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Dairy companies have raised milk selling prices by 8-10% in the past eight months due to sustained rise in milk procurement prices. Wholesale milk prices have increased both MoM and YoY. We note high global SMP prices (and INR depreciation), delayed onset of flush season as well as inflation in cattle feed prices are chief reasons for the higher milk prices. We model continued increase in milk procurement prices normalization of the consumption. Hence, we continue to factor contraction in dairy companies’ EBITDA margin by 75-125bps in FY23E. We believe dairy companies need to: (1) raise prices again in H2FY23, and (2) focus on increasing the share of Indian value-added products to protect their (the companies’) profitability. However, with higher inflation and likely better volumes (higher sales to HoReCa), revenue growth is likely to remain strong. Maintain BUY on Heritage Foods, Dodla Dairy, and HOLD on Hatsun Agro, Parag Milk Foods.

* Wholesale milk prices rising MoM and YoY: Pan-India wholesale milk prices have increased 8.1% YoY in Sep’22 so far. Milk prices in south India are up 6.1% YoY. Pan-India wholesale prices grew marginally by 1.2% MoM. We believe the rise in wholesale prices is attributable to: (1) inflation in animal feed prices, and (2) increasing consumption and late onset of flush season.

* Global SMP prices increased drastically: Though global SMP prices have corrected 21.3% from Mar’22 highs, they are still up 8.3% YoY in Sep’22. We believe the consequently attractive export opportunity may disturb the demand-supply equation in the domestic milk industry. INR depreciation also makes exports enticing.

* Higher crop prices are inflating animal feed prices: We note the prices of maize, wheat and soyabean are rising, which will lead to higher feed prices at the dairy farmer’s end. Hence, we expect farmers to pass on any further inflation in key raw materials via higher milk prices.

* Further price hikes are inevitable: All the dairy companies under our coverage have taken some price hikes (8-10%) in past eight months to protect their profitability. However, rising milk procurement prices still remain a key concern. We expect all dairy companies to take further price hikes in H2FY23E.

* Sector view and top picks: Considering the strong return ratios and growth potential, we remain positive on the dairy sector. We also expect migration from unorganised to organised sector to steadily generate value. Heritage Foods and Dodla Dairy are our top picks. Key risks: Higher-than-expected rise in milk prices, delay in price hikes, and irrational competition.

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