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Parag Milk Foods' Q2FY20 results (Outperformer) - Weak H1, strategy execution will be a key monitorable

Q2FY20 result highlights

• Net sales increased by 11.6% yoy to Rs6.4bn (est: Rs6.5bn), EBITDA decreased by 5% yoy to Rs555m (est: Rs664m), PAT decreased by 6% yoy to Rs285m (estRs353m).
• Overall volume growth for the quarter was ~2% yoy.
• Milk products grew by ~11% yoy, while SMP sales grew by ~4% yoy & Liquid milk grew by 15% yoy.
• Gross margins declined by 510bps yoy to 25.7% impacted due to due to higher milk prices and disruptions in milk availability caused by prolonged monsoons.
• Staff cost increased by 11.5% yoy and other expenses decreased by 13% yoy. Resultant EBITDA margins declined by 140bps yoy to 8.7%.
• Depreciation expense was down 3% yoy, interest cost was up 13% yoy & other income increased by 2x yoy. Tax rate was up 170bp yoy, resulting in PAT decline of 6% yoy

Key positives: Control over other overhead costs

Key negatives: Decline in gross margins considering higher input costs

Impact on financials: Factoring lower gross margins we have cut our FY20/21E EPS by 15-16%

Valuations & view

Parag Milk Foods reported weak results, with high input costs and lack of milk availability continuing to impact gross margins and overall profitability. Further, given the muted 1H performance, company is now targeting to achieve lower end of its revenue guidance and has reduced its margin guidance to 9-9.5% for FY20. However, with moderation in milk prices & improvement in supply company expects revenue & margin performance to improve from current levels. Further, the new CEO has clearly articulated the strategy for near to medium term in terms of consolidating the operations, improving execution and overall quality of growth, which we believe are the steps in right direction. Promoter’s intent to reduce pledge/debt is also a positive. Valuations at 10x/7x FY20/21E remain undemanding. Maintain Outperformer rating with revised target price of Rs193.