Parag Milk

By Geetanjali Kedia

Update (6 May 2016, 6:40 pm): Although issue was subscribed 1.32x on an overall basis till 5 pm, 6th May (last day), QIB portion remained under-subscribed, with just 55% subscription. IPO price band has now been revised to Rs. 215 to Rs. 227 per share, retaining Rs. 12 per share discount for retail investors, and issue closing has been extended by 3 days, to 11th May 2016. We still maintain our negative view on the issue, as the pricing remains aggressive.

Parag Milk Foods is entering the primary market on Wednesday 4th May 2016, to raise Rs. 300 crore via a fresh issue of equity shares of Rs. 10 each and an offer for sale (OFS) of upto 205.73 lakh equity shares, both in the price band of Rs. 220 to Rs. 227 per share. Retail investors will get a Rs. 12 discount on the final issue price. The total fund raising aggregates to Rs. 767 crore, at the upper end of the price band, of which, OFS portion is Rs. 467 crore. Representing 15.8% of the post issue paid-up capital at the upper end, issue closes on Friday 6^th May.

Motilal Oswal is one of the BRLMs to the issue and its PE fund, India Business Excellence Fund, is also a selling shareholder in the OFS, selling over 60 lakh shares, valued at Rs. 137 crore. If the BRLM is also on the sell side, conflict of interest is bound to rise and no points for guessing whose side will be favoured! Wonder why this was not red-flagged by SEBI, keeping in mind the interest of prospective shareholders.

Parag Milk Foods sells milk, ghee, cheese, paneer, curd and other dairy-based products under Gowardhan, Go,Topp Up and Pride of Cows brands, with an aggregate milk processing capacity of 2 million litres per day. It has cheese production capacity of 40 MT per day and distribution network comprising of 15 depots, 104 super stockists and over 3,000 distributors, as of February 29, 2016. Geographically, nearly 55% of company revenues are contributed by western regions.

For FY15, consolidated revenue rose 32% YoY to Rs. 1,441 crore. Dairy business having wafer thin net margin, standing at 1.8% for FY15, led to net profit of just Rs. 26 crore, yielding an EPS (basic) of Rs. 4.47, calculated on higher equity base, post bonus issue on 26-5-15. Although EBITDA rose 28% YoY to Rs. 108 crore, EBITDA margin slipped to 7.5% in FY15, from 7.7% of FY14. Despite sales CAGR of 24.6% over FY13-15, PAT CAGR registered only 12%, as rise in finance cost and employee expenses restricted bottomline growth.

For 9MFY16, however, PAT of Rs. 32 crore (EPS Rs. 4.67 for 9 months) has already surpassed FY15 PAT of Rs. 26 croreby 23%, as also EBITDA margin has widened by 127 bps over FY15, to 8.77%.

Company’s net worth, as of 31-12-15, stood at Rs. 278 crore, with promoters currently holding 61.13% stake, which will shrink to 54% post IPO, as 2 promoters are participating in the OFS, along with India Business Excellence Fund (Motilal Oswal PE) and IDFC PE Fund. Company’s consolidated net debt stands at Rs. 340 crore, as of 31.12.15 (down from Rs. 424 crore, as on 31.3.15). This will further reduce by Rs. 100 crore, thanks to repayment via fresh issue proceeds, while balance proceeds will be used for expansion and modernization of existing manufacturing facilities.

At upper end of the price band, Parag Milk will have market cap of Rs. 1,598 crore and Enterprise Value of Rs. 1,838 crore, which leads to EV/EBITDA of about 12 times, on an estimated EBITDA of Rs. 154 crore for FY16. Company is likely to close FY16 with an EPS below Rs.7, on an equity base of Rs. 70.42 crore, leading to a PE multiple of over 32 times. While the growth and margin expansion in 9MFY16 are quite encouraging, valuations seem stretched, vis-à-vis peers.

1.     Kwality Limited, having 3 million litres per day milk processing capacity, which is not only 50% more thanthat of Parag, across 6 units in North India, but also has nearly 4 times the sales of the latter, at Rs. 6,000 crore, indicating higher value added products. It is currently ruling atEV/EBITDA and PE multiples of 10x and 18x respectively, based on FY16 estimated earnings.

2.     Heritage Foods, with current milk processing capacity of 1.5 million litres per day and retail network of 1,08,000 outlets, is currently ruling at PE multiple of about 25x.

3.     Prabhat Dairy, which made its debut on the bourses in September 2015, has milk processing capacity of 1.5 million litres per day, is currently trading at EV/EBITDA multiple of less than 10 times, based on annualized 9mFY16 earnings.

Turning back the pages of history, one recalls that Prabhat Dairy IPO was earlier priced in the band of Rs. 140 to Rs. 147 per share, which was revised downward to Rs. 115 to Rs. 126 per share, due to extremely poor subscription numbers. Its IPO was finally priced at the lower end at Rs. 115 per share, with Rs. 5 per share retail discount, and the share is currently languishing below its IPO price.Thus, although dairy has attracted a lot of investment from both national and international PE funds, it does not seem to enjoy that kind of fancy in the listed space.

While dairy business may aspire to get valuation of FMCG companies, reality is a lot different. Wafer thin margins coupled with lack of pricing power in producers’ hand due to commoditization of productsand extremely competitive landscape,remain some of the key challenges facing the industry.

To conclude, despite healthy growth expected, Parag Milk Food’s IPO is richly valued, especially in relation to peers. All future financial upside seems to have already been priced in, leaving little room for growth.

Stretched valuations infer a clear advice towards NOT subscribing to this issue.

Disclosure: No interest