Dairy - Higher freight cost and increase in Global SMP prices - ICICI Securities

The freight cost (~400bps of net sales) has increased sharply post increase in diesel prices and global SMP prices increased almost 10% in Feb'21 vs Dec'20. We believe higher global SMP prices will result in higher exports of SMP from India and the milk procurement prices in India may also move upwards. Reopening of the economy has led to higher demand for value added products. The demand from HoReCa is also rising. Our channel checks also suggest minor increase in milk procurement prices in Dec'20-Feb'21. Dairy companies have not raised prices post Feb'20 and we do not model them to raise prices till Q1FY22. Migration of labour as well as professionals to cities is expected to result in higher demand for milk in FY22. We have a BUY rating on Heritage Foods with a TP of Rs400 (10x FY23E) and ADD on Hatsun Agro with a TP of Rs800 (46x FY23E).

- Increase in freight cost to result in higher milk procurement prices: With sharp increase in diesel prices, we expect the freight cost (freight inwards and outwards) to increase resulting in higher milk prices. Freight cost is ~400bps of net sales for dairy companies.

- Global SMP prices inching upwards: Global SMP prices had declined from US$3,036/MT in Jan'20 to US$2,380/MT in April'20. But, SMP prices have now increased again to US$3,207/MT in Feb'21. We believe sharp increase in global SMP pries to result in higher SMP prices in India too and will also lead to higher milk procurement prices in coming months.

- Exports of Indian SMP: We believe with rising global SMP prices, Indian companies will be able to export the excess SMP inventory. This will reduce supply pressures in India and may result in higher milk prices in next 2-3 quarters.

- Wholesale milk prices increase MoM: Wholesale milk prices have inched up 2.5% MoM. We believe the increase in wholesale prices is attributable to (1) increase in global SMP prices and (2) reopening up of the economy. With re-opening up of the economy, there is revival in demand from HoReCa.

- Milk procurement prices likely to move upwards soon: Milk procurement prices are expected to inch upwards in next 3-4 months due to (1) rising demand from HoReCa, (2) commencement of summer which hurts animal productivity and (3) higher global SMP prices. From our channel checks, we note there is a minor increase in milk procurement prices in Dec'20-Feb'21.

- No pricing action by dairy companies: We do not expect dairy companies to raise prices in near term even if milk procurement prices move upwards. However, we expect dairy companies to raise prices in H2FY22. Dairy companies may also reduce some of the trade schemes before raising selling prices.

- Impact on companies: We expect all dairy companies to benefit due to lower milk procurement prices in Q4FY21. As Hatsun and Heritage generate 60%+ revenues from liquid milk, they will benefit more.

Source : Equity Bulls

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