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Near term pricing pressures, expect FY20 to be better
* Heritage Foods reported strong EBITDA and PAT growth of 20%, in line with our expectations. Margins expanded by 80bps on higher VADP contribution and lower milk prices. Revenue growth was marginally ahead of our expectations due to 24% growth in VADP. Revenue was partially impacted by higher competition in liquid milk. However, management is foreseeing early signs of recovery with the SMP inventory reduction.
* Management indicated milk prices are expected to rise with the start of a lean season. While milk price inflation in VADP would be passed on, delay in increase in liquid milk prices in the run up to election would lead to a temporary moderation of margin.
* While operational performance is in line, we lower our earnings estimates due to higher depreciation and tax rates. We maintain our positive stance, given the growing contribution of VADP and moderation of competition in liquid milk. Valuations of 10x FY20E EBITDA look attractive, given 27% RoE (excl. FRL stake value). We maintain Buy, with a target price of Rs660, based on 15x FY20E EV/EBITDA.
* Strong growth in VADP continues; early signs of recovery in liquid milk:
Heritage’s revenues grew 7%, driven by strong growth of 24% in VADP. VADP growth was driven by 24% growth in curd. VADP contribution has increased to 25% in 9MFY19 vs. last year, in line with management guidance. Liquid milk volumes rose 5%, partially impacted by higher competition from unorganized players and co-operatives in Tamil Nadu and the northern states. However, management is foreseeing early signs of recovery in liquid milk with the reduction in SMP inventories in the country. Management is optimistic of achieving double-digit growth in liquid milk and 20%+ growth in VADP.
* Lower milk prices aid margin expansion:
Gross margins expanded by 120bps due to lower milk prices. Milk procurement was up 6%, while prices were down 4% on account of flush season. Overheads were up 10%, arresting the EBITDA margin expansion to 80bps. EBITDA and PAT grew 20%, in line with our estimates. Management highlighted there would be an uptick in milk procurement prices with the start of a lean season and SMP inventory reduction. Management indicated moderation of margins as price hikes of liquid milk would be delayed in the run up to elections; however, higher contribution and price hikes of VADP would support margins.
* Valuation remains attractive; maintain Buy:
We appreciate management’s focus on driving growth by entering into new geographies, expanding distribution and increasing VADP contribution. We have reduced our earnings estimates on revision of depreciation and tax rates. We maintain our positive stance, with a revised TP of Rs660 (from 710), valuing at 15x FY20E EV/EBITDA.
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