Please refer to important disclosures at the end of this report

Equity Research September 13, 2019 BSE Sensex: 37385

ICICI Securities Limited is the author and distributor of this report

Sector update

Heritage (BUY)

Hatsun (HOLD)

Dairy

Takeaways from FY19 annual report of GCMMF (Amul)

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Research Analysts:

Aniruddha Joshi anuruddha.joshi@icicisecurities.com +91 22 6637 7249

Manoj Menon manoj.menon@icicisecurities.com +91 22 6637 7209

INDIA

Amul’s revenue growth was back to teens (13.4%) in FY19 after reporting therevenue growth of just 8.1% in FY18, lowest in past decade. All consumerproducts reported double-digit growth and, we believe, Amul gained market sharein almost all its segments. The company has continued to strengthen its moats inthe business, such as 1) Amul brand and sub brands like EPIC, Kool, Amulya, andtru , 2) distribution network of 1mn outlets, 3) strong connect with 3.6mn farmers,and 4) 79 milk processing units pan-India. Management estimates the organisedindustry to move from 27% now to 40% in next decade. It also believes the nextwave of growth will be from ‘out of home’ consumption and Amul has takenmultiple initiatives to gain the share of next wave of growth.

Recovery in revenue growth: Amul has reported revenue growth of 13.4% in FY19.Its revenue growth of 8.1% in FY18 was the slowest. We note Amul’s revenue growthrecovered in FY19 due to 1) 174% growth in exports (largely SMP) and 2) healthygrowth of 10.6% in domestic business. Volume growth was 12% in FY19. Amul hasintroduced 101 new products in the past four years (two new launches every month).

Consumer products growing well: All value-added products of Amul have donewell in FY19. Revenue growth rates of key products were as follows: Cheese (17%),cream (34%), paneer (23%), curd (33%), buttermilk (27%), chocolates (69%), butter(14%) and ice cream (10%). Liquid milk (pouch) revenues were also up 5% YoY. Webelieve Amul has gained market share in most consumer products.

Investments in strengthening moat: Amul has continued to invest aggressively instrengthening the business moats: 1) Strong brand Amul, 2) network of 10,000distributors with 1mn retail outlets, and 3) strong relationships with 3.6mn dairyfarmers. Amul has increased milk procurement outside Gujarat to 12.9% in FY19from 8.2% in FY12. This will help reduce dependence on Gujarat and enable sale ofmore fresh products outside Gujarat. The company also has 79 milk processing unitspan-India. Multiple units have helped to reduce freight cost and sell liquid milk andfresh value-added products across India.

Management expects steady long-term growth: Amul has indicated only 27% ofdairy industry is organised. Amul believes, as a market leader, it is responsible toincrease the share to 40% in the coming decade. It also believes that with only 35%of Indian villages being covered under the dairy co-operative network, the promotionof dairy co-operatives is the key to enhance farmers’ income levels as well as drivegrowth of the organised sector.

Key financials of GCMMF (Amul) Year to March FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Revenues (Rsmn) 116,680 137,351 181,435 207,504 229,851 270,625 292,463 331,943 Growth (%) 19.4 17.7 32.1 14.4 10.8 17.7 8.1 13.5 EBITDA (Rsmn) 565 541 688 1,113 1,510 1,447 1,683 2,214 Growth (%) 43.4 (4.3) 27.3 61.8 35.7 (4.2) 16.3 31.5 PAT (Rsmn) 318 337 378 415 438 470 488 528 Growth (%) 16.2 5.8 12.3 9.9 5.4 7.4 3.7 8.3 EBITDA margin (%) 0.5 0.4 0.4 0.5 0.7 0.5 0.6 0.7 PAT margin (%) 0.3 0.2 0.2 0.2 0.2 0.2 0.2 0.2 RoE (%) 16.1 15.5 15.8 14.7 12.8 11.9 11.3 11.4 RoCE (%) 7.6 7.8 1.0 5.3 5.5 4.5 5.4 5.6

Source: Company data, I-Sec research

Dairy sector, September 13, 2019 ICICI Securities

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Takeaways - FY19 annual report of GCMMF (Amul)

Our analysis of the FY19 annual report of GCMMF (Amul) leads us to various interesting facts regarding 1) product-wise revenue growth rates, 2) efforts to strengthen the moats, and 3) management’s vision of long-term growth.

Revenue growth back in teens in FY19

After reporting the weakest revenue growth of 8.1% in FY18, Amul’s revenue growth is back in teens (13.4%) in FY19. It has reported revenue CAGR of 18.7% over FY07-19. Key reasons for higher revenue growth in FY19 were 1) 174% growth in exports (Mainly SMP) and 2) 10.6% growth in domestic business. The volume growth was 12% in FY19 indicating negligible price-led growth. The company has attributed its healthy growth to fresh products such as curd, buttermilk and paneer.

The company has introduced 101 new products in the past four years. (~two products every month).

Chart 1: Revenue growth back in teens in FY19

Source: Company data, I-Sec research

Product-wise revenue growth rates: We note all value-added products of Amul reported healthy growth rates (>10%) in FY19. The key product ‘liquid milk in pouches’ reported 5% YoY revenue growth. Fresh value-added products such as dahi (curd), buttermilk and paneer (cottage cheese) reported revenue growth of 33%, 27% and 23%, respectively.

Growth rates of other major dairy products were as follows: Cheese (17%), cream (34%), butter (14%), ice cream (10%) and chocolates (69%). Considering market as well as Amul growth rates, we believe, the company has gained market share in most of its segments.

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Table 1: Product-wise revenue growth rates, YoY Product FY18 FY19 Dairy commodities* (60.0) Cheese 26.0 17.0 Milk based beverages 38.5 Cream 34.0 34.0 Paneer 21.0 23.0 Dahi (curd) 26.0 33.0 Buttermilk 21.0 27.0 Liquid milk 12.0 5.0 Infant milk food 11.0 Dairy whitener 11.5 Butter 17.0 14.0 Ice cream 15.0 10.0 Chocolates 69.0

Source: Company, I-Sec research *SMP

Rising milk collection of Amul and increase in procurement prices

Amul has reported 10.8% CAGR in milk procurement over FY07-19 but milk procurement increased by 9.3% YoY in FY19. Interestingly, its milk procurement outside Gujarat, which was growing faster than milk procurement in Gujarat reported decline in FY19.

Milk procurement outside Gujarat declined 20%, YoY whereas milk procurement in Gujarat increased 15.6%, YoY.

The company’s milk procurement (fats) price has also declined from Rs705/kg in FY18 to Rs690 in FY19, indicating decline of 2.1%.

Chart 2: Rising milk procurement by Amul… Chart 3: …and higher milk procurement prices

Source: Company, I-Sec research

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Efforts to strengthen moats in the business

We note Amul is investing aggressively in creating and strengthening its competitive advantages. The company has created three sturdy moats as 1) brands, 2) distribution network, and 3) strong relationships with farmers. The company is also in the process to de-risk the business model by focusing on milk procurement outside Gujarat.

Table 2: Key moats in the dairy business created by Amul Moats Particulars

Brands

Amul - multiple milk & milk products Amulya - Dairy whitener Amulspray - Infant food Sagar – Ghee Amul Masti – Curd

Distribution network 10,000 distributors 1mn retailors across India

Milk procurement network 3.6mn farmers Milk processing plants 79 across India

Source: Company, I-Sec research

Healthy investments in brand building

Amul has continued to invest aggressively in brand building efforts. Its marketing spends have increased at CAGR of 16.3% over FY07-19. Amul spends 2-3% of net sales (~54% of gross profits) on brand building efforts.

Chart 4: Marketing spends as % of net sales Chart 5: Marketing spends as % of gross profits

Source: Company, I-Sec research

Stronger distribution network

Apart from investing in product portfolio, Amul has created a strong distribution network pan-India. It has 10,000 distributors which in turn cater to 1mn retail outlets. The company runs four separate distribution networks for:

Fresh products like milk, curd.

Products that require ambient temperatures such as ghee, cream.

Refrigerated products such as butter, cheese and chocolates.

Frozen products like ice cream.

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Plans to improve relationships with farmers

As direct milk procurement is the largest entry barrier/moat in the dairy industry, Amul has focused aggressively on expanding relationships with farmers. We note Amul procures milk from 3.6mn farmers across 18,559 villages. Apart from farmer education and awareness programmes, Amul has invested in two key initiatives to strengthen relationships with farmers. It provides organised animal feed as well as services of artificial insemination and veterinary care.

Amul’s animal feed division has reported CAGR of 8.5% over FY08-19. Amul has also resolved 4.3mn veterinary cases in FY19, up from 3.7mn in FY18.

Chart 6: Veterinary cases resolved by Amul Chart 7: Steady growth in animal feed sales

Source: Company, I-Sec research

Milk procurement outside Gujarat declined in FY19

In order to de-risk the business model as well as replicate the success in Gujarat, Amul has entered other states in India to procure milk. We note Amul’s milk procurement outside Gujarat was just 8.2% of total milk procurement in FY12. However, it has increased to 12.9% in FY19. Steady increase in milk procurement outside Gujarat will reduce the dependence on Gujarat and also help in selling more fresh products out of Gujarat.

However, we note with higher availability of milk in Gujarat as well as subsidy announcements by some states; Amul’s milk procurement outside Gujarat declined 20% in FY19 over FY18. We believe it to be a one-time issue and expect milk procurement outside Gujarat to grow FY20 onwards.

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Chart 8: Milk procurement* outside Gujarat

Source: Company, I-Sec research *Milk procured outside Gujarat/ Total milk procurement

Management outlook over long-term growth potential

Amul has indicated only 27% of dairy industry is organised. Amul believes, as a market leader, it has the responsibility to increase the share to 40% in the coming decade. It also believes that with only 35% of Indian villages being covered under the dairy co-operative network, the promotion of dairy co-operatives is the key to enhance farmers’ income levels as well as drive growth of the organised sector.

Launch of new products

Amul has introduced multiple new variants over the past four years. It has also introduced premium variants which will drive the overall realizations upwards. We also note the trend of creating sub-brands such as EPIC, tru, and Kool.

Table 4: Launch of new products

Segment Brand

Dairy Whitener Amul T-Special Dairy whitener

Milk Amul Buffalo milk with A2 protein, Amul Gold milk, Amul Camel milk

Ghee Amul cow ghee

Kulfi 8 variants (Rajasthani, Gulkandi, Kashmiri, Kathiawadi, Nawabi, Rajwadi, Ratnagiri, Amul Kulfi)

Curd Amul Meetha dahi, Amul Mishti Doi

Flavored milk 4 variants (Amul tru - Apple, Lychee, Mango, Orange)

Cake Amul cake magic

Roti softner Amul roti softner

Pizza Amul pizza

Chocolates Multiple variants

Irish drink Amul Irish drink

Cold coffee Amul Kool café (3 variants)

Pina Colada Amul Pina Colada

Milk shake Amul Milk shake (Vanilla variant)

Premium ready to drink milk Amul Good milk

Ice cream Multiple variants

Mithai (Indian sweets) Multiple variants Source: Company, I-Sec research

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Chart 9: Key financial ratios of GCMMF (Amul)

Source: Company, I-Sec research

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Table 7: Profit & loss statement (Rs mn)

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Gross Sales 97,825 116,767 137,520 181,715 207,809 230,170 271,016 292,618 331,943 Less: Excise Duty 84 87 168 280 304 319 392 155 - Net Sales 97,741 116,680 137,351 181,435 207,504 229,851 270,625 292,463 331,943 Growth (%) 22.2 19.4 17.7 32.1 14.4 10.8 17.7 8.1 13.5 Expenditure Cost of Goods Sold 93,230 111,395 130,558 173,120 197,732 219,043 258,198 279,116 316,447 Staff Cost 683 729 751 1,123 1,206 1,049 1,635 1,545 1,742 Manufacturing expenses 393 611 960 1,103 1,349 1,415 1,498 1,687 2,006 Marketing & selling expenses 2,486 2,843 3,816 4,512 5,142 5,914 6,913 7,429 8,378 Other Expenses 555 537 726 888 961 921 932 1,003 1,157 EBITDA 394 565 541 688 1,113 1,510 1,447 1,683 2,214 EBITDA margin (%) 0.4 0.5 0.4 0.4 0.5 0.7 0.5 0.6 0.7 Depreciation 251 407 361 659 799 871 883 944 1,248 EBIT 143 158 179 29 314 639 564 739 966 Interest Expense & Bank Exps 7 4 21 82 86 327 188 297 464 Other Income 240 305 341 629 406 355 340 307 297 Profit Before Tax 376 459 499 575 634 667 717 749 799 Income Taxes 102 140 162 197 218 230 246 262 271 Effective tax rate (%) 27.1 30.6 32.5 34.3 34.4 34.4 34.4 34.9 33.9 Profit After Tax 274 318 337 378 415 438 470 488 528

Source: Company data, I-Sec research

Table 8: Balance sheet (Rs mn)

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Sources of Funds Share Capital 1,000 1,000 1,000 1,000 1,500 1,900 2,401 2,401 2,401 Reserves and Surplus 930 1,095 1,279 1,504 1,692 1,855 1,983 2,111 2,638 Deferred Tax Liability (29) (34) (1) (4) (42) (87) (163) (119) (142) Net Worth 1,901 2,062 2,278 2,500 3,151 3,668 4,221 4,392 4,897 Secured Loans 72 90 157 1,042 4,282 10,338 4,708 11,369 12,236 Unsecured Loans - - - - 848 1,085 1,276 1,263 451 Total Loans 72 90 157 1,042 5,130 11,422 5,984 12,633 12,686 Total 1,973 2,152 2,435 3,542 8,281 15,090 10,205 17,024 17,583 Application of Funds Fixed Assets Gross Block 4,452 5,233 6,230 7,794 8,583 10,081 10,896 12,451 16,031 Less: Depreciation 3,006 3,389 3,715 4,158 4,832 5,646 6,487 7,343 8,582 Net Block 1,447 1,845 2,515 3,636 3,751 4,435 4,409 5,109 7,450 Capital WIP 99 68 164 38 76 573 499 1,832 135 Gross Block-Brand value 4,452 5,233 6,230 7,794 8,583 10,081 10,896 12,451 16,031 Other Investments 7 7 7 7 1,553 1,568 1,682 713 844 Current Assets 4,021 9,957 12,212 12,089 17,882 23,244 19,992 29,318 39,582 Inventories 2,668 5,345 8,693 4,412 9,069 11,898 10,414 14,448 16,208 Sundry Debtors 316 564 1,127 932 1,371 2,089 2,269 3,415 5,427 Cash & Bank Balances 963 3,848 1,894 6,267 3,474 3,848 4,753 6,937 8,840 Loans & Advances 74 200 498 478 3,968 5,409 2,555 4,518 9,107 Current Liabilities 3,601 9,725 12,463 12,229 14,982 14,730 16,377 19,948 30,428 Liabilities 3,266 9,311 12,064 11,805 14,605 14,296 15,854 19,420 30,143 Provisions 336 414 399 424 377 435 523 527 285 Net Current Assets 420 232 (251) (140) 2,900 8,514 3,615 9,371 9,154 Total 1,973 2,152 2,435 3,542 8,281 15,090 10,205 17,024 17,583

Source: Company data, I-Sec research

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Table 9: Cashflow statement (Rs mn)

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 OCF before W/C changes 496 684 717 930 1,205 1,210 1,268 1,582 1,704 W/c Changes (519) 3,050 (1,457) 4,365 (2,347) (3,106) 3,076 (1,287) 4,296 OCF After W/C Changes (23) 3,734 (740) 5,296 (1,142) (1,895) 4,344 294 6,000 Cash Flow from Investing Capital Expenditure (291) (779) (1,209) (1,759) (1,009) (2,107) (1,047) (3,148) (1,776) Disposal 2 1 78 102 18 10 20 37 2 Investments - - - - (1,600) (1,637) 2,499 (2,494) (3,778) Acquisitions - - - - - - - - - Net Cash used in Investing (289) (778) (1,131) (1,657) (2,591) (3,734) 1,473 (5,606) (5,553) Cash Flow from Financing Changes in Share Capital 250 0 0 0 500 400 500 - - Changes in Loans (13) 18 68 884 3,780 5,764 (5,614) 6,208 (51) Dividends & change in reserves (75) (90) (150) (150) (150) (213) (275) (341) (360) Net Cash used in Financing 162 (71) (82) 734 4,130 5,951 (5,389) 5,866 (412) Extraordinary Items - - - - - - - - - Changes in Cash & Equivalents (150) 2,884 (1,953) 4,373 398 322 429 555 36 Opening Cash & Equivalents 1,113 963 3,848 1,894 1,609 2,007 2,329 2,758 3,312 Closing Cash & Equivalents 963 3,848 1,894 6,267 2,007 2,329 2,758 3,312 3,348 Free Cash Flow (312) 2,956 (1,871) 3,639 (2,133) (3,992) 3,318 (2,817) 4,225

Source: Company data, I-Sec research

Table 10: Ratio analysis (Rs mn)

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Profitability Ratios (%) Gross margin 4.6 4.5 4.9 4.6 4.7 4.7 4.6 4.6 4.7 EBITDA Margin 0.4 0.5 0.4 0.4 0.5 0.7 0.5 0.6 0.7 EBIT Margin 0.1 0.1 0.1 0.0 0.2 0.3 0.2 0.3 0.3 PBT Margin 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.2 PAT Margin 0.3 0.3 0.2 0.2 0.2 0.2 0.2 0.2 0.2 Income Tax Rate 27.1 30.6 32.5 34.3 34.4 34.4 34.4 34.9 33.9 Excise Duty Rate 0.1 0.1 0.1 0.2 0.1 0.1 0.1 0.1 - RoE 16.1 16.1 15.5 15.8 14.7 12.8 11.9 11.3 11.4 RoCE 8.0 7.6 7.8 1.0 5.3 5.5 4.5 5.4 5.6 Growth rates (%) Revenues 22.2 19.4 17.7 32.1 14.4 10.8 17.7 8.1 13.5 EBITDA 0.7 43.4 (4.3) 27.3 61.8 35.7 (4.2) 16.3 31.5 PAT 14.7 16.2 5.8 12.3 9.9 5.4 7.4 3.7 8.3 Major Costs as % of Net Sales Cost of Goods Sold 95.4 95.5 95.1 95.4 95.3 95.3 95.4 95.4 95.3 Staff Cost 0.7 0.6 0.5 0.6 0.6 0.5 0.6 0.5 0.5 Manufacturing expenses 0.4 0.5 0.7 0.6 0.7 0.6 0.6 0.6 0.6 Marketing & selling expenses 2.5 2.4 2.8 2.5 2.5 2.6 2.6 2.5 2.5 Other Expenses 0.6 0.5 0.5 0.5 0.5 0.4 0.3 0.3 0.3 Turnover ratios (%) Debtors Turnover ratio 0.3 0.5 0.8 0.5 0.7 0.9 0.8 1.2 1.6 Current Liabilities Turnover Ratio 3.3 8.0 8.8 6.5 7.0 6.2 5.9 6.6 9.1 Inventory Turnover Ratio 2.7 4.6 6.3 2.4 4.4 5.2 3.8 4.9 4.9 Fixed Assets Turnover Ratio 1.6 1.6 2.0 2.0 1.8 2.2 1.8 2.4 2.3 Other ratios (%) Net debt/Equity (x) (0.5) (1.8) (0.8) (2.1) 0.5 2.1 0.3 1.3 0.8 FCF/EPS (114.0) 928.5 (555.8) 962.3 (513.3) (911.8) 705.4 (577.8) 800.5 OCF/Sales (0.0) 3.2 (0.5) 2.9 (0.6) (0.8) 1.6 0.1 1.8

Source: Company data, I-Sec research

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New I-Sec investment ratings (all ratings based on absolute return; All ratings and target price refers to 12-month performance horizon, unless mentioned otherwise)

BUY: >15% return; ADD: 5% to 15% return; HOLD: Negative 5% to Positive 5% return; REDUCE: Negative 5% to Negative 15% return; SELL: < negative 15% return

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