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Management Speak: Parag Milk Foods (Outperformer) - Strategy in place; execution is key

We interacted with Mr Vimal Agarwal, CFO of Parag Milk Foods (PMF). PMF’s new senior management team is confident of achieving the company’s Vision 2020 (revenue of Rs27-30bn, EBITDA margin of 11-12% and ROCE of 18-20% by FY20E) and is targeting 20% revenue growth in FY19. While product innovation has always been PMF’s forte, we would monitor two key factors that will be required to drive earnings growth and PE multiple expansion. These are a) expansion of PMF’s distribution reach without adversely affecting working capital days, and b) finding pockets of cost reduction to improve margins. Although PMF has its strategy in place, execution is key. On our estimated 23% earnings CAGR over FY18-20E, we believe valuations at 20xFY20E earnings are attractive. We reiterate our Outperformer rating with a target price of Rs391. Any adverse movement in milk prices and inability to maintain quality of products are key risks.

Nutrition and distribution are key focus areas – PMF’s innovation agenda will be in the health and nutrition segment. Here, it intends to primarily focus on whey protein, both in the mid-premium milk protein and in the premium sports protein segments through its brands, Avvatar and Go Protein Power. On the distribution front, greater focus will be to increase reach (adding 7,000-8,000 outlets per month) in current geographies and expand presence in North and East India (currently 35% of sales). These initiatives will drive PMF’s 20% revenue growth ambition for FY19.

Mix improvement and focus on cost efficiency to drive margins – Management reiterated its EBITDA margin guidance (including other income) from ~10.5% currently to 11-12% by FY20E, supported by improved mix and cost efficiencies. The company intends to drive mix improvement through growth in value-added products and scaling up presence in the nutrition segment. On the cost efficiency front, PMF is focusing on 3 components - ensuring efficacy of trade promotions, curtailing inflation in non-milk cost of goods sold (COGS) through value engineering and operating efficiencies across the value chain. We have however, factored in flat margins in our FY18-20E estimates.

Reduction in working capital and lower capex to aid return profile – Management highlighted that it targets to reduce working capital from ~19.5% of sales currently to ~17-17.5% of sales in FY19. While cheese will remain a focus segment, management expects to improve working capital by reducing losses on expiry/aging products, better inventory management post recalibration of network and through SAP implementation. Further, PMF does not require any major capacity expansion over next 2-3 years. We expect overall return profile to improve, as capex requirement will largely pertain to maintenance capex (2.5% of sales).