Dairy - Lower milk procurement prices - ICICI Securities

Wholesale milk prices declined 0.2% in Aug'20 (First MoM decline after Dec'19) due to (1) lower milk procurement prices, (2) Higher SMP inventory in India and lower global SMP prices and (3) beginning of flush season. Milk procurement prices continue to decline with lower demand from HoReCa, Value added products and commencement of flush season. Dairy companies were supposed to raise prices in H1FY21 but we expect them to further defer the price hike considering lower procurement prices. We also believe there is possibility of subsidy announcement by Government to arrest the decline in milk procurement prices. We have a BUY rating on Heritage Foods with a target price (TP) of Rs370 (15x FY22E) and HOLD on Hatsun Agro with a TP of Rs650 (43x FY22E).

- Wholesale prices correct on MoM basis: Wholesale milk prices were 0.2% lower MoM. The prices have corrected (MoM basis) after Dec'19 and key reasons are (1) lower demand from HoReCa, (2) Huge inventory of SMP in India and (3) beginning of flush season. However, wholesale milk prices are still up 7.6% YoY due to (1) Price hikes (c.5%) by dairy companies in Feb'20 and (2) supply chain disruption.

- Correction in global SMP prices: The global SMP prices have corrected from US$3,036/MT in Jan'20 to US$2,608MT in Aug'20. We believe correction in global SMP prices may lead to correction in SMP/ milk prices in India. However, INR depreciation of ~5% will arrest the impact of correction in global SMP prices.

- Milk procurement prices remains under pressure: Milk procurement prices continue to be under pressure with lower demand for value added products, lower off-take by HoReCa segment, and commencement of flush season. We expect milk procurement prices to dip further with potential decline in demand due to regional lockdowns and increased productivity during flush season.

- Possibility of subsidy on milk: Considering steady decline in milk prices, we expect the Government to announce subsidy on milk. The co-operatives initially halted the decline in milk prices by purchasing additional milk. However, as they have excess SMP inventory, we believe the subsidy may get announced.

- Pricing action could be further deferred by dairy companies: Dairy companies had raised milk selling prices by 10% in FY20 (5% in Jun'19 and 5% in Feb'20). They were expected to raise prices again in H1FY21. However, considering the (1) deflation in milk procurement prices, (2) weaker economic outlook post lockdown, and (3) more regional lockdowns, dairy companies could further defer price hikes.

- Impact on companies: We expect all dairy companies to benefit. As Hatsun and Heritage generate 60%+ revenues from liquid milk, they will benefit more.

Source : Equity Bulls

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