Hatsun Agro Product Ltd - Stock Valuation and Financial Performance

Sustained performance despite weak sales of value added products.

Click here for 10 year X-ray

Results: Hatsun Agro (HAP) reports 16% growth in sales. While the operating margin was 10%, the operating profit jumped by 41% year on year.

• For milk and milk products segment which comprises of Milk, Ice creams, Curd and Ghee (sold under the brand Arokya milk, Hatsun curd, Arun Ice-creams) the sales grew by 15% and operating profit grew by 56% year on year.
• For others which comprises of Cattle feed and Ready to eat products (Santosa cattle feed, Oyalo Pizza), sales grew by 32% year on year. This business is still into gestation period and hence making losses. However, the operating loss has reduced by 40% year on year.
• The company’s board approved setting up of an ice cream plant in Telangana which is expected to be commissioned by the third quarter of next financial year.

Outlook: During the quarter South India saw unseasonal rains which affected milk supply. Private milk producers passed on this cost to consumers by increasing prices of milk and milk products. HAP’s management said that the company will be expanding in new markets before competing aggressively with established rival brands. Currently dominant in South India, the company targets the state of Maharashtra. The strategy is to start with small towns like Solapur and Latur and then move to larger cities like Pune and Mumbai.

HAP may see healthy long term growth as it expands into newer geographies and products. Although the competition is high from from Amul and regional dairies HAP’s strong TN business, low cost procurement, and introduction of higher margin value added products makes it an attractive opportunity. It trades at high valuations ~41x P/E ratio versus long term consumer stocks P/E ratio of 28x. We look for price where we get enough margin of safety and upside of 15%+ CAGR.

About the Industry: -With population size of 132 crores growing at 3-4% CAGR, rising urbanization, health awareness and disposable income there is tremendous potential for growth for Indian dairy players. Organized dairy industry is expected to witness higher growth as overall organized share in milk products is less than 25-30%. Only ~20% of total Indian milk production is procured, processed and sold through by organized dairies in India. In fresh milk product category there is huge scope for private dairies as organized market share is as low as 5% in Paneer and ~7-8% in curd.

About the Company: -Hatsun Agro Products (Hatsun) is a private dairy headquartered in Chennai. Hatsun is promoted by Mr. R G Chandramogan and is a largest private dairy in South India. The company’s major products include milk, curd, flavoured milk, ghee, butter and ice cream. The company is known for its key brands like Arun Ice Creams, Arokya Milk & Hatsun Curd. The company has done backward integration by entering into animal feed business under the brand equity of Santosa. It has also entered ready-to-eat pizza business under the brand equity of Oyalo. The key areas of operations are South India, Maharashtra and Orissa.

Liquid milk forms around 60% of the overall revenue of the company. The liquid milk is a low margin business compensated by low working capital requirement. Whereas, the value added milk products is a high margin business with a much higher working capital requirement. Milk products segment consist of Ice creams, curd, ghee and retail stores sales. The Others segment consist of cattle feed.

The company has a diverse portfolio of largely fresh milk products such as pouch milk, curd, butter milk, lassi and paneer, in addition to ice-cream. It follows a model of having a higher number of small manufacturing facilities that are largely concentrated in Tamil Nadu. With presence mainly limited to southern India at present, it has plans to establish operations in Maharashtra.

In liquid milk business, milk procurement is the biggest challenge. Hatsun has been successful in creating a strong milk procurement network. It purchases milk directly from farmers and from agents (which is comparatively easy but costly). This procurement in turn also helps to earn superior margin on milk products versus competitors. In past, Nestle, Britannia and Danone have shied away from scaling up milk product business due to lack of procurement strategy. We believe Hatsun has edge to establish sustainable business model in value added products like curds, ghee, etc.

Results: Hatsun Agro reported a year on year increase of 7% in sales and 11.4% jump in operating profit in Q2FY20.

Outlook: Hatsun is incrementally growing high margin value added products in milk products and in newer geographies. It is actively growing its ice-cream through retail stores. Profit margins are improving every year as share of value added products is on rise. Its Gross profits have increased from 24% to current 30%. Investors may observe debt of ~ ?900 Cr. on balance sheet, but we believe that due to sticky business model, it can be serviced comfortably.

Due to large opportunity size of consumption in India, Hatsun Agro has drawn aggressive to expand in new geographies. The company is increasing its high margin value added products. Although we see the growth coming, but we are still cautious due to heavy competition from the bigger players like Amul, Nandini and regional diaries who have upper hand in procurement and high brand recall in those regions.