INSTITUTIONAL EQUITY RESEARCH Page | 1 | PHILLIPCAPITAL INDIA RESEARCH Parag Milk Foods Milking the growth in dairy consumption INDIA | Dairy | IPO Note 03 May 2016 Parag Milk Foods, founded in 1992, is one of the leading private dairy players in India with a pan-India presence. It manufactures dairy products such as cheese, ghee, curd, buttermilk, flavoured milk, and fresh milk, and markets these under brands Gowardhan, Go, ToppUp, and Pride of Cows. As was highlighted in our March 2016 Ground View edition , growth prospects for the Indian dairy industry are strong, and Parag Milk Foods, being among the leaders in value-added products, will benefit considerably from their increasing consumption and from a shift to organised players (in both rural and urban India). The stock is available at 21x our FY18 earnings (adjusting for sales tax refund) and we believe that its valuation is justified given the growth visibility, brand equity, innovations history, strong supply chain, and capable management team. We recommend SUBSCRIBE. Indian dairy to see 15% CAGR in 2014-20; organised segment to grow faster: The Indian dairy industry is poised to grow to Rs 9.4tn by 2020 from Rs 4.1tn in 2014 (15% CAGR), as per a report by research firm IMARC. Within this, the organised segment (20% value share) could see faster 20% CAGR. Organised players dominate high-margin categories (cheese, flavoured and UHT milk, flavoured yoghurts, lassi), which are poised to see >25% CAGR. Parag Milk Foods is likely to top overall dairy market growth due to its strong presence in high-growth, value-added categories. Leading private player in value-added milk products with strong brands: Parag Milk Foods has a cheese plant capacity of 40T/day and is the second-largest cheese player (32% market share) after Amul (42% share) in India. Apart from a strong retail presence, its institutional customers include major QSR brands like Dominos, Pizza Hut and KFC. Its brand Gowardhan Ghee sells at a 5-10% premium to others on a positioning of superior quality and purity. It is also present in other key high-margin categories like UHT, flavoured milk, buttermilk, and flavoured yoghurt. History of innovations and product premiumisation: Parag produces various types of cheese (mozzarella, shredded, cheddar, each in a variety of flavours) and recently launched super premium Go Almette cheese. It also produces flavoured yoghurt, buttermilk, and flavoured milk (highest number of variants/flavours in the market for each). It is one of the pioneers of the concept of farm-to-home fresh milk, which it supplies to Mumbai and Pune under its brand Pride of Cows (commands 100% premium to regular brands). Strong sourcing chain and pan-India presence: Parag sources milk from 250,000 farmers in 3,400 villages across Maharashtra, Andhra Pradesh, Karnataka, and Tamil Nadu, and also procures milk indirectly through wholesalers. It has a dairy farm near Pune with 2,000 cows of the Holstein breed, maintained mainly for R&D purposes. It is also among the few private dairy players with a pan-India presence. Currently, its distribution network consists of 15 depots and over 3,000 distributors across the country. It employs 560 people for distribution and marketing. We believe that the company has the right sourcing and distribution strategy and as its sales expand, its network will increase and aid growth. Margins, working capital, and cash-flow to improve as it expands: Gross/EBITDA margins in FY15 were 23.5%/7.4%; as its sales rise, (1) its margins will expand gradually – due to higher operating leverage and better supply-chain efficiencies, and (2) its receivables days will fall (slowly) in the medium term (44 days in FY15) led by strong retail focus and higher bargaining power with institutional clients. Also, by FY17 most of its capex will be in place and free cash flows should rise from FY18. High valuations justified; Recommend SUBSCRIBE: The stock is available at 26/21x our FY17/FY18 earnings vs. 33/21/10x FY17 earnings for Hatsun Agro/Prabhat Dairy/Kwality Dairy (our/Bloomberg estimates) while it is available at FY17/FY18 EV/EBITDA of 13/11 vs. 14/8/7x for FY17 EBITDA for the same peerset. The stock is slightly expensive to some peers but the higher valuation is justified by lower share of institutional sales, stronger brands, distribution reach, and strong execution history. Also, we believe that the lower RoE/RoCE for dairy players vs. FMCG companies is compensated by 35% discount to FMCG sector multiple and higher growth and premiumisation prospects compared to penetrated FMCG categories. SUBSCRIBE COMPANY DATA ISSUE OPENS 4 th May 2016 ISSUE CLOSES 6 th May 2016 PRE-ISSUE EQUITY SHARES 70.4mn PRICE BAND Rs. 220-227 NO OF SHARES TO BE ISSUED 13.3-13.7mn SHARES IN OFFER FOR SALE 20.57 mn P/E @ FY18E EARNINGS UPPER PRICE BAND 21 ISSUE SIZE Rs 3bn PROPOSED MKT CAP. (AT UPPER BAND) Rs 19bn SHARE HOLDING PATTERN, % Particulars Pre-offer (%) Post-offer (%) Promoters 61.1% 47.5% Public 38.6% 52.2% Employee trusts 0.3% 0.3% Details of Selling Shareholders IDFC PE 8.3mn IBEF/IBEF I 6.0mn Promoter group 3.1mn Others 3.2mn KEY FINANCIALS Rs mn FY16E FY17E FY18E Net sales 14,950 17,568 20,658 EBITDA 1,339 1,477 1,709 Net profit 407 707 875 EPS, Rs 4.8 8.4 10.4 PER, x @220 45.8 26.4 21.3 PER, x @227 44.4 25.6 20.7 ROCE, % 18.1 13.5 12.1 ROE, % 12.7 10.3 11.3 Source: PhillipCapital India Research Est. Jubil Jain (+ 9122 6667 9766) [email protected]Naveen Kulkarni (+ 9122 6667 9947) [email protected]Preeyam Tolia (+ 9122 6667 9950) [email protected]
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INSTITUTIONAL EQUITY RESEARCH
Page | 1 | PHILLIPCAPITAL INDIA RESEARCH
Parag Milk Foods
Milking the growth in dairy consumption
INDIA | Dairy | IPO Note
03 May 2016
Parag Milk Foods, founded in 1992, is one of the leading private dairy players in India with a
pan-India presence. It manufactures dairy products such as cheese, ghee, curd, buttermilk,
flavoured milk, and fresh milk, and markets these under brands Gowardhan, Go, ToppUp, and
Pride of Cows. As was highlighted in our March 2016 Ground View edition, growth prospects
for the Indian dairy industry are strong, and Parag Milk Foods, being among the leaders in
value-added products, will benefit considerably from their increasing consumption and from a
shift to organised players (in both rural and urban India). The stock is available at 21x our FY18
earnings (adjusting for sales tax refund) and we believe that its valuation is justified given the
About the IPO 13.7-13.3mn fresh shares in a band of Rs 220-227 per share, totalling Rs 3bn.
20.5mn shares for sale by existing investors — (IDFC PE – 8.3mn, Motilal Oswal’s IBEF/IBEF I – 6mn, promoter group – 3.1mn, others – 3.2mn).
Utilisation of funds: Rs 1.5bn for capex, Rs 1bn for loan repayment, and Rs 0.5bn for general corporate purposes and others.
Market capitalisation post-issue: Rs 19bn at upper price band (84.1mn shares).
Details of selling shareholders
Selling shareholder
No. of shares
sold (mn)
Total no. of
shares held
% of holding
sold
Promoters
Netra Shah 2.0 10.3 19%
Priti Shah 1.1 3.3 33%
PE investors
IDFC PE 8.3 14.1 59%
Motilal Oswal sponsored IBEF and IBEF I 6.0 6.7 90%
Others 3.2 - -
Total 20.6
Source: RHP
Shareholding structure: Before and after the issue Shareholding Pre-Issue % of total Post Issue % of total
Promoter & Promoter Group 43,045,822 61.1% 39,941,189 47.5%
Devendra Shah 14,570,832 20.7% 14,570,832 17.3%
Netra Shah 10,272,782 14.6% 8,268,149 9.8%
Pritam Shah 9,159,888 13.0% 9,159,888 10.9%
Other promoters 9,042,320 12.8% 7,942,320 9.4%
Public 27,143,065 38.5% 43,964,774 52.3%
IDFC PE 14,134,162 20.1% 5,874,234 7.0%
IBEF I 4,359,749 6.2% 442,511 0.5%
IDFC SPICE 2,411,870 3.4% 2,411,870 2.9%
IBEF I 2,316,866 3.3% 207,583 0.2%
Other Public 3,920,418 5.6% 35,028,576 41.6%
Shares in employee trusts 227,000 0.3% 227,000 0.3%
Total 70,415,887 100.0% 84,132,963 100.0%
Source: RHP
Page | 3 | PHILLIPCAPITAL INDIA RESEARCH
PARAG MILK FOODS IPO NOTE
About Parag Milk Foods Parag Milk Foods Ltd was founded in 1992. It is an integrated dairy company, and one of the largest private dairy players, with milk-processing capacity of 2mn litres per day. It is present in over seventeen dairy product categories and it markets products under the brands Gowardhan, Go, Pride of Cows, and Topp-up.
Brand-wise product categories of Parag Milk Foods Brands Categories Target
Go Flavoured cheese, tubes, slices etc Children and youth, primarily for direct
consumption
Pride of Cows Farm-to- home, subscription model Consumer seeking premium quality
Topp- Up Flavored milk with extra proteins Youth and travelers
Source: Company, PhillipCapital India Research
Currently, the biggest contributors to its revenue (>20% each) are fresh milk, ghee/butter and cheese/paneer. It intends to increase dairy-based beverages portfolio under the ‘Go’ brand, introduce milk-based high-protein drinks, and a new variant of curd with a higher protein and lower fat content. It also intends to set up a whey-proteins manufacturing facility and increase its presence in the premium health supplement space. Because of high proportion of sales from value-added products like cheese, UHT, flavoured milk, buttermilk and curd (~30%) and branding in the otherwise low-margin ghee business (~32%), Parag has consistently delivered gross margins of 22-25% in FY11-16.
Sales mix in FY14-9MFY16 Gross-margin movement from FY11-9MFY16
Source: Company, PhillipCapital India Research
Manufacturing facilities It has two manufacturing facilities in Pune (Maharashtra)/Palamner (Andhra Pradesh) with milk-processing capacities of 1.2/0.8mn litres per day; it plans to expand capacity of both plants to 2.0mn/1.4mn respectively through the IPO proceeds. It also plans to expand capacity for cheese, paneer, whey, curd-flavoured beverages, and UHT, which we believe will help it to meet the demand growth for the next five years in all its categories.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2014 2015 9MFY16
Other manufactured products
Skimmed milk powder
Whey
UHT
Cheese/Paneer
Ghee/Butter/Cream
Fresh Milk 20%
21%
22%
23%
24%
25%
26%
FY11 FY12 FY13 FY14 FY15 9MFY16
Gross margins
Page | 4 | PHILLIPCAPITAL INDIA RESEARCH
PARAG MILK FOODS IPO NOTE
Capacity for different product categories
Product Units Manchar Palamaner
Current
Total
Proposed
expansion
Milk processing capacity (litres per day) 1,200,000 800,000 2,000,000 1,400,000
Milk powders (includes drying capacity for whey
powders and dairy whiteners) (metric tons per day)
70 40 110 -
Liquid milk in pouches (litres per day) 200,000 175,000 375,000 150,000
Flavoured milk (packs per day) 30,000 70000 100,000 30,000
UHT Products* (litres per day) 0 165,000 165,000 80,000
Curd (includes pouch curd, cup curd, fruit yoghurt
and shrikhand) (metric tons per day)
20 40 60 20
Whey Processing (litres per day) 400,000 0 400,000 600,000
*Includes lassi and buttermilk
Source: Company, PhillipCapital India Research
Historical capacity utilisation
Capacity Utilisation (%)
Product Units 2013 2014 2015 9MFY16
Milk processing capacity 49 49 66 71
Milk powders (incl drying capacity for whey powders and dairy whiteners) 50 59 75 73
Liquid milk in pouches 64 61 60 52
Flavoured milk 2 28 29 65
UHT Products* 9 18 18 33
Cheese/Paneer 44 47 67 81
Ghee 31 28 27 47
Butter 16 14 32 38
Curd (includes pouch curd, cup curd, fruit yoghurt and shrikhand) 50 58 43 64
*Includes lassi and buttermilk
Source: Company, PhillipCapital India Research
Strong institutional base and retail distribution network A large part of its range includes long shelf-life food and beverage products that enables it to transport and sell to retail and institutional customers (such as QSRs (quick-service restaurants) – Pizza Hut, Taco Bell, KFC, Dominos, Sam’s Pizza, and FMCG companies such as Nestle) across India. Currently, its retail distribution network in India consists of 15 depots, 104 super stockists, and over 3,000 distributors. It has a workforce of 560 people, dedicated to distribution and marketing. Strong sourcing chain Parag sources milk from 29 districts across Maharashtra, Andhra Pradesh, Karnataka, and Tamil Nadu, through over 3,400 village-level milk-collection centres, comprising 250,000 farmer members. It also procures milk indirectly through chilling centres and bulk coolers. In addition, It has a dairy farm near Pune with 2,000 cows of the Holstein variety (known for high milk production), which the company says are mainly kept for R&D. Average daily milk procurement for 9MFY16/FY15/FY14/FY13 was 1.00/1.05/0.77/0.85mn litres. The company has proposed to spend Rs 116mn from its IPO proceeds to expand its sourcing network.
While current utilisation levels are high, proposed expansion will cover for growth in the next five years.
Page | 5 | PHILLIPCAPITAL INDIA RESEARCH
PARAG MILK FOODS IPO NOTE
Indian dairy poised to see 15% CAGR in 2014-20 India is currently the largest producer of milk – and the dairy industry is poised to grow to Rs 9.4tn by 2020 from Rs 4.1tn in 2014 (15% CAGR), as per a report by IMARC. The organised segment (20% share by value) is poised to see a faster 20% CAGR. High-margin categories – cheese, flavoured and UHT milk, flavoured yoghurts and lassi – in which organised players like Parag have dominant share are poised to see >25% CAGR in 2014-20. Key growth drivers for the sector are – rising middle class and urban population, changing dietary patterns, acceptance of milk as a perfect health food in India, and consumer shift towards packaged milk.
Indian dairy industry: Category-wise growth prospects
Industry size in
2010 (Rs bn)
Industry size in
2014 (Rs bn)
Industry size in
2020 (Rs bn)
CAGR 2014-
2020
CAGR 2014-
2020
Liquid milk 1501 2,621 6,068 15% 15%
Ghee 345 618 1,367 16% 14%
Paneer 164 293 654 16% 14%
Curd 124 216 493 15% 15%
Butter *96 168 382 15% 15%
Skimmed milk powder 28 50 113 15% 15%
UHT milk 10 26 104 27% 26%
Buttermilk 6 14 43 23% 21%
Cream 7 13 30 16% 15%
Flavoured milk 5 13 48 26% 25%
Lassi 5 12 39 26% 21%
Cheese 5 12 59 24% 31%
Whey (powder) *1.5 3 10 20% 21%
Flavoured & Frozen Yoghurt 1 2 12 23% 32%
Total 2,298 4,061 9,397 15% 15%
Source: IMARC report; * PC estimates
Currently, cooperatives (with 55% volume share) dominate the organised sector due to their strong sourcing capabilities. However, as our March 2016 edition of Ground View magazine highlighted, while cooperatives will continue to dominate, there is huge scope for private players to grow in value-added products through superior financial management.
High-margin categories – cheese, flavoured and UHT milk, flavoured yoghurts and lassi – in which organised players like Parag Milk Foods have dominant share are poised to see >25% CAGR in 2014-20..
Operational parameters for Parag Milk Foods to improve Sales growth to remain robust in the medium term We expect Parag’s sales growth of 15%+ to continue in the medium term because of the general growth in the dairy industry and rising consumption of value-added products.
Sales growth potential is high Sales mix to improve in favour of high-margin products
Source: Company, PhillipCapital India Research
We do not expect a drastic change in the portfolio mix in the medium term. The mix will gradually shift towards high-margin products such as cheese, whey, UHT, curd/buttermilk, and flavoured milk. Gross margins may not expand beyond current levels in the medium term Due to oversupply of milk globally and in India, milk procurement prices have been flattish or deflationary in the last two years. The supply glut is expected to end sometime in 2017, after which we expect prices to rise. As a result, Parag’s gross margins could slide down slightly.
Gross margins have been relatively stable Gross profit saw 24% CAGR in FY11-15
Source: Company, PhillipCapital India Research
0%
5%
10%
15%
20%
25%
30%
35%
40%
FY12 FY13 FY14 FY15 FY16E FY17E FY18E
Sales growth
0%
20%
40%
60%
80%
100%
FY14 FY15 FY16E FY17E FY18E
Other manufactured products
Skimmed milk powder
Whey
UHT
Cheese/Paneer
Ghee/Butter/Cream
Fresh Milk
20%
21%
22%
23%
24%
25%
26%
FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E
Gross margins
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
FY12 FY13 FY14 FY15 FY16E FY17E FY18E
Gross profit growth
Page | 7 | PHILLIPCAPITAL INDIA RESEARCH
PARAG MILK FOODS IPO NOTE
EBITDA growth to accelerate due to operating leverage Sales growth should provide operating leverage and contribute positively to margins. While margins will fall slightly due to rising input costs, EBITDA growth will accelerate from FY17, and grow in teens in the medium term.
EBITDA margins have been relatively stable at 7-9% EBITDA growth to accelerate from FY17 on operating leverage
Source: Company, PhillipCapital India Research
PAT to grow faster than EBITDA due to lower finance cost and higher other income With the IPO proceeds of Rs 3bn, the company will pay Rs 1bn of debt. The infusion of capital will help reduce finance costs and will also increase other income. We expect PAT to jump by 74%/24% to Rs 707/8mn in FY17/18 from Rs 260mn in FY15. From FY18 onwards, PAT should grow slightly ahead of revenue in the medium term.
PAT margins have been rising PAT growth to stabilise in mid teens from FY18
Source: Company, PhillipCapital India Research
0%
2%
4%
6%
8%
10%
FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E
EBITDA margins
-10%
0%
10%
20%
30%
40%
50%
60%
70%
FY12 FY13 FY14 FY15 FY16E FY17E FY18E
EBITDA growth
-1%
0%
1%
2%
3%
4%
5%
FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E
PAT margin
-40%
-20%
0%
20%
40%
60%
80%
FY13 FY14 FY15 FY16E FY17E FY18E
PAT growth
Page | 8 | PHILLIPCAPITAL INDIA RESEARCH
PARAG MILK FOODS IPO NOTE
Working capital days to reduce very gradually in the medium term Working capital as a percentage of sales, while higher compared to pure FMCGs, will start reducing gradually led by reduction in receivables, as its retail sales portfolio expands and inventory levels reduce due to growth of non-cheese high-margin products.
Working capital/sales will stay high, unlike pure FMCG players Historical and projected working capital days
Source: Company, PhillipCapital India Research
Free cash flow to see a decisive upward trend from FY18 Parag saw negative cash flow between FY11 and FY14 because of significant capex. In FY15, this parameter turned positive; we see cash flow remaining positive in FY16, turning negative in FY17 (high planned capex) and turning positive again in FY18. From FY18 onwards, most of its capacity will be in place for the next 3-5 years, and free cash flow should stay positive.
RoE and RoCE will stay lower than pure FMCG players Parag’s RoE and RoCE will continue to remain low, but see gradual improvement as margins and cash flow improve from FY18. Dairy players’ RoE and RoCE will stay lower than pure FMCG plays.
Historical RoE Historical RoCE
Source: Company, PhillipCapital India Research
Sales Tax incentive in Maharashtra has NPV of ~ 1bn The company received sales tax incentive of Rs 239mn in FY15 from the state of Maharashtra. This benefit will be available till FY22 as per the management. As per our estimates, the current NPV of the benefits is Rs 1bn which we have adjusted from profits and valuations.
NPV of sales tax incentive is ~Rs 1bn Rs mn FY2017 FY2018 FY2019 FY2020 FY2021 FY2022
Comparison of financial performance of key private dairy players
Sales: have increased significantly for all key players over the years.
Historical sales growth
Source: Company, PhillipCapital India Research
Gross margins: Except Kwality Dairy, which sells more of low-margin products, others have gross margins in range of 20-25%. Margins have not improved or fallen in last two years because of a fall in prices of global commodities such as skimmed milk powder. EBITDA margins: Are lower for dairy players because of higher operating expenses.
Dairy profit margins: Are lower than those of FMCG peers, because dairy requires higher capital expenditure and higher working capital.
Profit margins
Source: Company, PhillipCapital India Research
Receivable days: Except Hatsun, which has major portion of portfolio in retail, these are very high for others. Inventory days: Parag Milk Foods has high inventory days due to higher share of cheese in sales, which requires aging.
Payable days: Parag Milk Foods has the highest bargaining power with suppliers. Free cash: Most worrisome aspect of the dairy industry is that free cash flow has been negative for most companies for many years because of capital investment and increase in receivables.
Payables days Free cash flow
Source: Company, PhillipCapital India Research
Net debt and net debt/EBITDA: Very high for all four companies.
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Page | 18 | PHILLIPCAPITAL INDIA RESEARCH
PARAG MILK FOODS IPO NOTE
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