Outlook : Positive. White Gold

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1 White Gold Parag Milk Foods Ltd- Buy CMP: Rs 263 Target price : Rs 315 Upside: 20% Prabhat Dairy Ltd Buy CMP: Rs 110 Target price : Rs 134 Upside: 21% Kwality Ltd Buy CMP: Rs 130 Target price : Rs 180 Upside: 38% Varsha Bang Research Analyst varshab@systematixshares.com Arun Gopalan Vice President Research arungopalan@systematixshares.com Sector Report Outlook : Positive Global Dairy Industry Global milk production grew at a CAGR of 2.3% during to reach million metric tones (MMT) in 2014, on the back of population growth, rising disposable incomes, favorable demographics, brand awareness, increasing urbanization & westernization of diets in emerging economies, particularly India and China. During the period 2015E-2020E, global production of Milk and Dairy products is expected to grow at a CAGR of 2.1% to reach MMT by 2020E. Milk and Milk products production is expected to increase in India at a CAGR of 4.2% over the period of , which may resulting, India overtaking EU to become the largest producer in the milk and milk products by Dairy Industry in India-Emerging Trends The Indian dairy market is amongst the largest and fastest growing market in the world. India has been able to maintain its numero uno position in milk production during the past 18 years and milk production during stands at million MT. Milk production recorded about 4% CAGR during the last five years. The total production of milk and dairy products in India is expected to reach over 189 MMT in 2021E. The total consumption of milk and milk products in India is expected to increase from 146 MMT in FY16E to 192 MMT in FY21E, implying a CAGR growth of 5.6%. Total market size of milk and milk products in India is estimated to be Rs bn in FY16E, growing 15% annually and it is expected to reach Rs bn by 2020E. In India, Uttar Pradesh is the highest milk producing state. Top 10 milk producing states together accounted for close to ~75-80% of milk producing during Structural shift to organized segment Organized segment grew at a CAGR of 20.4% during as against unorganized sector CAGR of 14.2% during the same period on the back of shift in consumer preferences towards branded products. The trend is expected to continue in the coming years. During the period 2015E-2020E, organized segment is expected to grow at a CAGR of 19.6% as compared to 13.3% for the unorganized segment. Increasing focus on Value-Added Dairy Products (VADPs) and B2C In the recent past, change in demographics and rapid urbanization have resulted in significant demand for VADPs like cheese, condensed milk, UHT, flavored butter/milk/yoghurt, protein-based beverages/health supplements; VADP is expected to grow at a healthy rate of 23% annually till 2020E. Currently, about 42% of the total milk produced in India is purchased by consumers directly from milk farmers in a raw form. The remaining 58% goes for processing and is sold as processed milk and milk products like curd, yogurt, buttermilk, lassi, butter, ghee, ice cream, frozen desserts, cheese, paneer, SMP and WMP. The share of VADP in the milk and milk products segment is growing currently at around 25% every year. The profitability in liquid milk space ranges from 4-5%, whereas the profitability in VADPs ranges from 12 to 18%. the Indian dairy industry is all set to experience high growth rates in the next eight years with demand likely to reach 200 Mnt by 2022 from 132 Mnt in Product innovations are likely to accelerate India's dairy market which is anticipated to improve industry margins by attaining greater scale, higher capacity use and an increasing contribution from new milk variants. Shift towards branded products Rising disposable incomes and increasing brand awareness especially in urban markets resulting in strong demand for branded products, thereby organized segment; Tier-I and Tier-II cities offer significant growth opportunities for retail. Companies are enhancing their focus on brand building/marketing activities with aggressive spending and expansion of their marketing & sales team to create strong brand recall, customer retention, and reach. 1

2 Dairy Industry Overview Global Dairy Industry At its core, the dairy industry s perpetual drive to optimize production has led to a willingness to adopt new technologies that enable more to be done with less. Farmers are producing more milk per cow and dairy processors are increasing output and reducing operating costs. Due to a focus on efficiency, the dairy industry has shown steady growth the past five years despite an economy that has slowly recovered from a hard-hit decline. During this period the global demand for dairy is continuing to grow, at worth of US$ bn in 2015, growing at a CAGR of 2.6% during maintaining a stable growth of the global dairy market for the past decades. Fluid Milk, UHT Milk, Butter, Ghee, SMP, WMP, Whey Protein, Cheese, Yogurt, Ice-Cream are the key segments for the global dairy market. Currently, fluid milk represents the biggest product segment with Asia being the largest consumer. It is expected that, the total production of milk and milk products to grow at a CAGR of 2.1% to reach MMT during the period of Currently, EU, India and the USA are the largest producers of milk and milk products over the worldwide. As per the IMARC report, milk and milk products production is expected to increase in India at a CAGR of 4.2% over the period of , which may resulting, India overtaking EU to become the largest producer in the milk and milk products by Country wise top producers of milk and milk products E 2016E 2017E 2018E 2019E 2020E Global Production of Milk and Dairy Products for the year 2014 CAGR 15-20E EU % India % USA % China % Pakistan % Brazil % Source: IMARC Report Global Milk/Milk Products Production Volumes 2015E-2020E (MMT) CAGR 2.1% E 2016E 2017E 2018E 2019E 2020E 2

3 Overview of Indian Dairy Industry The Indian dairy industry is amongst the largest and fastest growing markets in the world. India has been able to maintain its leadership position in milk production during the past 18 years and also during , with an output of million MT. Milk production recorded about 4% CAGR during the last five years. Strong farm gate prices and rising domestic demand for value-added dairy products are the major factors providing impetus to a steady increase in milk production. Though India is the largest milk producing country but milk yield in the country is still very less as compared to other top milk producing countries like USA, Germany, France and New Zealand. High milk production in India is attributed to large population of cattle rather than good milk yields. Cow milk yield across the world s top milk producing countries is depicted in the chart below. Milk production (Mn Tons) Growth % 20% 10% % Source: NDDB Source: FAOSTAT In India, Uttar Pradesh is the highest milk producing state. Top 10 milk producing states together accounted for close to ~75-80% of milk producing during Source: Indiastat India's Milk production by species in 000tons Buffalo Milk Year E 2019E Prodn in tons % of total Prodn 52% 52% 51% 51% 51% 51% 52% 52% 52% 51% Cow Milk Prodn in tons % of total Prodn 43% 44% 45% 45% 45% 45% 45% 45% 45% 46% Goat Milk Prodn in tons % of total Prodn 4% 4% 4% 4% 4% 3% 3% 3% 3% 3% Total Production in tons In India, milk consumption mainly consists of buffalo milk at 52% followed by cow milk at 45% for the financial year However, cow milk is growing at a faster pace than buffalo milk 3

4 Structural shift to organized segment Organized segment grew at a CAGR of 20.4% during as against unorganized sector CAGR of 14.2% during the same period on the back of shift in consumer preferences towards branded products. The trend is expected to continue in the coming years. During the period 2015E-2020E, organized segment is expected to grow at a CAGR of 19.6% as compared to 13.3% for the unorganized segment. Dairy Industry in India 2020E 22.0% 17.0% 12.0% 20.4% 19.6% 14.2% 13.3% Organi zed, 26% 7.0% 2.0% E-2020E Unorga nized, 74% Unorganized Organized 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, as their milk procurement prices are much lower. This is because cooperatives are weaker and do not operate under a single umbrella. In the VADP segment too, capacities and branding require substantial investments and expertise, which generally are beyond the reach of cooperatives. Savvy marketing abilities and investment in cold chain technology aids the shift towards organized and branded products. A new Shift in Indian Dairy Market The Indian dairy industry is divided into the organized and unorganized segments. The unorganized segment consists of traditional milkmen, vendors and self-consumption at home and the organized segment consists of cooperatives and private dairies Indian Dairy Market Organized Dairy Market Unorganized Dairy Market Cooperatives Private Dairies Traditional Milkmen Self Consumption at Home Milk Production volume break-up by Marketability Marketable Milk Volume break-up by segment Organized Marketable Milk volume break-up by segment 54% 46% 55% 45% Self Consumption Marketable Milk Organized Unorganized Private Players Cooperatives & Government 4

5 The dairy industry in India is still predominantly unorganized with 30% of marketable milk being routed through the organized channel. Private players account for approximately 55% of marketable surplus milk routed through the organized channel and rest 45% is procured by the cooperatives. The Indian dairy industry was estimated at around INR 4,695 billion in A steep rise in farm gate prices of milk coupled with increasing consumption of value added dairy products has resulted in greater value growth than that of volume growth in the sector. Focus on prospect of Crème Run Currently, about 42% of the total milk produced in India is purchased by consumers directly from farmers in raw form, whereas remaining 58% is been utilized for processing and is sold in processed milk and milk products (VADP). Rising consumption coupled with better margins in the value added dairy products are enabling the dairy players to enter into a higher growth and profitability trajectory. This shift in the dynamics of the industry proved beneficial for the manufacturers since margins in VADPs are more than double that of the liquid milk segment. The profitability in liquid milk space ranges from 4-5%, whereas the profitability in VADPs ranges from 12% to 18%, attracting private participation in the industry. As per the industry estimates, the share of VADP in the milk and milk derivatives segment is growing currently at around 25% every year and is expected to grow at the stable rate until E. 5

6 Value Added Dairy Products (VADP): Nearly 55% of the milk produced in India is used for manufacturing Value Added Dairy Products. More details on value added products are available in the table below. Market Share of Milk and Milk Products in The dairy industry is expected to grow at 12-13% CAGR between and This growth will be mainly driven by rise in milk prices as well as change in product mix due to more focus on value added products. The Indian dairy industry is all set to experience high growth rates in the next eight years with demand likely to reach 200 MT by 2022 from 132 MT back in Presently, only 20% of the milk production comes from the organized sector comprising co-operatives and private dairies. The paramount factors driving the growth in the dairy sector include rising disposable incomes, advent of nuclear families and fast/instant food gaining ground in India. Other factors such as structural changes in food habits, expansion of fast food chains and popularity of pizzas and pastas aided the usage of milk variants of mozzarella cheese, processed cheese and flavored milk etc. Category Market Size Rs in Crs CAGR in % ( ) Polypack Milk Ghee Butter Cheese Baby Food Curd Icecream Flavoured Milk Cream Dairy Whitener Paneer Yoghurt based products Trends in VADP The Indian consumer, especially the affluent urban consumer is consuming more VADP, which bring in bigger profits for dairy companies than raw milk. The fact that the Indian cooperatives had largely stuck to basic milk, butter, processed cheese slices and ice cream for many decades, had left a gap in the market that allowed some of the new players to come in with new product offerings and the phenomenon of working couples, single men and women with high disposable income also provided the impetus to look at the category with fresh eyes. Finally, global prices of milk are dipping because of overcapacity, while the Indian market is still growing, both for basic milk as well as for value-added products. Shift towards branded products Rising disposable incomes and increasing brand awareness especially in urban markets resulting in strong demand for branded products, thereby organized segment; Tier-I and Tier-II cities offer significant growth opportunities for retail. Companies are enhancing their focus on brand building with aggressive marketing spend and expansion of their marketing & sales team to create strong brand recall, customer retention, and reach. 6

7 Our recommendations Parag Milk Foods Limited (PMFL) - Buy Valuation: Strong growth story with high margin product Mix PMFL is well focused towards maintaining its growth trajectory in milk and milk products supported by strong growth in the Indian dairy industry. The company s persistent efforts in upgrading its existing portfolio as well as regular launch of new products, proves its commitment towards adding value to customers. With processed milk & milk product segment expected to grow at double digits in coming years led by changing lifestyle, growth in food services industry & increasing health awareness, we believe, this will augur well for company s growth and margin expansion going ahead. PMFL has a strong milk procurement process, strong distribution model and a well diversified product mix with new innovative products. At a CMP of Rs. 263 PMFL is trading at 31x of its FY18E EPS of Rs. 8.5 per share. Considering the company s strong fundamentals, we recommend a BUY with a target price of Rs. 315, which implies potential upside of ~20% to the CMP, with a 1 year perspective. Prabhat Dairy Limited Buy Valuation: Emerging at right time Prabhat is well focused towards maintaining its growth trajectory in both the institutional segment and its retail segments supported by its premium product portfolio. PDL is aiming to increase its share of B2C segment from current 25% to 50% in the coming 3-5 years by focusing on its brands (Prabhat, Milk Magic and Flava) in VADP segments by increasing distribution channel in tier 2/3 towns and by capacity addition. We estimate Prabhat to clock revenue and EBITDA CAGR of 15% and 18% respectively over the period of FY16- FY19E which will aid by better earning mix, increase in VADP products and sales and increasing share of B2C segment. We initiate BUY rating on PDL. At a current CMP of Rs. 110, PDL, is currently trading at 22x of its FY18E EPS of Rs. 5 per share. Considering the company s strong fundamentals, we recommend BUY with a target price of Rs. 134, which implies potential upside of ~21% to the CMP from 1 year perspective. Kwality Limited Buy Valuation: Transforming B2C player at reasonable valuation Over the last five years i.e. from FY11 to FY16, Kwality revenue and profitability has grown at CAGR of 32% and 31% respectively. Also, during the same period, EBITDA has grown at CAGR of 31%. Business model transmission, margins expansion in VADP products, reduction in debt and declining in working capital cycle, will aid Kwality to net earnings to grow at a CAGR of 23% during the period from FY16-FY19E. With an improvement in revenue mix towards the retail segment, Kwality intends to reduce its receivables days from 93 to 75 days over the period of FY16-FY19E. ROCE will improve significantly from 15.6% in FY16 to 21.2% in FY19E, largely attributable to margin expansion through VADP segment. At CMP of Rs. 130 the stock is trading at 13x of its FY18E EPS of Rs. 10 per share. We recommend investors to BUY the stock with a target of Rs 180 (38% appreciation) in twelve months time. Valuation Summary Company Name CMP (Rs.) Target Price (Rs.) Upside (%) Market Cap (Rs. Cr.) PAT (Rs. Cr.) EPS (Rs.) PE (x) FY17E FY18E FY17E FY18E FY17E FY18E Parag Milk Foods Ltd % Prabhat Dairy Ltd % Kwality Ltd %

8 Parag Milk Foods Ltd. Dairy Date January 5, 2017 CMP (Rs.) 263 Target (Rs.) 315 Potential Upside 20% BSE Sensex NSE Nifty 8274 Scrip Code Bloomberg PARAG IN Reuters NA BSE Group B BSE Code NSE Symbol PARAGMILK Market Data Market Cap.(Rs. Cr) 2210 Equity Sh. Cap. (Rs Cr) Wk High/Low 357/202 Avg. Quarterly Volume Face Value (Rs.) 10 Shareholding Pattern (Jun-16) Comparative Price Chart DII, 3.9 Others, 21.5 FII, 27.1 Promot er, 47.5 Stock Idea Rating: BUY Parag Milk Foods Ltd. (PMFL) is one of the leading manufacturers and marketers of Dairybased branded foods in India. It is moving fast towards the high growth and high margin VADP segment with its new product innovation and diversified product portfolio with well established brands like Gowardhan, Go, Pride of cows and Topp Up, which have become household names among consumers. With new innovation in the VADP segment, mix improvement, high revenue growth and improvement in return ratios with better capacity utilization, PMFL would be able to improve its margins. We expect PMFL to report revenue CAGR of 13% over FY16-FY19E with strong brand recognition and with new product in VADP with competitive prices. Focus on VADP segment- to improve overall margins PFML manufactures a diverse range of products which includes fresh milk, ghee, cheese, butter, paneer, yoghurt and other dairy milk based beverages and powders under the Umbrella of four flagship brands Gowardhan, Go, Topp Up and Pride of Cows. The company has over the years innovated and improved its product portfolio so as to command pricing premium in the market. Innovation backed by advertisement exposure to help improve growth and margins. PMFL is strongly focusing on VADP product line with cheese and whey protein which will be the driving force. PMFL is setting up whey processing facility in current fiscal year to cater the demand of its retail consumers in the form of branded health supplement foods and beverages. Currently, PMFL sells whey only to its B2B segments includes Nestle and UTH Beverage Factory Private Limited and whey powders to bakeries and confectionaries. Integrated business model: Unlocking the value chain PMFL has an integrated business model that encompasses the entire value chain of the dairy based food and beverages business and includes a range of activities including manufacturing and processing to branding and distributing a wide variety of products. PMFL has established a strong relationship with farmers to procure raw milk at very competitive prices. It has a robust milk procurement base with 3400 village level collection centers that have presence in 29 districts across the states of Maharashtra, Andhra Pradesh, Karnataka and Tamil Nadu. Further, the strategic location of its manufacturing facilities (Manchar facility in Pune and Palamaner facility in Chittoor, Andhra Pradesh) enables PMFL to procure quality of milk at very reasonable price from farmers, it also helps to reduce the time and cost of the transportation and handling of raw milk, without wastage or any substantive loss of quality or nutritional value. Over the years PMFL has diversified and shaped its product portfolio, consisting a range of products including fresh milk and premium Milk products such as UHT milk, ghee, cheese, whey proteins, curd, Paneer, shrikhand etc. Robust distribution network Parag has built a robust distribution model over the years, which has provided depth for its products in urban market and width in the rural market. PMFL has extensive presence in pan India sales and distribution network which covers 15 depots, 104 super stockists and over 3000 distributors spread across the states. On account of their short shelf life, fresh milk and fresh milk products are largely sold in the western and southern regions of India, in proximity to our manufacturing facilities at Manchar and Palamaner. PMFL has established a separate route-to-market to focus on the distribution of our low unit price products including ghee, flavoured milk, UHT milk, dairy whiteners and gulab jamun mix in Tier 3 cities and rural areas in India. Company also caters to institutional customers, hotels, restaurants and caterers directly and through distributors appointed by them. 60 Valuation: Strong growth story with high margin product Mix PMFL is focused on maintaining its growth trajectory in milk and milk products supported by strong May Aug Nov-16 growth in the Indian dairy industry. The company s persistent efforts in upgrading its existing portfolio as well as creating new products every now and then, proves its commitment towards customers. PMFL BSE Sensex With processed milk & milk product segment is expected to grow at double digit in coming years led by changing lifestyle, growth in food services industry & increasing health awareness, we believe, this will augur well for the company s growth and margin expansion. PMFL has a strong procurement process, a strong distribution model, a diversified product mix with new innovative products. At the CMP of Rs. 263, PMFL is trading at 31x of its FY18E EPS of Rs. 8.5 per share. Considering the company s strong fundamentals, we recommend a BUY with a target price of Rs. 315, which implies potential upside of 20% to the CMP with a 1 year perspective. Year Sales (Rs.cr) Growth (%) EBITDA (Rs.cr) Margin (%) PAT (Rs.cr) Margin (%) Adj EPS (Rs) P/E (x) EV/EBITDA ROE% FY % % % FY17E % % % FY18E % % % FY19E % % % Source: Company, Systematix Research 8

9 Focus on VADP segment- to improve overall margins The difference between PMFL and many of its Competitors is its ability to create a strong brand image in the industry with new innovative products and sustain its goodwill. PFML manufactures a diverse range of products which includes fresh milk, ghee, cheese, butter, paneer, yoghurt and other dairy milk based beverages and powders under the Umbrella of four flagship brands Gowardhan, Go, Topp Up and Pride of Cows The company has over the last 3-4 years made several innovations in its product portfolio in all facets such as pricing, packaging and entry into new segments. Innovation has been a focus area, with a view to strengthening the base of health and nutrition. The company has over the years revamped its product portfolio so as to command pricing premium in the market. Innovation backed by advertisement exposure has helped improve growth and margins. With the largest manufacturing facility in India (40MT per day) and a market share of 32% (2nd largest players) in the Cheese segment, PMFL is now looking to expand its product basket by adding 10MT per day capacity in the cheese segment, new flavoured milk, UHT milk and Whey proteins to drive growth in VADP. Growth in Fast Food service outlets and changing food habits has triggered demand for cheese in India. In Cheese segment is dominated by organized market by 95% and is the second fastest growing segment of VADP with 31.5% projected CAGR between 2015 & 2020 and reach value of Rs 59bn by from Rs 15bn in Top 4 players command 89% of India cheese market and there is scope for more players. Whey Protein is a high margin product in the VADP segment of PMFL. It s a component of milk protein and by product of cheese which is further processed and refined which is to be sold as a branded product. The Company s current range of whey products include whey protein concentrates, whey permeate and demineralised whey powders. It sells whey proteins to institutional customers including Nestle India Limited and UTH Beverage Factory Private Limited and whey powders to bakeries and confectionaries. PMFL is setting up whey processing facility in current fiscal year to cater the demand of its retail consumers in the form of branded health supplement foods and beverages. This product will act as a gross margin driver going forward as it margins ranges between 20-35% VADP commands an EBITDA margin (14-16%) which is almost double of what is fetched by liquid milk (6-7%). In FY16, of the total turnover of Rs Crs, VADP contributed close to Rs crs, i.e 79%. Cheese and Ghee is the major contributor of VADP segment with 26% and 27% respectively. We expect VADP sales to grow at CAGR of 14.4% during the period of FY16-FY19E to reach Rs crs by FY19E led by Cheese, Ghee and Whey protein contribution. Company is actively striving to enhance the contribution of VADP to total Dairy sales to ~71% by FY19E (Rs crs). Increasing Proportion of VADP in total dairy sales should lead to improvement in operating margin of dairy division. Integrated business model: Unlocking the value chain PMFL has developed a strong and robust integrated business model, which encompasses the entire value chain of the dairy based food and beverages business, which includes the activities of manufacturing, processing to branding and distributing a wide range of products to the targeting various customers group. Over the years, PMFL has developed a strong relationship with farmers in the vicinity of its facilities and consistently procure raw milk at a competitive price. PMFL has a strong supply chain network to procure cow milk from 29 districts across Maharashtra, Andhra Pardesh, Karnataka, and Tamil Nadu. The company has aggregate milk processing capacity of 2mn litres per day, with manufacturing facilities are strategically located at a high dairy cow population areas of Manchar, Maharashtra with milk processing capacity of 1.2 mn litres per day and Palamaner, Andhra Pradesh with milk processing capacity of 0.8 mn litres per day. 9

10 Capacity utilization at Manchar and Palamaner Facility Capacity Utilzation % Manchar Palamaner Product FY13 FY14 FY15 FY16 FY13 FY14 FY15 FY16 Milk Processing capacity (Litres per day) Milk Powders (metric tons per day) Liquid milk in pouches (Litres per day) Flavored milk (packs per day) UHT products (Litres per day) Cheese/Paneer (metric tons per day) Ghee (metric tons per day) Butter (metric tons per day) Curd (metric tons per day) Capacity utilization levels for its major product varies from 40% to 80%, however, PMFL is increasing its capacity of Cheese, UHT and Whey protein by using its IPO proceeds. This capacity addition will cater the demand for the next five years. Production capacity of Parag facilities Product Manchar Palamaner Current Total Expansion Milk Processing capacity (Litres per day) Milk Powders (metric tons per day) Liquid milk in pouches (Litres per day) Flavored milk (packs per day) *UHT products (Litres per day) Cheese/Paneer (metric tons per day) Cheese Ghee (metric tons per day) Butter (metric tons per day) Curd (metric tons per day) Whey Processing (Litres per day) *Includes Lassi and Butter Milk PMFL procures around 1 mn litres per day with the help of 4300 villages level collection centers, reaching more than farmers across the catchment areas and 114 chilling centers and bulk coolers across both the facilities. It also propose to purchase new 75 bulk milk coolers and 100 automated milk collection systems thereby further increasing milk procurement base. PMFL has set up Bhagyalaxmi Dairy farm at Manchar, to educate farmers about the best practices of breeding, feeding, animal management and improving productivity. This farms is fully automated rotary milking parlor to milk cows without human intervention and ensure does not exposed to any impurities in the environment. The farm has over 2000 Holstein breed cows with higher yields of 25 Litres per day as compared to the Indian cows average is 5-6 litres per day. The premium product which directly comes from farms is sold to around customers in Mumbai and Pune under the brand of pride of cows. The company is planning to increase the daily procurement through setting up new collection centers and bulk coolers with strengthening the relationship with farmers. Parag has built a robust distribution model over the years, which has provided depth for its products in urban market and width in the rural market. PMFL has extensive presence in pan India sales and distribution network which cobvers 15 depots, 104 super stockists and over 3000 distributors spread across the states. 10

11 Region wise distribution network in India: table to be paste Region Depots Super Stockists Distributors Mumbai North East West South Total Pride of cows distribution models City Depots Delivery Routes No of Customers Mumbai Pune Total In a business where the freshness of milk is an important sales driver, the Company has selected to create milk collection centres within rich catchment areas. Brand Building: Indian dairy company focusing on building leadership positions in branded and value added markets across the dairy segment with innovation in products and competitive prices. PMFL has consistently invested in the creation of branded dairy products, which represent nutritive value, convenience, lifestyles and product integrity. Over the last five years leading to , the Company had invested an aggregate Rs.75 crs in brand building. In addition to brand spending, PMFL demonstrated capabilities in brand building, reflected in the creation of distinctive brands (Gowardhan, Go, Topp Up and Pride of Cows) that address diverse consumers, lifestyles and age profiles. It is the Company s conviction that progressive branding and packaging will help evolve consumers from products manufactured by the unorganized sector, a national trend that appears irreversible. Financial: Slow and steady Improvement in margins Demonstrating a healthy performance, PMFL has witnessed revenue CAGR of 21% over the period of FY13-FY16 led by factors like increase in milk prices, increased depth in distribution, and diversify of revenue portfolio. With increase in share of VADP, increasing the distribution channels and introducing of innovative products, we except PMFL to generate a 13% of revenue CAGR over FY16-19E. EBITDA margin improved on back of innovative products in VADP segments and favorable milk prices in India. 75% of revenue is coming from B2C segment whereas 25% of revenue is generating from B2B with its prestigious clients like Pizza Hut, Dominos etc. Going forward, we might see a EBITDA margin in the range of 8-9.5% on back of better product mix and launched of new high gross margin products like Whey protein etc. on back of higher revenue growth and Improvement in EBITDA margins, will led to improve the bottom line of the company by CAGR growth of 29% over the period of FY16-FY19E. 11

12 Company background Parag Milk Foods Ltd (PMFL) is one of the leading manufacturers and marketers of dairy-based branded foods in India. It was incorporated in 1992 with collection and distribution of milk and have now developed into a dairy-based branded consumer products company with an integrated business model, manufacturing a diverse range of products including cheese, ghee (clarified butter), fresh milk, whey proteins, paneer, curd, yoghurt, milk powders and dairy based beverages products that enable it to sell its products to retail and institutional clients across India. It derives all of its products only from cow s milk. Its manufacturing facilities are located at Manchar in the Pune district of Maharashtra and Palamaner in the Chittoor district of Andhra Pradesh with processing capacities of 1.2mn litres per day and 0.8mn litres per day, respectively. Brand wise Product categories of PARAG Brands Products Target Customer Group Fresh Milk Curd Ghee Paneer Butter Milk Powder Whey proteins Targeted at household consumption for traditional Indian recopies and to be used as cooking Cheese Products UHT milk Fruit Yoghurts Curd Fresh Cream Lassi, Butter Milk, Badam milk Targeted at children and the youth generation, primarily for direct consumption Premium Cow Milk Targeted at household consumers seeking premium quality cow s milk. Targeted at youth Flavoured Milk generation & travellers as source of instant nourishment Gowardhan Gowardhan brand is targeted at house-hold consumption and to be used as cooking ingredients. The products under this brand include fresh milk, curd products (curd, trim curd and buttermilk), ghee, paneer, butter, milk powders, whey proteins, gulab jamun mix and shrikhand. Go Targeted at children and the youth generation, primarily for direct consumption. The products under this brand include cheese products, UHT milk (go milk, go slim milk and go supremo milk), and fresh milk: go kidz, fruit yoghurts in six flavours, fresh cream and beverages (lassi and buttermilk in two flavours). Pride of Cows Farm-to-home concept of milk, directly delivered from the farm to a consumer's door-step, through a subscription model. Targeted at household consumers seeking premium quality cow's milk. Topp Up Targeted at the youth generation and travelers as a source of instant nourishment. The products under this brand include flavored milk in six flavours. Key Management Personnel: Mr.Devendra Shah He founded the company in 1992 and taken to new heights under his Chairman leaderships. Apart from promoting one of India s largest cow farm called Bhagyalaxmi Dairy farm, he also holds reputed positions in various ventures like Director- Bhimashankar Sahakari Sakhar Karkhana, Pargaon, Secretary of National centre for Rural Development, Chairman, Sharad Sahakari Bank and Director, NDRI. Mr. Pritam Shah He has 23 years of experience in the industry. He has strong understanding Managing Director in procurement and distribution channels Mr. Bharat Shah CFO He is a member of the Institute of Chartered Accountants of India and the Institute of Company Secretaries of India. He holds a bachelor's degree in commerce from Ranchi University. He has been the CFO at Parag Milk Foods Limited since January 2, Mr. Kedia holds experience in the finance field. He served as Assistant Manager of Accounts Department at Goodlass Nerolac Paints Private Limited. He served as a Finance Manager at Farvane Overseas Consultants Limited for a period of two years. 12

13 Financials Profit and Loss (Rs. Cr FY16 FY17E FY18E FY19E Balance Sheet (Rs. Cr) FY16 FY17E FY18E FY19E Net sales Share Capital % Growth 13.9% 9.1% 14.3% 15.9% Reserve & Surplus Operating Expenses 1, , , ,155.2 Networth EBITDA Net deffered tax Liab EBITDA Margin 9.0% 8.1% 8.6% 9.3% Long term Borrowings Depn & Amort Long term Liabilities Other Income Long term Provision Interest Total Loans Loss on FC Trade payable PBT Provisions Tax Current Liab Adj PAT Short term Borr PAT Margin 2.9% 3.0% 3.5% 4.3% Other Long term Liab Shares o/s ( No.in Cr.) Capital Deployed Adj EPS Net Fixed Assets Cash EPS Capital Work In progress Qterly (Rs. Cr) Q3FY16 Q4FY16 Q1FY17 Q2FY17 LT Loans & Adv Revenue Other Non Curr assets EBITDA Cash & Bank Depn & Amort Inventories Other Income Debtors Loss on FC Loans & Advances EBIT Other Current assets Interest Capital Employed , , ,445.5 PBT Cash Flow FY16 FY17E FY18E FY19E Tax PBT PAT Add:Depreciation EPS Add:Interest Performance Ratio FY16 FY17E FY18E FY19E Less: Other Income (1.6) (1.6) (1.6) (1.6) EBITDA Margin (%) 9.0% 8.1% 8.6% 9.3% Change in WC 4.0 (61.1) (64.0) (100.7) PAT Margin (%) 2.9% 3.0% 3.5% 4.3% Tax (19.5) (21.9) (29.4) (42.0) ROE (%) CF from Operations ROCE (%) CAPEX (91.2) (115.0) (115.0) (30.0) Sales Growth (%) 13.9% 9.1% 14.3% 15.9% WIP 0.6 (51.7) PAT Growth (%) 46.9% 12.5% 34.4% 42.5% Others Income Per Share Data FY16 FY17E FY18E FY19E CF from Investing (89.0) (165.1) (88.4) (28.4) BV Per Share Change in equity capital Cash Per Share Change in borrowings (156.2) (100.0) (30.0) (30.0) Dividend Per Share Interest paid (49.0) (30.3) (27.1) (24.0) Valuation Ratio FY16 FY17E FY18E FY19E Others (60.4) Price Earnings (x) CF from Financing (40.8) (57.1) (54.0) EV/EBITDA (x) Net Chg in cash (63.0) (3.6) Price/BV (x) Cash at beginning Mkt cap/sales (x) Cash at end EV/Sales (x) Turnover Ratio (x) FY16 FY17E FY18E FY19E Valuation Ratio FY16 FY17E FY18E FY19E Debtors Months D/E (x) Creditors Months Interest Coverage (X) Inventory Months

14 Prabhat Dairy Milk Ltd. Dairy Date January 5, 2017 CMP (Rs.) 110 Target (Rs.) 134 Potential Upside 21% BSE Sensex NSE Nifty 8274 Scrip Code Bloomberg PRABHAT IN Reuters NA BSE Group B BSE Code NSE Symbol PRABHAT Market Data Market Cap.(Rs. Cr) 1077 Equity Sh. Cap. (Rs Cr) Wk High/Low 145/72 Avg. Quarterly Volume Face Value (Rs.) 10 Shareholding Pattern (Jun-16) Comparative Price Chart DII, 3.3 Others, 25.8 FII, 26.5 Promot er, 44.4 Stock Idea Rating: BUY Prabhat Dairy Limited (PDL) is an integrated milk and dairy products company in India catering to institutional as well as retail customers. PDL procures ~65% of its milk requirement directly from milk farmers and registered milk vendors with Kms of its plant location. Direct procurement has enabled the company to reduce logistics costs, while providing access to quality raw milk on a consistent basis. Institutional business account for 75% of its sales and the rest is consumer retail with strong processes and quality enabling them to have double digit margins, above the industry average. PDL is aiming to increase its share of B2C segment from current 25% to 50% in the coming 3-5 years by focusing on its brands (Prabhat, Milk Magic and Flava) in VADP segments by increasing distribution channel in tier 2/3 towns and by capacity addition. Overall revenue and profit growth should accelerate given by reducing debt of Rs. 250 crs and also by better capacity utilization. We estimate consolidated revenue to post 15% CAGR over FY16-19E, resulting in EBITDA margin expansion of 75bps and EPS CAGR of 53%. Strong B2B model, Evolving B2C model with expansion in product portfolio. Since last 15 years, PDL has established a strong relationship with its MNC/ Indian institutional customers which has contributed 70% of revenue in FY16. Basically, PDL is a B2B player in the dairy segment and now rapidly moving towards on brand building and increasing it retail sales under its brands like Prabhat, Milk Magic and Flava. Prabhat targets to increase the proportion of B2C revenues from 30% currently to 50% of total revenues by It intends to achieve this target by focusing on the HORECA segment, expanding its distribution reach and enhancing its VADP. PDL is planning to penetrate in tier II and III cities where the presence of brand dairy product is low. The company has seen strong growth in B2C markets in pouch milk, curd and ghee. The retail consumer products attract higher gross margins, while the operating margins are similar to institutional products. With increasing share from retail consumer products, we expect operating margins to improve over the period and thus expect better profitability. Timely capacity expansion will aid to growth in VADP segments In order to capture the huge business opportunity in high growth and VADP segment, PDL has invested Rs. 275 crs over the period of FY The company has enhanced its capacity in VADP segment like in Cheese 30 MT dpd, Panner and shrikhand capacity at 5MT dpd. PDL s Shrirampur cheese plant is the third largest in the country and is currently ramping up to institutional players (pizza/ burger chains) for regular supplies. Currently, overall capacity utilization in milk segment is 68% wherein in VADP segment the capacity is underutilized in FY16, though we expect 16% CAGR growth during the period of FY16-FY19E which will be led by 85% capacity utilization. The capital expenditure should help PDL to grow revenue at 15% and margins at 18% by FY19E led by rising share in VADP, increasing share of B2C and spurt in capacity utilization. Deepening Pan India expansion and distribution model PDL has a well-entrenched distribution network of more than retail outlets for its milk and milk products, through 700 distributors and 100 minis stockiest, served by more than 25 sales professionals. PDL is planning to expand its reach to 100,000 retail outlets in next 2 years. For shorter shelf life products like curd the company has an alternative distribution model, known as raftar, it directly distributes products through a network of specially insulated and refrigerated vehicles,this distribution platform helps in catering to 6,500 outlets. In the next 2 years the company plans on expanding 15,000 outlets. PDL plants are located within 70-80kms of its plant location, thereby, helping to save on logistics cost. To further enhance its distribution reach, the company is increasing its penetration into the tier 2/3 cities and rural areas by entering into B2C model. 8-Jan-16 8-Apr-16 8-Jul-16 8-Oct-16 Valuation: Emerging at right time PDL BSE Sensex Prabhat is well focused towards maintaining its growth trajectory in both the institutional segment and its retail segments supported by its premium product portfolio. We estimate Prabhat to clock revenue and EBITDA CAGR of 15% and 18% respectively over the period of FY16-FY19E which will aid by better earning mix, increase in VADP products and sales and increasing share of B2C segment. We initiate BUY rating on PDL. At a current CMP of Rs. 110, PDL is currently trading at 22x of its FY18E EPS of Rs. 5 per share. Considering the company s strong fundamentals, we recommend BUY with a target price of Rs. 134, which implies potential upside of 21% to the CMP from 1 year perspective. Year Sales (Rs.cr) Growth (%) EBITDA (Rs.cr) Margin (%) PAT (Rs.cr) Margin (%) Adj EPS (Rs) P/E (x) EV/EBITDA ROE% FY % % % FY17E % % % FY18E % % % FY19E % % % Source: Company, Systematix Research 14

15 Strong B2B model, Evolving B2C model with expansion in product portfolio. After establishing strong institutional business in SMP and CMP (73% of revenue in FY16), Prabhat has significantly moved towards the retail business as well as planning to enhance its contribution of the B2C business foraying into VADP segments and trying to scale up direct milk procurement. In an aid to provide a boost to its revenue-base, PDL has launched high growth products in VADP segments like Panner, Cheese, Dahi and Lassi in last year which has created impact on its revenue-base in B2B and B2C segments. PDL enjoys highest EBITDA margin in B2B segment due to the scale of condensed milk and SMP to its institutional clients. Brands Prabhat Milk Magic Flava Products Pasteurized milk, clarified butter, dairy whitener, SMP, WMP, curd, lassi and chass Sweetened condensed milk Flavoured Milk PDL has been a supplier of dairy products and ingredients to many leading players in the domestic market. The company supplies specialty ingredients products such as baby food to Abbot Healthcare and sweetened condensed milk to Mondelez India. Institutional customers for speciality ingredients Speciality Ingredients products Partially skimmed milk sugar concentrate, skim milk powder, skimmed milk preparations, full cream milk powder Specialty milk powder for baby foods Specialty milk powder and sweetened condensed milk Customers Mondelez India Food Abbot Healthcare Other MNC and Indian Cos It also supplies co-manufactured products including specialty milk powder, curd, clarified butter (ghee), dairy whiteners, yogurts, processed and condensed milk and ice creams to various institutional customers including Britannia, Mother Dairy and Heritage Foods. Institutional customers for co-manufactured products Products Customers Dairy Whitener, Curd, Butter Milk Heritage foods Curd Britannia Industries, Nandini Brand Ghee Britannia Dairy Ice Cream Mother Dairy Fruit and Vegetable Pvt Ltd Pouch Milk Nandini Brand In Q2FY16, PDL has commissioned its Cheese plant with a capacity of 30tpd, third largest capacity in India, currently focused on the HORECA (Hotel, Restaurants and Café) and B2B players to impel cheese sales. PDL has planning to expand its footprint network to cater the HORECA and B2C segment for its VADP products wherein margins are higher than B2B segment. As per the blueprint of Management, after establishing strong foothold in B2B segment and PDL is enhancing the scale towards the HORECA and B2C segment with product gains steady traction with its competitors. PDL B2C business is in a nascent stage, the demand for its product will grow only gradually. PDL is further scaling up with sales of Other VADP products such as panner, Curd, Ghee UHT milk, ice cream and flavored milk and aims to capture this demand. It sells its products under the brand name of Prabhat and Flava. PDL is planning to penetrate in tier II and III cities where the presence of brand dairy product is low. The company has seen strong growth in B2C markets in pouch milk, curd and ghee. Currently, B2B segment contributes 70% of revenue in FY16 for PDL. As per the management, PDL operates in a cost plus model with its institutional clients, which help company to generate the fixed profit margin despite the volatility in raw material prices. However, company is planning to increase it retail consumer products from 30% to 50% by FY20E which will help PDL to improve its share to the revenue and also by expanding its distribution network and intensive marketing of its branded products. The management aims for 50:50 ratio from institutional segment and retail consumer segment by FY20E. The retail consumer products attract higher gross margins, while the operating margins are similar to institutional products. With increasing share from retail consumer products, we expect operating margins to improve over the period and thus expect better profitability. 15

16 Timely capacity expansion will aid to growth in VADP segments In order to capture the huge business opportunity in high growth and VADP segment, PDL has invested Rs. 275 crs over the period of FY The company has enhanced its capacity in VADP segment like in Cheese 30 MT dpd, Panner and shrikhand capacity at 5MT dpd. Currently, overall capacity utilization in milk segment is 68% wherein in VADP segment the capacity is underutilized in FY16, though we expect 16% CAGR growth during the period of FY16-FY19E which will be led by 85% capacity utilization. The capital expenditure should help PDL to grow revenue at 15% and margins at 18% by FY19E led by rising share in VADP, increasing share of B2C and spurt in capacity utilization. Prabhat currently has an aggregate milk processing capacity of 1.5mn lpd across both its plants at Shrirampur and Navi Mumbai. The current capacity utilization stands at 60-70% and management expects to attain ~80-85% capacity utilization over the next few years. For the cheese plant, Prabhat expects 10-15% utilization in FY17 and by FY20E. Product Shrirampur Facility Navi Mumbai Facility Total Milk processing capacity (Litres/day) Pasteurized and Pouch Milk (Litres/day) Milk Powders (SMP, WMP, DW) (Kg/day) Condensed Milk (Kg/day) Ghee (Kg/day) Butter (Kg/day) Flavored Milk (Litres/day) Ice Cream (Litres/day) Curd (Kg/day) UHT Milk (Litres/day) Cheese Paneer (Kg/day) Shrikhand (Kg/day) Deepening Pan India expansion and distribution model PDL has a well-entrenched distribution network of more than retail outlets for its milk and milk products, through 700 distributors and 100 minis stockiest, served by more than 25 sales professionals. PDL is planning to expand its reach to 100,000 retail outlets in next 2 years. PDL has created strong relations with the institutional clients like Mondelez India foods pvt ltd, Abbot Healthcare Pvt Ltd, Mcdonalds, Dominos, Pizza hut etc. PDL enjoys moderate pricing power due to its diversified product mix, prominent brands and extensive distribution network. For shorter shelf life products like curd the company has an alternative distribution model, known as Raftar, it directly distributes products through a network of specially insulated and refrigerated vehicles,this distribution platform helps in catering to 6,500 outlets. In the next 2 years the company plans to expand to 15,000 outlets. PDL procures bulk of its milk requirement directly from the farmers and has around 450 milk collection centres with 100 bulk coolers and 30 chilling plants which help it to save on agent s commission. PDL plants are located within 70-80kms of its plant location, thereby, helping to save on logistics cost. To further enhance its distribution reach, the company is increasing its penetration into the tier 2/3 cities and rural areas by entering into B2C model. These markets are less penetrated and give immense opportunity to grow with mere competition with top Dairy players. Growth set to surge with expansion in VADP segment and B2C With evolution in consumer segment (B2C) and improvement in capacity utilization, we expect PDL to witness a revenue CAGR growth of 15% during the period of FY16-FY19E. VADP is the key growth driver in the dairy segment; the segment is expected to register a growth of 16% between FY16-FY19E compared to 12% growth registered by milk segment during the same period. With an increase in VADP proportion in overall revenue mix from 53% to 81% over FY13-FY19E and rise in contribution of B2C segment from 12% to 40% during the same period. EBITDA margins of PDL is always above industry average of mid single digit margins stands at 10%-10.5% PDL always enjoy high margin due to sale of high margin product condensed milk to its institutional clients, which ensures steady growth and margins. We expect operating margin is all set to improve by ~75 bps between FY16-FY19E on back of increasing contribution from its institutional clients, retail consumers and rising share in VADP segment. 16

17 Company Background Incorporated in 1998, Prabhat Dairy Limited (PDL) has evolved from being an established specialty dairy ingredients company to emerging milk and dairy products. It s an integrated milk and dairy products company in India catering to institutional and co manufactured products to a number of institutional and multinational companies as well as retail customers. Over the years, PDL sells wide range of VADP under strong and appealing brand name of Prabhat, Milk Magic, and Flava. It produce fresh, dry, frozen, cultured and fermented dairy products, including pasteurized milk, flavoured milk, sweetened condensed milk, ultra-pasteurised or ultra-high temperature (UHT) milk, yoghurt, dairy whitener, clarified butter (ghee), milk powder, ingredients for baby foods, lassi and chaas. PDL has integrated business model encompasses almost all aspects of the dairy industry value chain, including cattle feed supply, engaging with farmers on cattle health and milk production, procurement of raw milk, state of the art manufacturing, fast expanding distribution model and brand presence. PDL has set up an automated production facilities at Shrirampur (Ahmednagar) and at Turbhe (Navi Mumbai), which is strategically located within proximity of their milk procurement region as well as target market with an aggregate milk processing capacity of 1.5 mn lpd.pdl procure majority of raw milk directly from farmers and remaining with registered milk vendor in Ahmednagar, Pune, Nashik and adjoining districts in Maharashtra. Key Management Personnel: Mr. Sarangdhar R Nirmal Chariman and Manging Director Mr. Vivek S Nirmal Joint Managing Director He holds a Bachelor s degree in Commerce from the University of Poona and a Master s degree in Business Administration from the University of Poona. He has approximately 16 years of professional experience in the dairy industry. He holds a Bachelor s degree in Commerce from University of Pune. He was instrumental in the incorporation of SAIPL on January 22, 2007, which later became a subsidiary of our Company and is currently the Managing Director of SAIPL. He has approximately 7 years of professional experience in the dairy industry. 17

18 Financials Profit and Loss (Rs. Cr) FY16 FY17E FY18E FY19E Balance Sheet (Rs. Cr) FY16 FY17E FY18E FY19E Net sales Share Capital % Growth 16.7% 8.0% 16.3% 21.9% Reserve & Surplus Operating Expenses 1, , , ,598.5 Networth EBITDA Net deffered tax Liab EBITDA Margin 10.2% 8.9% 9.5% 10.9% Long term Borrowings Depn & Amort Long term Provision Other Income Total Loans Interest Trade payable Loss on FC Provisions PBT Current Liab Tax Short term Borr Adj PAT Capital Deployed PAT Margin 2.1% 2.4% 3.3% 4.9% Net Fixed Assets Shares o/s ( No.in Cr.) Capital Work In progress Adj EPS Investments Cash EPS LT Loans & Adv Qterly (Rs. Cr) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Other Non Curr assets Revenue Cash & Bank EBITDA Inventories Depn & Amort Debtors Other Income Loans & Advances Loss on FC Other Current assets EBIT Capital Employed ,060.3 Interest Cash Flow FY16 FY17E FY18E FY19E PBT PBT Tax Add:Depreciation PAT Add:Interest EPS Less: Other Income (1.5) (1.3) (1.3) (1.3) Performance Ratio FY16 FY17E FY18E FY19E Change in WC (76.0) (57.4) (50.3) (89.8) EBITDA Margin (%) 10.2% 8.9% 9.5% 10.9% Tax (13.6) (13.0) (22.8) (42.9) PAT Margin (%) 2.1% 2.4% 3.3% 4.9% CF from Operations ROE (%) CAPEX (163.2) (40.0) (12.5) (12.5) ROCE (%) WIP (5.5) - - Sales Growth (%) 16.7% 8.0% 16.3% 21.9% Others Income PAT Growth (%) -5.7% 24.1% 59.4% 79.5% CF from Investing (27.2) (44.3) (11.2) (11.2) Per Share Data FY16 FY17E FY18E FY19E Change in equity capital BV Per Share Change in borrowings (253.2) 30.0 (35.0) (30.0) Cash Per Share Dividend paid (4.70) (4.70) (4.70) (4.70) Dividend Per Share Interest paid (42.7) (23.6) (19.2) (15.4) Valuation Ratio FY16 FY17E FY18E FY19E Others Price Earnings (x) CF from Financing (12.0) 1.7 (58.9) (50.1) EV/EBITDA (x) Net Chg in cash (9.6) 0.2 (3.0) 2.0 Price/BV (x) Cash at beginning Mkt cap/sales (x) Cash at end EV/Sales (x) Turnover Ratio (x) FY16 FY17E FY18E FY19E Valuation Ratio FY16 FY17E FY18E FY19E Debtors Months D/E (x) Creditors Months Interest Coverage (X) Inventory Months

19 Kwality Ltd. Dairy Date January 5, 2017 CMP (Rs.) 131 Target (Rs.) 180 Potential Upside 38% BSE Sensex NSE Nifty 8274 Scrip Code Bloomberg Reuters BSE Group KWALITY IN KDAI.BO BSE Code NSE Symbol Market Data B KWALITY Market Cap.(Rs. Cr) 3080 Equity Sh. Cap. (Rs Cr) Wk High/Low 159/78 Avg. Quarterly Volume Face Value (Rs.) 1 Shareholding Pattern (Jun-16) Comparative Price Chart DII, 0.0 FII, 2.1 Other s, 33.4 Prom oter, Jan-16 8-Apr-16 8-Jul-16 8-Oct-16 Kwality BSE Sensex Stock Idea Rating: BUY Kwality is one of the fastest growing private sector dairy companies with a new range of innovative products and enjoys a large presence in Northern India. The company has six processing plants across the states of Haryana, Uttar Pradesh and Rajasthan and procures ~78% from milk aggregators and the remaining ~22% from farmers. To transform from a B2B player to B2C player, Kwality intends to increase its retail consumer presence from 31% to 70% by FY20E by adding capacity expansion will be done for high margin VADP products which will be marketed under its umbrella brand Kwality and Dairy Best. Recently, the company has won the legal battle of Kwality Brand. We expect new capacity addition in VADP products will aid EBITDA and Gross margin expansion and debt repayment will drive earnings for the Kwality over the next few years. With Superior growth and deleveraging its balance sheet, ROCE and ROE will enhanced by 21.2% and 20.2% respectively over the next 2-3 years. We expect, revenue to grow at CAGR of 8% over the FY16-FY19E, on back of improving product mix from institutional clients to retail customers as well shift towards high margin products of value added dairy products. Strengthening its backward integration network Kwality has created a strong network of farmers and vendors to procure raw milk on a consistent basis. It procures milk from three ways i) is directly from farmers ii) from local contractors and iii) is from hybrid procurement channel. About 78% of milk is been procure from the local contractors and hybrid procurement and remaining 22% of milk is been collected from farmers (direct procurement), directly from farmers spread across 4500 villages through 22 Milk Chilling centers (MCC) in the state of Rajasthan, Haryana and Uttar Pradesh. Kwality is planning to increase its milk direct procurement from farmers to 50% from 22% over the next 3-4 years, in line with product portfolio expansion with VADP segment. Kwality is planning to investment Rs crs towards building milk procurement infrastructure. Transformation towards retail presence through VADP Kwality is moving from traditional B2B business model to B2C business model with strong focus on direct milk procurement infrastructure, high-margin branded VADP and brand building. In FY16, company has generates 69% of revenue from its Institutional customers while rest from the retail (fresh milk products) in north markets. To transform from a B2B player to B2C player, Kwality intends to increase its retail consumer presence from 31% to 70% by FY20E by adding capacity expansion will be done for high margin value added product such as cheese, paneer, table butters, tetra-packs, flavoured milk, cream, yoghurt amongst others. The Company plans to launch variants over next months. We expect that Kwality business model is moving from low margin business to high margin by introducing VADP product into retail segment which will inch the EBITDA margin over the next 2-3 years. Focusing on Brand Building Kwality and Dairy Best Kwality is at a critical stage of growth where they are focusing on building a modern and youthful brand, with transforming their business model from B2B player to one of the consumer oriented. Engaged with gobal advertising and marketing agencies including McCann, Zenith Optimedia and Digital Quotient will help the company in its brand building initiatives. The company has roped in Bollywood actor Akshay Kumar as a Brand Ambassador to promote an entire range of dairy products (VADP) and gain consumer mindshare under the brand name Kwality. Retail segment with high targeted market will drive revenue growth and expansion in operating margin during the year FY16- FY20E for Kwality. Valuation: Transforming B2C player at reasonable valuation Over the last five years i.e. from FY11 to FY16, Kwality revenue and profitability has grown at CAGR of 32% and 31% respectively. Also, during the same period, EBITDA has grown at CAGR of 31%. Business model transmission, margins expansion in VADP products, reduction in debt and declining in working capital cycle, will aid Kwality to net earnings to grow at a CAGR of 23% during the period from FY16-FY19E. With an improvement in revenue mix towards the retail segment, Kwality intends to reduce its receivables days from 93 to 75 days over the period of FY16-FY19E. ROCE will improve significantly from 15.6% in FY16 to 21.2% in FY19E, largely attributable to margin expansion through VADP segment. At CMP of Rs. 130 the stock is trading at 13x of its FY18E EPS of Rs. 10 per share. We recommend investors to BUY the stock with a target of Rs 180 (38% appreciation) in twelve months time. Year Sales (Rs.cr) Growth (%) EBITDA (Rs.cr) Margin (%) PAT (Rs.cr) Margin (%) Adj EPS (Rs) P/E (x) EV/EBITDA ROE% FY % % % FY17E % % % FY18E % % % FY19E % % % Source: Company, Systematix Research Strengthening its backward integration network 19

20 Kwality has created a strong network of farmers and vendors to procure raw milk on a consistent basis. It procures milk from three ways i) is directly from farmers ii) from local contractors and iii) is from hybrid procurement channel. About 78% of milk is been procure from the local contractors and hybrid procurement and remaining 22% of milk is been collected from farmers (direct procurement), directly from farmers spread across 4500 villages through 22 Milk Chilling centers (MCC) in the state of Rajasthan, Haryana and Uttar Pradesh. This MCC are strategically located near its manufacturing facilities ensuring the quality protection and delivery on time. This model enables kwality with consistent quality and taste of milk and key parameters to maintain quality in VADP. Kwality is planning to increase its milk direct procurement from farmers to 50% from 22% over the next 3-4 years, in line with product portfolio expansion with VADP segment. Kwality is planning to investment Rs crs towards building milk procurement infrastructure. Currently, kwality has a processing capacity of 3.4 mn lpd and planning to increase processing capacity by 9.0 lakhs lpd for VADP segment. Transformation towards retail presence through VADP Kwality is moving from traditional B2B business model to B2C business model with a strong focus on direct milk procurement infrastructure, high-margin branded VADP and brand building. In FY16, company has generates 69% of revenue from its Institutional customers while rest from the retail (fresh milk products) in north markets. As part of a change in its business strategy, Kwality is revamping all business functions across the value chain including procurement, changing product mix to cater to evolving needs of customers and ensure high quality, brand building, building an extensive distribution network to boost retail presence, set up robust IT infrastructure for process integration, and improve managerial competencies. To transform from a B2B player to B2C player, Kwality intends to increase its retail consumer presence from 31% to 70% by FY20E by adding capacity expansion will be done for high margin value added product such as cheese, paneer, table butters, tetra-packs, flavoured milk, cream, yoghurt amongst others. The Company plans to launch variants over next months. We expect that Kwality business model is moving from low margin business to high margin by introducing VADP product into retail segment which will inch the EBITDA margin over the years. B2C Expansion Kwality is expanding up it capacities (at existing facilities) to produce VADP and also undertaken an expansion plan at its plant at Softa, Haryana with total CAPEX of Rs. 400 crs in a phased manner along with Rs. 120crs to building up procurement infrastructure. This enhancement in production is aimed at primarily for value-added products such as flavoured milk, variants of cheese, UHT milk, table butter, paneer, yoghurts, and cream. Focusing on Brand Building Kwality and Dairy Best Kwality is at a critical stage of growth where they are focusing on building a modern and youthful brand, with transforming their business model from B2B player to one of the consumer oriented. Engaged with gobal advertising and marketing agencies including McCann, Zenith Optimedia and Digital Quotient will help the company in its brand building initiatives. The company has roped in Bollywood actor Akshay Kumar as a Brand Ambassador to promote an entire range of dairy products (VADP) and gain consumer mindshare under the brand name Kwality. Retail segment with high targeted market will drive revenue growth and expansion in operating margin during the year FY16-FY20E for Kwality. A strong regional brand supported by a wide distribution network. 20

21 Kwality is strongly positioned near the highest dairy consumption market of the India (northern India), offering wide range of market to cater and creating brand awareness. Kwality is increasing their reach by strengthening the trade channels to reach to their customer base across the northern pockets of the country. The Kwality and Dairy Best brand is supported by 1900 distributor s access to 45,000 points of sale across Northern India; continuous efforts underway to further expand into new and existing markets. The company will promoted his product through general and modern trade channels to cover the target market share. Kwality is aiming to enhance their presence by increasing 1,00,000 point of sale in the northern region over the period of next 3-4 years. Kwality has created a presence across the continents of Asia, Africa and Australia, with export to over 28 countries. Growing Retail Network Kwality aim is to increase their product penetration to their target market, to achieve this, Kwality has applied a SBU (Strategic Business Unit) based approach to generate high growth and profit in below of three divisions. Fresh Product Division (For Pouch Milk, Dahi and Chaas) Consumer Product division (for flavoured milk, ghee, panner, cheese, yoghurts etc)i.e VADP Institutional/B2B division (for SMP/WMP, dairy whiteners, bulk milk etc) Each division is headed by profit managers who are the responsible for their performance. Financial Prospectus Kwality has delivered robust revenue growth of 32% CAGR during the FY11-FY16, with gross margin of 8.5%-9.5% range. We expect, revenue to grow at CAGR of 8% over the FY16-FY19E, on back of improving product mix from institutional clients to retail customers as well shift towards high margin products of value added dairy products. With the shift in VADP segment and making presence in retail segment is likely to support the Gross and EBITDA margins of the company. We expect EBITDA margin is all set to improve by 210 bps to 8.2% between FY16-FY19E. We expect, Kwality to report a 23% CAGR growth in net earnings over the period of FY16-FY19E Due to greater contribution from institutional clients, receivable days for KLD are on the higher side. But with an improving client mix in favour of the retail segment, the company intends to reduce the working capital days in the next 2-3 years. The company will use free cash flows to reduce balance sheet leverage. Debt/Equity ratio will be reducing from 1.6x to 0.6x between FY16 to FY19E. We expect new capacity addition in VADP, EBITDA and Gross margin expansion and debt repayment will drive earnings for the Kwality over the next few years. With Superior growth and deleveraging its balance sheet, ROCE and ROE will enhanced by 21% and 20% respectively over the period of FY16-FY19E. Company Background 21