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Hatsun’s Q4FY23 gross margin of 26.8% was lowest in past 24 quarters. Higher milk procurement led by lumpy skin disease, muted flush season and intense summer have impacted the margins. However, we model the inflation in milk procurement prices to moderate by H2FY24 with ~30% correction in global SMP prices and flat cattle feed prices. The margins have likely bottomed out in our view and we model recovery in H2FY24. Strong recovery in ice cream sales is also expected to be margin accretive.

We cut FY24-25 earnings estimates to factor in higher milk procurement prices. We model strong earnings recovery over FY24-25 post cyclically weak FY23. We model EBITDA CAGR of 25.5% over FY23-25 with: (1) high single-digit growth in milk procurement, (2) better utilization of three new plants (3) higher share of value-added products especially single-serve ice creams and (4) correction in milk procurement prices. We remain structurally positive on Hatsun due to its competitive advantages and growth opportunity in South India. Maintain HOLD rating with a revised DCF-based TP of Rs880 (45x FY25E; prior TP: Rs931).

* Q4FY23 performance: Hatsun reported revenue growth of 10% YoY but EBITDA and PAT declined 1.6% and 28.5%, respectively. Volumes have likely remained flat in our view. While gross margin declined 305bps YoY, lower other expenditure as % of sales (likely lower ad-spend) arrested EBITDA contraction to 104bps.

* Higher milk procurement prices and muted flush season: The flush season (OctFeb each year) was impacted in FY23 due to the impact of lumpy skin disease, prolonged monsoon and delayed winter. It has resulted in lower milk production and higher milk procurement prices.

* Recovery in H2FY24: Considering ~30% correction in global SMP prices and flattish cattle feed prices, we model the milk procurement prices to stabilize by H2FY24 and the EBITDA margin to recover. However, we believe the milk procurement prices are likely to remain at elevated levels in H1FY24 and may continue to hurt in H1FY24.

* Strong recovery in ice cream sales: From our channel checks, we understand there is strong recovery in ice cream sales in CY23 due to (1) intense summer, (2) commencement of ice cream plant at Govindapur, Andhra Pradesh and (3) favorable base. We model higher revenue share of ice cream to be margin accretive.

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