Stock Idea: Heritage Foods Ltd
CMP: 410
Heritage Foods is a Hyderabad
based dairy company operating predominately in AP, Telangana, Karnataka, Tamil
Nadu but off late expanding in Maharashtra, New Delhi, Haryana and Punjab. Its topline is 2473 Cr and NP of 148 cr in
Fy-2020-21. At CMP of 410 it is trading at 12 PE whereas Dodla dairy which was
listed two days back is trading at a PE of 25. In the IPO analysis reports from
brokers, they were surprisingly comparing the PE of Dodla to Parag milk who is
trading at a PE ratio of 32 but whose business is very different from Dodla as
Parag is predominately a Value added dairy player(70%-75%). They have not compared the
valuation of Dodla with Heritage foods (12 PE) which is also a southern India
player with almost similar business model (fresh Milk heavy). The size, margin
and net profit profiles of Dodla and heritage are almost the same though i
think Heritage has a better brand recall and higher share of Value added
products (VAP) (30-33% vs 25% of Dodla). I
am yet to do a detailed analysis of both Heritage and Dodla...this note is just
a compilation of my preliminary study.
The margins in fresh milk business
are low but the ROCE is high due to lower capital requirements if the firm can
manage working capital issues. But for Value added products like Ice cream,
Ghee, Curd, Milk shakes etc. margins are high but ROE is lower until the firm
reaches a critical large scale of operations to drive the economies of scale
because the shelf life of these products is much longer requiring investments
in working capital and then capital investments in the form of plant and
machinery is also high. But brand connection in the form of fresh milk drives the sale of VAP as customer who are using fresh milk brand are more likely to use the VAP of the same brands. The higher investments by Heritage in assets shows the under-utilization
of VAP capacity and margin profile as of now of VAP must have been quite weak
but the same will improve once the economies of scale kicks in. Working capital
days in case of Heritage are 11 which is one of the best in the industry (Dodla
also has similar levels). Heritage is the second biggest private sector dairy player after Hatsun and they have done well in building long standing relationships with farmers amid tough competition from milk co-operatives.
Last year due to covid, farm gate
milk prices were low so dairy companies earned much higher profits which may
not happen in the future although though milk prices are still low this year.
But I am more interested in the growth of value added products which in the
case of heritage is going good and they have very strong brand recall. Heritage
belongs to Chandrababu Naidu (Former CM of AP) so this political link forced me
to wait for the last 3-4 years. Current Jagan govt tried hard to prove some foul play at Heritage
growth but nothing came to materialize and Heritage is growing strength by
strength even when Naidu is not in power. So this has made me to have a relook.
They are paying good dividends and i have a feeling that they are the most
liberal here and after Hatsun they have the best books. They have grown the
share of VAP to some 33% last year. FY-21 there was low share of VAP due to
covid as the sale of VAP products like Ice cream was hit hard. But this year
the same will grow fast and Heritage is quite aggressive in the branding and
distribution. So I feel that at 12 PE Heritage is trading cheap and rerating
may be fast.
Heritage is also into cattle feed
business with turnover of 120 cr and NP of 7 cr. Its topline has doubled in the
last 4-5 years and it is a fantastic fit for them as they can use their milk
procurement supply chain to sell these products to farmers. It is all about
relationships in Indian Dairy. Here farmer is the producer and the relationship
with the farmer in the form of milk sourcing tie up acts as a big entry
barrier. It is very costly to run a dairy farm in India due to high land prices
etc. That's why global giants couldn't do well in India as their global model
of having large farm houses will not work in India. So the milk supply chain is
a high entry barrier business.
Also, Heritage has almost paid the
entire debt of some 260 cr last year (35 cr now). So this will save interest
cost of around 20 cr which means its effective PE is just 10. With cash balance
growing in the future we can expect more liberal dividends and some good
acquisitions. keeping in view that it is yet to grow its VAP share to a meaningful levels, volatility in fresh milk margins, still some sort of political overhang please treat this one as risky business. Tier 3 Investment as of now.