 9.9
Gujarat 12,262 7.9 5.9
Madhya Pradesh 12,148 7.8 11.2
Andhra Pradesh 10,817 7.0 (5.4)
Punjab 10,774 6.9 3.5
Maharashtra 10,153 6.5 5.1
Haryana 8,381 5.4 6.0
Bihar 8,288 5.3 6.6
Tamil Nadu 7,244 4.7 1.1
Karnataka 6344 4.1 3.5
West Bengal 5038 3.2 1.2
Telangana 4442 2.9 NA
Kerala 2650 1.7 (1.7)
J & K 2273 1.5 11.7
Source: NDDB, Edelweiss research

Dairy

THIS PAGE IS INTENTIONALLY LEFT BLANK

India Midcaps
INITIATING COVERAGE

PARAG MILK FOODS
Redefining categories
India Equity Research| Dairy
EDELWEISS RATINGS
Parag Milk Foods (Parag) has made a commendable leap in a short span
by capturing leading market share in high‐margin value‐added products Absolute Rating BUY
(VADP)—No. 2 in cheese (32% market share) and largest cow ghee brand Investment Characteristics Growth
in India. We estimate VADP’s share in sales to catapult to 70% (64%
currently) over FY17‐20 riding sustained innovation focus, investment in MARKET DATA (R: NA, B: PARAG IN)
high‐margin products (whey consumer) and capacity augmentation. CMP : INR 242
Hence, we envisage Parag’s EBITDA to jump ~2.3x and RoCE to catapult
1064bps to 19.0% over FY17‐20E. Initiate with ‘BUY’ valuing at 24x FY20E Target Price : INR 340
P/E, with TP of INR340, implying 40% upside. 52‐week range (INR) : 292 / 203
Share in issue (mn) : 84.1

M cap (INR bn/USD mn) : 20 / 309
Innovation focus, capacity augmentation to bolster value add share
Avg. Daily Vol. BSE/NSE (‘000) : 334
Parag boasts of strongest value‐added portfolio—cheese, ghee, paneer, UHT, curd—
contributing 64% to sales, way ahead industry’s 34%, with strong 170 plus SKUs. This SHARE HOLDING PATTERN (%)
has resulted in it gaining leading market share in VADP (cheese, ghee) in record time.
Further, we estimate its VADP sales share to jump to 70% spearheaded by: a) Current Q1FY18 Q4FY17
sustained focus on innovation—introducing 3‐4 products per year; b) overall 53% Promoters * 48.7 48.2 47.5
MF's, FI's & BKs 12.2 2.7 2.3
capacity expansion led by—cheese 50%, whey 150%, paneer 4x, UHT 48% and curd
FII's 19.9 21.2 24.4
33%. Management is targeting INR1.5bn sales (INR15bn category) in 3 years and Others 19.2 27.93 25.9
INR3bn in 5 years in whey consumer brand Avvatar fortifying its VADP sales. * Promoters pledged shares : NIL
(% of share in issue)
Improving mix to spur earnings and return ratios
The company’s biggest competitive advantage is the scale created—invested INR3.5 bn PRICE PERFORMANCE (%)
over FY08‐17 on high‐margin cheese and whey. This has enabled Parag move up value Sensex Stock
Stock over
Sensex
chain into whey consumer, a strong 45% gross margin segment (other VADP 25‐40%
1 month 1.7 (10.4) (12.1)
gross margin). Hence, we estimate the already strong gross margin (27%) to surge
3 months 6.2 (2.8) (9.1)
303bps to 30.3% and EBIDTA margin by 335bps to 9.6% over FY17‐20. It will also 12 months 28.0 (12.6) (40.6)
strengthen its moat by enhancing capital efficiency, leading to RoCE expanding
1064bps.

Outlook and valuations: Solid value‐added play; initiate with ‘BUY’
With strongest position in VADP and further moving up the value chain, along with
strong brands and innovative portfolio, we have valued the stock at 24x FY20E EPS
(~28% discount to FMCG estimates). With robust earnings visibility with revenue and
PAT CAGR of 14% and 49%, respectively over FY17‐20E, initiate with ‘BUY’.

Financials
Year to March FY17 FY18E FY19E FY20E Shradha Sheth
+91 22 6623 3308
Net Revenues (INR mn) 17,307 19,027 22,144 25,680
[email protected]
EBITDA (INR mn) 1,082 1,715 1,984 2,466
Adjusted PAT (INR mn) 361 733 847 1,190 Sanyam Jain
+91 22 4040 7412
Adjusted Diluted EPS (INR) 4.3 8.7 10.1 14.2 [email protected]
Diluted P/E (x) 56.4 27.8 24.0 17.1
EV/EBITDA (x) 20.3 12.9 10.8 8.5
RoE (%) 7.1 10.6 11.0 13.8 December 1, 2017
Edelweiss Research is also available on www.edelresearch.com, Edelweiss Securities Limited
Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.
Dairy
Investment Rationale

Vibrant brand portfolio underpinned by prudent marketing strategy
Parag has the distinction of having created strong brands—Gowardhan, Go and Pride
Of Cows (premium milk)—over the years, lending it competitive edge. Besides creating
brands, the company’s USP is scaling them up in record time. Case in point is Go
Cheese, which captured the No. 2 spot within 8 years of launch. Parag’s brand push is
underpinned by robust 31% CAGR in ad spends to INR520mn over FY13‐17. We
estimate ad & marketing spends to jump to ~4.5% of sales from ~3.0% in FY17 further
led by rationalisation of in‐store expenses.

“At Parag, we have always
Parag, since inception, has focused on creating brands. A well thought out marketing &
led through innovation. We have
branding strategy with distinct brands for different products lends competitive edge. It has
created products that redefine
created strong and recognisable brands like Gowardhan (fresh milk, ghee, paneer), Go
categories and, in many cases, we
(cheese products, UHT milk) and Pride Of Cows (premium milk). The company’s focus now is
have launched products for the
on creating the Avvatar brand in the whey consumer segment. Leveraging its product
first time in the country”
diversification strategy, the company has been scaling the value curve from traditional to
Mr. Devendra Shah niche branded products.
Chairman
Besides creating brands, Parag’s USP is scaling up new brands in record time. Case in point is
Go Cheese—production commenced in 2008‐09 and it captured strong No. 2 spot with 17%
sales CAGR over FY13‐17. Reinvestment from the growth of cheese has given way to
movement up the value chain into whey consumer (a by‐product while manufacturing
cheese), a high gross margin product, with the introduction of brand Avvatar. Management
is targeting to attain INR1.5bn sales in 3 years, INR3bn sales in 5 years in Avvatar.

Fig. 1: Strong market share in record time

2022
Target of making
Avvatar INR3bn brand,
Parag has created strong brands in in high gross margin
2017 whey consumer
record time—Go Cheese captured Go: Second largest category
strong No. 2 spot within 8 years of cheese player with 32%
market share
launch
2008
Avvatar ‐ India's first
company to launch
Commissioned “Go made in India Whey
Cheese World” ‐India’s protein powder versus
largest cheese imported brands
manufacturing plant with
a capacity of 40 MT per
day


Parag Milk Foods
Fig. 2: Parag’s product portfolio across categories

Source:Company, Edelweiss research

Ad & marketing spends to jump to Aggressive ad spends strengthening brand equity
~4.5% of sales in FY20E from ~3.0%
Parag uses various media channels to promote its brands and extensively promotes them in
in FY17
stores and supermarkets through in‐shop activities. Its ad spends have clocked a robust 31%
CAGR to INR520mn over FY13‐17 helping the company garner a strong brand image. It aims
to enhance brand recall of products via strategic branding initiatives through use of social
media and consumer engagement programmes. For example, for its recently launched
Parag reinforces brand recall via
Avvatar brand, Parag has introduced free sampling in gyms along with free jars.
social media and consumer

engagement programmes like free
We estimate the company’s ad & marketing spend to jump to ~4.5% of sales from ~3.0% in
sampling of Avvatar whey protein
FY17, further led by rationalisation of in‐store expenses (BTL activities). Parag has strong
in gyms along with distribution of
combined marketing and in‐store expenses at ~8.5‐9% of sales.
free jars

Dairy
Chart 1: Sharp rise in ad spend fuelling strong brand equity
1,400 6.0
1,120 4.8
840 3.6
(INR mn)
(%)
560 2.4
280 1.2
0 0.0
FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Ad spend % of sales

Source: Company, Edelweiss research

Parag’s brand equity enables it to command pricing premium of ~4‐5% versus organised
players in key categories like cheese & ghee and 20% in paneer.

Table 1: Pricing of ghee, cheese and paneer of Parag versus peers
Premium/
Brand Description Size MRP Discount (%)
Parag commands ~4‐5% pricing Ghee
premium over organised players in Gowardhan Premium Cow Ghee (Jar) 1lt 565
cheese and ghee underpinned by Amul Pure Ghee (Tin) 1lt 505 11.9
its strong brand equity Prabhat Pure Cow Ghee (Jar) 1lt 550 2.7
Dynamix Cow Ghee (Jar) 1lt 565 0.0
Cheese
Go Cheese slices 200gms 135
Amul Cheese slices 200gms 118 14.4
Mother Dairy Cheese slices 200gms 130 3.8
Britannia Processed cheddar slices 200gms 145 ‐6.9
Paneer
Gowaradhan Classic Block Paneer 200gm 85
Mother Dairy Fresh Paneer 200gm 70 21.4
Amul Fresh Paneer 200gm 65 30.8
Prabhat Fresh Malai Paneer 200gm 75 13.3
Punjab Sind High Protein Low Fat 200gm 75 13.3

Parag Milk Foods
Sub‐segmentation, premuimisation driving innovation DNA
Parag, as a policy, introduces 3‐4 differentiated products every year. This lends it a
distinctive edge as it presciently invests in future categories, bolstering a strong
sustainable business model. Moreover, the company has steadily developed a portfolio
Sustained product innovation
of variants of core brands, while also devising a premiumisation strategy. This is
reflected in 75 SKUs in cheese
envisaged to not only differentiate it from peers, but also help garner & retain
plant
customers as well as boost realisations and margins.

Parag has, anchored by sustained innovations, introduced multiple new products based on
consumer preferences and also to tap additional demand. This is demonstrated by their
capability of manufacturing 75 SKUs in their cheese plant.
As a policy, it introduces 3‐4
products every year, differentiating As a policy, it introduces 3‐4 products every year, differentiating it from other players. This
it from other players lends Parag a distinctive edge as it presciently invests in future categories bolstering a
strong sustainable business model. Comparatively, peers with lower share of value added
products are more dependent on milk, where the competition from co‐operatives is intense.

Fig. 3: Strong thrust on R&D

Source: Company
Dairy
Sub‐segmentation strategy across products
What differentiates Parag is the steady development of a portfolio of variants around core
brands. Post launching Go cheese cheese, it has launched a slew of cheese variants such as
mozzarella, cheddar, ricotta and processed cheese. The company also sells different formats
of cheese such as cheese sauce for nachos, cheese slices in different flavours, pizza cheese,
cheese cubes, cheese spread and cheese triangles. This strategy is envisaged to not only
differentiate it from peers, but also help garner and retain customers.

Fig. 4: Parag’s cheese range

Source: Company

Premiumisation strategy
Parag is undertaking premiumisation strategy for its cheese products. Most products are
priced at a premium to the base cheese product range. As consumer preferences evolve, the
company aims to cater to a larger set of consumers, which is envisaged to improve its
realisation and margin.

Chart 2: Product portfolio across the price range
170
MRP (INR/200gms)
145
120
95
70
Green Chutney
Orange Cheddar
Soft & Creamy
Plain Cheese slices
Plain Cheese spread
Angles
Flavoured Angles
Pizza Cheese block
Flavoured Spread
Shredded Cheese
Mozzarella Block
Spread
Slices
Slices

Pride Of Cows: Premium milk offering
Parag sells premium milk through its subsidiary Bhagyalaxmi Dairy under the Pride Of Cows
brand. The company has set up a dairy farm with ~2,000 Holstein cows in Manchar. Thus,
the product is integrated right from the farm till branding, enabling it to charge ~INR90/ltr
for milk, 2x normal fresh milk. This is a high‐margin brand with ~45‐50% gross margin,
leading to premiumisation in a basic commodity product such as milk.
Parag Milk Foods
Strong value added products portfolio
Parag boasts of a vibrant range of value‐added products—cheese, UHT, whey, curd,
flavoured milk,etc—which contributed 64% to FY17 sales. As a result of sustained focus
on innovation, we estimate overall VADP share to jump to 70% of sales and clock 17%
CAGR over FY17‐20 versus 14% overall sales CAGR. This growth in VADP will be led by
Strongest VADP at 64% of sales cheese, whey consumer, paneer and curd.

versus overall dairy industry’s 34%
Parag has the largest range of value‐added products amongst—cheese, UHT, whey, curd,
flavored milk and more—which contribute 64% to sales. This is way ahead of industry’s 34%.
This differentiates the company from other dairy players, who focus only on fresh milk
products.

Chart 3: Diversified mix with strong value‐added portfolio at 64% of sales (FY17)
FY17 FY20
Other Other
3% Cheese 2%
SMP Cheese Ghee
19% SMP
13% 18% 22%
Ghee 9%
VADP 22% VADP
64% UHT 70% UHT
Products Products Paneer
5% Paneer 6% 5%
Fresh milk 2% Fresh milk Curd
Butter
20% Other Curd 18% Butter Other 7%
5% Whey 5%
VADP 2% VADP Whey
3% 3% 8%
3%

The company has a strong 32% market share in cheese (~19% of revenue in FY17), making it
the second largest player after Amul (~40% share). Also, it has the largest cow ghee brand in
India with the distinction of having created the category.
VADP is estimated to clock 17%
sales CAGR over FY17‐20, leading The value‐added category in the company’s portfolio has posted a strong 22% CAGR over
to its contribution expanding to FY13‐17, surpassing Parag’s overall 17% CAGR. With sustained focus on innovation and
70% of sales increasing capacity in VADP, we estimate 70% of sales from VADP in FY20.

Dairy
Chart 4: Improving mix leading to strong 17% CAGR in VADP sales
22,000 85.0
18,400 76.0
14,800 67.0
(INR mn)
(%)
11,200 58.0
7,600 49.0
4,000 40.0
Value added products revenue Revenue share


A) Cheese: Strong innovator
Cheese contributed 19% to sales, but 28% to gross profit in FY17.

Parag’s value proposition
 Strong market share: Parag is a strong player in the high‐growth cheese segment
with 32% market share, second largest after Amul (~40% share).
 Widest portfolio: The company has created widest portfolio of cheese products
with strong (75) SKUs. Apart from selling different types of cheese such as
mozzarella, cheddar, ricotta and processed, the company also sells different
cheese formats—rolled out cheese sauce for nachos, cheese slices in different
flavours, pizza cheese, cheese cubes, cheese spread & cheese creamy spread and
cheese triangles.
 Premiumisation strategy: Apart from a wide range of portfolio, Parag has
continuously introduced new products at a premium to the base cheese product
range, such as flavoured slices, flavoured spreads, nacho cheese, etc. This will help
improve realisations and margins with changing consumer preferences.
 Strong capacity addition: Cheese is a high‐margin segment with ~32% gross
margin. Parag has been strategically expanding capacity in this value‐added
segment. With IPO proceeds, the company has expanded its cheese facility by 50%
to 60MT per day to cater to expanding retail and institutional demand. According
to management, Parag is running at ~60‐65% utilisation post cheese division’s
capacity expansion.
 Strong player across cheese segments: The company has a strong leading position
in the institutional segment, which contributes 55% to cheese sales; retail
contributes 45%. While Parag has strong presence in the institutional segment
(supplies to McCainFoods, Jubilant Foodworks, Yum Foods, Sam’s Pizza, MTR Foods,
Mother Dairy, etc), increasing advertisement & promotional expenses and network
expansion are envisaged to expand B2C sales as well.

Parag Milk Foods
The company has roped in Chef Ranveer Brar to promote its cheese brand to gain
further traction among consumers. Further, it has hired Vector Consulting with a
mandate to ensure doubling of the HORECA (Hotels, Restaurants and Caterers)
Cheese manufacturing is a high direct customers base.
capital intensive business, hence it  Huge first‐mover advantage: Cheese manufacturing is a high capital intensive
is largely organised business, requiring capex as well as working capital. Hence, the cheese market is
largely organised.
Parag leagues ahead of competition underpinned by prescient capex, INR3.5bn
investment in cheese & whey over the past 8 years, further bolstered by strong
innovation & branding. Further, huge cheese volumes impart Parag the scale to
produce the hugely profitable whey consumer, lending it strong first‐mover
Parag is leagues ahead of advantage.
competition underpinned by
prescient capex—INR3.5bn While growth in cheese sales was strong till FY16, weak macroeconomic factors took a
investment in cheese & whey in toll on sales of QSR & restaurants leading to weak volumes over the past 18‐24 months.
past 8 years With improving economy and increasing utilisation in the expanded capacity we see
gradual pick up in the segment and estimate cheese sales to clock 13% CAGR to
INR4.7bn over FY17‐20. We have been conservative in our cheese revenue forecasts
due to Amul’s increasing aggression in the segment, particularly HORECA.

Chart 5: Parag’s cheese revenue to grow at 13% CAGR over FY17‐20E
5,000
4,200
3,400
(INR mn)
2,600
1,800
1,000

B) Whey consumer (Avvatar): Huge gross margin driver ‐ With focus on high gross margin
products and having attained scale in cheese, Parag has expanded capacity in whey
consumer. Till now, the company was selling whey protein to institutional customers.
We estimate whey consumer to
However, it has recently launched whey protein consumer in retail markets under the
contribute 5% to sales (INR1.3bn)
Avvatar brand. While whey consumer commands 12‐13x higher realisation (INR2000,
with robust gross margin of ~45%
ex factory realisation) over institutional whey (net realisation of ~INR150), it also entails
in FY20—highest in value‐added
strong gross margin of ~45% —highest in value‐added products (average gross margin
products—leading to 7%
for value‐added products stands at ~30%).
contribution at the gross profit

As of FY17, whey contributes mere ~3% to Parag’s total sales and 3% to gross profit.
However, we expect total whey sales to catapult 4x from INR470mn in FY17 to
Dairy
INR2.1bn in FY20, led by the rapid growth of Avvatar sales at INR1.3bn in FY20. Further,
this segment is estimated to contribute ~8% to the company’s sales (5% from whey
consumer), but strong 11% (7% from whey consumer) to gross profit in FY20.

Sports nutrition industry: Euro Monitor pegs the sports protein powder category at
INR7bn, which is estimated to post 13% CAGR over 2016‐2021E to INR12.2bn by FY21.
With unorganized segment constituting ~50% of the market, overall addressable
market stands at ~INR15bn.

Whey consumer’s overall Chart 6: Sports protein powder industry to grow at 13% CAGR over 2016‐21E
addressable market stands at Sports protein powder
~INR15bn as unorganised segment 14.0
constitutes ~50%
12.2
10.4
(INR bn)
8.6
6.8
5.0
2016 2021E
Source:Euromonitor, Edelweiss research

Entry barriers in consumer whey
 Scale advantage: Parag has scale advantage, which will be difficult for other
players to replicate since producing whey consumer becomes feasible only after
reaching a certain scale of production in cheese. The company has touched 40MT
Separating whey protein from
capacity in cheese and has further expanded it to 60MT.
whey is a cumbersome process
entailing high investments, which  Investment in infrastructure: Parag has invested ~INR2bn in creating whey
precludes competition like Amul products’ filtration processing infrastructure over the past 8 years. It is further
from entering the segment investing INR323mn for additional technological infrastructure to increase
concentration and grading of whey proteins and sell them directly to retail
consumers. As per large competitors like Amul, creating infrastructure for
separating whey protein from whey is a cumbersome process with high
Parag is estimated to generate 25%
investments required, which precludes competition.
plus RoCE in cheese & whey
Parag has recently expanded whey capacity from 0.4mn to 1.0mn ltr per day,
consumer compared to other pure
which will help it cater to retail consumers with branded health supplements at a
cheese players’ RoCE of ~20‐22%
capex of INR146mn. Further, after receiving overwhelming response from
consumers, the Board has approved for capex of INR177mn to be redirected to
expansion in the whey processing facility in the Manchar Plant.

Parag Milk Foods
Whey consumer to increase RoCE for cheese, strong advantage versus peers
We believe, Parag will have strong advantage over peers and generate 25%+ RoCE on
cheese and whey consumer plant on full utilisation compared to ~20% for other players
purely in cheese as:
1. Parag has invested INR3.5bn in cheese & whey plant over FY08‐17, thereby
entailing lower incremental investments for the whey consumer business. Players
can enter whey consumer only after reaching certain scale in cheese, lending
advantage to Parag. Further, whey consumer is a high ~45% plus gross margin
product compared to cheese (~32% gross margin).
2. All other players are entering HORECA in a big way, which Amul is targeting. Amul
has tripled cheese capacity and is targeting 50% spurt in cheese sales over the next
1 year primarily driven by HORECA, where gross margins will be below ~30% and
debtor days will remain high.

The above factors result in lower return ratios for other pure cheese players. We
believe, once the brand Avvatar is established and the end‐consumer cheese demand
picks strongly, Parag’s realisations and return ratios will improve steadily.

Table 2: Cheese (combination of B2B and B2C) & whey to generate pre‐tax ROCE of ~25%
Revenue INR Cost (for 10l of milk) INR INR mn
Cheese Milk Cash Conversion Cycle 90
Production (kgs) 1 Milk Required (litres) 10
Realisation (INR/kg) 310 Price of Milk 28 Annual Volume
Total Milk Cost 280 Cheese (mn kgs) 18
Institutional Whey Add: Packing and other cost 230 Institutional Whey (mn kgs) 5
Production (kgs) 0.3 Total Costs 510 Whey Consumer (mn kgs) 1
Realisation 163
Net Revenue (INR) 49 Gross Profit (B) 282 Annual Revenue
Gross Margin (%) 36% Cheese 5431
Consumer Whey Institutional Whey 791
Production (kgs) 0.2 Operating Costs Whey Consumer 2529
Realisation 2165 Ad Spends @ 6% 48 8751
Net Revenue (INR) 433 Other Op Exp @ 10% 79
Total ( C) 127 Working Capital 2158
Total Revenue (A) 792 Capex 3500
EBITDA (B‐C) 155 Total 5658
EBITDA Margin (%) 20%
OP 1715
Less: Depreciation 280
EBIT 1435

RoCE (%) 25%
Source:Industry, Edelweiss research
Note: Above data is based on our interactions with industry participants, however, there may be
some variations company wise. We have assumed 80% utilisation for cheese and whey consumer.

Dairy
We believe Avvatar’s success will be crucial to drive profitability of cheese.

Strategy to penetrate Avvatar
Parag is targeting INR1.5bn whey  Parag is creating a completely new division for whey consumer as it is a hugely
consumer sales over next 3 years profitable product with strong 45% plus gross margin.
and INR3bn of whey consumer  Separate SBU head: The company has appointed Mr. Vinay Jain from Amway to
sales over 5 years head the whey consumer division.
 Targeting INR1.5bn over next 3 years and INR3bn of whey consumer sales over 5
years. Management pegs the market size of whey consumer (organised and
unorganised) at INR15bn.
 Parag’s go‐to‐market strategy is in place and has been customised with an
“Our go‐to‐market strategy is in
emphasis on reaching out to nutrition supplement stores, pharmacies, modern
place and is customised with an
retail stores and e‐commerce portals.
emphasis on reaching out to
nutrition supplement stores,  Tying up with e‐commerce partners: The product will be distributed via tie ups
pharmacies, modern retail stores with premium sports gyms, nutrition outlets and e‐portals. Parag has tied up with
and e‐commerce portals. the biggest e‐tailer Amazon India to sell Avvatar since 35‐40% of whey sales are
Educating gym trainers and owners via e‐commerce.
who are key influencers in this
 Tying up with gyms: The company has been educating gym trainers and owners
category is going to be our key
who are key influencers in this category. It has been providing free sachets to gym
platform.”
trainers to increase outreach of the product.
‐Parag management
 Right tie ups: Parag is tying up with Shivoham for certification classes for trainers.
Shivoham runs a complete fitness programme which includes fitness of body and
mind. He has been in the fitness industry for almost a decade and opened the first
CrossFit box in India.

Fig. 5: Product available on Amazon India from 5 Sep

Source: Amazon.com, Edelweiss research

Parag Milk Foods
 Product and price proposition versus leader:
o Higher protein per scoop and better pricing
Avvatar is priced ~10% lower per scoop versus leader ON despite higher
protein per scoop (BCAA).
Avvatar is priced ~10% lower per
scoop versus leader ON despite
higher protein per scoop (BCAA) Table 3: Pricing comparison of Avvatar versus leader ON
Avvatar Optimum Nutrition
1kg (2.2lbs) 2lbs
Servings 29 29
Price (Amazon) 2,720 3,035
INR/scoop 94 105
Per Scoop (gms)
Size 35.0 30.4
Protein 24.0 24.0
BCAAs 7.8 5.5
Glutamic Acid 4.9 4.0
Source:Edelweiss research

o It is gluten and soya free.
Avvatar boasts of Sports
o It is fresh and 100% vegetarian versus 7‐9 month old products and unknown
Certification
sourcing of peers being imported.
o Informed Sports Certification: Parag has obtained Informed Sports
Certification for Avvatar, certifing that the product is abusive substance free.
This is a strong advantage for Avvatar as even market leader ON does not
have this certification.

 Reinvesting whey profits into cheese: The company is planning to reinvest ~25% of the
higher profit from whey business into cheese, which will further boost future
production.

Case Study: Global giant Glanbia
Performance nutrition is a USD12bn category globally. Glanbia, a global nutrition
company with annual turnover of EUR2.8bn, is the market leader in global whey protein.
Performance nutrition is a USD12bn It clocked EUR1bn sales in Glanbia Performance Nutrition (GPN) segment, having
category globally delivered 15% sales CAGR in this division over past 4 years with 16% EBIT margin and
18% RoCE. Growth has been driven by brand development and strategic acquisitions.

GPN is the No.1 global performance nutrition brand portfolio comprising Optimum
Nutrition, BSN, Isopure, thinkThin, Nutramino, ABB and Trusource. It produces the
entire range of performance nutrition products with broad consumer appeal and is the
market leader in innovation and new product development.

Dairy
Fig. 6: Glanbia performance nutrition product portfolio

Glanbia Performance Nutrition
(GPN) segment has EUR1bn sales,
having delivered 15% sales CAGR in
past 4 years with 16% EBIT margin

and 18% RoCE in CY16

Chart 7: Glanbia Performance Nutrition grew at 15% CAGR in past 4 years
1,150 20.0
Revenue EBITA Margin
1,020 17.4
890 14.8
(INR mn)
(%)
760 12.2
16.1
14.7
630 9.6 12.0
10.8
9.8
500 7.0
CY12 CY13 CY14 CY15 CY16 CY12 CY13 CY14 CY15 CY16


The company has strong reach in US in nearly 10,000 specialty retail stores, gyms and
fitness centers as well as in major grocery chains and drug stores. Optimum Nutrition
(Glanbia’s flagship brand) products are also distributed in over 70 countries worldwide.

Parag is following the Glanbia route, whereby it is focusing on high margin nutrition
based dairy products, which entail high growth and margin (in excess of 16% plus EBITA
margin).

Parag Milk Foods
Chart 8: Parag’s whey sales to grow 4.4x over FY17‐20, driven by Avvatar sales growth
2,500 1,500
Total Whey Avvatar
2,000 1,200
1,500 900
(INR mn)
(INR mn)
1,000 600
500 300
0 0
FY13 FY14 FY15 FY16 FY17 FY18EFY19EFY20E FY18E FY19E FY20E


On ground industry check: Huge expanding market
We visited the International Health, Sports and Fitness Exhibition held on 13‐15
October, 2017 to gain on‐ground perspective on the whey protein and sports
Market leader ON’s sales have supplements market and competition in the space. The industry is dominated by
expanded exponentially from Glanbia brands ‐ ON (market leader), BSN and Isopure. However, beyond such global
merely INR540mn in FY12 to brands, the industry is highly fragmented. There are a large number of Indian players
INR6.4bn in FY17 (~12x in 4 years), who source whey externally and process, pack & sell it under their own brand name.
which highlights the category’s MuscleBlaze is the largest Indian brand.
growth potential Parag utilised International Health, Sports and Fitness Exhibition to showcase and
launch Avvatar, catering directly to its target market—sports and fitness enthusiasts.

Insights from Glanbia: Its India (ON, BSN, Isopure brands) sales have grown
exponentially over the past 5 years—from merely INR540mn in FY12 to INR6.4bn in
FY17 (~12x in 4 years). This rapid surge highlights the growth potential of the category.
This spurt will be spearheaded by rising awareness of health and fitness in the country.
Further, to penetrate deeper into the rapidly growing Indian market, ON has launched a
mass variant targeted at the wider public, with more country specific products in the
pipeline.

MuscleBlaze is the largest Indian manufacturer. It sources whey from external sources
(including Glanbia Nutritionals’ ingredients segment) and manufactures and packs it in
India. It has implemented verification codes on products to provide assurance of their
genuineness to combat widespread issue of fakes sold. It has 2 variants of whey
protein—Whey and Whey Gold. The latter competes with Avvatar and ON. It is priced
at similar level as Avvatar. MuscleBlaze is present in all states and across tier I & II
towns.

Dairy
C) Ghee: Big category shifting from unorganised to organised
Parag is the largest cow ghee brand in India and is also known as the category creator.
Pure cow’s ghee currently accounts for less than 10% of India’s total ghee market and is
growing faster than the overall ghee market with higher margin.

Ghee contributes around ~22% to Parag’s revenue and 28% to gross profit. It has
posted CAGR of 16% over FY13‐17. We estimate the company’s ghee revenue to post
14% CAGR to INR5.6bn over FY17‐20 led by the company’s strong brand positioning of
100% cow’s milk & purity and rising shift from traditional & unorganised to organised
Parag, the largest cow ghee brand
players as ghee is the largest consumed dairy product in India after liquid milk at
in India and is also known as the
INR811bn with organised penetration at ~19% (INR154bn).
category creator

Further, Parag is moving towards premiumisation. On the anvil is premium ghee priced
at INR1,500/kg, which will be made with a malai and cream base versus butter and fat
base currently.

Chart 9: Ghee sales to grow at 14% CAGR over FY17‐20E
6,000
5,100
4,200
(INR mn)
3,300
Expanded paneer capacity to 4x
with German machinery, which
2,400
keeps paneer 15‐20% softer and
improves shelf life to 75‐90 days
1,500


D) Paneer: To clock strong 50% plus CAGR
Parag has expanded its paneer manufacturing capacity from 5MT to 20MT per day with
German machinery and an automated plant, which keeps paneer 15‐20% softer and
increases shelf life to 75‐90 days.

According to management, they are running at ~40% capacity utilisation (8MT on a
20MT per day capacity) post capacity expansion in the paneer division. We expect
improving utilisation, leading to 54% revenue CAGR over FY17‐20E to INR1.2bn. Further,
we expect this strong growth to be led by rising shift from traditional & unorganised to
organised players as paneer is the third largest consumed dairy product in India at
INR386bn with organised penetration at mere ~3% (INR11bn). With increased capacity,
we estimate paneer’s sales as well as gross profit contribution to jump from 2% to 6%
by FY17‐20.

Parag Milk Foods
Chart 10: Paneer sales to grow at 54% CAGR over FY17‐20E
1,500
1,200
900
(INR mn)
600
300
0
FY14 FY15 FY16 FY17 FY18E FY19E FY20E


E) UHT (ultra heat treated) milk + lassi + buttermilk ‐ High growth products: UHT milk has
a longer shelf life than regular liquid milk and demand for it is expected to surge due to
urbanisation and changing consumer preference for value‐added UHT milk with low fat
content and added nutritional value. UHT milk contributed 5% to Parag’s FY17 sales,
but 7% to gross profit. We estimate the company’s UHT sales to clock 20% CAGR to
Parag’s UHT sales are estimated to INR1.5bn over FY17‐20E aided by 48% capacity expansion.
clock 20% CAGR to INR1.5bn over
FY17‐20 aided by 48% capacity Chart 11: UHT+lassi+buttermilk+cream sales to grow at 20% CAGR over FY17‐20E
expansion 1,800
1,500
1,200
(INR mn)
900
600
300
0


F) Curd: Growth driven by demand shift from unorganised to organised segment Curd
Parag’s curd sales are estimated to contributed 5% to Parag’s sales, but ~7% to gross profit in FY17. We estimate the
clock 24% CAGR to INR1.7bn over company’s curd sales to post 24% CAGR to INR1.7bn over FY17‐20 led by: 1) 33%
FY17‐20E aided by 33% capacity capacity expansion; and 2) nuclear families with working couples spurring sales of
expansion packaged curd.

Dairy
Further, we expect this strong spurt to be led by rising shift from traditional &
unorganised to organised players as curd is the fourth largest consumed dairy product
in India at INR288bn with organised penetration at mere ~6% (INR17bn) in FY17.

Chart 12: Parag’s curd sales to grow at 24% CAGR over FY17‐20E
2,000
1,600
1,200
(INR mn)
800
400
0


Parag Milk Foods
High capacities set up raise entry barriers
Parag is fortifying its value‐added share by expanding capacity—cheese 50%, whey
150%, paneer 4x, UHT 48% and curd 33%—leading to 53% overall capacity addition.
This is estimated to lead to sales CAGR of 17% in VADP versus 14% sales CAGR for
overall company over FY17‐20 and VADP share growing to 70% of sales in FY20,
keeping it ahead of the industry.

Parag has been undertaking several capital investments ahead of the curve in profitable
segments to prune cost of operations. The company has invested INR3.5bn over FY08‐17 in
Post initial capex, capital
cheese and whey. These capital investments have increased capital intensity in the dairy
requirement has reduced as
sector, making it increasingly difficult for a new entrant to enter this sector or match Parag’s
reflected in Parag’s gross block
operating efficiency.
expansion of 35% over FY17‐20,
post jumping ~123% during FY11‐
Parag’s gross block jumped ~123% over FY11‐17. Having scaled up rapidly in recent years,
17
going forward capex requirement is lower. Thereby, capital requirement has waned post
installation of initial equipment, as reflected in gross block expansion of 35% expected over
FY17‐20, primarily in value‐added segments cheese, whey and paneer. The company has
incurred mere INR261mn to enhance cheese capacity by 50% to 60MT/day (from 40MT/day
in FY16) and whey processing capacity by 150% to 10lac ltr/day (from 4lac ltr/day in FY16).
Further, capex of INR177mn previously earmarked out of IPO funds for setting up new
production line of milk based beverages has been redirected to whey processing facility in
Manchar.

Table 4: Additional capacity expansion in cheese and whey
Particulars Capacity Expansion Total estimated
cost (mn)
Expansion of cheese manufacturing facility 40 MT to 60MT per day 115
Expansion of whey processing facility 0.4mn litre per day to 1mn litre per day 146
Expansion of whey processing facility ‐ Redirected 177
This should enable Parag to grow ahead of the market and wrest market share from
competitors.

Investing in profitable VADP
Parag is expanding cheese capacity by 50%, whey by 150%, paneer by 4x, curd by 33% and
UHT products by 48%. These are profitable segments wherein out‐of‐home consumption is
burgeoning. This is estimated to lead to sales CAGR of 17% in VADP versus 14% sales CAGR
for overall company over FY17‐20 and VADP share growing to 70% of sales in FY20, keeping
it ahead of the industry.

Dairy
Table 5: Consistent capacity expansion in VADP to support growth and margins
Product FY16 FY18E % increase
Milk processing capacity(litres per day) 2,000,000 3,400,000 70%
Milk powders(kg per day) 110,000 110,000 0%
Liquid milk in pouches (packs per day) 375,000 375,000 0%
Flavoured milk (packs per day) 100,000 100,000 0%
UHT Products (litres per day) 165,000 245,000 48%
Cheese (kg per day) 40,000 60,000 50%
Ghee (kg per day) 70,000 70,000 0%
Butter (kg per day) 75,000 75,000 0%
Curd (kg per day) 60,000 80,000 33%
Paneer capacity(kg per day) ‐ 20,000 NM
Whey Processing (litres per day) 400,000 1,000,000 150%
Overall product capacity increase 1,395,000 2,135,000 53%
Source: Company

Thus, scale and capacity augmentation in high growth and margin value‐added products like
cheese and whey consumer will keep the company much ahead of the curve.

Parag Milk Foods
Bolstering strong distributor network: Edge over competition
Parag has augmented its pan‐India distribution network rapidly over the past 5 years
with 250,000 retail outlets (having grown at 33% CAGR) via 3,000 distributors catered
to by over 140 super stockists. Further, the company has hired Vector Consulting to
help build supply chain and logistics capabilities at the back end and distribution
capabilities in the front end, which is envisaged to boost margin further.

Parag has a strong pan‐India distribution network, lending it a distinct competitive
A strong network of 3,000 advantage versus other regional peers.
distributors, 15 depots and 104
super stockists catering to 2.5 lakh The company has augmented its pan‐India distribution network by rapidly over last 5 years
outlets, to further expand by ~12% with 250,000 retail outlets (having grown at 33% CAGR) via 3,000 distributors catered to by
CAGR to 3.0‐3.5 lakh outlets over over 140 super stockists. The company has established 17 sales depots throughout India.
next 3 years Further, it targets to expand network by 6‐12% CAGR to 3.0‐3.5 lac over the next 3 years.

Chart 13: Rapidly expanding distribution network ‐ retail outlets
400
320
240
(000s)
160
80
‐
FY12 FY13 FY14 FY15 FY16 FY17 FY20

Parag has prudently established its distribution in 3 ways addressing different product
groups and consumer segments to sharpen focus on its pan‐India distribution infrastructure:

1) Fresh milk products: Fresh products like milk and dahi, which have limited shelf life, are
distributed in Maharashtra and Mumbai from the Manchar plant. In the South, these
are distributed from the Palamner plant.

2) Cold storage value‐added products: Cheese, paneer and other value‐added products
like butter are distributed and sold pan‐India via distributors and transported via chilled
vans.

3) High shelf life products: High shelf life products that do not require refrigeration and
are shelf stable like ghee and dairy whiteners are sold pan‐India via distributors.

Dairy
Fig. 7: Route to market strategy
Focus is on building cold chain
distribution in top 100 cities with
focus on paneer and cheese
Source: Company

The expansion focus is on building cold chain distribution in top 100 cities with focus on
paneer and cheese. Distribution capabilities are being further enhanced with roll out of SFA
(sales force automation) and DMS (distribution management system), which will help with
real time data on secondary sales.

Vector Consulting appointed to Further, Parag has appointed Vector Consulting to optimise its distribution model. Vector
optimise Parag’s distribution Consulting will help build supply chain and logistics capabilities at the back end and
model based on theory of distribution capabilities in the front end. This project is specifically based on the concept of
constraints with Vector’s variable “Theory of Constraints” to improve the distribution reach with lower stock outs and better
remuneration linked to rationalisation of inventory at dealers, retailers and the company level by reducing non‐
performance based on revenue moving inventory. Vector Consultant’s variable remuneration is linked to its performance
growth and margin expansion based on revenue growth and margin expansion.

Vector Consultants has helped create many success stories in the consumer space: a) VIP
Industries’: Improvement in secondary sales by 50% & same store sales at 20%; and b)
Liberty Shoes: Working capital improved with reduced inventory days and improved lead
time, resulting in robust sales surge.

Fig. 8: Vector Consulting Framework Fig.9: Post implementation benefit in VIP Industries

Source:Vector Consulting, Edelweiss research

Parag’s total selling and distribution expenses have stood at 7‐8% of sales over the years, of
which distribution stands at ~4.0‐4.5%. Led by sales growth with better supply chain
management, margins will continue to improve.
Parag Milk Foods
Valuation
• Bolstered by strong positioning and riding strong market penetration & capacity
addition in high growth and margin VADP, the stock entails immense potential.
• Underpinned by strong industry drivers along with structural shift from unorganised to
organised players we estimate: 1) Parag to clock revenue, EBITDA and PAT CAGR of
14%, 32% and 49%, respectively, over FY17‐20; and 2) its pre‐tax RoCE to jump
1064bps to 19.0% in FY20.
• We initiate coverage with ‘BUY’ valuing Parag at P/E of 24x FY20E EPS, at 28% discount
to domestic FMCG players. Globally, value‐added dairy companies trade in line with
their FMCG peers.

We perceive rerating potential for under‐penetrated emerging VADP oriented companies.
Hence we initiate coverage on Parag with a ‘BUY’ and target price of INR340, based on P/E of
24x FY20E (at ~28% discount to our FMCG universe) and 20% discount to fresh dairy product
players like Heritage, implying 40% upside from current levels.

We estimate Parag to clock revenue, EBITDA and PAT CAGR of 14%, 32% and 49% (17%, 10%
and 32% CAGR during FY14‐17), respectively, over FY17‐20E. Riding superior earnings matrix
and increase in value‐added sales, we estimate RoCE to jump 1064bps to 19.0% over FY17‐
20E.

Parag, derives ~64% of sales from value‐added dairy products, is best‐placed to benefit from
the shift towards organised and value‐added dairy consumption and trades at 17x FY20 versus
the median of 33x FY20 for Indian FMCG peers. Globally, value‐added dairy companies trade in
line with their FMCG peers. Owing to its higher emerging VADP (~27% of sales in FY17),
where capital intensity is higher versus higher RoCE traditional dairy companies, we have
valued Parag at 24x FY20E EPS, which is at 20% discount to Heritage’s target FY20E P/E of
30x and 28% discount to FMCG players. While we value Parag at 28% discount to domestic
FMCG players, we believe the discount will gradually reduce with improving return ratios and
margins.

We initiate coverage on Parag with ‘BUY’ recommendation and TP of INR340, implying ~40%
upside from current level, based on P/E of 24x FY20E.
This is riding: 1) robust earnings growth visibility & return ratios; 2) pan‐India dairy brands (Go,
Gowardhan and Avvatar); and 3) first‐mover advantage in value‐added & profitable segments
like whey consumer by virtue of scale created in cheese.

Also pertinent to note: a) this is considering cheese utilisation of 71% and consumer whey
utilisation of ~42% for FY20 (assuming 4MT/day capacity of whey consumer); 2) Parag is
drawing parallel to Glanbia, a global leader in whey consumer and diversified player in dairy
products, which earns 16% EBITDA margin and 18% RoCE in the performance nutrition division.
Hence, we believe our FY20 valuation entails scope for upward bias.

At current level, the stock is trading at P/E of 24.0x FY19E and 17.1x FY20E for 49% PAT CAGR
over FY17‐20E. We believe, Parag is well placed to capture the dairy opportunity in India being
a branded pan‐India dairy player investing strongly in value‐added sales.
Dairy
Key Risks

Volatility in raw milk prices
Any material and sudden rise in milk prices may impact Parag’s margin. Milk procurement
prices jumped 27% in FY17, which Parag was able to absorb due to premiumisation as
demonstrated by 39bps rise in gross margin.

Competitive pressure
The domestic dairy products industry is highly competitive with presence of large
multinational companies as well as regional and local players in each of the regions Parag
operates in. The company also competes with large dairy cooperatives; incentives offered
by central or state governments to these could benefit such entities, which in turn will
adversely affects Parag’s business. Any steep increase in competitive pressure—Amul
getting aggressive in the HORECA segment—may impact Parag’s revenue growth prospects.
However, according to management, cheese as a category will grow 25%+ leading to growth
across players.
Failure of launches
Parag is steadily launching new products. If these products are not successful it may lead to
increased expenses with no proportionate sales.

Parag Milk Foods
Company Description

Parag, incorporated in 1992 with operations in just collection and distribution of milk, has
now developed into a FMCG dairy company. It has diversified its product portfolio with 170
plus SKUs to cater to a wide range of customers via 6 brands—Gowardhan, Go, Pride Of
Cows, ToppUp, Milkrich and Avvatar. The company has recently ventured into the whey
consumer protein powder segment with Avvatar brand and fruit beverages category with
Slurp brand.

The company’s aggregate milk processing capacity stands at 2mn ltr per day. Its cheese
plant boasts of one of the largest production capacities in India with raw cheese capacity of
60MT per day.

Chart 14: Revenue mix (FY17)
Curd Other VADP
Parag is an integrated and 6% Fresh milk
5%
diversified private dairy player with Paneer 20%
2 of the strongest consumer (B2C) 2%
dairy brands—Gowardhan and Go
Ghee
22% SMP
13%
Other
3%
Butter
Cheese UHT Products 5%
19% 5%

Dairy
Table 6: Parag—Evolution
Year Evolution of Parag milk foods
1992 Parag Milk Foods Limited started in 1992 to help farmers by collecting milk on milk holidays during Operation
Flood. Back then, Parag was primarily involved in the distribution and collection of milk
1998 Manchar plant was commissioned and began manufacturing traditional products like Butter and Ghee under the
brand, ‘Gowardhan’
2000 Began exporting products to South‐East Asia, the Middle East and Africa (At present company exports products to 36
countries overseas)
2005 Set up of Bhagyalaxmi Dairy Farms (a fully automated cow farm housing over 2000 Holstein breed cows) at
Manchar,Pune; a moden dairy farm with international equipment
2008 Raised INR600mn from Motilal Oswal PE; Commissioned “Go Cheese World” ‐ India’s largest cheese manufacturing
plant with a capacity of 40 MT per day
2010 Palamaner plant established with a world‐class UHT facility
2011 Launched 'Pride of Cows' ‐ a first‐of‐its‐kind premium farm‐to‐home milk brand (Taken from the Bhagyalaxmi Diary
Farm and sold in Mumbai and Pune )
2013 Launched 'Topp Up' branded flavoured milk and other products like Emmental cheese, mozzarella cheese, yogurt in 3
new flavours , cheese spread in 6 flavours, Parmesan cheese, cheezlets and vital milk
2014 Launch of B2B Whey products and expanded cheese product ranges
2015 Company was converted into a public limited company pursuant to approval of the shareholders at an extraordinary
general meeting and name of the company changed to Parag Milk Foods Limited
2015 Remodelled the brand Parag with a new identity and launched the Parag logo
2016 Got listed on the bourses, becoming a publicly owned entity
2017 Entered into the Juice drink market by launching Slurp ‐ a mango drink with a dash of milk; Launched a 100% Whey
protein, first‐of‐its‐kind manufactured in India under the brand Avvatar
Source: Company, Edelweis research

Diverse range of customers
Retail and institutional businesses contribute 67% and 33% to the company’s revenue,
respectively.

Parag sells products to several customer categories such as retail customers, hotels,
restaurants, institutional customers and caterers. Some of its marquee institutional
customers include leading restaurants & cafe chains such as Yum! Restaurants (Pizza Hut,
Taco Bell, KFC), Jubilant Foodworks (Domino’s Pizza) and Sankalp Recreation (Sam’s Pizza).
Parag is one of the leading whey protein suppliers in India to consumer product companies
such as Nestle India and UTH Beverage Factory. Further, its branded products are available
in more than 250,000 retail touch points across the country.

Diversified manufacturing and procurement
The company derives all its products only from cow’s milk. Its manufacturing facilities are
strategically located at Manchar in Maharashtra’s Pune district and Palamaner in Andhra
Pradesh’s Chittoor district, which have a high population of dairy cows. The plants have milk
processing capacity of 1.2mn litres per day and 0.8mn litres per day, respectively—
aggregate milk processing capacity of 2mn ltr per day. The company produces cheese and
whey products only at its Manchar facility, UHT products only at the Palamaner facility and
other products at both the facilities.

Parag has an integrated business model encompassing the entire value chain—procurement,
manufacturing, distribution and branding.
Parag Milk Foods
Fig. 10: Integrated business model

Source: Company

Currently, Parag has overall milk handling capacity of 2mn ltr per day, which will increase
to 3.4mn ltr post the capacity expansion in FY18.

Strong management team
Parag is building a strong management team with significant industry experience to scale up
Strong management team at helm its market share in the dairy industry. The company is promoted by Mr. Devendra Shah,
with the former MD of the Gujarat Chairman; Mr. Pritam Shah, Managing Director; each has over 20 years’ experience in the
Cooperative Milk Marketing milk & dairy based food business. Further, Mr. B. M. Vyas, former Managing Director of the
Federation since 2010 as an Gujarat Cooperative Milk Marketing Federation (Amul), has been with the company since
advisor and director 2010 as an advisor and is a Director on Parag’s board. This strong management team of
qualified and experienced professionals enables Parag identify new growth avenues and
develop successful products.

Dairy
Table 7 : Management Overview
Key Personnel Profile
Mr. Devendra Shah Founder of Parag Milk Foods Ltd and currently the Executive Chairman,whole time Director as well as
Chairman the promoter of the company, he has been on the board since December 1992. He has an experience of
25 years in the industry in which the company operates.His hands‐on approach in managing the
organisation has involved him in new product development, being being personally involved in
branding and advertising.He is a member of the Executive Committee of Indian Diary Association
(IDA) West zone and has been nominated by the Government of India to the Managing Committee of
National Diary Research Institute(NDRI).
Mr. Pritam Shah Currently the Managing Director as well as promoter of the company and brother of Mr. Devendra
Managing Director Shah, he has been on the board since December, 1992. In his current role, Mr. Pritam Shah is
responsible for the overall executional strategy of the Company and consolidating the market
presence. He is responsible for bringing in the best manufacturing technology for the Company,
enabling it to compete globally. His strong understanding of procurement and production process
has helped Parag Milk Foods enhance its overall performance.
Mr. Vimal Agarwal Mr. Vimal Agarwal, a Chartered Accountant and MBA, is a professional with experience of over 18
CFO years in the corporate sector. He worked in various corporate finance roles before joining PepsiCo
India in 2004. His work experience spans across Financial Planning & Analysis, Process Governance,
Financial Reporting, Budgeting, Working Capital Management and Cost efficiency strategies. Mr.
Agarwal was recognised with multiple awards by PepsiCo Inc. including worldwide Performance and
Purpose award in 2015 for enhancing Governance Standards and in 2010 for creaing Strategic Impact
as Project Manager for the F&A Shared Services Outsourcing initiative.
Mr. Shirish Upadhyay He joined the company in 2010 and his role includes Planning & Forecasting, Project Management,
Senior Vice President Food Procurement, Rural Management, Marketing and Sales Systems, amongst other corporate
(Strategic Planning) responsibilities. He has over 17 years of experience in Corporate Strategy & Planning in the diary
industry of which, 12 years were with GCMMF (Amul).
Mr. H.S. Oberoi Mr. H.S. Oberoi advises the leadership team on strategic business initiatives and the overall company
President ‐ Cheese development at large. A Mozzarella Cheese manufacturing expert, he has a B. Tech degree and over 52
Manufacturing years of extensive experience in the dairy industry. In his career, he has worked with leading dairy
and food companies like Modern Dairies Ltd., Road Master Food Ltd., Milk Federation, Indodan Milk
Products, Dalmia Dairy Industries and Haryana Milk Foods. He has travelled across the world to
study and implement best practices in the dairy industry.
Mr. Vinay Jain Mr. Vinay Jain joined from Amway and heads the Avvatar division.

Parag Milk Foods
Financial Outlook
• Comprehensive product portfolio to sustain revenue momentum: Parag is
estimated to sustain sales CAGR of 14% over FY17‐20 with strong 17% CAGR in
VADP sales.
• Rising share of value‐add products, B2C mix potent margin kickers: Gross margin is
likely to catapult 303bps over FY17‐20E to 30.3% aided by rising share of high
margin value‐added segment sales. EBITDA margin is estimated to jump 335bps to
9.6% in FY20 (6.2% in FY17) on account of rising capacity utilisation.
• Improving balance sheet and return ratios: Parag’s debt/equity ratio improved
from 4.4x in FY15 to 1.1x post IPO and 0.4x in FY17 and will further improve to 0.1x
by FY20. Further, pre‐tax RoCE is estimated to rise 1064bps to 19.0% in FY20 from
8.4% in FY17 with improving capacity utilisation and higher share of VADP.
Superior profitability is envisaged to boost cash flow.

Strong growth in VADP to drive revenue momentum
We have built sales CAGR of 14% Parag clocked 17% revenue CAGR over FY13‐17 led by market share gains and strong growth
over FY17‐20E led by increasing in value‐added segments. We estimate sales to post 14% CAGR over FY17‐20 bolstered by
capacity and penetration in high the company’s strong brand spending, enhanced capacity leading to healthy growth in value
growth, value‐ added segments added‐segments (cheese, paneer, ghee, UHT milk, curd), penetration in new product
categories like whey consumer and distribution expansion.

Chart 15: Healthy revenue growth momentum to sustain
27,000
Total Revenue 21,500
Value added Revenue
23,000 18,000
19,000 14,500
(INR mn)
(INR mn)
15,000 11,000
11,000 7,500
7,000 4,000
FY18E
FY19E
FY20E
FY13
FY14
FY15
FY16
FY17
FY18E
FY19E
FY20E
FY13
FY14
FY15
FY16
FY17


Rising share of value‐added products mix: Potent gross margin kicker
The company’s gross margin has expanded 410bps to 27.3% over FY14‐17 driven by higher
We estimate gross margin to jump
sales of value‐added products and premiumisation. We estimate Parag’s gross margin to
303bps to 30.3% over FY17‐20
jump 303bps to 30.3% in FY20 led by: a) rising share of high margin, value‐added products
from 64% of sales in FY17 to 70% in FY20 and improving mix within value‐added segments
like premium variants within cheese, consumer whey within whey with concentration &
Dairy
grading of whey proteins, premium quality ghee within ghee; b) stable milk prices; c) rising
share of B2C sales within the product mix to 77% in FY20 versus 67% in FY17; and d) higher
premiumisation.

Further, premiumisation was evident from the gross margin expansion of 39bps in FY17
despite milk prices having gone up by 27%.

Chart 16: Sharp gross margin expansion with higher VADP
Gross margin is likely to catapult 32
on: 1) rising share of value‐added
sales to 70% from 64%; and 2) 30
expanding share of B2C sales to
77% over FY17‐20E from 67% in 28
FY17
(%)
26
24
22
Gross margin

Improving utilisation to spur 32% EBITDA CAGR over FY17‐20E
Parag’s operating margin expanded from 7.6% in FY14 to 9.0% in FY16. However, lower
volumes in VADP sales at mere 2% due to price hikes resulted in EBITDA margin contracting
276bps in FY17 over FY16 to 6.2%. This was led by employee cost expanding 50bps to 4.6%
of sales and increase in overall selling & distribution expenses by 120bps from 6.2% to 7.4%.

With implementation of GST, Parag will claim input tax credits for excise on packaging
We estimate EBITDA margin to material, service tax, etc. Further, GST will drive operational efficiencies by reducing the
jump 335bps to 9.6% over FY17‐20 complexity of inter‐state transportation and uniform laws across states. This will also enable
with operating leverage benefit Parag to reconfigure its logistics and rationalise depot operations, leading to annual savings
leading to 32% EBITDA CAGR of INR100‐120mn.

Over FY17‐20E, with: 1) improved utilisation across value‐added segments leading to gross
margin expansion; 2) benefits of GST; and 3) operating leverage benefits, we forecast
EBIDTA margin expansion of 335bps to 9.6% and EBITDA CAGR of 32% .

Parag Milk Foods
Chart 17: EBIDTA CAGR— trajectory at strong 32% over FY17‐20E
3,000 12.0
Decline led by higher Expansion led by gross
2,500 employee costs by 50 margin and operating 10.4
bps and S&D by 120 bps leverage leading to
335bps expansion
2,000 8.8
(INR mn)
We estimate PAT CAGR of 49%
(%)
over FY17‐20, much ahead of 32%
1,500 7.2
EBIDTA CAGR, led by declining
capex and financial leverage
1,000 5.6
500 4.0
EBITDA EBITDA Margin

We forecast net profit margin of Further, we estimate PAT CAGR of 49% over FY17‐20 from adjusted PAT of INR365mn in FY17 to
4.6% in FY20, in line with INR1.17bn in FY20 led by declining capex and improving balance sheet. This will lead to
management guidance of ~5% plus depreciation and finance expense clocking mere 8% and ‐22% CAGR, respectively, over FY17‐20E.

Hence, we estimate net profit margin of 4.6% in FY20. Management has guided for 5% plus
net profit margin.

Chart 18: Robust PAT spurt at 49% CAGR over FY17‐20E
1,400 6.0
1,120 5.0
840 4.0
(INR mn)
(%)
560 3.0
280 2.0
0 1.0
FY13 FY14 FY15 FY16 FY17 FY18EFY19EFY20E FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
PAT PAT Margin


Improving balance sheet and return ratios
Parag’s debt/equity ratio stood at 4.4x in FY15. The company raised INR3bn equity via IPO in
FY16. It has used these funds to repay working capital debt of INR1bn and meet capex
requirements of INR1.5bn for expansion & modernisation. As a result, the company’s
debt/equity improved to 1.1x in FY16 and 0.4x in FY17. Further, with improved cash flow,
we forecast the debt/equity to fall further to 0.1x in FY20.

Dairy
Chart 19: Deleveraging balance sheet
6,500 8.0
5,500 6.4
4,500 4.8
(INR mn)
With repayment of debt, end of
(%)
major capex and improvement in
3,500 3.2
cash flows, we estimate debt equity
to improve from 0.4x in FY17 (4.3x
in FY15) to 0.3x in FY20
2,500 1.6
1,500 0.0
FY13 FY14 FY15 FY16 FY17 FY18E FY19 FY20E
Debt Debt‐Equity


Parag’s cash conversion cycle stands at 80 days, up from 77 in FY14, primarily on account of
increasing value‐added segment sales (cheese), leading to increased inventory days. Going
forward, with scale in cheese, we expect cash conversion cycle to remain at ~80 days.

Scale up in RoCE as utilisation ramps up
As of FY17, Parag’s pre‐tax RoCE stands at 8.4%, down from 16.4% in FY16, due to dip in
margin. The company has chalked out INR1.5bn capex over FY17‐18 post the IPO for: a)
enhancing milk handling & processing capacity from 2.0mn ltr per day to 3.4mn ltr per day;
and (b) increasing capacity in VADP—cheese capacity from 40MT/day to 60MT/day,
separate paneer manufacturing facility of 20MT/day and upgrading whey infrastructure for
consumer whey.

With increasing utilisation in value‐added products leading to improving margins by
335bps to 9.6% and relatively low capex requirement leading to higher total asset turn
(from 2.0x to 2.3x), we estimate pre‐tax RoCE to catapult 1,064bps to 19.0% over FY17‐20.
Management has guided for 20% plus.

Parag Milk Foods
Chart 20: RoCE—On a strong wicket
20.0
17.2
Pre‐tax RoCE to improve to 19.0% in
FY20E from 8.4% in FY17
14.4
(%)
11.6
8.8
6.0

We estimate free cash flows of INR1.5bn over FY19‐20 due to improving operating cash
flow versus negative FCF of INR277mn over FY17‐18E.

Chart 21: Improving cash flows
1,900
1,450
(INR mn)
1,000
550
100
(350)
FY18E
FY19E
FY20E
FY17
Operating Cash flow Free Cash flow


Dairy
Financial Statements

Key assumptions Income statement (INR mn)
Year to March FY17 FY18E FY19E FY20E Year to March FY17 FY18E FY19E FY20E
Macro Net revenues 17,307 19,027 22,144 25,680
GDP(Y‐o‐Y %) 6.6 6.8 7.4 7.4 Raw material costs 12,588 13,442 15,519 17,900
Inflation (Avg) 4.5 4.0 4.5 4.5 Gross profit 4,719 5,585 6,625 7,780
Repo rate (exit rate) 6.3 5.8 5.8 5.8 Employee expenses 794 851 956 1,089
USD/INR (Avg) 67.1 65.0 66.0 66.0 Other expenses 2,843 3,019 3,685 4,225
Company Operating expenses 3,637 3,870 4,641 5,314
Procurement price (INR/litre) 26.8 26.2 27.3 28.3 EBITDA 1,082 1,715 1,984 2,466
Procurement price increase (%) 26.8 (2.3) 4.0 4.0 Depreciation & amortisation 490 528 577 619
Procurement (mn litres/day) 1.2 1.2 1.4 1.6 EBIT 592 1,187 1,407 1,847
Growth (%) 14.4 2.4 13.4 13.0 Less: Interest Expense 333 308 232 155
Sales Growth (%) Add: Other income 110 111 88 85
UHT+lassi+buttermilk 4.9 16.2 22.7 22.7 Add: Exceptional items (194) ‐ ‐ ‐
Flavoured milk 9.0 15.1 22.7 21.7 Profit Before Tax 175 990 1264 1777
Cheese 11.7 10.0 14.0 15.0 Less: Provision for Tax 4 257 417 586
Ghee 13.1 11.1 15.4 14.4 Reported Profit 171 733 847 1,190
Paneer 11.0 61.6 56.0 44.6 Less: Except. Items (Net of Tax) (189) ‐ ‐ ‐
Milkpowder (SMP) 20.3 13.1 (2.2) (4.2) Adjusted Profit 361 733 847 1,190
Fresh milk 13.7 7.1 12.3 12.3 No. of Shares outstanding (mn) 84.1 84.1 84.1 84.1
Butter (41.5) (39.4) (6.4) (9.5) Adjusted Basic EPS 4.3 8.7 10.1 14.2
Curd 27.5 18.2 30.0 24.8 No. of Dil. Sh.outstanding (mn) 84.1 84.1 84.1 84.1
Whey Processing (18.2) 13.1 16.5 19.6 Adjusted Diluted EPS 4.3 8.7 10.1 14.2
Whey Consumer 0.0 0.0 253.6 87.2 Adjusted Cash EPS 10.1 15.0 16.9 21.5
Pride of Cows 29.2 25.0 20.0 20.0 Dividend per share (DPS) ‐ ‐ 0.5 1.5
Revenue Share (%) Dividend Payout Ratio (%) 0.0 0.0 5.0 10.6
UHT+lassi+buttermilk+cream 5.0 5.2 5.5 5.9
Flavoured milk 0.5 0.6 0.6 0.6 Common size metrics (% net reven 0.39 2.09 0.56 0.38
Cheese 19.0 19.0 18.6 18.5 Year to March FY17 FY18E FY19E FY20E
Ghee 22.0 22.2 22.0 21.7 Gross margin 27.3 29.4 29.9 30.3
Paneer 2.0 2.9 3.8 4.8 Staff costs 4.6 4.5 4.3 4.2
Milkpowder (SMP) 12.9 13.3 11.2 9.2 SG&A expenses 16.4 15.9 16.6 16.5
Fresh milk 19.9 19.4 18.7 18.1 Depreciation 2.8 2.8 2.6 2.4
Butter 5.1 2.8 2.3 1.8 Interest 1.9 1.6 1.0 0.6
Curd 5.0 5.4 6.1 6.5 EBITDA margins 6.2 9.0 9.0 9.6
Whey Processing 2.7 2.8 2.8 2.9 Net profit margin 2.1 3.9 3.8 4.6
Whey Consumer 0.0 1.1 3.2 5.2 ‐2.76 2.76 ‐0.06 0.64
Others 1.6 1.2 0.9 0.7 Growth metrics (%)
Pride of Cows 1.6 1.8 1.9 1.9 Year to March FY17 FY18E FY19E FY20E
B2C Share (% of revenue) 67.3 69.7 73.3 76.6 Revenues 5.2 9.9 16.4 16.0
VADP Share (% of revenue) 64.4 65.0 67.7 70.4 Gross Profit 6.7 18.4 18.6 17.4
Expenses (% of sales) EBITDA (27.0) 58.6 15.7 24.3
Carriage & Transport 4.4 4.2 4.2 4.1 PBT (73.8) 465.0 27.6 40.6
Ad Spends 3.0 3.2 4.3 4.5 Adjusted Profit (23.8) 103.2 15.5 40.6
Other Variable Costs 2.9 2.8 2.7 2.7 EPS (36.2) 103.2 15.5 40.6
Fixed Costs 6.1 5.7 5.4 5.2
Financial Assumptions
Depreciation (% of gross block) 8.4 8.5 8.5 8.5
Interest (% of total borrowings) 12.7 12.7 12.7 12.7
Tax Rate (%) 2.3 26.0 33.0 33.0
Capex (INR mn) 498.9 750.0 400.0 600.0
Parag Milk Foods
Balance sheet (INR mn) Cash flow metrics (INR mn)

As on 31st March FY17 FY18E FY19E FY20E Year to March FY17 FY18E FY19E FY20E
Share capital 841 841 841 841 Operating cash flow 641 815 1,127 1,372
Reserves & surplus 5,733 6,466 7,262 8,301 Investing cash flow (1,506) (750) (400) (600)
Shareholder equity 6,574 7,307 8,103 9,142 Financing cash flow 1,225 (397) (794) (822)
Minority interest ‐ ‐ ‐ ‐ Net cash flow 360 (332) (67) (50)
Long term borrowings 713 713 413 13 Capex (983) (750) (400) (600)
Short term borrowings 1,911 1,711 1,411 1,211 Dividends paid 0 0 (50) (151)
Total Borrowings 2,624 2,424 1,824 1,224
Long Term Liabilities & Provisions 181 199 231 268 Profitability ratios
Deferred Tax Liability (net) 99 99 99 99 Year to March FY17 FY18E FY19E FY20E
Sources of funds 9,477 10,028 10,257 10,733 RoACE (%) 8.4 13.7 15.2 19.0
Gross block 5,833 6,583 6,983 7,583 RoAE (%) 7.1 10.6 11.0 13.8
Net Block 3,583 3,805 3,629 3,610 Inventory (days) 102 107 91 90
Capital work in progress 164 164 164 164 Receivables (days) 48 44 42 42
Intangible assets 5 5 5 5 Payables (days) 70 70 51 52
Total Fixed Assets 3,752 3,974 3,798 3,779 Cash conversion cycle (days) 80 81 82 80
Non current investments 0 0 0 0 Current ratio (x) 2.5 3.1 3.0 2.8
Cash and cash equivalents 1,008 695 661 648 Gross Debt/EBITDA (x) 2.4 1.4 0.9 0.5
Inventories 4,285 3,609 4,124 4,708 Gross Debt/Equity (x) 0.4 0.3 0.2 0.1
Sundry debtors 2,150 2,398 2,730 3,166 Adjusted debt/Equity (x) 0.4 0.3 0.2 0.1
Loans and advances 1,586 1,586 1,586 1,586 Net Debt/Equity (x) 0.2 0.2 0.1 0.1
Other Current Assets 475 522 554 642 Interest coverage (x) 1.8 3.9 6.1 11.9
Total current assets (ex cash) 8,496 8,115 8,994 10,102
Trade payable 3,119 2,025 2,338 2,795 Operating ratios (x)
Other Current Liab. & ST Prov. 703 773 899 1,043 Year to March FY17 FY18E FY19E FY20E
Total Current Liabilities & Prov. 3,821 2,798 3,237 3,838 Total asset turnover 2.0 2.0 2.2 2.5
Net Current Assets (ex cash) 4,675 5,317 5,756 6,264 Fixed asset turnover 4.9 5.1 5.9 7.1
Uses of funds 9,435 9,986 10,215 10,691 Equity turnover 3.4 2.7 2.9 3.0
Book Value per share (INR) 78 87 96 109
Valuation parameters
Free cash flow (INR mn) Year to March FY17 FY18E FY19E FY20E
Year to March FY17 FY18E FY19E FY20E Adjusted Diluted EPS (INR) 4.3 8.7 10.1 14.2
Reported Profit 171 733 847 1,190 Y‐o‐Y growth (%) (36.2) 103.2 15.5 40.6
Add: Depreciation 490 528 577 619 Adjusted Cash EPS (INR) 10.1 15.0 16.9 21.5
Interest 333 308 232 155 Diluted P/E (x) 56.4 27.8 24.0 17.1
Add:Others (153) (111) (88) (85) P/BV (x) 3.1 2.8 2.5 2.2
Less: Changes in working cap. (200) (642) (439) (508) EV/Sales (x) 1.3 1.2 1.0 0.8
Operating cash flow 641 815 1,127 1,372 EV/EBITDA (x) 20.3 12.9 10.8 8.5
Less: Capex 983 750 400 600 Dividend Yield (%) 0.0 0.0 0.2 0.6
Free cash flow (342) 65 727 772
Dairy
Additional Data
Directors Data
Mr. Devendra Shah Chairman Mr. Narendra Ambwani Director
Mr. Pritam Shah Managing Director Mr. Nitin Dhavalikar Director
Mr. B.M. Vyas Director Mrs. Radhika Pereira Director
Mr. Sunil Goyal Director Mr. Ramesh Chandak Director

Auditors ‐ Haribhakti & Co. LLP
*as per last annual report

Holding ‐ Top 10
Perc. Holding Perc. Holding
IDFC MUTUAL FUND 8.90 NOMURA 4.29
CANARA ROBECO ASSET MANAGEMENT 3.19 GOLDMAN SACHS GROUP INC 2.92
NEW HORIZON OPP FUND 2.91 IRIS BUSINESS SOLUT LTD 2.75
NORGES BANK 2.66 GOVERNMENT PENSION FUND ‐ GLOBAL 2.66
CANARA ROBECO MUTUAL FUND 2.41 ABU DHABI INVESTMENT AUTHORITY 2.10
*as per last available data

Bulk Deals
Data Acquired / Seller B/S Qty Traded Price
27‐Dec‐16 New Horizon Opportunities Buy 2,479,552 253.43
Master Fund
27‐Dec‐16 Copthall Mauritius Sell 496,200 253
Investment Ltd
27‐Dec‐16 Macquarie Emerging Sell 1,983,352 253.85
Markets Asian Trading Pte
Ltd
15‐Feb‐17 New Horizon Wealth Sell 438,825 222.16
Management Pvt Ltd
6‐Nov‐17 Abu Dhabi Investment Sell 496,501 282.5
Authority ‐ Behave
27‐Dec‐16 New Horizon Opportunities Buy 2,479,552 253.43
Master Fund
*in last one year
Insider Trades
Reporting Data Acquired / Seller B/S Qty Traded
18‐Apr‐17 Mrs.Netra Pritam Shah Buy 30000
6‐Jun‐17 Mrs.Netra Pritam Shah Buy 20000
1‐Aug‐17 Mr.Devendra P.Shah Buy 20000
5‐Sep‐17 Mr.Devendra P.Shah Buy 100000
*in last one year
India Midcaps
INITIATING COVERAGE

HERITAGE FOODS
Leveraging moat to take the right stride
Heritage Foods (HFL), a strong private dairy player in south (AP) with 10% EDELWEISS RATINGS
organised market share, has set a target to be a VADP dairy player with Absolute Rating BUY
INR60bn in sales in FY22 (INR18bn in FY17), implying 26% CAGR over Investment Characteristics Growth
FY17‐22E. With a strong franchisee in liquid milk, Heritage is diversifying
into VADP with 24% of dairy sales in FY17 and has set a strong target of
40% of sales, potential of ~34‐40% sales CAGR over FY17‐22E. The MARKET DATA (R: HEFI, B: HTFL IN)
strategy is prudently straddling the high ROCE pouch milk and high‐ CMP : INR 758
growth & margin curd, yogurt, ice‐cream segments, leading to Heritage Target Price : INR 976
sustaining its highest pre‐tax RoCE in the industry at 42% (adjusted) with 52‐week range (INR) : 830 / 412
strong 23% sales and 21% EBIT CAGR over FY17‐20E. Initiate coverage
with ‘BUY’ valuing at 30x FY20E P/E, (~10% discount to FMCG players) in
Avg. Daily Vol. BSE/NSE (‘000) : 68.4
light of growing scale in high growth VADP and sustenance of high RoCE.

Vision 2022 – INR 60 bn sales in 5 years with 26% CAGR SHARE HOLDING PATTERN (%)
While Heritage commendably expanded its procurement from 20,000 LPD in 1997 to Current Q1FY18 Q4FY17
>1.2 mn LPD in 20 years and attained dairy sales of INR18bn in FY17, it has set a strong Promoters * 39.9 39.9 39.9
MF's, FI's & BKs 6.0 6.0 5.8
target of INR60bn of sales with procurement of ~2.8 mn litres per day in 5 years. This
FII's 8.2 7.4 7.2
will be driven by: ~25% sales CAGR in fresh milk segment led by: a) deepening Others 45.9 46.7 47.1
penetration in current markets and expanding reach in new geographies by inorganic
acquisition, and (2) 34‐40% sales CAGR in VADP to INR24bn in FY22 (INR4.2bn in FY17). * Promoters pledged shares : NIL

Unwavering focus on high margins alongside RoCE PRICE PERFORMANCE (%)
The company is prudently straddling the high RoCE pouch milk segment and high‐ Sensex Stock
Stock over
Sensex
growth & margin curd, yogurt and ice‐cream segments to attain its target. Targeting
large categories like curd (INR288bn) with organised penetration at mere 6% and high 1 month 1.7 (2.9) (4.6)
margin segments like ice‐cream are envisaged to spur Heritage’s growth and margin. 3 months 6.2 3.9 (2.3)
12 months 28.0 72.3 44.3
Outlook and valuations: Straddling the right mix; initiate with ‘BUY’
Despite transitioning to a VADP dairy player with strong ~23% sales and 21% EBIT
CAGR over FY17‐20E and adjusted ROCE at ~42%, a rare combination in this sector, the
stock entails immense potential. We value it at P/E of 30x FY20E EPS (at ~10% discount
to FMCG players) and add the market value of investment in Future Retail with a 20%
holding company discount. Initiate coverage with ‘BUY’ with TP of INR976, implying

29% upside.

Financials

Year to March FY17 FY18E FY19E FY20E
Shradha Sheth
Net Revenues (INR mn) 26,429 24,665 29,021 34,457
+91 22 6623 3308
EBITDA (INR mn) 1,413 1,407 2,016 2,600 [email protected]
Adjusted PAT (INR mn) 817 643 999 1,358
Sanyam Jain
Adjusted Diluted EPS (INR) 17.6 13.9 21.5 29.3 +91 22 4040 7412
Diluted P/E (x) 43.1 54.7 35.2 25.9 [email protected]
EV/EBITDA (x) 24.6 25.1 17.5 13.4

Adjusted RoCE (%) 39.4 32.3 38.8 41.7
RoE (%) 30.2 19.9 26.0 28.5 December 1, 2017
Edelweiss Research is also available on www.edelresearch.com, Edelweiss Securities Limited
Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.
Dairy
Investment Rationale
Competitive advantage
Creating an end‐to‐end dairy business to strengthen moats
Heritage’s capital investments are helping it create a completely integrated dairy
business.
 Heritage procures milk in 9 states from 0.35mn dairy farmers. A farmer is tied up
with Heritage through its cattle fodder, cattle feed and veterinary services.
 Further, the cattle feed is now being produced at Heritage’s own plant.
“The vision for our company is to
be a INR6000 crores company in  It processes and manufactures a range of 22 products at 15 own processing plants as
the next five years. To achieve that well as 5 leased plants.
we need to become a nationally
recognised brand”  Heritage’s dairy products are sold in 15 states through ~120,000 outlets including
1,279 Heritage Parlours (Heritage’s franchise outlets).
Ms. Brahmini Nara
Executive director
Heritage has steadily built its competitive advantages and strength in milk led by: a)
strong procurement, b) infrastructure and c) distribution.

Strength in pouch milk segment
Heritage is a strong player in the dairy business with pouch milk contributing 65% to sales
and balance from milk products. The company had focused on the pouch milk category as
there is a huge addressable market for this product, at INR3.5trn with organized market at
“Our go to market strategy is to mere 22% (INR760bn).
always procure milk directly and as
close to the market as possible. We With strong procurement, distribution and processing plants (15 plants with procurement
have gained an expertise in this
from 9 states), Heritage’s pouch milk sales have clocked 8% CAGR to INR11.7bn over FY12‐
over the last 25 years.”
17. We believe there is strong potential within its high ROCE milk segment led by huge
industry size and organized segment clocking a strong 20% CAGR. Hence, company set a
strong target of more than doubling procurement.

Chart 1: Heritage has high exposure to high RoCE milk segment with rising organised penetration
100.0
Milk
64% of Dairy Industry
80.0 Size: INR3.5trn
Growing at 15%
60.0
(%)
40.0
Organised
20.0 Size: INR760bn
22% penetration
Growing at 20%
0.0
Heritage Parag Prabhat Hatsun Kwality
Milk Non‐milk

Source: IMARC, Edelweiss research
Heritage Foods
Chart 2: Milk sales to pick up at 22% CAGR over FY17‐20E Chart 3: Procurement grew at 18% CAGR during 1993‐2017
Liquid Milk Sales
23,500 3.0 Procurement
20,000 2.4
(mn litres/day)
16,500
(INR mn)
1.8
13,000
1.2
9,500 1.86
0.6 1.04
6,000
FY18E 0.02
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
0.0
FY93 FY17 FY20E


A) Strong procurement in milk segment
Heritage is a strong player in pouch
milk (contributes 65% to sales), Heritage’s milk collection of merely 20,000 litres per day in 1993 has grown to 1.04 mn
which is procured from 0.35mn litres per day in FY17, CAGR of 18%. This is led by its strength in following areas:
dairy farmers from 9 states and
sold in 15 states currently i) 95% direct procurement
Among private dairy players, Heritage stands tall in terms of procurement, as it
sources ~95% of its requirement directly from farmers. The company has
commendably expanded its procurement base from mere 2 states a decade ago
to 8 in FY17—Andhra Pradesh, Telangana, Tamil Nadu, Karnataka, Maharashtra,
Having clocked 18% procurement Haryana, Rajasthan and Gujarat. The company has a procurement network of
CAGR over 24 years, Heritage has 0.35mn dairy farmers.
set target of acheiving 22% CAGR
over next 5 years Chart 4: Consistent increase in direct milk procurement by Heritage Foods
1.5
1.2
(mn litres per day)
0.9
The company has commendably
expanded its procurement base 0.6
from mere 2 states a decade ago
to 8 in FY17 0.3
0.0
FY13 FY14 FY15 FY16 FY17 Q1FY18 Q2FY18

Dairy
Building a milk procurement network is a function of winning farmers’ trust.
Heritage has built a multi‐state milk procurement network by focusing on
processes such as complete transparency, timely payments through banks and
providing allied dairy services. The transparency in milk procurement process
helps the company win the farmer’s trust. Further, the company is leveraging
this model across regions and creating a scalable model of milk procurement.

ii) Becoming the farmers’ trusted brand
“Looking ahead, we intend to Over the past two and half decades, Heritage, through its milk procurement network,
cement our identity as the best has established its brand equity amongst farmers in South India, leading to sustained
supporter of the Indian dairy expanding procurement reach. This is due to the following factors as the company is
farmer”. offering multiple support systems to them through:
N Bhuvaneshwari
 Facilitating loans from commercial banks for purchase of cattle.
Vice Chairman and MD
 Facilitating cattle insurance.

 Conducting health camps for animals through mobile veterinary clinics at frequent
intervals.
Over the past 2.5 decades,  Supply of high quality cattle feed and fodder seeds.
Heritage has established its brand  Helping farmers source good productive animals.
equity amongst farmers in South
 Supply of milk analyzers for ensuring accurate measurement of milk quality and
India via multiple support systems
complete transparency in measurement in quantity and quality of milk.
 Ensuring punctual payment to farmers.
 Farmers welfare fund, mobile veterinary clinics, certificate courses in dairy farming,
amongst others.
 Heritage provides 100% assurance of procuring milk total supply of milk from
farmers, even in an oversupply situation.
 Recently, the company commenced a 20 tonnes per day animal feed plant in
Anantapur (Andhra Pradesh) to supply to its milk farmers.
Heritage has transferred INR30mn

to MCC centers in the past 5 years
Milk collection center development
for veterinary care and social
security schemes Heritage Farmer Welfare Trust (HFTW) was set up in 2010 to prioritise areas of
veterinary care and social security schemes. A case in point is the company setting up
an Executive Committee (EC) at all enrolled milk collection centers whenever their
corpus reached INR7,500. The trust has proposed 26 development activities like
distribution of milk cans, milk analysers, feeding bowls, mosquito nets for cattle sheds,
umbrellas, pressure cookers, water pots, containers, flasks, solar lamps, sprayers, milk
machines, cattle insurance etc., for farmers. A total of 1,313 ECs were formed at Milk
Collection Centre (MCC) level for execution of above activities. Heritage has transferred
INR30mn to MCC centers in the past 5 years.

These measures ensure retention of strong relationships with farmers. As a result,
Heritage enjoys ~10% liquid milk market share in South India (AP), which contributes
~65% to the company’s dairy revenue. Further, the company has created brand equity
which the company can leverage to enter new regions for milk procurement in South
India with its credibility amongst farmers.
Heritage Foods
This model for procurement and sales has been replicated across regions by Heritage,
growing to one of the largest private dairy company with major presence in AP,
Telangana, and growing presence in Tamil Nadu & Karnataka.

B) Created infrastructure to keep distribution costs low
Heritage has built a strong direct milk procurement network and expanded its pouch
milk capacity. The company has steadily built a 1.3mn litre per day direct milk
procurement network across 9 states. It sources milk directly through 12,774 collection
centres and 159 bulk milk coolers & chilling centres combined across villages, further
augmented by ~23% with Reliance Dairy’s network in North with 36 bulk milk coolers
and chilling centers. Totally, post some rationalization of Reliance Dairy’s operations,
the company’s combined procurement network from 195 bulk coolers and chilling
centers has come down to 186 currently.
Table 1: Heritage’s strong procurement infrastructure
Established a 1.3mn direct milk States Chilling Centres Bulk Milk Coolers
procurement network across 9 Heritage 10 62 97
states with 12,774 collection Reliance 10 27 9
centres, 195 bulk milk coolers & Total 15 89 106
chilling centres. This has been Source: Company, Edelweiss research
further augmented ~23% with
Reliance Dairy’s network of 36 bulk The company has invested INR3bn in quality improvement and capacity
milk coolers and chilling centers expansion over the past 5 years.

The key procurement centers are in proximity to key markets. This ensures freshness of
milk by cutting down lead time. As a means to this end, Heritage has made sizeable
investments in 15 well distributed state‐of‐the‐art production hubs. Thereby, instead of
setting up 1‐2 large dairy plants, Heritage has set up a network of smaller milk
processing and pouching plants across South India.

This network has been mapped in a way that the end‐market is within 200km radius of
the plant, thus keeping logistics cost low. Higher capacity utilisation of the regional
dairy plant increases its profitability. Regional dairy plants also give Heritage more
flexibility to adjust to local demands and still have a state‐wide brand.

Dairy
Table 2: Heritage’s network of 15 factories
Number Plant State
1 B. Kotha Kota Andhra Pradesh
2 Bayyavaram Andhra Pradesh
3 Bhattiprolu Andhra Pradesh
4 Bobbili Andhra Pradesh
5 Chittoor Andhra Pradesh
6 Gokul Andhra Pradesh
7 Pamarru Andhra Pradesh
8 Bengaluru Karnataka
Heritage has made sizeable 9 Sindhanur Karnataka
investments in 15 well distributed 10 Vadamadurai Tamil Nadu
state‐of‐the‐art production hubs 11 Kalluru Telangana
12 Narketpalli Telangana
13 Uppal Telangana
14 Sangvi Maharashtra
15 Rai Haryana

(C) Strong brand with enhancing distribution
Heritage has created a strong brand recall with direct reach, selling 100% of its products
in the B2C segment. Since inception in 1992, the company has now become a
household name in dairy business in its home state of Andhra Pradesh, as well as in
neighbouring states. The brand has strong credibility in these states, with its image in
line with its slogan of ‘Health and Happiness’ due to its stable and consistent sourcing
Heritage enjoys strong brand recall of raw material.
as it sells 100% of its products in
the B2C segment Chart 5: Strong direct distribution versus peers
100.0
80.0
60.0
(%)
40.0
20.0
0.0
Heritage Parag Prabhat Hatsun Kwality
Heritage sells across 15 states in B2C B2B

India via 6,330 distributors, more Source: Edelweiss research
than 118,500 retail outlets and
1,279 Heritage Parlours Further 86% of the company’s distribution is directly via own agents/parlours enabling
stringent control over distribution. Heritage sells dairy products under the Heritage
brand across 15 states in India via 6,330 distributors, more than 118,500 retail outlets
and 1,279 Heritage Parlours.

Heritage Foods
Fig. 1: Robust distribution structure


86% of the company’s distribution Heritage Parlours further strengthen brand visibility
is via own agents/parlours enabling Heritage Parlours are modern day kirana stores which exclusively offer a range of Heritage
stringent control over the network products and authorized products & services. They are operated on a franchisee basis, with
strong development support from the company. Heritage has rationalised a few Parlours
(due to various reasons such as indiscipline amongst some franchisees, conversion of some
to milk distributing agents and closure of some unviable outlets).

Chart 6: Healthy mix of over 6,000 distributors and 1,279 Heritage Parlours
7,500 2,000
Distributors Heritage Parlours
6,000 1,700
1,400
4,500
(Nos.)
(Nos.)
1,100
3,000
800
1,500
500
Q1FY18
Q2FY18
FY13
FY14
FY15
FY16
FY17
0

Dairy
The integration should help it weather any attack from larger dairy co‐operatives.

Fig. 2: Integrated operations
Milk
Processing Distribution
Procurement
•Procurement from 9 •Operates 15 own •Products sold in 15
states processing plants and states across India
•Direct milk 5 leased processign •Over ~120,000 outlets
procurement from plants across India selling
0.35mn farmers •Installed processing Heritage products
•Operates 186 bulk capacity of 18.9llpd •Enjoys loyalty of
coolers and chilling through own plants 15lakh households
plants and 4llpld through •Operates 1,279
leased plants Heritage Parlours
•Manufacture of 22
products and 277 SKUs


Heritage Foods
Vision 2022: Strong 26% sales CAGR
Heritage has set the target to emerge as a USD1bn company (revenue of INR60bn) by
the year 2022 versus INR18bn in FY17. Further, the company aims to achieve
procurement of 2.8mn litres per day by 2022, from just ~1.2mn currently. The target is
driven by 25% CAGR in pouch milk sales and ~34‐40% CAGR in VADP. Milk is expected
to contribute 60% of sales and VADP which currently contributes 24% of dairy sales is
Heritage aims to procure 2.8mn
expected to contribute ~30‐40% of sales by 2022.
litres per day milk by 2022 from
mere ~1.2mn currently. This target
Heritage has set a target to emerge as a USD1bn company (revenues of INR60bn) by 2022
will be driven by 25% CAGR in
driving overall sales CAGR of 26% over 5 years. Further, it aims to achieve procurement of
pouch milk sales and ~34‐40% CAGR
~2.8mn litres per day by 2022 from ~1.043mn in FY17 and 1.3mn currently.
in VADP over FY17‐22

This vision was conceived based on studies and analysis done by KPMG for Heritage, after
which it set this towering but achievable target. Growth will be driven by 25% CAGR in
pouch milk sales and ~34‐40% CAGR in VADP. Milk is expected to contribute 60% to sales
and VADP, which currently contributes 24% to dairy sales, is expected to contribute ~30‐
40% by 2022. Further, this will be met through a prudent combination of organic as well as
inorganic growth in liquid milk and VADP.

Fig. 3: Heritage’s Vision 2022 implies strong growth trajectory of 26% revenue CAGR versus 11% in history (FY12‐17)

FY12 FY17 FY2022

11% CAGR 26% CAGR
• Revenue: • Revenue: • Revenue:

INR10.9bn INR18.5bn INR60bn
• VADP: 14% • VADP: 24% • VADP: ~30‐
40%

Fig. 4: Strategy for growth in milk and VADP in existing and new states

Milk VADP

Inorganic JV entered for
expansion new products

New states through and acquisitions
acquisition of for existing
smaller dairies products

Increase Agressively
Existing states procurement increase share
through deeper of value added
penetration products

Dairy
Milk procurement to reach 2.8mn lpd by FY22E
Over FY17‐22, Heritage has set a target to more than double its direct milk procurement
from 1.043mn lpd in FY17 to ~2.8mn lpd in 2022, a 22% CAGR. Led by investments in
procurement network, we expect milk procurement CAGR of 21% over FY17‐20 from 1.043
mn lpd in FY17 to 1.86 mn lpd in FY20E.

Chart 7: Expansion of procurement network to continue rapidly
3.0
Procurement
2.4
(mn litres/day)
1.8
1.2
1.86
0.6 1.04
0.02
0.0
FY93 FY17 FY20E


Heritage Foods
Strengthening pouch milk segment
We estimate the company’s pouch milk business to post 22% revenue CAGR over FY17‐
20E to INR21bn led by: a) Rising penetration in current states and b) Geographic
expansion into other states via organic and inorganic means like recently acquired
Reliance Dairy. This is inline with the company’s target of 25% CAGR in fresh milk sales.
We are inline with company’s target.

Heritage is a leading private dairy player with 10% organised market share in South India
(AP). We estimate the company’s pouch milk business to post 22% revenue CAGR over FY17‐
20E to INR21bn inline with company’s target.

a) Greater penetration in current markets
Heritage’s home market is Andhra Pradesh and Telangana, where it is the market
leader. Yet, due to the highly fragmented nature of the industry, the company’s
procurement as a percentage of total milk production stands at merely ~1‐2% in AP and
Telangana. Further, milk production in Andhra Pradesh and Telangana cumulatively has
been clocking CAGR of 7% (FY06‐16). We believe Heritage has huge scope to grow in
these 2 states.

While Heritage has 10% organised
Hence, despite its already strong positioning in the southern states, there is still huge
market share in South India (AP), its
scope to penetrate deeper into the market and garner further market share in Andhra
procurement as a percentage of
Pradesh and surrounding states. The company is also targeting Tier II & III towns in the
total milk production stands at
region.
mere ~1‐2% in the key states of AP
Table 3: Robust potential in already strong home markets (mn litres per day)
and Telangana
Total Milk Heritage Market
production Procurement Share (%)
Andhra Pradesh 29.6 0.6 2.1
Telangana 12.2 0.2 1.3
Tamil Nadu 19.8 0.2 0.9
Karnataka 17.4 0.0 0.1
Maharashtra 27.8 0.1 0.3
Source: Company, NDDB, Edelweiss research
Note: The procurement number is prior to the addition of Reliance Dairy

b) Expansion in other states to open up new opportunities
Heritage’s top 4 states (Andhra Pradesh, Telangana, Tamil Nadu and Karnataka)
account for 85‐90% of its milk procurement and ~90% of milk sales. Hence, large
markets of North and West with states like Maharashtra, Delhi and Rajasthan remain
untapped and offer a huge opportunity.

Dairy
Chart 8: Huge opportunity in the untapped northern and western states
Top 4 southern states account for Milk Sales (FY17)
85‐90% of its milk procurement and
~90% of milk sales Kerala Odisha Haryana/Delhi
Maharashtra 1% 1% 2%
5%
Andhra Pradesh
Karnataka
24%
14%
Tamil Nadu
16% Telangana
37%


Eight of the top 10 milk producing states are in North, West and Central India, where
Heritage has little or no presence.

In order to expand its distribution reach in these states, Heritage is expanding its
procurement reach both organically and inorganically (Reliance Dairy) which will facilitate
Heritage products to tap in to high potential states.

Chart 9: Top 10 milk producing states are strong expansion opportunity for Heritage
(%)
0.0 3.0 6.0 9.0 12.0 15.0 18.0
Uttar Pradesh
Rajasthan
Gujarat
Madhya Pradesh
Andhra Pradesh
Punjab
Maharashtra
Haryana
Bihar
Tamil Nadu
Production share

Source: NDDB

With Reliance Dairy’s acquisition, Acquisition of Reliance Dairy to boost geographical reach
Heritage’s procurement jumped Heritage has expanded its footprint to North and Western India through the acquisition of
~20%, adding new states—Punjab, Reliance Dairy. The company’s products are now sold in 15 states, of which they are present
Uttarakhand—and strengthened in 5 states through Reliance Dairy. Reliance operates pan‐India dairy procurement,
synergies in Mumbai and Delhi‐NCR processing and distribution operations under 2 brands Dairy Life and Dairy Pure. It has a
milk procurement network of ~0.23 mn litres per day from over 2,400 villages across 10
states with 36 chilling centres and bulk milk coolers combined.
Heritage Foods
We believe this acquisition will strengthen Heritage’s procurement and distribution as it will
add new states to its operations—Punjab, Uttarakhand and Rajasthan—and add strong
synergies in markets like Mumbai and Delhi‐NCR, where Heritage’s presence is not strong.
This acquisition will also open up Reliance Fresh as a customer, to which Heritage was not
supplying earlier. Reliance Dairy generated revenue of ~INR5.5bn in FY16.

As a result of the Reliance Dairy acquisition, Heritage’s procurement jumped ~21%. We
estimate 37% YoY growth in fresh milk sales in FY18 with 23% growth led by Reliance Dairy
and 14% growth organically.

Further inorganic expansion on cards
Heritage has also acquired Shah Motilal Foods, based in Telangana, and Vaman Milk Foods,
based in Punjab for INR120mn and INR200mn respectively. These are asset acquisitions
undertaken to bolster packing capacities for future growth and shift volumes from third
party packing stations to its own. Further, the company has taken on board E&Y to assist its
inorganic expansion. Management has indicated that this will be an ongoing activity for the
next 5 years to expand its milk procurement and increase fresh milk sales.

With increased penetration in current states and geographical expansion via organic and
inorganic routes, we forecast fresh milk sales CAGR of 22% to INR21bn over FY17‐20E. This is
in line with the company’s target of 25% CAGR in fresh milk sales to INR36bn over FY17‐22E.
Further, this potentially implies ~30% CAGR over FY20‐22E for the company to attain its
stated target.

Dairy
Scaling up in high‐margin, RoCE fresh dairy products
Heritage is smartly straddling the high ROCE pouch milk segment and curd and yogurt
segments leading it to the highest RoCEs amongst peers (core pre tax ROCE at 39%
versus 22% for Hatsun, 8% for Parag, 10% for Prabhat in FY17). We expect the adjusted
pre tax RoCE to expand 230bps to ~42% over FY17‐20E as INR1.3bn capital employed in
retail and agri is released and value added sales scale up.

Heritage is expanding its sales in VADP as fresh milk, despite being a strong RoCE business,
can be scaled only via strong procurement across states, which happens gradually. Hence
the company, leveraging its strong procurement prowess, continues to raise the revenue
share of VADP.

Within VADP, Heritage is judiciously moving towards high margin, high value added
products—curd, ice cream, paneer and flavoured milk. These products entail, on an average,
2x EBITDA margin versus liquid milk.

Value‐added product consumption is also growing at a faster rate than liquid milk, due to
the low penetration as well as negligible organised share. With industry growth of these
products surging and negligible organized share (~6% in curd – Heritage’s highest share of
VADP), it will be well placed to ride the VADP wave.

Chart 10: Scale up of VADP – High share of curd in VADP segment which has mere 6% organised penetration offers huge scope
15.5 Curd
Butter milk Sweets Others
INR288bn
Flavoured 4% 2% 1%
Milk 14.5
Ghee
Industry Growth (%)
4%
INR811bn
Paneer 13.5 Paneer
4% INR386bn
Ice‐cream
8% 12.5
11.5
Ice‐cream
INR100bn
10.5
Curd (10) 10 30 50 70
77% Organised Penetration (%)
Source: Company, IMARC report, Edelweiss research

Heritage Foods
VADP contributed 24% to Heritage’s total dairy revenue in FY17, up from merely 14% in
We estimate 31% CAGR in curd FY12. The company has set a target of increasing contribution of value‐added products to
sales over FY17‐20. ~30‐40% by 2022 from 24% currently, potentially implying INR18‐24bn sales in 2022 from
VADP and ~34‐40% sales CAGR over FY17‐22E. We have given a range as we have assumed
fat products to continue at ~10% of sales and hence VADP share at ~30% of sales. We expect
28% of sales from VADP in FY20 driven by:

a) Low organised penetration in curd offers huge potential
Heritage’s curd segment clocked robust 32% CAGR over FY12‐17 leading to ~77% strong
contribution of the company’s VADP and 18% to overall dairy sales at INR3.26bn in
FY17. Further, we perceive huge scope as curd is the fourth largest value‐added
product in the dairy industry in terms of market size (INR288bn in FY16), after milk,
ghee and paneer. The curd market is dominated by unorganised players, with the
organised segment garnering mere ~6% market share. The industry has clocked ~15%
CAGR (FY10‐16), though the organised segment has grown at ~20%. We envisage the
demand shift to organised players to sustain due to rising income levels, rapid
Curd is the fourth largest value‐ urbanisation and increasing working women.
added product in the dairy industry
in terms of market size (INR288bn We believe, Heritage is well poised to capitalise on this opportunity due to its large
in FY16) with organised segment at presence in the segment and expect a strong 31%CAGR in sales over FY17‐20E. Further,
mere ~6% share and South India South India is currently India’s biggest curd market, accounting for 35% of total curd
accounting for largest share at 35% consumption which, which will sustain Heritage’s growth. The overall curd market is
expected to grow to ~INR493bn by FY20E (14% CAGR), of which organised share is
estimated at INR35bn from INR17bn currently (20% CAGR over FY16‐20E).

Chart 11: Organised curd industry growing at ~20% CAGR Heritage curd sales grew at 32% CAGR during FY12‐17
500 8.0 8,000
Curd sales
400 7.0 6,500
300 6.0 5,000

(INR mn)
(INR bn)
(%)
200 5.0 3,500
100 4.0 2,000
0 3.0 500
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
2015P
2016P
2017P
2018E
2019E
2020E
2010
2011
2012
2013
2014
Unorganised Organised Organised Share (RHS)

Source: IMARC Report, Company, Edelweiss research

b) Inorganic opportunities in VADP – Flavoured yogurt: Alongside organic growth
potential, the company has also forged partnership in VADP and is in discussions with
international players for products like curd and yogurt.

Dairy
Joint venture with Novandie to expand capacity and range
Heritage has entered into a joint venture with French company Novandie SNC with a
50:50 partnership for manufacturing and marketing flavoured yogurt and western style
desserts. The JV will produce flavoured yoghurt. Later, it will manufacture fruit yogurt
lines.

Novandie, a leading yogurt player, is a subsidiary of French food giant Andros. Andros is
a family owned and run private company, headquartered in the southwest France, and
known as a global leader in fruit processing, frozen desserts, dairy and
Heritage has entered into a JV with confectionery. Heritage gets to leverage on technology, recipe and marketing
a leading French company experience of a globally recognized brand Mammie Nova with this partnership.
Novandie SNC for flavoured yogurt
and western style desserts to High growth flavored yogurt market
leverage on the globally recognised The high growth flavoured and frozen yoghurt market in India posted CAGR of 32% over
Mammie Nova brand FY10‐16, reaching INR4bn in 2016. Further, the segment is expected to register CAGR of
32% over FY16‐20 to INR12.1bn primarily driven by increasing urban middle class.

Potential from joint venture
Management expects ~INR300mn A 20MT/ day capacity greenfield plant will be set up in Vashi, Maharashtra, at an
revenue in the first year from the investment of INR160mn in the first year to cater to key markets of Mumbai and Pune
JV, rising up to INR3bn in 5 years in FY18. Commercial operations will commence in FY19. Management expects revenue
bolstered by capacity expansion of around INR300mn in the first year, rising up to INR3bn in 5 years bolstered by further
(INR750mn over 6 years) capacity expansion (INR750mn over 6 years). The first plant will be able to generate
revenue of INR1bn at 100% capacity utilisation. Heritage expects it to breakeven in the
second year, while EBITDA margin will scale up from 10% to 20% as utilisation increases.
Heritage expects growth in this JV to be led by flavoured yogurts and further expand
into stirred yoghurts, European/western desserts and milk & rice based desserts.

c) Strong growth in other VADP— Ice cream, flavoured milk, butter milk and lassi
The ice cream market in India is estimated at ~INR100bn with organised sector pegged
at 2/3rd of the industry and forecast to clock 11% CAGR over FY16‐21.

Management expects ice cream Ice cream sales at ~INR340mn contribute 8% to Heritage’s VADP revenue and the
sales to jump to ~INR3bn from company estimates sales to catapult to INR3bn over the next 5 years. We have
INR340mn in FY17; we have assumed mere INR680mn sales at 26% CAGR over FY17‐20 based on pure organic
assumed mere INR680mn sales at growth. Further inorganic plans are yet being firmed up.
26% CAGR over FY17‐20 based on
pure organic growth
Heritage Foods
Chart 12: Growth in other VADP (icecreams, flavoured milk, buttermilk and lassi)
1,650 Ice‐creams, Flavoured Milk, Buttermilk and Lassi
1,450
1,250
(INR mn)
1,050
850
Management expects sales of
buttermilk, lassi and flavoured milk
variants to catapult to ~INR2bn in 650
2020; we have assumed mere
FY17 FY18E FY19E FY20E

INR800mn sales at 28% CAGR over Source: Company, Edelweiss research
FY17‐20 based on pure organic
growth Further, the company has ~9% combined revenue share from sales of buttermilk, lassi and
flavoured milk variants at INR380mn. Heritage expects sales to catapult to INR2bn over 5
years led by organic and inorganic growth. We have assumed mere INR800mn sales at 28%
CAGR over FY17‐20E based on organic growth at current capacities.

Overall, we have assumed 30%
With acceleration of high growth and margin fresh dairy and VADP going forward, we
sales CAGR in VADP over FY17‐20
forecast VADP’s contribution to grow from 24% to 28% of sales over FY17‐20E and sales
versus management’s guidance of
CAGR of 30% leading to overall sales CAGR of 23%. This is much lower than the stated
~34‐40% CAGR over FY17‐22
target of INR18‐24bn, with our forecasts based on organic growth at current capacities.
Further, this potentially implies 40‐62% CAGR over FY20‐22 for the company to attain its
stated target which we believe will be via further inorganic acquisitions and entering new
categories.

Chart 13: Rapid growth of revenue share of VADP sales
10,000 31.0
Value added revenues
26.8
8,200
22.6
6,400
(INR mn)
(%)
18.4
4,600
14.2
2,800
10.0
1,000
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
Share of Value added products


Dairy
Focus on right product mix helps maintain high RoCE
While Heritage has a higher share of milk sales (65% revenue share), which is a low‐margin
business, it generates high RoCE (~44‐45%) due to negligible capital outlay requirement as
well as low working capital cycle (~5 days). Hence, liquid milk generates the highest asset
turnover (10‐12x). With strong procurement & distribution and proximity to processing
plants (15 plants spread across procurement & distribution regions), the company’s asset
turn for milk is high, resulting in the segment clocking superior RoCE.

Curd is a high‐growth value‐added product and generates higher margin than milk without
With higher revenue share of high
significant capital outlay and working capital requirements. It generates gross margin of
RoCE milk and curd sales at ~83%,
~30% and RoCE of ~30%. Despite being a VADP, moderate capital requirement supports
Heritage enjoys highest RoCE
RoCE. Hence, due to high share of curd in VADP, Heritage is able to generate high growth
amongst peers
and improve margin without compromising on RoCE.

Chart 14: Curd and milk generate highest RoCEs
50.0
RoCE
40.0
30.0
(%)
20.0
10.0
0.0
Milk Curd Butter Ghee UHT Milk Cheese Paneer
RoCE


Due to the high proportion of milk and curd in its portfolio, Heritage enjoys the highest RoCE
amongst peers (core RoCE at 39% versus 8% for Parag and 10% for Prabhat in FY17). Further,
this is higher than even Hatsun (~22%), which has a strong 14% market share in South in milk,
due to Heritage’s better product mix and high capital intensity of Hatsun due to its deeper
penetration strategy.

Heritage Foods
Chart 15: Heritage has highest (core dairy) RoCEs due to its product mix
80.0
65.0
50.0
(%)
35.0
20.0
5.0
Heritage* Prabhat Parag Hatsun Kwality

*Adjusted RoCE (excluding demerged segments)

EBIT margin to decline 210bps in Margin and return ratio levers
FY18 to 4.5%, post which it is With increase in VADP from 24% to 28% of sales over FY17‐20E, we estimate EBIT CAGR of
envisaged to jump 180bps to 6.3% 21%. The margin expansion is lower since we expect a decline in FY18 due to acquisition of
over FY18‐20 loss‐making operations of Reliance Dairy, which is estimated to break even by H2FY18.

Hence, we expect Heritage’s EBIT margin to dip 210bps to 4.4% in FY18, post which it is
envisaged to jump 180bps to 6.3% over FY18‐20E leading to 40% EBIT CAGR over the period
for the dairy business.

Chart 16: Overall margin and dairy EBIT margin
11.0 75.0
EBIT Margin RoCE
9.0 60.0
7.0 45.0
(%)
(%)
5.0 30.0
3.0 15.0
1.0 0.0
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
Overall Margin Adjusted Margin Company RoCE Adjusted RoCE

Note: EBIT margin has been adjusted to exclude demerged segments
Note: RoCE has been adjusted to exclude demerged segments and investment in Future Retail

Dairy
With operations restricted to the dairy segment currently, we expect Heritage to generate
RoCE of closer to that of dairy segment (~45%), adjusting for INR1.48bn investment in
Future Retail. We estimate adjusted RoCE to jump 230bps over FY17‐20 to 41.7% led by
prudently increasing VADP mix from ~24% to 28%.

Even without adjusting for the investment in Future Retail, RoCE will surge to ~32.4% in
FY20E from 26.5% in FY17 since the segments sold off generated negative margin
(INR158mn of EBIT loss in FY16 and INR132mn EBIT loss in FY17) and returns, while margins
and returns will improve going forward with growing VADP sales. Hence, even with the
investment generating no revenue returns, it is better off than earlier. Capital employed
that was blocked in demerged segments was ~INR1.3bn, while the book value of investment
in Future Retail is INR1.5bn.

Heritage Foods
Valuation

• Transitioning to a pan‐India VADP dairy player with strong growth and RoCE, a rare
combination in this sector, the stock entails immense potential.
 We estimate Heritage to clock revenue and EBIT CAGR of 23% and 21% respectively
over FY17‐20 with pre‐tax RoCE expanding 230bps to 41.7% in FY20. This will be
spearheaded by strong industry drivers and Heritage’s drive to be a value added
player with USD1bn (INR60bn) revenues.
 As fresh dairy players can be compared to Indian FMCG players which command
strong growth and superior RoCEs, we value Heritage at P/E of 30x FY20E EPS (at
~10% discount to FMCG players). Further, adding the market value of investment in
Future Retail with a 20% holding company discount. Initiate coverage with ‘BUY’.

Fresh dairy products players can be compared to Indian FMCG players which have strong
brands, superior RoCE, significant scope of growth led by shift to organised hence available at
a median of 33x FY20 P/E. We initiate coverage on Heritage with a ‘BUY’ at ~10% discount to
FMCG players.

Heritage scores the highest in the industry due to its direct procurement, pure B2C sales and
robust RoCE. We believe, the company is well poised for growth along with expanding RoCE,
which is already highest in sector, with: 1) sharpened focus on expanding its procurement
on pan‐India level in fresh milk; and 2) increasing the share of VADP led by high growth &
margin and low capital requiring curd and yogurt businesses via JVs.

We believe, Heritage is strongly placed with rising organised penetration in the dairy sector
and further transition to a VADP dairy player with strong growth and ROCE, a rare
combination in this sector.

Hence, we value the stock at 30x FY20E EPS (at ~10% discount to FMCG players) led by strong
regional moat leading to healthy return ratio at ~42% and scope of shift in the huge fresh dairy
segments that Heritage deals in. We also add the market value of investment in Future Retail
with a 20% holding company discount giving INR98. Thereby, overall we get a target price of
INR 976, 29% upside from current levels. At current levels, the stock is trading at P/E of 35.2x
FY19E and 25.9x FY20E (unadjusted for the investments in Future retail).

Table 4: SoTP valuation
Particulars Valuation Value/Share Remarks
methodology (INR)
Heritage Foods Earning multiple 878 Valued at 30x FY20E EPS
Future Retail Investment Market Value 98 Valued at market value with 20% holding company
discount
Target Price 976

Dairy
Key Risks

High dependency on low margin milk business
Pouch milk business, wherein margins are low, contributes a sizeable 65% to Heritage’s sales.
Hence, an increasing milk price scenario impacts the company’s margin adversely as the
increase in procurement price is passed on with a lag.

Increasing competition
Increase in competition from co‐operatives or private players, either in form of
procurement (by increasing prices to farmers) or selling price (via lower prices), can impact
Heritage’s performance. However, increasing procurement on pan‐India basis by acquiring
dairies and processing plants which are strong in their states will diversify and strengthen
Heritage’s procurement beyond its home states of AP and Telangana.

Heritage Foods
Company Description

Heritage was founded by Mr. Chandrababu Naidu in 1992 as a dairy company to provide
fresh and healthy products to customers and remunerate dairy farmers. Over the years,
Heritage has operated in dairy, retail, agri, bakery and veterinary care. However, it has now
demerged its loss making retail, agri and bakery businesses, selling them off to Future Retail
for a consideration of 17.85mn shares (3.6% stake), rendering the company a pure dairy
play. Veterinary care contributes less than 1% to the company’s revenue.

Heritage sells milk and milk products such as curd (largest share), ice cream, paneer,
flavoured milk, ghee, butter and milk powders. Entire dairy sales are B2C and are sold under
the Heritage brand. Of FY17 dairy revenues, milk constituted ~66%, VADP 24% and fat
products 9% share. Curd’s contribution within VADP is 77% and ~18% to Heritage’s
manufactured dairy sales.

Chart 17: Revenue mix (FY17)
Fat Products SMP
9% 1%
Other VADP
6%
Curd
18%
Milk
66%


Dairy
Fig. 5: Evolution of Heritage
1994‐2006
1992
Established plants in AP, 2006
Founded by N. 1994
Tamil Nadu and Karnataka; Business expansion into
Chandrababu Naidu and Initial Public Offer
consolidating position in Retail segment
family
South India
2009 Entered into Maharashtra ‐ 2008

establishing a procurement 2006
Business expansion into network and processing Business expansion into Entered into ice creams
Bakery Segment plant Agri Segment
2012‐2015 2016 2017

Entered Delhi, Rajasthan Board approved demerger Acquisition of dairy
and Haryana of Retail business business of Reliance Retail

Source: Company, Edelweis research

Strong presence in South; expanding reach in other states
Heritage is a strong brand in South India, particularly its home state of Andhra Pradesh and
surrounding states. Before the acquisition of Reliance Dairy, ~90% of milk procurement and
milk sales were in southern states of Andhra Pradesh, Telangana, Tamil Nadu and Karnataka.

Post the acquisition, Heritage has the widest regional footprint in India among privately held
dairy companies, spread across 15 states with procurement in 9 states. Further expansion
will be driven by deeper penetration in existing markets by entering tier 2 and 3 towns,
increasing milk procurement, entering & expanding in new markets via acquisitions and JVs,
such as the one with Novandie SNC.

Fig. 6: Heritage range of products

Source: Company

Heritage Foods
Management Overview
Heritage was founded by Mr. Chandrababu Naidu and is now carried forward by his family.

Table 5: Management profile
Key Personnel Profile
Mr. Seetharamaiah Devineni Commerce graduate from Andhra University and a fellow member of the Institute of Chartered
Chairperson Accountants of India. Senior partner of Brahmayya & Co., a leading Chartered Accountancy
firm and has been practicing for the last five decades. Has held various coveted posts, which
include Membership of the Southern Regional Board of Reserve Bank of India, and Federation
of Andhra Pradesh Chamber of Commerce and Industry, Chairpersonship of the Tirumala
Tirupati Devasthanams Trust Board and Trusteeship of the NTR Memorial Trust. Is also on the
Board of several other companies.
Mrs. Bhuvaneswari Nara B.A Graduate, Is a Director in several other Companies. Is a dynamic leader who has extensive
Vice‐Chairperson & Managing experience in business and has been successfully steering Heritage towards growth and better
Director prospects.
Mrs. Brahmani Nara Master's Degree in Business Administration from Stanford University, Bachelor of Science
Executive Director degree in Electrical Engineering from Santa Clara University USA and Bachelor of Engineering
with specialization of Electronics and Communications from Chaitanya Bharathi Institute of
Technology. Investment Associate in Vertex Venture Management Pvt Ltd between 2009‐2011
in Singapore and was associated with the Company as a Vice‐President (Business
Development).
Dr. M. Sambasiva Rao Post Graduate and Doctorate in Zoology. Served the state and central governments for about
President two decades as a member of the Indian Administrative Services(IAS). Dr Rao was the Joint
Secretary in the Department of Commerce under the Ministry of Commerce and Industry,
Government of India
Mr. CA A Prabhakara Naidu Fellow Member of the Institute of Chartered Accountants of India and Graduated from Sri
Vice President ‐ Finance & Venkateswara University with a University rank in Science. Has 23 years of experience in
Accounts (CFO) Finance and Accounts. Has been associated with the Heritage group since It's inception.
Mr. Umakanta Barik Has Masters in Economics, LLB, FCS, LIII. Is a Fellow Member of the Institute of Company
Company Secretary Secretaries of India, New Delhi and a Licentiate from Insurance Institute of India, Mumbai.
Has over 14 years of experience in the domains of Secretarial, Legal, Insurance & Intellectual
Property Rights.
Mr. J Samba Murthy Holds an MBA in Marketing and a Bachelors of Science degree. Is the Senior Vice President at
Head ‐ Dairy Division Heritage and has been associated with the Company since 2007. Has worked previously in
APDDCF Limited, Visakha Dairy NDDB, and Reliance in various positions in the field of Sales &
Marketing.

Dairy
Financial Outlook
 Sales momentum at strong 20% plus CAGR: Sales estimated to grow at 23% CAGR led
by healthy 30% CAGR in VADP and 22% sales CAGR in fresh milk business over FY17‐
20E.
 Rising share of value‐add products: Potent gross margin kickers: We expect Heritage’s
EBIT margin to catapult 180bps to 6.3% in FY20 from 4.5% in FY18 driven by healthy
growth in the high margin VADP.
 Improving return ratios: The company’s dairy segment has generated average pre‐tax
RoCE of ~50% over FY12‐17 versus average 23% for the overall company. As Heritage
is now a pure‐play dairy company, its margins will move closer to dairy RoCE. We
forecast company’s pre‐tax RoCE to improve 230bps to 41.7% in FY20 over FY17 (ex
of demerged segments and investment in Future Retail).

Strong revenue momentum in line with vision, leading to 23% sales CAGR
We estimate dairy sales to clock Heritage’s dairy business reported 11% revenue CAGR over FY12‐17 led by liquid milk sales
23% revenue CAGR over FY17‐20 clocking 8% CAGR and strong 24% CAGR in VADP. We estimate dairy sales to report 23%
revenue CAGR over FY17‐20 led by 22% CAGR in milk sales boosted by the Reliance Dairy
acquisition and healthy 30% CAGR in VADP over FY17‐20E. We expect VADP sales to
contribute 28% to overall sales by FY20. Heritage’s overall revenue CAGR is estimated at 9%
over FY17‐20 (without adjusting for divested retail and bakery in the base year).

Chart 18: Healthy revenue growth momentum to sustain driven by milk and VADP
40,000
Total: 23% CAGR
32,000
24,000
(INR mn)
16,000
8,000
0
Milk Value added Others


Heritage Foods
Rising share of value‐added products: Margin driver
EBIT of the dairy business clocked CAGR of 16% over FY12‐17. With jump in VADP from 24%
to 28% of sales over FY17‐20E, we estimate EBIT CAGR of 21%. The margin expansion is
lower since we expect a decline in FY18 due to acquisition of loss‐making operations of
Reliance Dairy, which are envisaged to break even by H2FY18.

Reliance Dairy to turnaround under Heritage
While Reliance Retail’s dairy operations were loss making (~INR200mn EBITDA loss),
Heritage is working on optimising costs and aligning the product mix in line with its own.
While the spread of Reliance Dairy’s operations is a key benefit for Heritage, it was not in a
cost efficient manner at the time of acquisition.

Heritage has started rationalising Reliance Dairy’s operations—Uttar Pradesh and Madhya
Pradesh operations have been shut down due to lack of viability, certain milk procurement
routes have been closed (20 of 186) and cost optimization in chilling centers and logistics
Adjusted EBIT margin will decline has been implemented.
210bps in FY18, though is
envisaged to jump 180bps over Further, Heritage has also planned rebalance of product mix. Reliance Dairy was procuring a
FY18‐20, leading to 12% CAGR over much larger volume of milk than it was selling in the retail market. Hence, it was producing
FY17‐20 low margin milk powders. Heritage has now balanced procurement volumes and sales to
restrict the share of these low margin products. Bulk quantities, which Reliance Dairy was
selling, have also been curtailed.

Hence, we expect EBIT margin to drop 210bps in FY18 to 4.5%, post which it is estimated to
jump 180bps to 6.3% over FY18‐20E leading to 40% EBIT CAGR for the dairy business over
FY18‐20E. Overall, Heritage’s EBIT margin is estimated to catapult 210bps to 6.3% in FY20
from 4.1% in FY17 (suppressed by loss‐making retail business).

Chart 19: EBIT Margin (adjusted) to decline in FY18 Adjusted EBIT trajectory at strong 21% CAGR
10.0 2,500
Adjusted EBIT Margin Adjusted EBIT
8.0 2,000
6.0 1,500
(INR mn)
(%)
4.0 1,000
2.0 500
0.0 0
FY18E
FY19E
FY20E
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18E
FY19E
FY20E
FY11
FY12
FY13
FY14
FY15
FY16
FY17

Note: EBIT adjusted to exclude demerged segments

We estimate PAT CAGR of 18% over FY17‐20E led by improving margins.

Dairy
Chart 20: Robust PAT spurt to sustain
1,500
Adjusted PAT
1,300
1,100
(INR mn)
We estimate PAT CAGR of 18% over 900
FY17‐20
700
500
Note: PAT adjusted for discontinued operations

Improvement in already high return ratios
Heritage’s dairy segment has generated average pre‐tax RoCE of ~50% over FY12‐17 versus
average 23% for the overall company. As the company is now a pure‐play dairy company, its
RoCE will move closer to dairy industry’s RoCE. We forecast pre‐tax RoCE to improve 230bps
over FY17‐20E to 41.7% in FY20 (excluding retail and investment in Future Retail) due to
improvement in EBIT margin on account of increase in VADP sales from 24% to 28% of sales.
Chart 21: Return ratios to improve over FY18
49.0
42.8

Pre‐tax RoCE to jump 230bps to
36.6
41.7% in FY20E over FY17.
(%)
30.4
24.2
18.0
Adjusted RoCE RoE

Note: RoCE adjusted for demerged segments and investment in Future Retail

Heritage Foods

Macro Net Revenues 26,429 24,665 29,021 34,457
GDP(Y‐o‐Y %) 6.6 6.8 7.4 7.4 Raw Material Costs 20,628 19,502 22,614 26,713
Inflation (Avg) 4.5 4.0 4.5 4.5 Employee costs 1,647 1,270 1,480 1,723
Repo rate (exit rate) 6.3 5.8 5.8 5.8 Other expenses 2,740 2,486 2,911 3,421
USD/INR (Avg) 67.1 65.0 66.0 66.0 Total expenses 25,016 23,258 27,005 31,857
EBITDA 1,413 1,407 2,016 2,600
Company Depreciation & amortization 378 373 451 529
Procurement price (INR/litre) 32.5 33.1 33.8 35.1 EBIT 1,035 1,034 1,565 2,071
Procurement price increase (%) 5.2 1.8 2.0 4.0 Less: Interest Expense 112 161 179 161
Procurement (mn litres/day) 1.0 1.4 1.6 1.9 Add: Other income 60 73 82 86
Growth(%) (8.2) 38.2 13.6 13.8 Profit Before Tax 983 946 1,469 1,997
Sales growth (%) Less: Provision for Tax 315 303 470 639
Manufactured Reported Profit 668 643 999 1,358
Milk 7.4 37.2 14.3 15.4 Less: Profit from Discont. oper. (149) 0 0 0
Curd 14.0 33.5 28.8 30.0 Adjusted Profit 817 643 999 1,358
Ice‐cream 14.0 24.1 27.4 27.4 No. of Shares outstanding (mn) 46 46 46 46
Paneer 28.0 30.0 30.0 Adjusted Basic EPS 17.6 13.9 21.5 29.3
Flavoured Milk 28.0 30.0 30.0 No. of dil. shares outstand. (mn) 46 46 46 46
Butter milk 25.0 28.0 28.0 Adjusted Diluted EPS 17.6 13.9 21.5 29.3
Sweets 20.0 20.0 20.0 Adjusted Cash EPS 25.8 21.9 31.2 40.7
Others 14.0 25.0 28.0 28.0 Dividend per share 4.0 4.0 6.0 8.0
Vetca 10.0 10.0 10.0 Dividend Payout Ratio (%) 22.7 28.9 27.9 27.3
Traded 29.9 (85.6) 23.4 18.9
Common size metrics ‐ as % of reve 4.1% 4.5% 5.7% 6.3%
Revenue Share (%) Year to March FY17 FY18E FY19E FY20E
Milk 63.0 65.1 63.2 61.5 Gross margin 21.9 20.9 22.1 22.5
Curd 17.6 17.7 19.3 21.2 Staff costs 6.2 5.2 5.1 5.0
Ice‐Cream 1.8 1.7 1.8 2.0 S G & A expenses 10.4 10.1 10.0 9.9
Other Value Added Products 3.4 3.2 3.5 3.8 Depreciation 1.4 1.5 1.6 1.5
Fat Products 8.7 7.2 6.7 6.2 Interest Expense 0.4 0.7 0.6 0.5
SMP 0.5 0.5 0.5 0.5 EBITDA margins 5.3 5.7 6.9 7.5
Vet Ca 0.0 0.0 0.0 0.0 Net Profit margins 3.1 2.6 3.4 3.9
Traded 42.0 4.5 4.8 4.8
Growth metrics (%) ‐2.13% 1.78%
Financial Assumptions Year to March FY17 FY18E FY19E FY20E
Depreciation (% of gross block) 8.5 6.5 6.5 6.5 Revenues 11.0 (6.7) 17.7 18.7
Interest (% of total borrowings) 7.1 9.0 9.0 9.0 EBITDA 8.0 (0.4) 43.3 29.0
Tax Rate (%) 32.0 32.0 32.0 32.0 PBT 14.3 (3.8) 55.3 36.0
Capex (INR mn) (592.8) 1,300.0 1,200.0 1,200.0 Adjusted Profit 15.1 (21.3) 55.3 36.0
EPS 15.1 (21.3) 55.3 36.0
Adjusted Growth metrics (%) ######## ########

Revenues 6.4 32.9 17.7 18.7
EBIT 3.4 (9.8) 48.9 31.0
Adjusted PAT 15.1 (21.3) 55.3 36.0
*Adjusted for demerged segments
Dairy
Balance sheet (INR mn) Cash flow statement

Share capital 232 232 232 232 Operating cash flow 1,119 1,124 1,667 1,994
Reserves & Surplus 2,775 3,213 4,007 5,058 Investments cashflow (1,183) (1,300) (1,200) (1,200)
Total shareholders funds 3,007 3,445 4,239 5,290 Financing cash flow 139 (165) (183) (667)
Minority interest 0 0 0 0 Net cash Flow 76 (342) 284 127
Long term Borrowings 745 1,145 1,345 1,145 Capex (1,205) (1,300) (1,200) (1,200)
Short term Borrowings 840 640 640 640 Dividends Paid (84) (204) (204) (307)
Total Borrowings 1,584 1,784 1,984 1,784
Long Term Liabilities & Prov. 164 147 155 162 Profitability & liquidity ratios
Deferred Tax Liability (net) 198 198 198 198 Year to March FY17 FY18E FY19E FY20E
Sources of funds 4,952 5,574 6,576 7,435 ROAE (%) 30.2 19.9 26.0 28.5
Gross Block 4,441 5,741 6,941 8,141 ROACE (%) 26.5 22.5 28.8 32.4
Net Block 2,966 3,928 4,677 5,347 Adjusted RoCE (%)* 39.4 32.3 38.8 41.7
Capital work in progress 79 79 79 79 Inventory Days 24 21 19 18
Intangible Assets 5 5 5 5 Debtors Days 3 2 2 2
Total Fixed Assets 3,049 4,011 4,760 5,431 Payble Days 13 10 8 8
Non current investments 1,488 1,488 1,488 1,488 Cash conversion cycle (days) 14 14 12 12
Cash & bank balances 470 129 413 540 Current Ratio 1.3 1.1 1.2 1.3
Inventories 1,227 1,069 1,239 1,464 Gross Debt/EBITDA 1.1 1.3 1.0 0.7
Sundry Debtors 156 135 159 283 Gross Debt/Equity 0.5 0.5 0.5 0.3
Loans & Advances 160 153 169 190 Adjusted Debt/Equity 0.5 0.5 0.5 0.3
Other Current Assets 19 18 20 22 Net Debt/Equity 0.4 0.5 0.4 0.2
Total Current Assets (Ex Cash) 1,561 1,375 1,587 1,959 Interest Coverage Ratio 9.2 6.4 8.8 12.9
Trade payable 602 481 558 659 Cash Conversion (%) 79 80 83 77
Other Current Liab. & ST Prov. 1,016 948 1,115 1,324
Total Current Liab. & Provisions 1,617 1,429 1,673 1,983 Operating ratios
Net Current Assets (ex cash) (56) (54) (86) (24) Year to March FY17 FY18 FY19 FY20E
Uses of funds 4,952 5,574 6,576 7,435 Total asset turnover(x) 5.9 4.7 4.8 4.9
Book value per share (BV) (INR) 65 74 91 114 Fixed asset turnover(x) 8.7 7.1 6.7 6.9
Equity turnover(x) 9.8 7.6 7.6 7.2
Free cash flow (INR mn)
Year to March FY17 FY18E FY19E FY20E Valuation parameters
Reported Profit 668 643 999 1,358 Year to March FY17 FY18E FY19E FY20E
Add: Depreciation 378 373 451 529 Adjusted Diluted EPS (INR) 17.6 13.9 21.5 29.3
Interest (Net of Tax) 76 109 121 109 Y‐o‐Y growth (%) 15.1 (21.3) 55.3 36.0
Others 104 16 57 51 Adjusted Cash EPS (INR) 25.8 21.9 31.2 40.7
Less:Changes in WC 107 18 (39) 54 Diluted P/E (x) 43.1 54.7 35.2 25.9
Operating cash flow 1,119 1,124 1,667 1,994 Price/BV (x) 11.7 10.2 8.3 6.7
Less: Capex 1,205 1,300 1,200 1,200 EV/Sales (x) 1.3 1.4 1.2 1.0
Free cash flow (86) (176) 467 794 EV/EBITDA (x) 24.6 25.1 17.5 13.4
Dividend yield (%) 0.5 0.5 0.8 1.1
*Adjusted for demerged segments and investment in Future Retail
Heritage Foods
Additional Data
Directors Data
Mrs. N Bhuvaneswari Vice Chairperson and Managing Director Mr. M Siva Rama Vara Prasad Non Executive Independent Director (up to 12‐may‐16)
Mrs. N Brahmani Executive Director Mr. Rajesh Thakur Ahuja Non Executive Independent Director
Mr. D. Seetharamaiah Non Executive Independent Chairperson Dr. V Nagaraja Naidu Non Executive Director
Mr. N Sri Vishnu Raju Non Executive Independent Director Mr. N Lokesh Non Executive Director (upto 31‐Mar‐17)

Auditors ‐ Walker Chandiok & Co LLP
*as per last annual report

Holding ‐ Top 10
NIRVANA HOLDINGS PVT LTD 11.09 MEGABID FINANCE INVESTMENT 5.28
SUNDARAM ASSET MANAGEMENT CO LTD 3.81 KEDIA SECURITIES PVT LTD 1.01
RELIGARE INDIA ASSET MANAGEMENT 0.90 TATA ASSET MANAGEMENT LTD 0.64
DIMENSIONAL FUND ADVISORS LP 0.31 HSBC ASSET MGMT INDIA PVT LTD 0.20
BOI AXA INVESTMENT MANAGERS PVT 0.20 UNION KBC MUTUAL FUND 0.13
Bulk Deals
21‐Nov‐17 Indgrowth Capital Fund I Buy 358,709 740
Striver Capital Advisors Pvt
21‐Nov‐17 Ltd Sell 359,500 740
*in last one year
Insider Trades
No Insider Trades
*in last one year
Dairy

India Midcaps
COMPANY UPDATE

PRABHAT DAIRY
Metamorphosing into value‐added B2C player
EDELWEISS RATINGS
Prabhat Dairy (Prabhat) is set to shift from a specialty ingredients B2B
provider towards a value‐added retailer. Management has set a target of Absolute Rating BUY
INR20bn sales by 2020 driven by doubling of B2C sales to INR10bn (to Investment Characteristics Growth
50% share) and envisages overall revenue growth to be spearheaded by
milk (~25% CAGR), ghee (15% CAGR), cheese (125% CAGR) and UHT (8x)
MARKET DATA (R: , B: PRABHAT IN)
over FY17‐20. Further, with brand building, Prabhat will be able to
CMP : INR 163
command brand premium and improve market share, thus boosting
margin 110bps over FY17‐20 to 10.1%. With the company’s aggressively Target Price : INR 211
metamorphosing into a value‐added B2C player, we forecast sales and 52‐week range (INR) : 173 / 91
earnings CAGR of 15% and 39%, respectively, over FY17‐20. Maintain
‘BUY’, valuing the company at 22x FY20E, with TP of INR211.
Avg. Daily Vol. BSE/NSE (‘000) : 300.1

B2C, value‐added products to drive growth
SHARE HOLDING PATTERN (%)
Prabhat is eyeing doubling of B2C sales to INR10bn from INR5bn, propelling its
Current Q1FY18 Q4FY17
revenue share to 50% from 30%, implying strong 37% CAGR over FY17‐20. B2C
revenue push will be driven by milk, cheese, ghee and UHT milk. Management is
Promoters * 48.9 48.9 48.9
MF's, FI's & BKs 3.5 3.6 3.9
targeting robust INR1bn sales in B2C segment in 5 years from own ice‐cream brand
FII's 4.6 3.7 2.6
Volup (launched in 2017). We believe the ice‐cream industry in Maharashtra entails
Others 42.9 43.7 44.6
huge potential (~INR8.5bn) as it is highly fragmented, particularly in smaller cities * Promoters pledged shares : NIL
which Prabhat is targeting. Further, the company is targeting cheese plant utilisation (% of share in issue)
to 85‐90% by 2020 from 20‐25% currently.
PRICE PERFORMANCE (%)
Rapid expansion of distribution network BSE Midcap
Stock
Stock over
Index Index
Management has guided for consumer division, milk, cheese, ghee and UHT to propel
1 month 4.7 7.5 2.8
sales to INR20bn by FY20 . Further, it expects B2B:B2C mix to improve to 50:50 from
70:30 currently. This, Prabhat aims to achieve, via doubling of outlets from current 3 months 11.0 17.8 6.8
12 months 40.8 52.3 11.5
100k in general trade by 2020 and enhancing presence in modern trade from mere 300
outlets currently to a pan‐India presence with 3,000 outlets.

Outlook and valuations: Transition underway; maintain ‘BUY’
With Prabhat shifting focus to value‐added products and B2C segment, we estimate
sales, EBIDTA and PAT CAGR of 15%, 19% and 39%, respectively, over FY17‐20. We
maintain ‘BUY’ with TP of INR211, based on 22x FY20E EPS.

Financials


Revenues (INR mn) 14,099 16,370 18,846 21,335
EBITDA (INR mn)
1,268 1,426 1,758 2,153 Shradha Sheth
Adjusted PAT (INR mn)
469 429 680 938 +91 22 6623 3308
Adjusted Dil. EPS (INR) 3.6 4.4 7.0 9.6 [email protected]

Diluted P/E (x) 45.5
37.1 23.4 17.0 Sanyam Jain
EV/EBITDA (x) 14.1 12.8 10.3 8.3 +91 22 4040 7412
[email protected]
RoACE (%)* 9.9 9.5 11.7 14.4
RoAE (%)* 5.8 6.7 9.9 12.4
*Adjusted for revaluation reserves, not including sales tax incentives December 1, 2017
Edelweiss Research is also available on www.edelresearch.com,
Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited
Dairy

B2C to rise to 50% revenue share
Currently, the B2C channel contributes ~27% to Prabhat’s revenue, which the company aims
to expand to 50% by 2020. Management’s strategy is to chase growth in the B2C segment
and profitability in the B2B segment. It is eyeing B2C sales of INR10bn by FY20 (from
~INR5bn in FY18). In line with its strategy to focus on brand building, the company is
targeting brand spends from ~INR200mn currently to INR400mn in FY20, 2% of sales, led by
B2C push. It believes this will help command brand premium, negotiate better credit terms
and improve market share & capacity utilisation.
Prabhat estimates B2C revenue surge to be driven by ~35% CAGR in milk, 150% CAGR in
cheese and 9x sales in UHT milk.
Ramping up distribution
In general trade, Prabhat is present via ~100k outlets, which the company wants to double
by FY20. Further, in modern trade, it has access to 300 outlets, which management wants to
increase to 1,100 across India by year end, and further to 3,000 till FY20. Prabhat currently
has 1,800‐2,000 key accounts in the HORECA segment across India. It is targeting 10,000
clients by FY20 and expects exponential growth in the segment going forward.

Strong expansion of procurement network
Prabhat aims to double its dairy farmer base in 2 years, while also widening milk collection
and chilling centre network by 80% in 3 years. Further, its target is to associate with 10 more
registered milk vendors in 2 years. Prabhat aims to take milk procurement from less than 10
lakh litres per day (llpd) to 14llpd by FY20.

Well placed to capitalise on strong growth potential in ice cream
The domestic ice cream industry is pegged at INR100bn, of which 2/3rd is estimated to be
organised.
Prabhat has soft launched its ice cream brand Volup in 10 cities—in Nashik and adjoining
towns—which has received good response; a pan‐Maharashtra launch is on the anvil. Volup
ice cream is at a premium to Amul, with the former’s premium range Sinsane contributing
20% to sales.
There is a strong opportunity in Maharashtra as the ~INR8.5bn market, growing at 20%, is
fragmented, with no strong players in the segment except Kwality Walls and Amul, which
have sales of INR1bn plus . Management has guided for INR1bn sales in Maharashtra over
the next 5 years and pegs Volup sales in FY18 at ~INR30‐40mn. Prabhat’s strategy is to
target smaller towns rather than big metros like Mumbai and Pune where competition is
intense.
Prabhat already manufactures ice cream for Mother Dairy and the same plant is being
utilised to manufacture Volup, precluding any additional capex.

Prabhat Dairy Ltd

Fig. 1: Prabhat range of ice creams

Source: Company

Cheese to continue rapid ramp up
Cheese production and sales have ramped up rapidly from ~INR240mn in FY17 to expected
revenue of ~INR1bn in FY18, which are estimated to catapult further to ~INR2.8bn in FY20,
~12x over FY17‐20. At full capacity utilisation, management estimates cheese revenue to
grow to INR3.5bn. Prabhat has ramped up the cheese segment rapidly wherein breakeven
was achieved in mere 1.5 years. Management expects plant utilisation to ramp up from 20‐
25% currently to 40‐45% by FY18 end and further to 85‐90% by FY20, boosting profitability
through operating leverage.

In cheese, Prabhat’s focus is on the HORECA segment, where realisation is ~12% higher than
B2B. Sales in the HORECA segment command a premium of ~20%, but this premium is offset
by 7‐8% higher expenses. Prabhat caters to orders from major chains and QSRs such as
Dominos, Pizza Hut and McDonalds. HORECA sales are currently in Maharashtra & Gujarat
and expansion in North and South India is on the anvil.

Strong revenue growth to sustain as margin improves
Prabhat’s revenue has clocked a strong 24% CAGR over FY12‐17 and this strong trajectory is
envisaged to sustain (15% CAGR over FY17‐20) led by robust volume growth, 2x jump in B2C
business over FY17‐20 and rapidly expanding distribution network.

Management has guided for INR20bn revenue by FY20. Major growth drivers will be fresh
milk, ghee (B2C), cheese and UHT products. This will be supported by expanding direct
procurement network by enhancing the number of procurement partners through increased
engagement with farmers by providing additional services and cattle feed.

Gross margins are estimated to improve 366bps to 23.1%, however this gross margin
expansion will be reinvested into development of B2C business. With higher B2C
development expenses, we expect EBITDA margin to expand 110bps to 10.1% in FY20 from
9.0% in FY17. Further, management is targeting improved profitability in B2B as well with
improved product mix. Improving margin and capacity utilisation will prop up RoCE to 14.4%.

Dairy

Chart 1: Strong sales trajectory to sustain at 15% CAGR over FY17‐20E
24,000
20,000
16,000
(INR mn)
12,000
8,000
4,000
FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E


Prabhat Dairy Ltd

Company Description
Prabhat is an integrated milk and dairy products player with aggregate milk processing
capacity of 1.5mn ltr per day. Over the years, the company has diversified into pasteurised
milk, flavoured milk, sweetened condensed milk, ultra‐pasteurised or ultra‐high
temperature (UHT) milk, yoghurt, dairy whitener, clarified butter (ghee), milk powder,
ingredients for baby foods, lassi and chaas. It sells these products under retail consumer
brands as well as ingredient products or as co‐manufactured products to a number of
institutional and multinational companies. Prabhat commenced commercial production of
cheese, paneer and shrikhand in FY16. It caters to institutional (~73% revenue contribution
in FY17) as well as retail customers (27% revenue contribution).

Investment Theme
Leveraging its strong track record as a specialty ingredients supplier to large global dairy
players, Prabhat catapulted its gross block in value‐added products >40% in FY16, to be the
third largest cheese player in India. On the anvil is a 2‐pronged strategy to scale up its value‐
added sales in HORECA and B2C segments via tier II/III cities with targeted ad spends at ~2%
of sales. The company is focusing on growing its higher margin B2C sales, taking its revenue
share from ~30% currently to 50% in FY20. This shift in strategy will boost margin as well as
the company is able to command brand premium, negotiate better terms and improve
market share & utilisation. Prabhat’s gross margin is likely to surge ~370bps over FY17‐20E
led by: a) rising share of B2C & value‐added products; and b) increasing utilisation. Hence,
we estimate adjusted pre‐tax RoCE to catapult 450bps over the period to 14.4%.

Key Risks
Availability and price volatility of raw milk
Prabhat’s business depends on its ability to procure sufficient good quality raw milk at
commercially viable prices. Though the company has long‐standing relationships with milk
farmers and other suppliers, it has not entered into any formal supply agreements.

Overdependence on a few institutional customers
Prabhat’s top 5 custormers contribute 35%+ to revenue, hence it faces the risk of
concentration and overdependence on a few institutional customers. Any change in
positioning with these customers could impact revenues.

Dairy


Macro
Net revenue 14,099 16,370 18,846 21,335
GVA(Y‐o‐Y %) 6.6 6.8 7.4 7.4
Materials costs 11,358 12,789 14,642 16,408
Inflation (Avg) 4.5 4.0 4.5 4.5
Gross profit 2,740 3,581 4,205 4,928
Repo rate (exit rate) 6.3 5.8 5.8 5.8
Employee costs 347 458 563 651
Milk purchase prices (INR/litre) 26.7 24.0 25.0 26.0 Other Expenses 1,126 1,697 1,883 2,124
Sales growth Operating expenses 1,472 2,155 2,446 2,775
Processed and Pouch Milk (%) (24) 44 16 16 Total operating expenses 12,831 14,944 17,088 19,182
SMP / WMP/ DW (%) 81 12 (3) (3) EBITDA 1,268 1,426 1,758 2,153
Condensed milk added sugar (SCM) (%) (41) (34) (9) (10) Depreciation 432 465 475 487
Ghee (%) 13 5 20 20 EBIT 836 961 1,283 1,666
Flavoured Milk (%) 59 (1) 4 6 Add: Other income 12.65 28.22 32.14 33.36
Butter (%) NA NA NA NA
Less: Interest Expense 294 339 285 278
Ice Cream (%) (21) 69 50 48
Add: Exceptional items 189 ‐ ‐ ‐
Curd (%) 14 63 51 17
Profit Before Tax 743 650 1,030 1,421
Long shelf Milk (UHT Milk) (%) 0 112 118 82
Less: Provision for Tax 274 221 350 483
Cheese (%) 967 323 95 41
Paneer (%) 5,466 75 58 25 Reported Profit 469 429 680 938
Shrikhand (%) 871 40 36 33 Exceptional Items 119 ‐ ‐ ‐
% of sales Adjusted Profit 350 429 680 938
Processed and Pouch Milk (%) 14 17 17 17 Shares o /s (mn) 98 98 98 98
SMP / WMP/ DW (%) 44 43 36 31 Adjusted Basic EPS 3.6 4.4 7.0 9.6
Condensed milk added sugar (SCM) (%) 12 7 5 4 Diluted shares o/s (mn) 98 98 98 98
Total commodity products (%) 69 66 58 52 Adjusted Diluted EPS 3.6 4.4 7.0 9.6
Ghee (%) 20 18 19 20 Adjusted Cash EPS 7.0 9.2 11.8 14.6
Ice Cream (%) 1 1 1 2
Dividend per share (DPS) 0.4 0.6 0.9 1.2
Curd (%) 1 2 3 3
Dividend Payout Ratio(%) 10.0 15.6 15.6 15.6
Long shelf Milk (UHT Milk) (%) 1 2 3 5

Cheese (%) 2 6 10 13
Paneer (%) 1 1 2 2 Common size metrics
Total value added products (%) 26 31 39 45 Year to March FY17 FY18E FY19E FY20E
Capacity utilisation (%) Gross margin 19.4 21.9 22.3 23.1
Cheese (%) 9 39 73 96 Interest Expense 2.1 2.1 1.5 1.3
Channel mix EBITDA margins 9.0 8.7 9.3 10.1
B2B (%) 73 70 63 54 EBIT margins 5.9 5.9 6.8 7.8
B2C (%) 27 30 37 46 Net Profit margins 2.5 2.6 3.6 4.4
Financial Assumptions
Depreciation (% of gross block) 9.1 9.2 9.0 8.8 Growth ratios (%)
Interest rate (%) 8.2 8.5 6.5 6.5 Year to March FY17 FY18E FY19E FY20E
Tax rate (%) 37 34 34 34
Revenues 20.7 16.1 15.1 13.2
Capex (INR mn) 329 195 250 250
EBITDA 10.0 12.5 23.3 22.4
PBT 103.0 (12.5) 58.4 37.9
Adjusted Profit 51.2 22.6 58.4 37.9
EPS 51.2 22.6 58.4 37.9

Prabhat Dairy Ltd
Balance sheet (INR mn) Cash flow metrics

Share capital 977 977 977 977 Operating cash flow 200 223 680 934
Reserves & Surplus 5,905 6,267 6,841 7,632 Investing cash flow (884) (195) (250) (250)
Shareholders' funds 6,882 7,244 7,818 8,609 Financing cash flow 1,659 423 (359) (592)
Short term borrowings 3,197 3,997 3,997 3,797 Net cash Flow 975 451 71 92
Long term borrowings 386 386 386 386 Capex (329) (195) (250) (250)
Total Borrowings 3,583 4,383 4,383 4,183 Dividend paid (47) (67) (106) (147)
Long Term Liabilities 14 14 14 14
Def. Tax Liability (net) 159 159 159 159 Profitability and efficiency ratios
Sources of funds 10,638 11,800 12,374 12,965 Year to March FY17 FY18E FY19E FY20E
Gross Block 4,957 5,157 5,407 5,657 ROAE (%) 5.8 6.7 9.9 12.4
Net Block 4,143 3,878 3,652 3,415 ROACE (%) 9.9 9.5 11.7 14.4
Capital work in progress 265 260 260 260 ROA 3.7 3.8 5.6 7.4
Intangible Assets 7 7 7 7 Inventory Days 36 43 46 50
Total net fixed assets 4,415 4,145 3,919 3,683 Debtors Days 64 67 64 59
Non current investments ‐ ‐ ‐ ‐ Payable Days 17 16 15 14
Cash and Equivalents 1,656 2,107 2,178 2,270 Cash Conversion Cycle 83 93 96 96
Inventories 1,333 1,654 2,029 2,467 Current Ratio 8.3 9.8 9.8 9.8
Sundry Debtors 2,711 3,256 3,377 3,578 Debt/EBITDA (x) 2.8 3.1 2.5 1.9
Loans & Advances 530 512 732 820 Debt/Equity (x) 0.5 0.6 0.6 0.5
Other Current Assets 841 1,000 1,100 1,200 Adjusted Debt/Equity 0.5 0.6 0.6 0.5
Current Assets (ex cash) 5,415 6,421 7,238 8,065 Interest Coverage Ratio 2.8 2.8 4.5 6.0
Trade payable 538 562 601 638 LT debt /Cap empl. (%) 33.7 37.1 35.4 32.3
Other Current Liab 310 310 360 415 Debt / Cap employed (%) 43.1 45.9 44.5 41.6
Total Current Liab 848 872 961 1,053
Net Curr Assets‐ex cash 4,567 5,548 6,277 7,013 Operating ratios
Uses of funds 10,638 11,800 12,374 12,965 Year to March FY17 FY18E FY19E FY20E
BVPS (INR) 70.5 74.2 80.0 88.1 Total Asset Turnover 1.5 1.5 1.6 1.7
Fixed Asset Turnover 3.4 4.1 5.0 6.0
Free cash flow (INR mn) Equity Turnover 2.1 2.3 2.5 2.6
Reported Profit 469 429 680 938 Valuation parameters
Add: Depreciation 432 465 475 487 Year to March FY17 FY18E FY19E FY20E
Interest (Net of Tax) 197 227 191 187 Adj. Diluted EPS (INR) 3.6 4.4 7.0 9.6
Others 292 84 62 59 Y‐o‐Y growth (%) 51.2 22.6 58.4 37.9
Less: Changes in WC 1,192 981 728 736 Adjusted Cash EPS (INR) 7.0 9.2 11.8 14.6
Operating cash flow 200 223 680 934 Diluted P/E (x) 45.5 37.1 23.4 17.0
Less: Capex 329 195 250 250 P/B (x) 2.3 2.2 2.0 1.8
Free Cash Flow (129) 29 430 684 EV / Sales (x) 1.3 1.1 1.0 0.8
EV / EBITDA (x) 14.1 12.8 10.3 8.3
Dividend Yield (%) 0.2 0.4 0.6 0.8
Dairy
Additional Data
Directors Data
Mr. Sarangdhar R. Nirmal Chairman & Managing Director Mr. Vivek S. Nirmal Joint Managing Director
Mr. Ashok Sinha Independent Director Mrs. Seemantinee Khot Independent Director
Mr. Haresh Shah Additional Independent Director Mr. Soundararajan Bangarusamy Independent Director

Mr. Rajesh Srivastava Independent Director

Auditors ‐ B S R & Associates LLP
Holding Top ‐10
Indian Agribusiness Fund 14.37 Stryrax Commodities 1.88
Societe Prom & Part Econom 8.68 Payone Enterprises Pvt Ltd 1.07
Vistra Itcl India Limited 7.57 Ecap Equities Ltd 1.06
Wasatch Advisors Inc 5.06 Sundaram Asset Management Co Ltd 0.7
Dsp Blackrock Investment Manager 3.50 Alquity Investment Management 0.52
Bulk Deals
28 Feb 2017 Nirmal Family Trust Buy 4246912 128.75
07 Feb 2017 Dsp Blackrock Mutual Fund‐ Dsp Blackrock Micro Cap Fund Buy 2854354 129.99
07 Feb 2017 Reliance Capital Ltd Sell 2744000 130.00
Insider Trades
06 Mar 2017 Sarangdhar R.Nirmal ‐ Trustee of Nirmal Family Trust Buy 225000.00
India Midcaps
COMPANY PROFILE

AMUL
The pioneer
Amul is India’s largest dairy player with an annual turnover of INR270bn as EDELWEISS RATINGS
on FY17. It is the 13th largest dairy organisation globally and commands 25‐ Absolute Rating NOT LISTED
30% market share of the organised milk market. It has clocked 19% CAGR in
dairy sales over FY10‐17. The company has set a target of ~20% sales CAGR
to INR500bn by FY21, for which it is planning to catapult its milk processing
capacity from 30mn liters per day currently to 38mn liters over the next 3
years. Further, it is increasing aggression in cheese, having tripled capacity
with the target of dominating the domestic market. Amul’s biggest USP is
that it is run by and for farmers.

Robust procurement network
Amul’s procurement stands healthy at ~18mn liters per day from 18,549 village milk co‐
operative societies, 18 member unions covering 33 districts and 3.6mn milk producer
members. As Gujarat Co‐operatives Milk Marketing Federation (GCMMF) is a non‐profit
organisation, any benefit from increase in milk prices is passed on to milk producer
members. Therefore, it has been able to increase milk procurement from 9.3mn kg/day
in FY10 to 18.2mn kg/day in FY17, 10% CAGR.

Aggressive capacity addition to augment sales
The company has aggressively added milk processing capacity—16% CAGR over FY11‐17
to 30mn litres/day. Amul’s target is to expand it to 38mn litres/day over the next 3 years.
Its new cheese factory has led to a 3x jump in cheese manufacturing capacity. With this
massive expansion, Amul forecasts a quantum jump in sales of Amul Cheese in FY18. This
will be augmented by huge investments in advertising and promotion to aggressively
capture more market share and dominate India’s cheese market. Amul is also adding
capacity in milk powders, paneer and chocolates.

Future plans: 20% sales CAGR with >INR500bn sales in 2021
Amul anticipates at least 20% CAGR in sales over the next 5 years, with sales exceeding
INR500bn by 2021, backed by strong capacity addition. The company aims to become the
largest FMCG organisation in India by 2020‐21 and the largest dairy organisation globally
over the long term.

Shradha Sheth
+91 22 6623 3308
[email protected]

Sanyam Jain
+91 22 4040 7412
[email protected]

December 1, 2017
Dairy

Pioneer of direct procurement
Amul sources milk from ~3.6mn farmers covering 18,549 villages, largely from Gujarat.
Though currently ~15% of milk is procured from members outside Gujarat, going forward
Amul is planning to enhance this source.

When the company procures milk, it makes provisional payment to farmers. Only once the
milk is processed, fat concentration ascertained and quality determined, it makes the final
payment. At every district level, quality control systems are in place. The key reason for
farmers’ sustained association with Amul is that the company buys all the milk brought by
them. Any excess milk is either converted into milk powder or is used to manufacture value‐
added products.

As GCMMF is a non‐profit organisation, any benefit from increase in milk prices is passed on
to the milk producer member. Therefore, GCMMF has been able to increase its milk
procurement from 9.3mn kg/day in FY10 to 18.2mn kg/day in FY17, at CAGR 10%.

Chart 1: GCMMF Daily Milk Procurement (Million Litres/Day)
20
16
(mn litres/day)
12
8
4
0
FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17

Aggressive capacity expansion to drive revenue
Amul has aggressively added milk processing capacity—16% CAGR over FY11‐17 to 30mn
litres/day. Further, its target is to expand it to 38mn litres/day to INR500bn in sales by FY21
to become the largest FMCG company in India.

The company’s new cheese factory was inaugurated in Palanpur, Gujarat, in December,
2016, which has led to 3x increase in its cheese manufacturing capacity. With this massive
expansion, Amul forecasts a quantum growth in sales of Amul Cheese in FY18. This will be
augmented by huge investments in advertising and promotion to aggressively capture more
market share and dominate India’s cheese market.

Further, plants in Maharashtra, Kolkata and Gujarat are in various stages of construction and
will further add to capacities when commissioned. It is also enhancing its milk powder
manufacturing capacity with a new factory of 150MT per day production coming up at
AmulFed Dairy, Gandhinagar, along with another new milk powder plant at Himmatnagar.
They are also putting into effect significant capacity expansions for chocolates and paneer.
Amul

Chart 2: Revenue Growth (INR Million)
600,000
480,000
360,000
(INR mn)
240,000
120,000
0
FY 10 FY 11 FY 12 FY 13 FY 14 FY 15 FY 16 FY 17 FY21E

Strong distribution network
Over the years, GCMMF has sustained its expansion spree by expanding its distribution
coverage across geographical areas, consumer segments and age groups to ensure product
availability to consumers.

Amul has simultaneously enhanced its distribution footprint by adding 15 new branch
offices in recent years and expanding the network of distributors, super‐stockists and sub‐
stockists to reach millions of retail shops across the country. Using information technology,
its common distributor management software application integrates all its distributors,
enabling tracking & enhancing shop‐wise sales, across India. Product innovation has always
been part of Amul’s DNA and has inspired it to launch more than 50 new products in the
market during the past 3 years.

Dairy

Company Description

GCMMF is India’s largest food product marketing organization with turnover of INR270bn
over FY16‐17. Its daily milk procurement stands at 18.17mn litres from 18,549 village milk
co‐operative societies, 18 member unions covering 33 districts and 3.6mn milk producer
members. It is the apex organisation of the Dairy Cooperatives of Gujarat, popularly known
as AMUL, which aims to provide remunerative returns to farmers and also serve interests of
consumers by providing quality value‐for‐money products .

GCMMF is the exclusive marketing organisation of Amul and Sagar branded products. It
operates via 56 sales offices and has a network of 10,000 dealers and 10 lakh retailers, one of
the largest in India. Its product range comprises milk, milk powder, health beverages, ghee,
butter, cheese, pizza cheese, ice cream, paneer, chocolates and traditional Indian sweets.

GCMMF is the poster child for the white revolution, which took place in India and has played
an indispensible role in making India the largest milk producer in the world.

Chart 3: Amul’s Product Mix
Flavoured milk
Others
2%
6%
Cheese
3%
Ghee
8%
Liquid milk
55%
Butter
10%
SMP
11%
Source: Edelweiss Research

Amul

The Amul Model
The Amul Model of dairy development is a three‐tiered structure with dairy cooperative
societies at the village level federated under a milk union at the district level and a
federation of member unions at the state level. Milk collection is done at the village dairy
society, milk procurement & processing at the District Milk Union and milk products
marketing at the state milk federation.

This establishes a direct linkage between milk producers and consumers by eliminating
middlemen, gives farmers control over procurement, processsing & marketing and ensures
professional managment.

Fig. 1: Amul’s business model

Source: Company

Dairy

Fig. 2: Flow of milk

Source: Company
India Midcaps
COMPANY PROFILE

HATSUN AGRO PRODUCT
Home state king
Hatsun Agro Product (Hatsun) is the dominant dairy player in its home EDELWEISS RATINGS
state Tamil Nadu & surrounding southern states, underpinned by Absolute Rating NOT RATED
established brands Arokya, Arun Ice‐creams and Ibaco. The company has
aggressively expanded its procurement network in untapped regions over
the past few decades and boasts of 10,000 milk banks covering 13,000
villages spearheaded by strong relationships with farmers. Hatsun’s
strength lies in its near 100% direct procurement as well as 100% exposure
MARKET DATA (R: HAPL.BO, B: HTSMF IN)
to the retail segment, commanding strong 9% EBITDA margin despite milk
CMP : INR 880
revenue share of nearly 70%. The company’s focus on untapped regions,
Target Price : NA
premium product offerings and high ad spends has reinforced its pole 52‐week range (INR) : 970 / 340
position. Further expansion of its procurement network outside of Tamil Share in issue (mn) : 152.2
Nadu and deeper into untapped geographies will drive Hatsun going M cap (INR bn/USD mn) : 133 / 2,049
forward. Avg. Daily Vol.NSE (‘000) : 50.3

Strong procurement and distribution network SHARE HOLDING PATTERN (%)
Hatsun procures milk directly from farmers, facilitated by 10,000 Hatsun Milk Banks Current Q1FY18 Q4FY17
covering over 13,000 villages. It has the largest procurement network of ~2.7mn litres per Promoters * 74.7 74.7 74.7
day amongst private dairy players, procuring from a strong base of 3.2 lakh plus farmers. MF's, FI's & BK’s 0.5 0.4 0.2
The company has built its procurement network by focusing on complete transparency, FII's 3.7 3.4 3.3
timely bank payments and providing allied dairy services. It aims to triple its Hatsun Daily Others 21.1 21.7 22.0
outlet count to 3,000 in a year. * Promoters pledged shares : Nil

Strong brands drive leadership
While the company supplies milk under Arokya Milk and ice‐creams under Arun & Ibaco PRICE PERFORMANCE (%)
brands, all other branded dairy products are sold under the Hatsun brand. These brands Stock over
Sensex Stock
Sensex
are household names in South India, particularly in the company’s home state of Tamil
Nadu and are also gaining traction in North India. While Hatsun has garnered strong 14% 1 month 1.7 22.7 20.9
market share in curd and milk in South India, Arun holds ~60% market share in Tamil 3 months 6.2 37.5 31.3
Nadu and ~30% in South India. 12 months 28.0 152.6 124.6

Outlook and valuations: Not Rated
Hatsun’s strong establishment in South India will continue to consolidate its position
through its differentiated strategies and further strengthening its dominance. Entry in
new states as well as deeper penetration into untapped regions will drive Hatsun.
Financials
Year to March FY14 FY15 FY16 FY17 Shradha Sheth
Net Revenues (INR mn) 24,935 29,331 34,447 41,997 +91 22 6623 3308
[email protected]
EBITDA (INR mn) 1,778 1,983 3,047 3,795
Sanyam Jain
Adjusted PAT (INR mn) 817 392 605 1,340
+91 22 4040 7412
Diluted P/E (x) 116.1 244.4 158.2 100.0
EV/EBITDA (x) 56.1 51.2 33.5 37.6
RoE (%) 52.9 19.5 26.8 46.4 December 1, 2017
Dairy

Strong direct procurement network; focus on milk
Hatsun procures milk directly from farmers, facilitated by 10,000 Hatsun Milk Banks
covering over 13,000 villages. The company the largest procurement network of ~2.7mn
litres per day amongst private dairy players. It procures from a strong base of 3.2 lakh plus
farmers. The milk is then tested for quality on parameters of fat and SNF content; thereafter,
farmers are paid every 10 days into farmers’ bank accounts, without exception.

Strong processes enable scalable model
The company has built its procurement network by focusing on complete transparency,
timely bank payments and providing allied dairy services. This has enabled a scalable model,
which can be used to expand in other regions as well for milk procurement. Further, Hatsun
has established new process of procuring and chilling milk at the village level using active
bulk coolers, which helps retain freshness and improves quality.

Focus on milk procurement
Hatsun focuses on increasing milk procurement in a region, which in turn optimizes logistics
and other procurement costs due to higher volumes. These savings are used to further
strengthen the framework by offering higher prices and support services for farmers and
building procurement infrastructure by adding bulk coolers. Hatsun uses this process in all
regions it enters, giving it a leading presence in Tamil Nadu and growing presence in
Karnataka, Andhra Pradesh and Telangana.

Established relationships with farmers
Strong payment track record maintained over the past 2 decades has led to healthy
relationships with farmers. Hatsun has an animal husbandry team which is used to provide
support services to farmers, such as veterinary doctors, artificial insemination, cattle feed
and management advices for large farms.

Established brands facilitate market leadership
Hatsun supplies milk under the brand name Arokya Milk, ice‐creams under Arun and Ibaco
brands, while all other branded dairy products are sold under the Hatsun brand. These
brands are household names in South India, particularly in Tamil Nadu, and are also gaining
traction in North India. Further, products under these brands are also exported to America,
Middle East and South Asian markets.

While Hatsun has garnered strong 14% market share in milk and curd in South India, Arun
holds ~60% market share in Tamil Nadu and ~30% in South India.

High advertisement and sales promotion expenses
Hatsun maintains strong focus on ad & sales promotions and has historically spent the
highest on it amongst private dairy players. The company has on an average spent 2.1% of
revenue on advertisement & sales promotion, up from 1.5% in FY13 to 2.6% in FY17. Parag
has been the second strongest in this regard and has ramped up ad spends aggressively.

Hatsun Agro Product

Chart 1: Hatsun has spent the highest on ad spends on average
4.0
3.2
2.4
(%)
1.6
0.8
0.0
Hatsun Agro Products Ltd. Heritage Foods Ltd.
Kwality Ltd. Parag Milk Foods Ltd.
Prabhat Dairy Ltd.

Differentiated strategies boost distribution network
Hatsun has a formidable presence across Tamil Nadu, Karnataka, Andhra Pradesh,
Telangana and Maharashtra. It aims to triple its Hatsun Daily outlet count to 3,000 in a year.

Focus on untapped regions
Hatsun built its pouch milk business by focusing on smaller towns in southern states, where
penetration was low, gaining first mover advantage and establishing its presence. While
distributing milk in smaller regions was unprofitable initially, increasing volumes turned
them profitable.

Premium product and operational efficiencies
The company largely sells full cream/standardized milk (~80% of milk revenue), whereas
competitors offer toned milk. This enables Hatsun charge around 10% premium for its milk.
Further, the company transports milk in a concentrated form, saving on logistics cost.

Setting up franchise outlets to create an exclusive distribution network
Hatsun has set up a franchise based distribution network called Hatsun Distribution Centre
(HDC). Any franchisee who wishes to be part of this network is provided premises by Hatsun.
This creates a significant barrier for any encroachment by competitors on Hatsun’s
distribution network, ensuring exclusivity. The company distributes its milk products
through the aforementioned franchisee outlets only. It currently has a network of 2,289
HDCs spread across 6 states.

Dairy

Company Description

Hatsun, incorporated in 1986, is a leading dairy company based in Tamil Nadu. The company
commenced operations as an ice‐cream player, transforming into a full fledged dairy
company over the years. It sells fresh milk under the Arokya brand, ice‐cream & premium
ice‐cream under Arun & Ibaco brands and other value‐added products like paneer, ghee and
milk powders under the Hatsun brand. Further, it sells cattle feed under the Santosa brand.
Milk constitutes 68% of total revenue.

Chart 2: Hatsun’s revenue mix
Cattle feed
Other milk
5%
products
13%
Curd
7%
Ice‐cream
7%
Milk
68%


Hatsun’s brands
Arokya: Launched in 1995, it is one of the most popular milk brands in South India and is
also expanding in North. Under this brand it sells standardized, full cream & toned milk and
curd. Goodness of Arokya is a parlour set up under this brand for milk‐based refreshments.
Due to its strong brand reputation, it commands ~10% price premium over co‐operatives in
Tamil Nadu.

Arun ice creams: This was Hatsun’s first product and is now a widely recognized brand.

Ibaco: Ibaco ice creams have grown rapidly, sold in parlours across India. Ice creams under
this brand are in the more premium range.

Hatsun: Dairy products like curd, paneer, ghee, butter, milk powders, buttermilk and lassi
are sold under this brand.

Santosa: Cattle feed is sold under Santosa brand. Its plant at Palani manufactures
12,000MT/month of cattle feed, with another 10,000MT to be added, and is sold to farmers.

Strong progression into a global player
On back of rising skimmed milk powder prices globally, Hatsun entered into the export
business in FY05. Since then, the company has not only been able been to garner healthy
global presence with dairy ingredients being exported to 40 countries around the world, but
Hatsun Agro Product

has also increased its direct milk procurement from 1.3mn litres per day in FY05 to 2.7mn
litres per day in FY17.

Regional concentration for direct milk procurement
Hatsun has identified economies of scale in its direct milk procurement strategy. The
company focuses on constantly increasing milk procurement from an identified region,
enabling it to employ large tankers. This not only prunes freight cost, but also enhances
utilisation of processing facilities. Savings from this has enabled the company to not only
make further investments in its own facilities, but also to increase milk procurement prices
paid to farmers.

Dairy


Income statement (INR mn) Balance sheet (INR mn)
Year to March FY14 FY15 FY16 FY17 As on 31st March FY14 FY15 FY16 FY17
Net Revenues 24,935 29,331 34,447 41,997 Share capital 108 109 109 152
Raw Material Costs 18,496 21,842 24,889 30,490 Reserves & Surplus 1,686 2,106 2,198 3,319
Employee costs 760 931 1,102 1,269 Total shareholders funds 1,794 2,215 2,307 3,471
Other expenses 3,902 4,574 5,409 6,444 Minority interest 0 0 0 0
Total expenses 23,158 27,348 31,400 38,202 Long term Borrowings 2,453 2,816 2,304 3,699
EBITDA 1,778 1,983 3,047 3,795 Short term Borrowings 2,482 3,321 4,411 5,503
Depreciation & amortization 650 940 1,071 1,456 Total Borrowings 4,935 6,137 6,715 9,202
EBIT 1,128 1,043 1,976 2,339 Long Term Liabilities & Prov. 5 5 4 8
Less: Interest Expense 417 634 683 702 Deferred Tax Liability (net) 278 285 261 629
Add: Other income 104 65 46 56 Sources of funds 7,013 8,641 9,287 13,311
Profit Before Tax 814 474 1,340 1,693 Gross Block 7,722 9,930 11,076 15,358
Less: Provision for Tax (2.4) 82 735 353 Net Block 4,856 6,184 6,372 9,799
Reported Profit 817 392 605 1,340 Capital work in progress 1,063 234 325 903
Adjusted Profit 817 392 605 1,340 Intangible Assets 181 138 100 87
No. of Shares outstanding (mn) 108 109 109 152 Total Fixed Assets 6,100 6,556 6,798 10,789
Adjusted Basic EPS 7.6 3.6 5.6 8.8 Non current investments 8 1 3 3
No. of dil. shares outstand. (mn) 107.7 108.7 108.7 152.2 Cash & bank balances 107 242 294 553
Adjusted Diluted EPS 7.6 3.6 5.6 8.8 Inventories 886 2,585 3,468 2,965
Adjusted Cash EPS 13.6 12.3 15.4 18.4 Sundry Debtors 219 126 149 410
Dividend per share Loans & Advances 1,083 1,025 820 1,474

2.5 1.8 4.0 4.0
Other Current Assets 34 20 43 32
Dividend Payout Ratio (%) 33.0 50.0 71.9 45.4
Total Current Assets (Ex Cash) 2,222 3,757 4,480 4,881
Trade payable 906 1,092 1,368 1,700
Common size metrics ‐ as % of revenues
Year to March FY14 FY15 FY16 FY17 Other Current Liab. & ST Prov. 519 823 920 1,215
Total Current Liab. & Provisions 1,424 1,915 2,287 2,915
Gross margin 25.8 25.5 27.7 27.4
Staff costs 3.0 3.2 3.2 3.0 Net Current Assets (ex cash) 798 1,841 2,193 1,966
Uses of funds 7,013 8,641 9,287 13,311
S G & A expenses 15.6 15.6 15.7 15.3
Depreciation 2.6 3.2 3.1 3.5 Book value per share (BV) (INR) 17 20 21 23
Interest Expense 1.7 2.2 2.0 1.7

EBITDA margins 7.1 6.8 8.8 9.0 Free cash flow
Year to March FY14 FY15 FY16 FY17
Net Profit margins 3.3 1.3 1.8 3.2
Reported Profit 817 392 605 1,340
Add: Depreciation 650 940 1,071 1,456
Growth metrics (%)
Year to March FY14 FY15 FY16 FY17 Interest (Net of Tax) 419 524 308 556
Others (274) 40 739 94
Revenues 15.2 17.6 17.4 21.9
EBITDA 20.3 11.6 53.6 24.5 Less:Changes in WC (394) 1,281 537 (940)
PBT 43.4 (41.9) 182.9 26.3 Operating cash flow 2,006 615 2,186 4,386
Adjusted Profit 82.9 (52.1) 54.5 121.4 Less: Capex 2,432 1,287 1,403 5,789
EPS 82.9 (52.5) 54.5 58.2 Free cash flow (427) (672) 783 (1,403)

Hatsun Agro Product

Cash flow statement Operating ratios
Year to March FY14 FY15 FY16 FY17 Year to March FY14 FY15 FY16 FY17
Operating cash flow 2,006 615 2,186 4,386 Total asset turnover(x) 4.0 3.7 3.8 3.7
Investments cashflow (2,124) (1,243) (1,342) (5,757) Fixed asset turnover(x) 5.6 5.2 5.4 5.1
Financing cash flow 131 756 (786) 1,630 Equity turnover(x) 16.1 14.6 15.2 14.5
Net cash Flow 13 128 59 259
Capex (2,432) (1,287) (1,403) (5,789) Valuation parameters
Dividends Paid (365) (78) (675) (185) Year to March FY14 FY15 FY16 FY17
Adjusted Diluted EPS (INR) 7.6 3.6 5.6 8.8
Profitability & liquidity ratios Y‐o‐Y growth (%) 82.9 (52.5) 54.5 58.2
Year to March FY14 FY15 FY16 FY17 Adjusted Cash EPS (INR) 13.6 12.3 15.4 18.4
ROAE (%) 52.9 19.5 26.8 46.4 Diluted P/E (x) 116.1 244.4 158.2 100.0
ROACE (%) 20.4 14.7 23.3 22.1 Price/BV (x) 52.9 43.2 41.5 38.6
Inventory Days 20 29 44 39 EV/Sales (x) 4.0 3.5 3.0 3.4
Debtors Days 5 2 1 2 EV/EBITDA (x) 56.1 51.2 33.5 37.6
Payble Days 17 17 18 18 Dividend yield (%) 0.3 0.2 0.5 0.5
Cash conversion cycle (days) 7 14 28 23
Current Ratio 1.6 2.1 2.1 1.9
Gross Debt/EBITDA 2.8 3.1 2.2 2.4
Gross Debt/Equity 2.8 2.8 2.9 2.7
Adjusted Debt/Equity 3.8 2.9 3.1 2.7
Net Debt/Equity 2.7 2.7 2.8 2.5
Interest Coverage Ratio 2.7 1.6 2.9 3.3
Cash Connversion (%) 113 31 72 116

Consumer Goods

India Midcaps
COMPANY PROFILE

KWALITY
Leveraging scale to shift to B2C
Kwality is one of India’s fastest growing (23% revenue CAGR over FY12‐17) EDELWEISS RATINGS
and largest private dairy company with revenue of INR68.7bn and milk Absolute Rating NOT RATED
processing capacity of 4.3mn litres per day. The company enjoys a large
presence in high milk producing states of North India such as UP, Rajasthan
and Haryana. While, historically, Kwality concentrated on the institutional
segment, it is now strategically looking to change the current business mix
from 60:40 B2B:B2C to 30:70 in favour of retail by 2020. This it plans to
MARKET DATA (R: KDAI.BO, B: KWALITY IN)
achieve via addition of a range of value‐added products, increasing ad
CMP : INR 101
spends, tie ups with multiple agencies and signing of Akshay Kumar as
Target Price : NA
brand ambassador. Further, it is aiming to increase direct procurement 52‐week range (INR) : 169 / 95
from merely 26% to 50%. These strategic moves are envisaged to boost Share in issue (mn) : 238.0
margin, establish Kwality brand and propel its evolution from a M cap (INR bn/USD mn) : 26 / 399
commoditised to a branded value‐added player. Avg. Daily Vol.NSE (‘000) : 1,616.5

Strong presence in lucrative markets SHARE HOLDING PATTERN (%)
Kwality operates largely in UP, Rajasthan and Haryana, which are ranked first, second and Current Q1FY18 Q4FY17
eighth highest milk producing states, respectively, accounting for 34% of national milk Promoters * 63.9 64.0 64.1
production. Due to its presence in milk abundant states, Kwality has strong procurement MF's, FI's & BK’s 0.7 0.2 0.4
supply. This places the company in a sweet spot to expand its direct procurement reach FII's 5.7 8.0 6.3
from states of abundant supply. Others 29.6 27.8 29.2
* Promoters pledged shares : Nil
Expanding direct procurement outreach
The company lags in direct procurement, with merely 26% procurement from direct
channels; peers procure 80‐100% milk directly. Kwality intends to increase this PRICE PERFORMANCE (%)
procurement mix from current 26% to 50% directly from farmers in 3‐4 years. This will be Stock over
Sensex Stock
Sensex
achieved by expanding its current network of MCCs in UP, Rajasthan and Haryana.
1 month 1.7 11.0 9.3
3 months 6.2 (28.9) (35.1)
Outlook and valuations: NOT RATED
12 months 28.0 (16.1) (44.1)
Kwality is transitioning from a commoditised B2B player to a value‐added branded B2C
player. With introduction of new products and incorporation of retail margins, margin is
envisaged to expand going forward, commanding a brand premium and improvement in
working capital.

Financials
Year to March FY14 FY15 FY16 FY17 Shradha Sheth
Net Revenues (INR mn) 50,110 58,783 63,481 68,718 +91 22 6623 3308
[email protected]
EBITDA (INR mn) 2,932 3,499 3,865 4,536
Sanyam Jain
Adjusted PAT (INR mn) 1,449 1,665 1,640 1,941
+91 22 4040 7412
Diluted P/E (x) 14.1 13.2 13.7 12.3
EV/EBITDA (x) 10.6 9.7 9.5 8.7
RoE (%) 40.7 30.5 21.6 19.7 December 1, 2017
Dairy

Shifting strategy to B2C
Kwality is now focusing on transforming from a traditional B2B to B2C company,
strategically looking to change the current business mix from 60:40 B2B:B2C to 30:70 in
favour of retail by 2020. To achieve this, it will expand product portfolio with the addition of
value‐added products like flavoured milk, cheese, UHT milk, butter, cream, paneer, yoghurts
and other value‐added dairy products.

Push to increase brand outreach
Kwality has roped in Bollywood actor Akshay Kumar as Brand Ambassador as part of its
strategy of brand building and transformation to a B2C player. Further, the company is
looking to increase ad spends, both ATL and BTL, while also strengthening its retail
distribution network. To achieve this, it has tied up with different agencies like McCANN &
Cheil India for Creative, Adfactors for PR, Digital Quotient for Social Media, Zenith
Optimedia for Media Planning and Ernst & Young for IT. The company has also signed an ad‐
for‐equity deal worth INR600mn with Bennett Coleman and HT media. Kwality has also
engaged EY to develop comprehensive growth strategy for its B2C expansion.

Largest private sector player operating in lucrative markets
Kwality is the largest private player in terms of processing capacity, with a capacity of 4.3mn
litres per day. It is behind only Amul (30mn litres/day) and Nandini (6mn litres/day). Further,
the company operates largely in UP, Rajasthan and Haryana which rank has the first, second
and eighth highest milk producing states, respectively, accounting for 34% of national milk
production. Due to its presence in milk‐abundant states, Kwality has strong procurement
supply.

Chart 1: Top 10 milk producing states
(%)
‐ 3 6 9 12 15 18
Uttar Pradesh
Rajasthan
Gujarat
Madhya Pradesh
Andhra Pradesh
Punjab
Maharashtra
Haryana
Bihar
Tamil Nadu
Production share

Source: NDDB

Increasing direct procurement
Currently, Kwality procures around 26% of milk requirement directly from more than
350,000 farmers spread across 4,700 villages through 29 MCCs. This is the lowest by a great
margin amongst listed dairy players. While Heritage and Hatsun source close to 100%
directly, Prabhat and Parag source 70‐80% directly. To improve this, the company intends to
increase the procurement mix from the current 26% to 50% directly from farmers in 3‐4
Kwality

years. This will be achieved through expanding its current network of MCCs in UP, Rajasthan
and Haryana.

Tie up with Bank of Baroda
To develop strong relationships with farmers, an MoU has been signed with Bank of Baroda
to disburse INR40bn loans at 8.6% to its 1 lakh farmers to buy milching animals, a smart
phone and a two wheeler. This will boost its direct procurement without straining financials
as Kwality is merely the facilitator in this deal and assumes no liabilities.

KKR investment deal
Kohlberg Kravis Roberts & Co. has agreed to invest up to INR5.2bn in Kwality through
structured debt over 6 years. This will be used for debt consolidation, investment in direct
procurement infrastructure, processing capacity expansion by 0.9mn litres/day for value‐
added product categories like cheese, paneer, UHT milk, flavoured milk, table butter and
others. The investment will further be used in brand building, sales promotion and
marketing activities and developing IT infrastructure.

Dairy

Company Description

Kwality is one of the largest manufacturers and processors of dairy products in the private
sector in India. It was established in 1992 as a backward integration unit of Kwality Ice
Creams and was acquired by the current promoters in 2002. Currently, it has processing
capacity of more than 4.3mn litres of milk per day (lower than only Amul and Nandini) with
6 milk processing units in Palwal (Haryana), Saharanpur (UP), Bulandshaher (UP), Jarar (UP),
Sitapur (UP) & Ajmer (Rajasthan).

Kwality is a strong player in North India with a procurement network of 350,000 farmers
across 4,700 villages across UP, Haryana and Rajasthan, which are amongst the top milk
producing states in the country. However, merely 26% procurement is done directly through
farmers, which is significantly lower than peers.

Table 1: Kwality’s portfolio of products
Milk Pouch milk, Butter milk, Skimmed milk
Milk Powders Skimmed milk powder, whole milk powder, dairy whiteners
Curd & Buttermilk Set curd, pouch curd, pouch buttermilk
Ghee & Fat Pure ghee, cow ghee, low cholesterol ghee, bulk butter
Value added products UHT Milk, flavoured milk, cream in tetra packs
Source: Company

Fig.1: Kwality’s product portfolio

Source: Company

Kwality

Commencement of new plant
Commercial production began in February 2017 at the new unit at Softa plant, Haryana,
dedicated primarily to value‐added products. The unit is fully automated, equipped with
ultra‐modern machinery, world‐class quality control systems and state‐of‐the‐art R&D lab
for which it has applied for National Accreditation Board for Testing and Calibration
Laboratories (NABL) certification. The unit has milk handling capacity of 0.9mn litres/day
primarily for value‐added products such as flavoured milk, paneer, cheese, UHT milk, cream
in tetra packs, table butter, yoghurt, amongst others. With this unit, Kwality’s cumulative
milk processing capacity will be 4.3mn litres/day across its 6 plants.

Distribution network
Kwality has established a strong position in key consumption markets of North India where
its products are available in general and modern trade channels and select online platforms.
It has set up SBUs headed by respective profit managers for increased penetration and
roped in learning facilitators with rich experience for developing sales & distribution design
and training modules (classroom and e‐learning based) aimed to improve efficiency,
effective channel management, query/complaint handling, customer care.

Further, it is in the process of implementing cloud‐based solution ‘Field‐Assist’ to facilitate
real‐time decision making based on comprehensive data analytics. Kwality aims to enhance
its presence to 100,000 plus points of sale over the medium term including modern trade
channels, exclusive brand stores and select online modes.

Chart 2: Rapid growth in retail network
2,000 50,000
1,600 40,000
1,200 30,000
(Nos.)
(Nos.)
800 20,000
400 10,000
0 0
FY12 FY13 FY14 FY15 FY16 FY17
Distributors (LHS) Points of Sale (RHS)


Dairy


Income statement (INR mn) Balance sheet (INR mn)
Year to March FY14 FY15 FY16 FY17 As on 31st March FY14 FY15 FY16 FY17
Net Revenues 50,110 58,783 63,481 68,718 Share capital 203 219 224 237
Raw Material Costs 45,869 53,658 58,100 62,046 Reserves & Surplus 4,081 6,430 8,312 10,936
Employee costs 163 220 374 401 Total shareholders funds 4,284 6,649 8,536 11,173
Other expenses 1,145 1,406 1,143 1,735 Minority interest 0 0 0 0
Total expenses 47,178 55,284 59,616 64,182 Long term Borrowings 1,092 1,481 2,546 5,031
EBITDA 2,932 3,499 3,865 4,536 Short term Borrowings 9,868 11,011 12,650 11,586
Depreciation & amortization 130 253 234 223 Total Borrowings 10,960 12,491 15,196 16,617
EBIT 2,802 3,246 3,631 4,313 Long Term Liabilities & Prov. 7 14 18 130
Less: Interest Expense 1,156 1,403 1,585 1,814 Deferred Tax Liability (net) (8) (15) (257) (82)
Add: Other income 42 117 298 137 Sources of funds 15,243 19,140 23,493 27,838
Profit Before Tax 1,688 1,961 2,344 2,636 Gross Block 1,526 1,262 1,458 5,326
Less: Provision for Tax 239 295 704 694 Net Block 1,044 673 649 4,314
Reported Profit 1,449 1,665 1,640 1,941 Capital work in progress 220 1,184 1,941 66
Adjusted Profit 1,449 1,665 1,640 1,941 Intangible Assets 14 0 14 13
No. of Shares outstanding (mn) 203 219 224 237 Total Fixed Assets 1,278 1,857 2,604 4,393
Adjusted Basic EPS 7.1 7.6 7.3 8.2 Non current investments 0 0 61 62
No. of dil. shares outstand. (mn) 203 219 224 237 Cash & bank balances 315 517 864 1,133
Adjusted Diluted EPS 7.1 7.6 7.3 8.2 Inventories 1,874 2,910 1,706 3,514
Adjusted Cash EPS 7.8 8.8 8.4 9.1 Sundry Debtors 13,312 13,246 16,554 15,792
Dividend per share 0.1 0.1 0.1 0.1 Loans & Advances 23 17 22 45
Dividend Payout Ratio (%) 1.4 1.3 1.4 1.2 Other Current Assets 727 2,098 3,426 5,261
Total Current Assets (Ex Cash) 15,935 18,271 21,707 24,612
Common size metrics ‐ as % of revenues Trade payable 1,663 520 521 969
Year to March FY14 FY15 FY16 FY17 Other Current Liab. & ST Prov. 621 985 1,222 1,394
Gross margin 8.5 8.7 8.5 9.7 Total Current Liab. & Provisions 2,284 1,505 1,743 2,363
Staff costs 0.3 0.4 0.6 0.6 Net Current Assets (ex cash) 13,651 16,766 19,964 22,249
S G & A expenses 2.3 2.4 1.8 2.5 Uses of funds 15,243 19,140 23,493 27,838
Depreciation 0.3 0.4 0.4 0.3 Book value per share (BV) (INR) 21 30 38 47
Interest Expense 2.3 2.4 2.5 2.6
EBITDA margins 5.9 6.0 6.1 6.6 Free cash flow
Net Profit margins 2.9 2.8 2.6 2.8 Year to March FY14 FY15 FY16 FY17
Reported Profit 1,449 1,665 1,640 1,941
Growth metrics (%) Add: Depreciation 130 253 234 223
Year to March FY14 FY15 FY16 FY17 Interest (Net of Tax) 992 1,192 1,109 1,336
Revenues 27.5 17.3 8.0 8.2 Others 134 537 878 853
EBITDA 31.0 19.4 10.4 17.4 Less:Changes in WC 2,842 3,056 3,975 2,427
PBT 43.6 16.1 19.5 12.4 Operating cash flow (136) 591 (114) 1,927
Adjusted Profit 33.4 14.9 (1.5) 18.4 Less: Capex 591 1,518 1,044 1,982
EPS 33.4 6.7 (3.8) 11.7 Free cash flow (727) (927) (1,159) (54)

Kwality

Cash flow statement Operating ratios
Year to March FY14 FY15 FY16 FY17 Year to March FY16 FY16 FY16 FY17
Operating cash flow (136) 591 (114) 1,927 Total asset turnover(x) 3.6 3.4 3.0 2.7
Investments cashflow (586) (1,509) (1,009) (1,974) Fixed asset turnover(x) 56.0 67.9 95.0 27.5
Financing cash flow 161 1,044 1,338 383 Equity turnover(x) 14.1 10.8 8.4 7.0
Net cash Flow (561) 126 215 336
Capex (591) (1,518) (1,044) (1,982) Valuation parameters
Dividends Paid (24) (24) (26) (28) Year to March FY14 FY15 FY16 FY17
Adjusted Diluted EPS (INR) 7.1 7.6 7.3 8.2
Profitability & liquidity ratios Y‐o‐Y growth (%) 33.4 6.7 (3.8) 11.7
Year to March FY14 FY15 FY16 FY17 Adjusted Cash EPS (INR) 7.8 8.8 8.4 9.1
ROAE (%) 40.7 30.5 21.6 19.7 Diluted P/E (x) 14.1 13.2 13.7 12.3
ROACE (%) 20.5 19.6 18.3 17.3 Price/BV (x) 4.8 3.3 2.6 2.1
Inventory Days 12 16 14 15 EV/Sales (x) 0.6 0.6 0.6 0.6
Debtors Days 85 82 86 86 EV/EBITDA (x) 10.6 9.7 9.5 8.7
Payble Days 10 7 3 4
Cash conversion cycle (days) 87 91 97 97
Current Ratio 7.1 12.5 12.9 10.9
Gross Debt/EBITDA 3.7 3.6 3.9 3.7
Gross Debt/Equity 2.6 1.9 1.8 1.5
Adjusted Debt/Equity 3.0 1.9 1.8 1.5
Net Debt/Equity 2.5 1.8 1.7 1.4
Interest Coverage Ratio 2.4 2.3 2.3 2.4
Cash Connversion (%) (5) 17 (3) 42

Dairy

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai – 400 098.
Board: (91‐22) 4009 4400, Email: [email protected]
ADITYA
Digitally signed by ADITYA NARAIN
DN: c=IN, o=EDELWEISS SECURITIES LIMITED,
Aditya Narain ou=HEAD RESEARCH, cn=ADITYA NARAIN,
serialNumber=e0576796072ad1a3266c27990
f20bf0213f69235fc3f1bcd0fa1c30092792c20,
Head of Research
NARAIN
postalCode=400005,
2.5.4.20=6b7d777d3c8c77e0e2c454e91543f9
f4d9b8311cf0678cd975097fc645327865,
[email protected] st=Maharashtra
Date: 2017.12.04 18:50:12 +05'30'

Coverage group(s) of stocks by primary analyst(s): Dairy
Heritage Foods, Parag Milk Foods, Prabhat Dairy

Recent Research
Date Company Title Price (INR) Recos
14‐Nov‐17 Prabhat Scaling up in value added 144 Buy
Dairy products and B2C ;
Result Update
17‐Aug‐17 Prabhat Value‐added products drive 131 Buy
Dairy strong revenue trajectory;
Result Update
15‐Nov‐16 Prabhat Story intact but procurement 103 Buy
Dairy hurts; Result Update
Distribution of Ratings / Market Cap
Edelweiss Research Coverage Universe Rating Interpretation

Buy Hold Reduce Total Rating Expected to

Rating Distribution* 161 67 11 240 Buy appreciate more than 15% over a 12‐month period
* 1stocks under review
Hold appreciate up to 15% over a 12‐month period
> 50bn Between 10bn and 50 bn < 10bn

Reduce depreciate more than 5% over a 12‐month period
Market Cap (INR) 156 62 11

(INR) (INR) (INR)
80
100
120
140
160
180
300
430
560
690
820
950
70
90
110
130
150
170
Nov‐16 Dec 16 Dec 16
Dec 16 Dec 16
Dec‐16
Jan 17 Jan 17
Jan‐17
One year price chart
Feb 17 Feb 17
Feb‐17
Mar 17 Mar 17
Mar‐17
Apr 17 Apr 17
Apr‐17
May 17 May 17
May‐17
Kwality
Jun 17 Jun 17
Prabhat Dairy
Jun‐17
Heritage Foods
137
Jul 17 Jul 17
Jul‐17
Aug 17 Aug 17
Aug‐17 Sep 17 Sep 17
Sep‐17 Oct 17 Oct 17
Oct‐17 Nov 17 Nov 17
Nov‐17 Nov 17 Nov 17

180 (INR) (INR)

205
230
255
280
305
200
370
540
710
880
1,050
Dec 16 Dec 16
Dec 16 Dec 16
Jan 17 Jan 17
Feb 17 Feb 17
Mar 17 Mar 17
Apr 17 Apr 17
May 17 May 17
Jun 17 Jun 17
Parag Milk Foods
Jul 17 Jul 17
Hatson Agro Products
Aug 17 Aug 17
Sep 17 Sep 17
Oct 17 Oct 17
Nov 17 Nov 17
Dairy
Nov 17 Nov 17
Dairy
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Dairy

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Dairy
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India Dairy

Crème de la crème: Milking the value chain

Shradha Sheth Sanyam Jain

Butter FY16: INR288bn FY20: INR6,068bn

13% 24% 25% 32% 32%

 India India has come a long way from being in deficit from 20mn MT IN 1970 to

 Rising share of organised sector: Led by rising disposable income, and growing

2004 2009 2010 2011 2012 2014

Commodity Traditional Emerging

65.6% share 32.6% share 1.9% share

Liquid milk 3,483,000 760,000 22 6,068,000 1,593,000 26 15 20

Ghee 811,000 154,000 19 1,367,212 288,912 21 14 17

Whey (powder) 15,000 7,000 47 24,457 12,229 50 13 15

Milk Requirement (litre) 1 Production (mn kgs) 300

Less: Operating Expenses @ 11% 4 EBITDA 423

Milk Requirement (litre) 1 Production (mn kgs) 100

Less: Operating Expenses 6 EBITDA 848

Total Revenue 817 Capex 5000

Balance sheet (INR mn) Cash flow metrics (INR mn)

• Revenue: • Revenue: • Revenue:

400 7.0 6,500

300 6.0 5,000

200 5.0 3,500

100 4.0 2,000

Unorganised Organised Organised Share (RHS)

1,650 Ice‐creams, Flavoured Milk, Buttermilk and Lassi

Overall Margin Adjusted Margin Company RoCE Adjusted RoCE

2009 Entered into Maharashtra ‐ 2008

2012‐2015 2016 2017

Adjusted Growth metrics (%) ######## ########

Balance sheet (INR mn) Cash flow statement

Balance sheet (INR mn) Cash flow metrics

Nadu and ~30% in South India. 12 months 28.0 152.6 124.6

Less: Provision for Tax (2.4) 82 735 353 Net Block 4,856 6,184 6,372 9,799

Adjusted Profit 817 392 605 1,340 Intangible Assets 181 138 100 87

Adjusted Basic EPS 7.6 3.6 5.6 8.8 Non current investments 8 1 3 3

Dividend per share Loans & Advances 1,083 1,025 820 1,474

Interest Expense 1.7 2.2 2.0 1.7

180 (INR) (INR)

ESL and its associates, officer, directors, and employees, research analyst (including relatives) worldwide may: (a) from time to

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