Heritage Foods – Reasonably valued milk supplier


Company NameHeritage Foods Limited (HFL)


Current Share Price – INR 293 (May 10, 2022)


Market Cap – INR 1,360 cr


 

1. What is interesting about the stock?


“Doodh pi lo nahin toh Gabbar Singh le jayega”. Many mothers threatened their kids with this dialogue when we were growing up. After all, milk is the most widely consumed dairy product in India and is considered a vital source of essential nutrients. The market for liquid milk, currently an INR 11 lakh crore market, is expected to grow at a CAGR of 7% over 2021-25. The industry is seen aggressively transitioning from loose milk to a value-added product market and from unorganized to an organized and branded market. These two structural shifts will provide the organized dairy sector with long-term growth visibility.


Heritage Foods Limited (HFL) is one of the largest private-sector dairy enterprises in Southern India. with a processing capacity of 26.7 lakh liter per day and enjoys a significant market share in Andhra Pradesh, Telangana, Karnataka, and Tamil Nadu. HFL also has over 25 products in its portfolio, which are marketed through over a lakh retailers and 858 exclusive franchisee parlors under the brand, Heritage. These products contribute nearly 25% to the revenues of the Company, which have been consistently growing. HFL has established a market position in the dairy business, a strong distribution network, and has experienced promoters.


Revenue break-up in FY21 was:

  • Milk - 67%

  • Value Added Products - 25%

  • Fat - 6%

  • Others – 2%

The promoters own ~39% business in the stake. Bhuvaneswari Nara, wife of Chandrababu Naidu (ex-CM of Andhra Pradesh) has been involved with the business since 1994. Her daughter, Brahmani Nara, also joined the business in 2011. They are supported by a full-fledged professional management team with extensive experience in the business.


In 2016, The company sold its retail division to Future Retail in an all-stock deal. It got 3.65% stake in Future Retail worth ~INR 300 cr at that time. It sold its entire stake in future retail for ~ INR 130 cr in December 2020.


The Company acquired the dairy business of Reliance Retail in 2018. It had a manufacturing capacity of 2.25 lakh liters of milk per day.

Why invest in Heritage Foods?


The key investment arguments summarized would be:

  • Strong presence and distribution in Southern states

  • Wide range of product portfolios beyond liquid milk

  • Experienced promoters with political background (Chandrababu Naidu (ex-AP CM) family), which helps in milk sourcing (0.3 million milk suppliers)

  • Investment into cattle feed and supplements through a subsidiary, Heritage Nutrivet Ltd. Improvement in milk yields and reproductive ability of the livestock help in increased earning ability of the supplier. The business has grown to INR 120 cr with a CAGR of ~16% over the last 5 years

  • 50:50 Joint Venture with French milk products specialist – Argos group, to launch new value-added products for the Indian market

2. Key Historical Financials

The Company has been facing higher procurement costs in the last few months, which has reduced the company's profitability margins. The gross margins have contracted ~6.5% (from ~28.2% to ~21.7% on a year-to-year basis) leading to a contraction in EBITDA margins (from ~9% to ~6%) in the last reported quarter (Q3FY22). Over the last 5 years, as the contribution from value-added products has increased, the gross profit margin has also gone up from ~18% to ~23%. The current inflationary environment would put pressure on the margins, but it is likely to rebound in the next few quarters.


Results in FY20 got impacted due to the sale of Future Retail shares at a discount.


ROE/ROCE is quite healthy at ~30% in FY21. Cash flow convertibility (CFO/EBITDA) is at 67% due to an increase in inventory level and reduction in payables.


3. What is my view on company valuation?


At a price of INR 293 per share, the P/E (TTM) ratio is ~13x, which is reasonable in the current market. The sector P/E ratio is ~65x, but the Company has always been discounted due to it being owned by a politically sensitive family. Even its 52-week high, which was near 2x the current price, reflected a P/E ratio of ~27x. However, the possibility of multiples improving significantly remains, as the Company grows and becomes an attractive target for a pan-India or a foreign player. On an overall basis, the Company looks attractive for the long term and should be evaluated by investors.


4. What are the risks to the investment analysis?


Risks to the analysis are:

  • Procurement of milk requires political support so the business can get disrupted by political whims

  • Dairy Business faces competition from existing brands and it is difficult to establish the brand and capture the market. Company is currently operating predominantly in southern India and spreading to the western and northern India, which is challenging

  • Profitability remains susceptible to volatility in milk prices and the realizations of the players are also impacted by volatility in global skim milk powder prices. Given the intense competition in the business, the company's ability to pass on the increase in prices is limited

 

About the Author


I have over 16 years of experience in private equity and public markets. I am an engineer by background and MBA from a premier institute in India.


Disclosure


I have no stock, option or similar derivative position in any of the companies mentioned since last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.


I am not a SEBI registered advisor. This article is purely for educational purpose and not to be construed as an investment advice. Please consult your financial advisor before acting on it.


I have used publicly available information while writing this article.


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