PARAG MILK: IPO ANALYSIS

PARAG MILK: IPO ANALYSIS

Not as Sweet as Milk.

Parag Milk Foods is entering the primary market to raise Rs. 300 crore via a fresh issue of equity shares of Rs. 10 each and an offer for sale (OFS) of up to 205.73 lakh equity shares, both in the price band of Rs. 220 to Rs. 227 per share. With a issue size of Rs 767 crore at the upper end of the price band.

Retail investors will get a Rs. 12 discount on the final issue price. OFS portion is Rs. 467 crore. Representing 15.8% of the post issue paid-up capital at the upper end.

Parag Milk Foods sells milk, ghee, cheese, paneer, curd and other dairy-based products under Gowardhan, Go, Topp Up and Pride of Cows brands, with an aggregate milk processing capacity of 2 million liters per day. It has cheese production capacity of 40 MT per day and distribution network comprising of 15 depots, 104 super stockiest and over 3,000 distributors.

Geographically, nearly western regions contribute 55% of company revenues.

Growing Pan-India Distribution Network: The Company has established a pan-India distribution network, which comprised 15 depots, 104 super stockiest and over 3,000 distributors as of February 29, 2016. Their depots are present in 13 states and union territories in India with a wide network of retail stores. Total milk processing capacity is 20lakh liters/day and average milk procurement is around 10 lakh liters /day. On account of their short shelf life, the fresh milk and fresh milk products are largely sold in the western and southern regions of India, in proximity to the manufacturing facilities at Manchar and Palamaner. They sell farm-to-home premium fresh milk directly to retail customers in Mumbai and Pune and also beverages to direct consumption outlets such as canteens, railway stations, roadside and highway eateries and educational institutions. It has established a separate route-to-market to focus on the distribution of low unit price products including ghee, flavored milk, UHT milk, dairy whiteners and gulab jamun mix in Tier 3 cities and rural areas in India. They cater to institutional customers, hotels, restaurants and caterers directly through distributors appointed by them.

For FY15, consolidated revenue rose 32% YoY to Rs. 1,441 crore. Dairy business having wafer thin net margin, standing at 1.8% for FY15, led to net profit of just Rs. 26 crore, yielding an EPS (basic) of Rs. 4.47. Although EBITDA rose 28% YoY to Rs. 108 crore, EBITDA margin slipped to 7.5% in FY15, from 7.7% of FY14. Despite sales CAGR of 24.6% over FY13-15, PAT CAGR registered only 12%, as rise in finance cost and employee expenses restricted bottom line growth

Object of the Issue: Where the money raised would be utilized :

·      Expansion and Modernisation Plan (Rs.147.70 Cr) :

    The company currently operate from two manufacturing facilities, the Manchar Facility in Pune, Maharashtra and the Palamaner Facility in Chittoor, Andhra Pradesh, with milk processing capacities of 1.2 million litres per day and 0.8 million litres per day, respectively. In line with the strategy of increasing value added products portfolio, PMFL propose to enhance the production capacity for products such as cheese, whey and curd. Further, they propose to enhance the facilities for milk handling, milk packing, warehousing and cold storage and other facilities at the existing sites. They further propose to set up a research and development center at the Manchar Facility to develop new products and processes. The above expansions will enable them to meet the increasing demands for their products, increase the penetration of the products in markets, increase value-added products portfolio, improve operational efficiency and reduce production costs.

·      Expansion and modernization of the subsidiary- Bhagyalaxmi Dairy Farm (“BDFPL”)

    Company’s subsidiary, BDFPL, is involved in the business of, amongst others, purchasing, selling, importing, exporting, breeding, raising, acquiring, owning, holding, dealing in, using and rearing milk animals and dairy farming. They have set up Bhagyalaxmi Dairy Farm, through BDFPL, at Manchar, Pune, in 2005. The BD Farm is a fully automated cow farm, housing over 2,000 Holstein breed cows with superior quality yields. The company proposes to utilize the proceeds from this investment in BDFPL towards (a) setting up of a technology center; and (b) undertaking utility expansion, at the BD Farm. Such investment is being undertaken in furtherance of the Company‘s objective of using the BD Farm as a research and development base, to meet the increasing demand of its milk products.

·      Partial repayment of the Working Capital Consortium Loan

    Company’s business is working capital intensive and they fund majority of the working capital requirements in the ordinary course of its business from internal accruals and from various banks and financial institutions. The company has availed of the Working Capital Consortium Loan through the working capital consortium Agreement, as supplemented from time to time. The amounts outstanding under the Working Capital Consortium Loan are dependent on several factors, which may vary with the business cycle and could include interim repayments and drawdown. The company intends to utilize Rs.100 Crores in Fiscal 2016 to repay a part of the Working Capital Consortium Loan. Such repayment will help reduce the outstanding indebtedness.

·      General corporate purposes.

For 9MFY16, however, PAT of Rs. 32 crore (EPS Rs. 4.67 for 9 months) has already surpassed FY15 PAT of Rs. 26 croreby 23%, as also EBITDA margin has widened by 127 bps over FY15, to 8.77

Company’s net worth, stood at Rs. 278 crore, with promoters currently holding 61.13% stake, which will shrink to 54% post IPO, as 2 promoters are participating in the OFS, along with India Business Excellence Fund (Motilal Oswal PE) and IDFC PE Fund. Company’s consolidated net debt stands at Rs. 340 crore, (down from Rs. 424 crore, as on 31.3.15). This will further reduce by Rs. 100 crore, thanks to repayment via fresh issue proceeds, while balance proceeds will be used for expansion and modernization of existing manufacturing facilities.

At upper end of the price band, Parag Milk will have market cap of Rs. 1,598 crore and Enterprise Value of Rs. 1,838 crore, which leads to EV/EBITDA of about 12 times, on an estimated EBITDA of Rs. 154 crore for FY16. Company is likely to close FY16 with an EPS below Rs.7, on an equity base of Rs. 70.42 crore, leading to a PE multiple of over 32 times. While the growth and margin expansion in 9MFY16 are quite encouraging,

Leverage position

PMFL had a very high debt-equity ratio of 7.7x as of FY2011, which the company has gradually reduced to 1.3x as of December 2015. Going ahead, the company plans to further improve the leverage position to below 1x by FY2017. Further, PMFL’s larger portion of debt is towards working capital loans. In the event if the company is unable to generate adequate cash in the future to meet the working capital needs, than the debt levels could rise going ahead

When compared to the other listed peers the valuations for the proposed issue seem very stretched:

·      Kwality Limited, having 3 million litres per day milk processing capacity, which is not only 50% more than that of Parag, across 6 units in North India, but also has nearly 4 times the sales of the latter, at Rs. 6,000 crore, indicating higher value added products. It is currently ruling at EV/EBITDA and PE multiples of 10x and 18x respectively, based on FY16 estimated earnings.

·    Heritage Foods, with current milk processing capacity of 1.5 million liters per day and retail network of 1,08,000 outlets, is currently ruling at PE multiple of about 25x.

·  Prabhat Dairy, which made its debut a few months ago, has milk processing capacity of 1.5 million liters per day, is currently trading at EV/EBITDA multiple of less than 10 times, based on annualized 9mFY16 earnings.

Outlook: Parag milk foods ltd is the integrated farm company, which has presence in entire value chain. Each of its brands is positioned to get premium pricing. It is growing its business in value added products like ghee, butter, cheese, Paneer, Whey protein, etc. and is having 32% market share in cheese market. Revenue for 9MFY16 is around 12,311.8 Mn and is growing around 21.6% CAGR over 5years. Its EBIDTA for 9MFY16 is around 8.8%, which was 7.8% in FY11. PAT for 9MFY16 stood at around 319.2 Mn and the margin was around 2.6% compared to 0.1% in FY11. We believe with Parag being in production and distribution of cow milk and all other products being vegetarian is positive for a company.

While dairy business may aspire to get valuation of FMCG companies, reality is a lot different. Wafer thin margins coupled with lack of pricing power in producers’ hand due to commoditization of products and extremely competitive landscape, remain some of the key challenges facing the industry.

To conclude, despite healthy growth expected, Parag Milk Food’s IPO is richly valued, especially in relation to peers. All future financial upside seems to have already been priced in, leaving little room for growth.

Hence the dairy business is a could be a great avenue for professional investors like Private equity funds but for the relatively smaller investors with this kind of valuation in place the upside seems relatively limited and the IPO should be avoided.

_Farzan Ghadially