The profit margins of dairy companies are likely to remain strong in the near term on soft milk prices and increased focus on value addition to avail subsidy announced by various state governments. Analysts are cautious on their top line growth.

Organised players such as Heritage Foods, Parag Milk Foods and Prabhat Dairy face stiff competition from the unorganised sector in terms of milk procurement. Co-operative dairies, including Gujarat Cooperative Milk Marketing Federation Ltd (GCMMF), which sells its dairy products under Amul brand, have developed its strong relations with farmers over years. Higher milk procurement prices, therefore, are compensated through subsidy from their respective state governments.

The improved margin forecast, therefore, is set to help dairy companies pay higher prices for milk procurement to farmers. Thus, both farmers and dairy companies are on a firm footing in the short term. Organised sector players’ strategy of investing in scaling procurement, brand building and distribution expansion will lead to healthy growth over the next few years, say experts.

“While Q2FY19 sales growth of Heritage, Parag and Prabhat is likely to be mere around 5 per cent, 12 per cent and 6 per cent, respectively, we estimate their Ebitda to jump 114 per cent, 19 per cent and 10 per cent, as milk over-supply is likely to drive margins,” said Shradha Sheth, an analyst with Edelweiss Securities Ltd.

Analysts are expecting Heritage Foods, for example, to post its sales of Rs 6,469 million for the second quarter of the current fiscal as against Rs 6,161 million in the comparable quarter last year. Its Ebitda margin is forecast to jump to 7 per cent for the quarter ended September 2018 versus 3.4 per cent in the corresponding period last year. Profit margins of Parag Milk Food and Prabhat Dairy are also likely to improve for the quarter ended September 2018.

“Amul expects per capita milk consumption to clock a compounded annual growth rate (CAGR) of 2.1 per cent over next 50 years, indicating milk production CAGR of 3.5 per cent. It expects the organised sector to handle at least 50 per cent of milk production from current level of 20 per cent. Considering industry volume growth of 3.5 per cent, shift from unorganised to organised sector, higher revenue share of value-added products and inflation, we believe the organized sector can report low double-digit CAGR,” said Aniruddha Joshi, an analyst with ICICI Securities, while decoding financial year 2017-18 annual report of GCMMF.

A soft milk price scenario is favourable for organised players. However, the current situation has given rise to a number of new entrants and penetration of unorganised players in the south.

Meanwhile, Parag has a relatively higher working capital requirement due to high concentration of value-added products. With Maharashtra government subsidy in place, the milk procurement cost works out to Rs 20 a litre for use in producing such products.

“While we expect the working capital cycle to improve and Parag to generate positive free cash flow in FY19, increase in cost of funds is likely to impact its working capital funding and cash flows. Further, the government’s recently announced subsidy on export of skimmed milk powder (SMP) and Rs 5 per litre subsidy for procuring milk from farmers at a higher rate of Rs 25 per litre, is likely to further stretch the working capital,” said Sheth.

Prabhat derives around 67 per cent revenue from the B2B segment, which operates on a cost-plus model. Therefore, in a low milk price scenario, which is likely to persist over the short to medium term, the company’s ability to drive value growth is limited. Further, the company is consciously reinvesting benefits of gross margin expansion in brand building and distribution expansion.