Heritage foods shows an upward trend in Gross margins and EBIDTA

Heritage Foods (HFL) has doubled from its March low (down 58% from its January-2018-high). FY20 was a challenging year owing to a harsh season, which dragged down core Ebitda by 32% y-o-y. That said, we remain convinced about HFL’s prospects following: (i) Margin revival on the back of benign milk prices and pricing power to drive up Ebitda 30% in FY21 (up 25% y-o-y in Q1FY21); (ii) robust B2C milk portfolio (65% of sales) relatively insulated from Covid-19 fallout; (iii) focus on technology-enabled integrated milk procurement and a consistent scale-up (procurement up 34% in last three years). Also read April-June performance by dairy majors showed slow growth against no growth despite Covid-19

All in all, we expect RoCE to jump 640bps in FY21 and 860bps over FY20–22 to 23%. Hence, we are revising up TP by ~15% to Rs 456 as we raise the core business’s PE by 15% to 18x FY22e (15.5x earlier).

Structural: Procurement scale-up on track

HFL has increased milk chilling capacity by 4.95 LLPD over the past three years. As a result, its overall handling has gone up by 34% (from 10.3 LLPD to 13.77 LLPD) over the period. Furthermore, HFL maintains its mission of doubling capacity to 2.8mn LLPD over the next four–five years. Also read Seven listed dairy stocks almost doubled their investor’s wealth during Covid

Strong margin and RoCE improvement: Procurement was hit in FY20—down 0.3% y-o-y. However, it improved 15% q-o-q in Q1FY21 as Covid-19 catalysed a spurt in milk and powder supply. Hence, procurement prices, rising 10.8% in FY20, cooled off 9% q-o-q in Q1FY21. And they continue to fall in south. As a result, we expect Ebitda to grow 30% in FY21 (25% y-o-y in Q1FY21). We expect RoCE to expand 640bps in FY21. Also read A2 is the way 2 Heritage foods launched A2 milk

Outlook: Positive—HFL is well placed, underpinned by B2C nature of its business (~90%), strong return ratios. In light of its improving procurement, we expect strong 26% Ebitda CAGR over FY20–22e. Maintain Buy with a revised SoTP-based TP of Rs 456 (18x FY22E core EPS plus 30% discount to market value of its Future Retail stake).