Parag Milk Foods (PARAG) is one of the leading dairy products companies in India. The company has been successful in creating strong brands like GO, Gowardhan and in introducing new products like Whey Protein. It has become the 2nd player in processed cheese (after Amul) in a short span of 10 years and commands 33% market share. Rising revenue share of high-margin value added products (VAP) is likely to boost its margins in coming years.
Favorable market dynamics: Indian dairy industry is valued at ~Rs. 600000 cr, growing at 10%+CAGR which presents a strong opportunity for the organized sector (currently contributes ~22%). Driven by rising awareness and income level, organized players share's is expected to increase to 26% by 2020. PARAG is likely to be one of the key beneficiaries of this shift.
Product portfolio shifting towards high margin products: VAP like cheese, whey protein enjoy higher gross margins of 25-45% versus 6-8% entailed in liquid milk. VAP forms ~66% to its revenue (the highest among the listed players versus 25-30% for others). With rising health awareness, its whey protein brand (Avvataar) could be a >Rs. 150 crore brand in next 2-3 years. Driven by recently launched products and higher share of VAP, its operating margins would improve to 10-11% in next few years.
Reducing leverage and improving return ratios: PARAG is likely to incur a capex of ~Rs. 150 cr over FY2017-20 which is to be internally funded. With regular debt repayments, DE ratio is also likely to go down. With improving margins, its return ratios would normalize to 14-15% after making a temporary dip in FY2017.
Outlook and valuation: We expect PARAG to report net revenue/PAT CAGR of 13%/27% respectively over FY2018-20E. The stock currently trades at a P/E of 14.9x FY2020E EPS. It is increasingly becoming a stable brand strory while it is still valued as commodity business. We feel that the company should somewhere start enjoying the valuation of FMCG companies. We initiate coverage on the stock with a BUY recommendation and Target Price of Rs. 333 (20x FY2020E EPS), an upside of 34% from the current levels.