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Lower procurement prices drive earnings growth

Three highlights from Q3FY21 earnings: (1) EBITDA margin expanded 790bps due to reduction in milk procurement prices. However, we expect milk procurement prices to rise in FY22 due to reopening of economy and higher global SMP prices, (2) revenue decline of 10% was largely attributable to consumers not returning to urban centres, extreme weather conditions and lower out-of-home consumption. Heritage lost revenues of ~7 days due to excess rainfall. Reopening of economy, lower covid cases and initiation of vaccination drive will steadily lead to higher revenues, and (3) the company has sold its stake in Future Retail, which will reduce its debt and interest cost in FY22. We model Heritage to report PAT CAGR of 49% over FY20-FY23 with improvement in core return ratios. Maintain BUY with a target price of Rs400 (10x FY23E).

* Revenue impacted due to reverse migration and extreme weather conditions: Heritage reported revenue decline of 10%, YoY. Liquid milk volume declined 13.7%. Decline in off-take is attributable to (1) consumers not yet returning to urban centres from their hometowns/ villages and (2) excess rainfall which impacted supply chain for ~7 days during the quarter. We believe Heritage generates ~15% revenues from HoReCa and institutions whose demand was also impacted during the quarter. Revenue of value-added products declined 12.6% due to (1) lower HoReCa sales and (2) reduction in out-of-home consumption.

* Lower input prices and better revenue drove margins upwards: EBITDA margin expanded 790bps, YoY, due to (1) carry-over of price hikes, (2) higher share of B2C sales and (3) lower procurement prices. Operating expenses and employee costs have largely reverted to pre-covid levels. PAT was up 220.1% YoY.

* Demand is expected to improve with opening up of educational institutes: We expect demand for milk and milk products to come back with families returning to urban centres with the opening up of educational institutes, lower number of covid cases and initiation of vaccination drive.

* Possibility of higher milk prices in Q1FY22: Milk procurement prices started declining post lockdown due to lower demand of milk. However, with reopening up of the economy as well as higher global SMP prices, we believe milk procurement prices will move upwards. Our channel checks also suggest that milk procurement prices have slightly increased in Dec’20-Jan’21. We have incorporated 200bps EBITDA margin decline in FY22 to factor in the likely impact of higher input prices.

* Retain BUY: We model Heritage to report revenue and PAT CAGRs of 7% and 49%, respectively, over FY20-FY23E. Core return ratios are expected to improve over the same timeframe. We have valued the stock as per DCF methodology at Rs400 (Implied P/E 10x FY23E).

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