Rising share of high margin products to boost earnings for Parag Milk Foods
Parag Milk Foods (PARAG) is one of the leading dairy products companies in India. PARAG started in 1992, has evolved as a one of the branded dairy player. The company has been successful in creating strong brands like GO, Gowardhan and in introducing new products like Whey Protein. It has become the 2nd largest player in processed cheese (after Amul) in a short span of 10 years and commands 33% market share. Rising revenue share of high-margin value added products (VAP) is likely to boost its margins in coming years.
Favorable Market Dynamics:
Indian dairy industry is valued at Rs.600000 cr, growing at 10%+CAGR which presents a strong opportunity for the organized sector (currently contributes ~22%). Driven by rising awareness and income level, organized players share’s is expected to increase to 26% by 2020. PARAG is likely to be one of the key beneficiaries of this shift.
Product portfolio shifting towards value added products:
Value Added Products (VAP) like paneer, whey protein and cheese enjoy higher gross margins of 25-45% as compared to 6-8% margins entailed in liquid milk. VAP currently contributes ~66% to company’s revenue (highest in the industry as against 25-30% for other leading players). This is likely to touch 75% in next 2-3 years. Increasing VAP’s revenue share will almost double its margins from 5.4% in FY2017 to 10.6% in FY2020. In FY18, the company has registered an OPM of 9.9%, increased from 4% in FY17.
Emerged as the leading player in cheese in a short span:
Cheese accounts for 21% of its FY2017 revenue and has grown to command 33% market share in Indian cheese market mainly driven by constant new product launch and aggressive marketing. Indian processed cheese market is valued at Rs.1000 cr market in FY2017 and is growing in excess of 15% for past couple of years. Amul is the market leader with 40% market share, Britannia-9% and Dynamix – 7%. The Indian fast food market is growing rapidly and cheese is quite popularly consumed with a number of fast foods such as Pizzas, Burgers, Garlic breads, and Sandwiches. Apart from western dishes, cheese is also being added as a taste enhancer in several traditional Indian recipes such as Dosas, Paratha, Pav Bhaji, amongst others. These trends would keep the buoyant demand for PARAG cheese segment.
New Product ‘Avatar’ has strong potential:
Avvatar is the first Indian whey protein powder which is pure vegetarian and is derived from milk protein only and is soya free and sugar free. The market size is estimated at Rs.1500 cr, growing at 12-13% CAGR. The market is dominated by imported brands that dominates over 80% of the market as there is no domestic brand in the market. Hence, with introduction of Avvatar, Parag has become first mover in this category and can capture this high margin segment (40%) as the imported products become little dated while Avvatar being a local brand offers a fresher and effective substitute. Avvatar’s revenue are expected to touch Rs.20cr in FY2018. With a better distribution and marketing strategy, the product sale is expected to touch Rs.100 cr in FY2019 and could be Rs.150cr brand in another 1-2 years.
Expanding its footprint in north and northeast markets:
In April 2018, Company has acquired Danone’s manufacturing facility in Sonipat, Haryana, which will help it expand its footprint in the north and northeast markets. Its current milk processing capacity is 0.75 LLPD (lakh litre per day) along with curd processing capacity of 15 tonne. PARAG is also in talks with various farmers to improve supply chain in north India. According to the management, this facility is expected to generate Rs.200cr revenue in FY19 and will contribute 6-7% of overall revenues in two years.
Reducing leverage and improving return ratios:
Demonetization and high raw milk procurement prices had led to poor performance in FY2017. With improving margins, its return ratios would also return to 14-15% from the temporary dip made in FY2017. Debt is expected to reduce over the next three years from the stabilization of profitability since FY2018. The company is likely to invest over Rs.150 cr over FY2017-20 in its manufacturing facilities which is to be funded by mix of IPO proceeds and internal accruals. The company is likely to generate Rs.100 cr+ annually as operating cash inflow which would fund its annual capex plan of Rs.50-60 cr. Its effort to improve its supply chain under the consultation of VECTOR CONSULTING is also likely to improve its working capital cycle as well as utilization of production capacity.
Management is confident of strong growth over the next few years:
Parag management revealed its Vision 2020 wherein it plans to achieve revenue of Rs 2,700-3,000 crore by FY2020, implying a CAGR of 18-24 per cent over the period FY 2018-20. Rising innovation agenda, scaling up presence in health & nutrition segment, and increasing the distribution network along with a professional management team would provide greater visibility to Parag’s earnings trajectory going forward. We expect company’s earnings to grow at 35-40% CAGR over the next 2 years. The stock is currently trading 17x its FY17 earnings much below the valuations of its peers. Though the stock has rallied 30% in last one month, it is still an attractive bet for the next two to three years.