Parag Milk Foods: "GO"ing for greener pastures

Parag Milk Foods

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Parag Consumer

Initiating Coverage | Sector:Milk Foods

CMP: INR330

TP: INR340 (+3%)

Neutral

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"GO"ing for greener pastures

A unique multi-year consumption play

Parag Milk Foods is a leading manufacturer and marketer of branded dairy foods and

beverages in India. It started off with collection and distribution of milk in 1992; over

the years, it has developed a portfolio of dairy products under its four flagship brands

Gowardhan, Go, Topp Up & Pride of Cows.

Key factors that underpin our long term bullishness on Parag’s prospects are:



Attractive dairy industry dynamics and shift from unorganized to organized

segment.



Parag’s focus on driving value added dairy products (VADP) contribution.



Long standing reputation as a category innovator especially in Value Added

Products.



Parag’s unique positioning as a national branded dairy player focused on value

added B2C segment in an industry populated by either regional players or players

focused on B2B segment.



Outstanding procurement strength constitutes a key competitive advantage.



Distribution expansion led medium term opportunity.



We are initiating coverage on Parag Milk Foods (Parag) with a Neutral rating. The

stock has appreciated by 53% since its IPO two months ago, capping the near term

upside at 3%. Nevertheless, from a medium term perspective, Parag offers a

compelling three year play with potential 22% CAGR returns. Key to this

our assumption of 32% CAGR EPS improvement over the next 5 years

and improvement in ROCE by 370 bps over this period.

Stock Info

Bloomberg

Equity Shares (m)

12-Week Range (INR)

1, 6, 12 Rel. Per (%)

M.Cap. (INR b)

M.Cap. (USD b)

Avg Val, INRm

Free float (%)

PARAG IN

84.1

334/202

28/-/-

27.9

0.4

345.0

52.5

Financial Snapshot (INR b)

Y/E Mar

2016 2017E 2018E

Sales

16.5 19.2 23.1

EBITDA

1.5

1.8

2.2

Adj. PAT

0.5

0.8

1.1

Adj. EPS (INR)

6.7

9.5 12.6

EPS Gr. (%)

-66.7 41.1 32.5

BV/Sh.(INR)

51.4 89.6 102.1

RoE (%)

19.5 14.3 13.1

RoCE (%)

12.4 11.3 11.5

Valuation

P/E (x)

49.0 34.8 26.2

P/BV (x)

6.4

3.7

3.2

EV/EBITDA (x)

159.7 155.5 126.1

Shareholding pattern (%)

As On

Promoter

Public

Others

Huge Size of Prize

India’s dairy market at 146m tons and sales of INR4,061b (USD61b) has been

growing at a CAGR of 15% in the last 5 years and is expected to grow to

INR9,300b (USD140b) by 2020. The industry is not just growing rapidly in size

but also improving from a profitability perspective due to significant increase in

the proportion of value added dairy products, owing to a combination of factors

like low base, favorable demographics, rise in aspiration & income levels and

change in consumption habits.

Shift from unorganized to organized segment provides growth visibility

Of the 146m tons of milk produced in India, around half is consumed at source.

Of the marketable portion of milk, only 30% is procured by organized players.

The organized segment is growing at 20% CAGR, faster than the 14% CAGR

growth of the unorganized segment and is expected to maintain this pace of

growth thereby increasing in salience. Within the organized component, half of

the milk is procured by cooperatives and the rest by private players. Private

players are particularly strong (a) in states like Maharashtra, where the

cooperatives are weaker and do not operate under a single umbrella which

means that milk procurement prices are much lower than other states; (b) in

value added products like cheese, where investment in capacities and branding

require substantial investments and expertise, which is beyond the reach of

cooperatives and (c) due to savvy marketing ability and technology investment

in cold chain which aids shift towards organized and branded products.

May-15

47.5

52.5

0.3

11 July 2016

Parag Milk Foods

Stock Performance (1-year)

Parag has a Right to Win

Parag Milk Foods’ focus on Value Added Dairy Products (VADP’s) sets it apart even

among the private players. The share of value added products (Milk products + SMP)

has been improving and now forms 79% of the portfolio compared to 39% in FY12.

Parag is particularly strong in Cheese (20% of revenues as on FY16) with the largest

facility in India (40 MT per day) and with a market share of 32%, the second largest

player after the cooperative Amul (~40% market share). Parag is the largest cow

ghee brand in India and is also known as the category creator. Going forward,

company aims to focus on UHT, whey protein (highest gross margin among VADP)

and milk based beverages along with cheese and ghee to drive topline growth as

well as profitability. In contrast, Parag’s competitors have product profile heavily

skewed in favor of commodity/B2B segments.

Parag enjoys several competitive advantages

Over the years it has developed strong relationships with the farmers in proximity to

its facilities which aid in procurement of raw milk at competitive prices. The supply

chain network includes cow milk procurement from 29 districts across Maharashtra,

Andhra Pradesh, Karnataka, and Tamil Nadu. The company procures around 1m

litres per day currently with the help of 4,300 village level collection centres,

reaching 2,30,000+ farmers across its catchment areas and 114 chilling centres and

bulk coolers across both its plants. The distribution strength of Parag has improved

over the years and now has an established pan-India distribution network of 15

depots, 104 super stockists and over 3,000+ distributors which services its products

to around 2,00,000+ retail outlets. Going forward, we expect Parag to build on this

distribution network and expand its presence across country. It is targeting to

increase direct distribution reach by ~15% per annum for next 3-5 years. Brand

Parag (Go, Gowardhan) already enjoys good awareness and equity in South and

West. Management is targeting to shift the profile of brand spends towards above

the line activities. This, coupled with expanding product portfolio augurs well from

top-line growth perspective.

Solid earnings growth visibility both in near and medium term

We expect Parag to report robust EPS CAGR of 36%/32% respectively over the next

3 years/5 years. Large capacity investments in value added products ahead of peers,

further expansion of distribution reach and focus on brand building will help Parag

take advantage of the massive opportunity in the branded value added dairy

products segment leading to a revenue growth of 19% CAGR over the next 3/5 years

(broadly in line with the topline growth clocked over last five years). Driven by

product mix improvement, we expect operating margins to expand by 110/200 bps

respectively over the next 3/5 years leading to EBITDA CAGR of 24% from a three

year and five year perspective. Reduction in debt/ equity from 1x in FY16 means

that EPS CAGR is likely to be higher (INR 1b of IPO funds to be utilized for debt

repayment). ROCE is also likely to increase gradually from 12.4% in FY16 to 16.1% in

FY21.

Initiate with NEUTRAL; stock up 53% since listing in two months

Opportunity size in Dairy is huge and in-turn offers strong growth visibility for

branded players. Parag, with its strengths on procurement, distribution, innovation

11 July 2016

Parag Milk Foods

and management bandwidth is best placed among peers, in our view. While rest of

the listed Dairy players are either regional in nature or have dominant B2B

positioning, Parag offers a pan-national branded dairy play with B2C focus. The stock

had a good run-up and is up 53% in less than two months post listing in May’16. At

CMP of INR330, the stock trades at 24x June 2018 EPS. We value Parag at 25x

June’18 EPS and arrive at a one year TP of INR 340, 3% upside. At 25x FY18, it will

trade at 20% discount to consumer universe (30% discount to ex-ITC consumer

universe). In our view, it is a fair multiple and balances the strong growth visibility of

Parag and its demonstrated innovator credentials with relatively lower RoE/RoCE’s

and size vs. other consumer peers. Thus, given the limited near term upside, we

initiate coverage with a Neutral rating. Key risks include: a) volatility in raw material

prices b) potential price competition with co-operative giants and c) execution risks

pertaining to portfolio and reach expansion.

Compelling three year consumption play

Notwithstanding the near term limited upside given the recent run-up, it still offers

a very compelling three year play with an exciting 36%/32% EPS CAGR over 3/5

years. Our detailed workings suggest that over a three year period over FY18-21,

the stock can deliver a healthy return of 22% CAGR in our view, even after assuming

a modest de-rating from 25x P/E to 22x.

11 July 2016

Parag Milk Foods

Indian dairy industry offers immense opportunities

Shift to organized sector and penetration of milk products set to drive

growth

Industry dynamics

India produces 146m tons of milk (as of FY15), around half of which is consumed at

source. Of the remaining marketable component, ~30% is procured by organized

players. Even within the organized portion of the dairy industry, around half of the

procurement is by cooperatives.

Gradual shift toward organized players

The INR4,061b Indian dairy market exhibited a CAGR of 15% from CY10-CY14, and is

expected to grow at a similar rate to INR 9,300b by 2020. The organized component

of the industry has grown at a faster CAGR of 20% (v/s 14% for the unorganized

segment), which is expected to continue as a result of continued shift in consumer

preference from loose milk to pasteurized packaged milk and value-added products.

The gradual shift from unorganized to organized sector provides ample room for

cooperatives and private players to grow. However, the opportunity is particularly

strong for private players (a) in states like Maharashtra, where the cooperatives are

weaker and do not operate under a single umbrella which means that milk

procurement prices are much lower than other states; (b) in value added products

like cheese, where investment in capacities and branding require substantial

investments and expertise, which is beyond the reach of cooperatives and (c) due

to savvy marketing ability and technology investment in cold chain which aids shift

towards organized and branded products.

Exhibit 1: In India, around half of milk produced is

consumed at source…

Exhibit 2: …with only 30% of marketable milk being

processed by organized players

Self

consumption

46%

Organized

30%

Marketable

milk

54%

Unorganized

70%

Source: NDDB, Company, MOSL

11 July 2016

Parag Milk Foods

Exhibit 4: Fresh milk and traditional dairy products still form

largest part of the dairy market

Exhibit 3: Private players form ~55% of organized segment

Cooperatives

& Govt.

45%

Private

Players

55%

Traditional

Dairy

Products

47%

Western

Dairy

Products

Fresh Milk

48%

Source: NDDB, Company, MOSL

Source: NDDB Company, MOSL

Rising middle class/urban population, increase in working population and

changing dietary pattern should drive consumption of milk & milk products

Consumption of milk as well as traditional milk products like dahi (curd) and lassi in

loose form has been part of Indian dietary habits since many years. However, over

the past few years, there have been increasing concerns about the quality of loose

milk sold by unorganized players. This has helped propel the share of organized

players in the Indian dairy industry.

Consumption of packaged liquid milk has increased from 21% of total liquid milk to

28% over the past five years, according to industry sources. The consumption trend

has also changed over the years, with people shifting from home-made dahi to

branded dahi due to convenience in buying and higher assurance of quality. People

have also started including various milk & milk products in their daily dietary plans

given the health benefits. Milk provides a useful source of protein to a large portion

of the consumer base who are vegetarians.

The shelf life of various dairy products has also increased over years due to the

development of processing/packaging technology, and an improvement in cold

storage infrastructure at the logistics as well as retail level led by organized players.

Growth in the middle class (expected to reach 586m by 2020) and an increase in the

percentage of urban population (expected to be 34.5% by 2021) are expected to

drive strong growth for milk and milk products.

11 July 2016

Parag Milk Foods

Exhibit 5: Huge demographic demand in terms of growing

share of working age group…

>69 years

% of population

15-69 years

<15 years

Exhibit 6: …rise in share of middle and affluent class

<$1,800

$1,800-$4,000

$4,000-$20,000

1995

2005

2015E

2025E

>$20,000

1990

1995

2000

2005

2010

2015E

Source: Company, MOSL

Exhibit 7: …expected increase in share of urban population

Proportion of urban population (%)

34.5

Exhibit 8: …along with shift in dietary patterns toward dairy

products

Dairy products

Milk / Milk Products

Fruits / Vegetables

Meat & Fish

Edible Oils

Pulses

Rice

Wheat

2000

64.1

48.4

4.7

5.3

10.6

78.3

54.2

13.1

2010

106.4

75.2

7.2

7.7

14.6

98.0

72.1

14.1

2020

165.8

113.2

10.8

10.9

19.5

118.9

92.4

15.6

% gr.

(2000-

2020)

159.0

134.0

131.0

107.0

85.0

52.0

70.0

19.0

31.2

2011

2021E

Source: Company, MOSL

Other Cereals

Source: India Vision 2020, Planning Commission of India, Company,

MOSL

11 July 2016

Parag Milk Foods

VADPs – a key differentiator

Focus on whey protein, UHT and milk-based beverages, along with ghee

and cheese

Parag Milk Foods Limited is one of the leading manufacturers and marketers of milk-

based branded foods in India targeting various consumer groups. The company is

known for deriving all of its products from cow’s milk. It manufactures a diverse

range of products, including fresh milk, ghee (clarified butter), cheese, whey protein,

paneer, curd, yoghurt, milk powders and dairy milk-based beverages under the

umbrella of four flagship brands: “Gowardhan”, “Go”, “Topp Up” and “Pride of

Cows”.

At the premium end, it targets traditional consumption at home with its flagship

brands “Gowardhan” (Ghee, Milk, Paneer, Dahi, Curd , Butter, Dairy Whitener and

Gulab Jamun Mix) and “Topp Up” (flavoured milk), and also has brands “Go”

(Cheese) and ”Pride of Cows” (Premium fresh milk) targeting the urban affluent,

youth and kids.

In the mass market segment, the company offers traditional products such as fresh

pouch milk, curd, etc which are largely used for in-kitchen/household consumption,

restaurants, eateries, etc., and also with western bulk consumption products such as

SMP, block cheese and butter, which are targeted at institutional and smaller

restaurant chains, etc.

Exhibit 9: Formidable food brands portfolio with traditional as well as western products

Source: Company, MOSL

Within the entire dairy industry, there is significant potential in value-added dairy

products (VADPs) as just 12-14% of total milk produced at the pan-India level gets

converted into VADPs. Major part of revenues for Parag comes from milk products

with a contribution of 67% as of FY16, followed by fresh milk (18%), SMP (12%) and

other revenues (2%). The share of value-added products (milk products+SMP) has

been improving (up to 79% of the portfolio, from 39% in FY12). Going forward, the

company aims to focus on UHT, whey protein and milk-based beverages, along with

cheese and ghee, to drive its top-line growth and profitability.

11 July 2016

Parag Milk Foods

Exhibit 10: Revenue mix to improve further towards value added products

Milk Products

Fresh milk

Skimmed milk powder

Other revenues

FY15

FY16

Source: Company, MOSL

Cheese – Large opportunity; Growth to sustain



Parag is particularly strong in cheese (20% of revenues as on FY16) with the

largest facility in India (40MT per day) and a market share of 32% (second

largest player after the cooperative Amul that has ~40% market share). The

cheese market hardly has any unorganized player, and is currently an INR12b

market, growing at a CAGR of 24-25%.

Parag’s cheese plant at Manchar is the only UHT facility for cheese in India, with

a separate line for Mozzarella cheese. The plant has the capabilities to produce

cheese in 75 stock-keeping units under a wide range, including cheddar,

mozzarella, processed and gourmet cheese. The plant runs at 80-85% capacity

utilization for cheese. Thus, in the current fiscal year, it will be expanding the

cheese facility to 60MT per day with the help of IPO proceeds to cater to

expanding retail and institutional demand. Retail forms about 50% of the overall

cheese market and for Parag as well. A significant portion of institutional sales of

cheese for Parag comes from hotels, restaurant and caterers (HoReCa), while

the rest comes from QSR (Quick Service Restaurant) players like Domino’s and

Pizza Hut. The company has also roped in Chef Ranveer Brar for brand

communication related to cheese to gain further traction in the growing market.

The cheese market in India is expected to grow at a 25-30% CAGR, driven by

growth in the consumption of western dishes, increasing use of cheese in

traditional dishes as well as premiumization. Thus, we expect Parag’s cheese

revenue to grow at a 19% CAGR over FY16-FY19 to INR6b and 19% CAGR over

FY16-21 to INR8.4b.

Exhibit 11: Parag’s cheese revenue to grow at a 19% CAGR over FY16-FY19

Indexed Parag's cheese growth (FY14 - base year)

Volume growth (%)

Value growth (%)

316

190

194

225

224

267

257

100

130

147

169

FY14

FY15

FY16

FY17E

FY18E

FY19E

Source: Company, MOSL

11 July 2016

Parag Milk Foods

Exhibit 12: Parag’s extensive, innovative and growing cheese portfolio

Source: Company, MOSL

Whey protein – Niche, High growth and Superior gross margins

Whey is a component of milk protein that is obtained during the manufacturing of

cheese. If 1kg of cheese is produced, then approximately 500g of raw whey as a

byproduct is obtained, which needs to be processed and refined further to be sold

as a branded product.

Parag is setting up a value-added whey processing facility (funded by IPO proceeds)

in FY17 to cater to retail consumers with branded health supplements and

beverages. At present, it sells whey only through B2B channel and is the leading

supplier in India of whey protein powder to Nestle.

Whey protein contributes only 3.5% of total business (as of FY16). The product will

act as a gross margin driver going forward as it commands the highest gross margin

in value-added products. We note that gross margin for value-added products

ranges from 25-40%.

Whey is currently an INR3b market, growing at a CAGR of 26%. Whey business for

Parag is expected to occupy much larger share in the overall pie going forward. We

expect Parag’s whey protein revenue to grow at a 45% CAGR over FY16-FY19 to

INR1.6b and 37% CAGR over FY16-21 to INR2.5b.

UHT (ultra heat treated) milk – High growth area

UHT

is a form of milk that is treated at temperature of at least 135 degree celsius to

kill the harmful bacteria. UHT milk is an INR26b market, growing exponentially off a

small base. Amul is the largest player in UHT milk segment in India, while Parag is

the largest private player. UHT milk market is expected to grow at a CAGR of 26% to

INR104b by 2020. We expect Parag’s whey protein revenue to grow at a 42% CAGR

over FY16-FY19 to INR1.9b and 36% CAGR over FY16-21 to INR3b.

Milk-based beverages (classified under UHT segment) – Exciting

opportunity

Milk based beverages is also one of the niche categories which the company has

identified for driving medium-term growth. At present, the company only sells

flavored milk under the brand “Topp Up”, while it is looking to launch additional

11 July 2016

Parag Milk Foods

milk-based beverages to benefit from consumers who are slowly moving from

carbonated soft drinks to healthier beverages.

Ghee – Growth driven by shift from unorganized to organized

Ghee

(clarified butter) is the largest consumed dairy product in India after liquid

milk and curd. It is a key ingredient in Indian recipes. As of 2014, the ghee market

stood at INR618b, growing at a CAGR of 17%, and is currently largely occupied by

unorganized players. Amul is the largest player in the organized ghee market. Retail

accounts for 55% of the total organized market. Parag is the largest cow ghee brand

in India and is also known as the category creator. The market for ghee is expected

to grow at a CAGR of 14% to INR1,367b by 2020. We expect Parag’s ghee revenue to

grow at a 14% CAGR over FY16-FY19 to INR4.8b and 13% CAGR over FY16-21 to

INR5.9b.

11 July 2016

Parag Milk Foods

Integrated Business Model

Strong procurement base + innovative product portfolio + expanding

distribution network

Strong procurement base

Parag Milk Foods has developed a robust integrated business model, which

encompasses the entire value chain of the dairy-based foods and beverage business.

Over the years, it has developed strong relationships with farmers in proximity to its

facilities, which aids in procurement of raw milk at competitive prices. The supply

chain network includes cow milk procurement from 29 districts across Maharashtra,

Andhra Pradesh, Karnataka and Tamil Nadu. The company procures around 1m liters

per day currently with the help of 4,300 village-level collection centers, reaching

2,30,000+ farmers across its catchment areas and 114 chilling centers and bulk

coolers across both its Manchar and Palamaner processing plants.

Exhibit 13: Parag’s procurement areas are among the top milk producing states

State

Uttar Pradesh

Rajasthan

Andhra Pradesh

Gujarat

Madhya Pradesh

Punjab

Maharashtra

Haryana

Bihar

Tamil Nadu

Karnataka

Milk production (m MT's)

25.2

16.9

13.9

11.7

10.8

10.4

9.5

7.9

7.8

7.1

6.1

Milk production 10yr CAGR

Source: Company, MOSL

The company has aggregate milk processing capacity of 2m liters per day, with

manufacturing facilities strategically located in high dairy cow population areas of

Manchar, Maharashtra (with milk processing capacity of 1.2m liters per day) and

Palamaner, Andhra Pradesh (0.8 million liters per day).

11 July 2016

Parag Milk Foods

Exhibit 14: Production capacity at Parag’s facilities

Product (units)

Milk processing capacity (liters per day)

Milk powders (includes drying capacity for whey

powders and dairy whiteners) (metric tons per day)

Liquid milk in pouches (liters per day)

Flavored milk (packs per day)

UHT Products* (liters per day)

Cheese/Paneer (metric tons per day)

Ghee (metric tons per day)

Butter (metric tons per day)

Curd (includes pouch curd, cup curd, fruit yoghurt

and shrikhand) (metric tons per day)

Whey Processing (liters per day)

*Includes lassi and buttermilk



Production/Processing Capacity

Manchar

Palamaner

Total

1,200,000

800,000

2,000,000

200,000

30,000

400,000

175,000

165,000

110

375,000

30,000

165,000

400,000

Source: Company, MOSL



In 2005, Parag set up Bhagyalaxmi Dairy Farms at Manchar to educate farmers

about best practices of breeding, feeding, animal management and improving

productivity.

The farm houses over 2,000 Holstein breed cows, as well as a fully automated

rotary milking parlor to milk cows without human intervention and ensure that

milk is not exposed to any impurities in the environment. The farm has average

milk yield of 25 liters/day compared to the Indian average of 4-5 liters. The

premium fresh milk produced by the farm is sold to around 13,000 customers in

Mumbai and Pune under the “Pride of Cows” brand.

Exhibit 15: State-of-the-art processing facilities

Source: Company, MOSL



The company is looking to raise its daily milk procurement via increasing the

procurement base by setting up new collection centers, strengthening existing

farmer relations, and installing 75 new bulk coolers and 100 automated

collection systems.

11 July 2016

Parag Milk Foods

Innovative product portfolio

With evolving customer trends and performances, research & development (R&D) is

critical to maintain a company’s competitive edge in the industry. Parag has built a

dedicated team of eight people based out of Manchar to support its new product

and process development initiatives, and has roped in Mr. B.M. Vyas (former

managing director of the GCMMF) as advisor and director on the board.

Over the past few years, Parag has introduced many products to expand its

consumer product offerings—with either changes in product composition, different

packaging material or process development work—thus minimizing losses and

reducing cycle time. All these efforts have helped the company earn a reputation in

the dairy industry as a category innovator.

Exhibit 16: Slew of innovative launches over the last three years

Period

Jan-13

Apr-13

May-13

Jun-13

Jul-13

Oct-13

Feb-14

Apr-14

Jul-14

Oct-14

Nov-14

Dec-14

Feb-15

Mar-15

Apr-15

Oct-15

Nov-15

Product Launched

Emmental cheese

Consumer packs of mozzarella cheese

Yogurt in three new flavors of saffron, pink guava and vanilla

Topp-up in four flavors

Cheese spread in six flavors

Parmesan cheese

Cheezlets

Vital milk in all markets

New flavors in Topp-up of pistachio and butterscotch

Cheese sandwich slices

Cheese toppings for pizzas

Spiced buttermilk in UHT

Fresh cream in UHT

Spiced buttermilk in Fino pack

Whey proteins

Sachet packs of ghee

Buttermilk in southern spices variant

Go Badam Milk

Go Almette Creamed Cottage Cheese in two flavors

Go Chutney cheese slices

Source: Company, MOSL

The company will be setting up an R&D facility funded through IPO proceeds to

enhance its capabilities in the industry. It will be focusing on health & nutrition in

developing premium products. The launch of new products is likely to be margin-

accretive as Parag aims to introduce products whose gross margins are higher than

the company’s prevalent gross margin. Advertisement spends, as a percentage sales,

are expected to increase with 3-4 new launches planned every year, but will be

adjusted by a reduction in below-the-line spends.

11 July 2016

Parag Milk Foods

Expanding distribution network

The distribution strength of Parag has improved over the years; it now has an

established pan-India distribution network of 15 depots, 104 super stockists and

over 3,000+ distributors which service its products to around 2,00,000+ retail

outlets. Parag has a marketing team of 560 people based in their key distribution

centers.

Exhibit 17: Distribution as on 2005

Exhibit 18: Distribution as on 29 Feb 2016

Source: Company, MOSL

Exhibit 19: Region-wise distribution network in India

Region

Mumbai

North

East

West

South

Total

Depots

Super Stockists

104

Distributors

250

450

300

800

1,200

3,000

Source: Company, MOSL

For Parag, the key markets include the state of Maharashtra, Gujarat, Delhi NCR,

Tamil Nadu, Karnataka, Assam, West Bengal and J&K. The company also exports

(only 2% of total revenues) its products to 36 countries across the world, majorly in

South-East Asia, the Middle East and Africa.

Parag has a seven route-to-markets strategy, addressing different product groups

and consumer segments.

11 July 2016

Parag Milk Foods

Exhibit 20: Pan-India distribution infrastructure targeted at different product/consumer

segments

Seven route-to-market

Channel type

Fresh milk

Fresh products

Milk products- General trade

Milk products- Modern trade

Milk products- Large Institutions & HoReCa

Beverages

Rural

Source: Company, MOSL

“Pride of Cows”, which is premium milk sold through Bhagyalaxmi dairy farms, has a

separate distribution network of around 8 depots in Mumbai and 4 depots in Pune

which cater to around 13,000 customers.

Exhibit 21: Pride of Cows - distribution

City

Mumbai

Pune

Total

Depots

Delivery Routes

134

184

No. of Customers

10,058

2,897

12,955

Source: Company, MOSL

The company will try to expand its product reach by strengthening its distributor

and stockist base to achieve higher retail penetration. It is aiming to add 6 more

depots in FY17. It also intends to increase its rural penetration by introducing low

unit packs (LUPs) in tier III cities to drive incremental growth. Besides, it is

identifying specific states and regions in India to focus on its sales efforts.

11 July 2016

Parag Milk Foods

Financials: Healthy track record

Better-than-peer margins and returns – likely to improve further

Expect robust revenue CAGR of 19% over FY16-19:

We expect Parag to post 19%

revenue CAGR over FY16-19, driven by:

a) a shift from unorganized to organized segment, underpinned by rising middle

class and urban population, an increase in working population as well as changing

dietary pattern,

b) increasing distribution reach, and

c) launching of innovative products.

EBITDA margin likely to improve to 10.1% by FY19:

Parag’s gross margin has been

improving for the last three years, led by a) an increase in the mix of high gross

margin milk products, b) favorable milk prices, c) introduction of innovative

products, and d) scale benefits. Going forward, gross margins might see a steady

improvement due to a better mix as well as the introduction of high gross margin

products (e.g. whey protein, which has the highest gross margin among VADPs).

Operating margins have stayed in the 7.5-9% range. Apart from increase in gross

margins, we believe that lower other expenses led by operating efficiencies should

lead to operating margin expansion of 110bp over FY16-19.

Exhibit 22: Net Sales to grow at a CAGR of 19% over FY16-19

Total revenue (INR b)

36.7

32.7

17.7

2.8

9.3

FY13

20.0

19.4

Revenue growth (%)

Exhibit 23: Gross margin to expand 120bps over FY16-19

Gross profit (INR b)

25.3

26.5

28.4

Gross margin (%)

28.7

29.0

29.6

22.1

13.9

17.0

23.2

9.0

FY12

10.9

FY14

14.4

FY15

16.5

19.2

23.1

27.6

2.0

FY12

2.3

FY13

2.5

FY14

3.8

FY15

4.7

FY16

5.5

6.7

8.2

FY16 FY17E FY18E FY19E

Source: Company, MOSL

FY17E FY18E FY19E

Source: Company, MOSL

Exhibit 24: EBITDA to see 24% CAGR over FY16-19..

64.1

EBITDA (INR b)

37.7

22.1

23.5

25.1

EBITDA growth (%)

Exhibit 25: ..led by EBITDA margin expansion of 110bps

EBITDA margin (%)

9.1

9.0

7.6

7.4

9.0

9.4

9.6

10.1

30.2

1.4

0.8

FY12

0.8

FY13

-1.2

0.8

FY14

1.1

FY15

1.5

FY16

1.8

2.2

2.8

FY12

FY13

FY14

FY15

FY16

FY17E FY18E FY19E

Source: Company, MOSL

FY17E FY18E FY19E

Source: Company, MOSL

11 July 2016

Parag Milk Foods

Exhibit 26: PAT to grow at 44% CAGR over FY16-19..

PAT (INR b)

101.5

69.2

46.7

9.8

0.2

FY12

0.2

FY13

-22.9

0.2

FY14

0.3

FY15

0.5

FY16

0.8

1.1

1.4

32.5

33.2

PAT growth (%)

Exhibit 27: ..with PAT margin to reach 5.1% by FY19

PAT margin (%)

4.2

2.9

2.1

2.2

1.5

2.2

4.6

5.1

FY17E FY18E FY19E

Source: Company, MOSL

FY12

FY13

FY14

FY15

FY16

FY17E FY18E FY19E

Source: Company, MOSL

Exhibit 28: RoCE to show gradual improvement

RoCE

25.2

Exhibit 29: Fixed asset turnover to improve from 3.1x to 3.7x

over FY16-19

Fixed asset turnover (x)

3.0

3.3

3.1

3.0

3.2

3.7

2.8

13.1

12.1

12.4

11.3

11.5

13.3

2.8

FY12

FY13

FY14

FY15

FY16 FY17E FY18E FY19E

Source: Company, MOSL

FY12

FY13

FY14

FY15

FY16 FY17E FY18E FY19E

Source: Company, MOSL

11 July 2016

Parag Milk Foods

Valuation & View

Initiate with NEUTRAL; stock up 53% since listing in two months



Opportunity size in Dairy is huge and in-turn offers strong growth visibility for

branded players. Parag, with its strengths on procurement, distribution,

innovation and management bandwidth is best placed among peers, in our

view.

While rest of the listed Dairy players are either regional in nature or have

dominant B2B positioning, Parag offers a pan-national branded dairy play with

B2C focus. The stock had a good run-up and is up 53% in less than two months

post listing in May’16. At CMP of INR330, the stock trades at 24x June 2018 EPS.

We value Parag at 25x June’18 EPS and arrive at a one year TP of INR 340, 3%

upside. At 25x FY18, it will trade at 20% discount to consumer universe (30%

discount to ex-ITC consumer universe). In our view, it is a fair multiple and

balances the strong growth visibility of Parag and its demonstrated innovator

credentials with relatively lower RoE/RoCE’s and size vs. other consumer peers.

Thus, given the limited near term upside, we initiate coverage with a Neutral

rating. Key risks include: a) volatility in raw material prices b) potential price

competition with co-operative giants and c) execution risks pertaining to

portfolio and reach expansion.

Compelling three year consumption play

Notwithstanding the near term limited upside given the recent run-up, it still offers

a very compelling three year play with an exciting 36%/32% EPS CAGR over 3/5

years. Our detailed workings suggest that over a three year period over FY18-21,

the stock can deliver a healthy return of 22% CAGR in our view, even after assuming

a modest de-rating from 25x P/E to 22x.

Exhibit 30: Returns attractive for 3 year investment perspective

EPS (INR)

Target PE (x)

Target price (INR)

Current market price

Potential return (annual, %)

June’18

13.6

340

330

FY21

27.3

601

330

Source: Company, MOSL

Analyzing the three year potential returns

The opportunity in the sector is immense and we believe Parag’s metrics will only

improve over the longer term as a result of strengths over peers. Parag’s earnings

momentum is not just between FY16-19 but will sustain beyond FY19. RoCE is

expected to swing upwards by 370bps to 16% over FY16-21 compared to 90bps over

FY16-19.

11 July 2016

Parag Milk Foods

Exhibit 31: Exciting 32% EPS CAGR over 5 years over FY16-21

INR m

Total Revenues

% Growth

Gross Profit

Gross margin (%)

EBITDA

EBITDA margin (%)

PAT after MI

EPS

EPS growth (%)

FY16

16,451

13.9%

4,676

28.4%

1,476

9.0%

473

6.7

-67%

FY17E

19,249

17.0%

5,517

28.7%

1,802

9.4%

801

9.5

41%

FY18E

23,094

20.0%

6,705

29.0%

2,225

9.6%

1,061

12.6

32%

FY19E

27,570

19.4%

8,160

29.6%

2,784

10.1%

1,413

16.7

33%

FY20E

32,703

18.6%

9,861

30.2%

3,451

10.6%

1,819

FY21E

38,642

18.2%

11,874

30.7%

4,262

11.0%

2,308

21.6

27.3

29%

27%

Source: Company, MOSL

11 July 2016

Parag Milk Foods

Key Risks

Seasonality Risk

Parag’s manufacturing operations are largely dependent on the supply of cow milk,

which is the primary raw material for all the dairy products. Given the seasonal

nature of the dairy industry, cattle farming patterns and no formal agreements with

the farmers, availability of raw milk keeps on fluctuating which thereby could

adversely impact the running of its operations.

New Product Risk

Over the years Parag has been able to anticipate and respond to changing consumer

preferences which helped in building strong consumer franchisee for its brands.

However continuous investment in research and development along with

introduction of new products and different variants of existing products, based on

consumer preferences and demand, is the key for smooth running of the business.

Brand Equity Risk

The products manufactured by Parag are subject to risks such as contamination,

adulteration and product tampering during their manufacture, transport or storage.

Any real or perceived contamination in products, could subject it to regulatory

action, damage its brand equity and thereby impact its business.

Execution Risk

Risks related to execution of its expansion plans.

11 July 2016

Parag Milk Foods

About: Parag Milk Foods

Parag Milk Foods is a leading manufacturer and marketer of dairy based branded

foods and beverages in India. It commenced business in 1992 with collection and

distribution of milk, and over the years it has developed a product portfolio of

branded dairy products with high brand equity. Parag is promoted by Mr Devendra

Shah, Mr Pritam Shah and Mr Parag Shah, who have over 20 years of dairy industry

experience and have well established relationships with various stakeholders

namely farmers, distributors and institutional customers.

Key events at Parag Milk Foods since inception



Launch of “Parag” Logo



Launch of “Go Almette”‖

cream cheese



Launch of “Go Fresh”‖

cream



“Go Cheese”‖ was

awarded as India‘s most

promising brand in the

FMCG category by World

Consulting & Research

Corporation

Source: Company, MOSL

11 July 2016

Parag Milk Foods

Exhibit 32: Profile of Board of Directors

Name

Devendra Shah

Pritam Shah

B.M. Vyas

Role

Whole-time Director and Chairman of Board

Managing Director

Non- Executive Director on Board

Age

51 years

45 years

65 years

Sunil Goyal

Independent Director on Board

47 years

Narendra Ambwani

Nitin Dhavalikar

Radhika Pereira

Independent Director on Board

66 years

45 years

Detail s



He has an experience of 23 years in the dairy industry



He has an experience of 23 years in the dairy industry



He is currently an independent dairy consultant



He has vast experience of 44 years in the dairy industry

with previously being an integral part of GCMMF Ltd



He has rich experience (20 years) in corporate activities

such as Management Consultancy, Business Structuring,

Capital Markets, Turnaround Strategies and Corporate

Governance.



He has held various positions and previously worked as

Managing Director of Johnson & Johnson’s consumer

group.



He has an experience of 20 years in Corporate Audits

for varied sectors and Consultancy for raising Debts for

corporate & SMEs.



Currently she is the Partner at Shardul Amarchand

Mangaldas & Co



April 2005: Restarted Dudhat Pereira & Associates



1996-2005: Partner of M/s Udwadia & Udeshi, Solicitors

& Advocates

Source: Company, MOSL

Exhibit 33: Details of Key Management Personnel

Name

Devendra Shah

Pritam Shah

Bharat Kedia

Mahesh Israni

Shirish Upadhyay

Rachana Sanganeria

Role

Whole-time Director and Chairman of Board

Managing Director

Chief Financial Officer

Chief Marketing Officer

Senior Vice President (SVP)-Planning

Company Secretary and Compliance Officer of

Company

Details



He has an experience of 23 years in the dairy industry.



He has an experience of 23 years in the dairy industry.



CA, CS by qualification, he has an experience of 23

years in the corporate sector



He has an experience of 29 years in the corporate

sector



He has an experience of 17 years in the dairy industry.



CS by qualification, she has an experience of 20 years

in the corporate sector

Source: Company, MOSL

11 July 2016

Parag Milk Foods

Exhibit 34: Organization Structure

Source: Company, MOSL

Exhibit 35: Shareholding Pattern (as on May’2016)

Category

No of Shares Held

% Holding

Total Foreign

Total Institutions

Total Govt Holding

Total Non-Promoter Corporate Holding

Total Promoters

Total Public & Others

Totals

21,705,567

3,757,520

5,369,069

39,941,189

13,341,237

84,114,582

25.8

4.5

0.0

6.4

47.5

15.9

100.0

Source: Company, MOSL

11 July 2016

Parag Milk Foods

Financials and Valuations

Income Statement

Y/E March

Total Income

Growth (%)

COGS

Gross Profit

Gross Margin (%)

Operating expenses

EBITDA

Change (%)

Margin (%)

Depreciation

Int. and Fin. Charges

Financial Other Income

Profit before Taxes

Change (%)

Margin (%)

Tax

Tax Rate (%)

Adjusted PAT

Change (%)

Margin (%)

2012

8,998

36.7

7,006

1,992

22.1

1,169

823

64.1

9.1

225

400

205

110.1

2.3

7.9

189

LTP

2.1

2013

9,250

2.8

6,907

2,343

25.3

1,509

834

1.4

9.0

261

403

191

-6.8

2.1

-16

-8.6

208

9.8

2.2

2014

10,883

17.7

8,359

2,524

23.2

1,701

823

-1.2

7.6

275

437

123

-35.4

1.1

-37

-29.6

160

-22.9

1.5

2015

14,442

32.7

10,616

3,826

26.5

2,753

1,072

30.2

7.4

275

469

343

177.9

2.4

6.0

322

101.5

2.2

2016

16,451

13.9

11,776

4,676

28.4

3,200

1,476

37.7

9.0

334

490

668

94.7

4.1

195

29.2

473

46.7

2.9

2017E

19,249

17.0

13,732

5,517

28.7

3,715

1,802

22.1

9.4

383

294

1,144

71.2

5.9

343

30.0

801

69.2

4.2

(INR Million)

2018E

2019E

23,094

27,570

20.0

16,388

6,705

29.0

4,480

2,225

23.5

9.6

456

252

1,537

34.4

6.7

476

31.0

1,061

32.5

4.6

19.4

19,410

8,160

29.6

5,376

2,784

25.1

10.1

494

234

2,078

35.2

7.5

665

32.0

1,413

33.2

5.1

Balance Sheet

Y/E March

Share Capital

Reserves

CCD's

Net Worth

Loans

Deferred Liability

Capital Employed

Gross Block

Less: Accum. Depn.

Net Fixed Assets

Capital WIP

Investments

Curr. Assets, L&A

Inventory

Account Receivables

Cash & Bank

Loans & Advances

Others

Long term advances

Curr. Liab. and Prov.

Account Payables

Other Liabilities

Provisions

Net Current Assets

Application of Funds

E: MOSL Estimates

2012

158

394

550

1,102

3,220

100

4,422

3,180

718

2,462

3,485

1,394

1,187

230

570

1,602

850

562

189

1,883

4,422

2013

160

638

1,250

2,048

3,314

5,437

3,348

914

2,434

4,393

1,395

1,473

215

351

938

1,464

922

528

2,928

5,437

2014

160

761

1,250

2,171

4,369

6,592

3,600

1,181

2,419

371

5,408

1,903

1,673

437

335

1,019

1,614

1,254

349

3,795

6,592

2015

160

1,079

1,239

4,409

5,708

4,367

1,456

2,911

283

6,043

2,119

1,709

974

522

665

3,531

1,931

1,591

2,511

5,708

2016

704

2,915

3,619

3,787

110

7,516

5,229

1,789

3,439

286

6,184

2,724

2,360

455

411

157

2,394

1,678

668

3,790

7,516

2017E

844

6,715

7,559

2,609

110

10,278

6,379

2,172

4,207

286

7,920

3,077

2,492

540

500

811

500

2,135

1,486

601

5,786

10,278

(INR Million)

2018E

2019E

844

7,776

9,189

8,620

10,033

2,433

2,258

110

11,163

12,401

7,129

2,628

4,500

286

9,022

4,136

2,949

115

550

971

300

2,646

2,057

541

6,376

11,163

7,479

3,122

4,357

286

10,163

4,777

3,093

605

1,164

500

2,405

1,871

487

7,758

12,401

11 July 2016

Parag Milk Foods

Financials and Valuations

Ratios

Y/E March

Basic (INR)

EPS

Cash EPS

BV/Share

Valuation (x)

P/E

Cash P/E

EV/Sales

EV/EBITDA

P/BV

Return Ratios (%)

RoE

RoCE (post-tax)

RoIC

Working Capital Ratios

Debtor (Days)

Asset Turnover (x)

Leverage Ratio

Debt/Equity (x)

2012

12.0

26.2

69.7

2013

13.0

29.4

128.3

2014

10.0

27.3

135.9

2015

20.2

37.5

77.6

2016

6.7

44.9

51.4

2017E

9.5

65.8

89.6

(INR Million)

2018E

2019E

12.6

84.3

102.1

16.7

106.0

118.9

16.3

8.8

3.9

53.1

4.2

49.0

7.3

14.3

159.7

6.4

34.8

5.0

14.6

155.5

3.7

26.2

3.9

12.1

126.1

3.2

19.7

3.1

10.2

100.7

2.8

17.1

25.2

25.8

2.0

13.2

13.1

13.3

1.7

7.6

12.1

12.6

1.7

18.9

12.4

13.2

2.5

19.5

12.4

13.1

2.2

14.3

11.3

12.1

1.9

13.1

11.5

12.2

2.1

15.2

13.3

13.8

2.2

6.8

5.7

5.9

3.3

1.0

0.3

0.2

Cash Flow Statement

Y/E March

OP/(loss) before Tax

Direct Taxes Paid

(Incr)/Decr in WC

CF from Operations

(Incr)/Decr in FA

Free Cash Flow

(Pur)/Sale of Investments

CF from Invest.

Change in Equity

(Incr)/Decr in Debt

Dividend Paid

Others

CF from Fin. Activity

Incr/Decr of Cash

Add: Opening Balance

Closing Balance

E: MOSL Estimates

2012

823

-16

-1,865

-1,059

-2,758

-3,816

-7

-2,765

913

3,220

-292

3,841

2013

834

-1,041

-191

-225

-416

-6

-230

738

-407

426

2014

823

-846

-570

-556

-560

-37

1,055

-451

567

2015

1,072

-21

1,295

2,347

-679

1,668

-679

-1,255

-442

-1,657

2016

1,476

-195

-1,256

-866

-840

-863

1,907

-622

-425

860

2017E

1,802

-343

-1,532

-73

-1,150

-1,223

-1,150

3,140

-1,178

-276

1,686

463

540

(INR Million)

2018E

2019E

2,225

2,784

-476

-665

-1,016

-1,473

733

646

-750

-17

-750

-176

-232

-408

-425

540

115

-350

296

-350

-175

-212

-387

-91

115

11 July 2016

REPORT GALLERY

RECENT INITIATING COVERAGE REPORTS

Parag Milk Foods

NOTES

11 July 2016

Disclosures

Parag Milk Foods

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11 July 2016

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