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Is it time to sell dairy stocks?

The opening up of the economy had helped dairy companies log strong revenue growth in the April-June quarter. But the long-standing pressure on their profitability remained unabated.

Hatsun Agro, Heritage foods and Dodla Dairy reported annual revenue growth of 27-40% on strong demand. However, their respective EBITDA margins dropped by as much as 530 bps during the quarter.

The industry attributed the subdued bottom-line performance to the rise in milk procurement prices, elevated raw material and logistic costs.

Moreover, inflation in cattle feed and cyclical production shortages aggravated the underperformance, experts said.

According to Punit Patni, Research Analyst at Swastika Investmart, “The milk production cycle has not witnessed a normal season since 2015 mainly due to weather impacts like excessive floods or drought and other factors like fluctuating prices of skim-milk powder. Moreover, we expect the current high prices of milk to sustain due to high inflation in food commodities, fuel, and fodder.”

Against this backdrop, analysts remain cautious on the sector and believe that the investment strategy should be guided by a company’s procurement network, contribution from value-added products, and working capital intensity.

AK Prabhakar, Head of Research, IDBI Capital says margins in milk are extremely low. Milk-dependent firms can’t absorb price hikes. Investors should evaluate management strategy before buying and look for companies with higher market share and focus on value-added products.

Value-added products like paneer, cheese, frozen desserts and ice cream are commodities where the margins are generally higher, or in some cases, even double that of milk.

The industry has taken price hikes of 5-8% during the first half of 2022, but more price hikes in the second half are likely to follow, analysts said.

Dodla Dairy’s management, for instance, has said that it aims to mitigate rising raw material and freight prices by increasing its selling prices in the coming quarters. Overall, experts foresee margin pressures to linger in the near-term despite some respite with the onset of the flush season.

Today, US retail inflation numbers for July will determine the markets’ mood as Q1 corporate earnings enter their last leg.

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