Dairy firms plagued with margin woes; pick value-added players: Analysts

Analysts are wary of companies majorly focused in the low-margin milk segment as they believe firms with a strong market share in value-added products (VAPs) are more likely to sustain in the industry

Milk, products, dairy
Dairy companies have hiked milk prices by 5-8 per cent in the past six months to combat margin erosion
Harshita Singh New Delhi
3 min read Last Updated : Jul 30 2022 | 1:26 AM IST
The emergence of the economy from Covid-19 lockdowns has lent comfort to dairy companies' revenues due to a pick-up in demand and out-of-home consumption. However, pressure on the sector's profit margins remains unabated amid steeply elevated prices of skim milk powder (SMP), cattle feed, and other operational costs. 

For instance, in the April-June quarter, Hatsun Agro and Heritage Foods reported yearly revenue growth of 31 per cent and 27 per cent, respectively. But their respective Ebitda margins sank 300 and 532 basis points due to a rise in raw material, packing material, and logistics costs. Net profits also declined 11 per cent and 76 per cent, respectively.
 
"Global SMP prices have steadily increased from the second half of calendar year 2021 (H2CY21). While we note a 10.6 per cent correction in prices from March highs, they are still up 36.8 per cent YoY in July," said ICICI Securities in a recent note.

Against this backdrop, analysts are wary of companies majorly focused in the low-margin milk segment as they believe firms with a strong market share in value-added products (VAPs) are more likely to sustain in the industry. 

"Any company operating only in core products like milk will not be able to absorb any price hikes due to the extremely low margins in these segments. So, you have to look for companies, which have a higher market share and a strong focus on value-added products," said AK Prabhakar, Head of Research at IDBI Capital.

VAPs include curd, cheese, frozen desserts, flavoured milk, and ice cream, among others. Margins on these products are generally higher or, in some cases, even double the margins in milk. 

Besides, margin woes for the cyclical sector have also been aggravated due to production shortage, which generally sets in during the summer months and pushes up milk procurement prices.

"The milk production cycle has not witnessed a normal season since 2015 mainly due to weather impacts like excessive floods or droughts and other factors like SMP price fluctuations. Moreover, we expect the current high prices of milk to sustain due to high inflation in food commodities, fuel, and fodder," said Punit Patni, Research Analyst at Swastika Investmart. 

Patni adds that the investment rationale in this space should be guided by a company’s procurement network, contribution from VAPs, leverage, and working capital intensity. He is positive on Heritage Foods and Dodla Dairy. In FY22, the VAP contribution of the two companies' to dairy revenues stood at 27 and 26 per cent, respectively, which they aim to increase to 30-40 per cent in the next 2-3 years. 

Price hikes

Dairy companies have hiked milk prices by 5-8 per cent in the past six months to combat margin erosion. However, analysts believe that the sector will have to continue undertaking price increases in the second half of fiscal 2022-23 (FY23) to protect profits.

"While the onset of the flush season (Sept-Feb) might give some relief to dairy companies in H2FY23, we model milk procurement prices to continue to rise with the re-opening up of the economy. We continue to model Ebitda margins of dairy companies to correct 50-100 bps in FY23," said ICICI Securities.

That apart, the recently levied 5 per cent goods and services tax on retail packs of pre-packaged and pre-labelled curd, lassi, and buttermilk will also be passed onto end customers as the firms don’t have margins to take a hit, analysts said. 

One subscription. Two world-class reads.

Already subscribed? Log in

Subscribe to read the full story →
Subscribe to Business Standard digital and get complimentary access to The New York Times

Quarterly Starter

₹900

3 Months

₹300/Month

SAVE 25%

Smart Essential

₹2,700

1 Year

₹225/Month

Save 46%

Super Saver

₹3,900

2 Years

₹162/Month

Subscribe

Renews automatically, cancel anytime

Here’s what’s included in our digital subscription plans

Access to Exclusive Premium Stories Online

  • Over 30 behind the paywall stories daily, handpicked by our editors for subscribers

Complimentary Access to The New York Times

  • News, Games, Cooking, Audio, Wirecutter & The Athletic

Business Standard Epaper

  • Digital replica of our daily newspaper — with options to read, save, and share

Curated Newsletters

  • Insights on markets, finance, politics, tech, and more delivered to your inbox

Market Analysis & Investment Insights

  • In-depth market analysis & insights with access to The Smart Investor

Archives

  • Repository of articles and publications dating back to 1997

Ad-free Reading

  • Uninterrupted reading experience with no advertisements

Seamless Access Across All Devices

  • Access Business Standard across devices — mobile, tablet, or PC, via web or app

Topics :dairy sectorDairy companiesDodla DairyHeritage FoodsHatsun Agro ProductQ1 results

Next Story