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Takeaways from Q2FY23: (1) Revenue growth of 6.9% YoY is largely price led and we believe volumes were flat YoY. Unprecedented and prolonged rains in South India also impacted procurement, (2) With higher milk procurement prices, Hatsun’s EBITDA margin declined 268bps YoY but we remain enthused with sequential recovery in margins. We believe the margins have bottomed out in H1FY23 and model recovery from H2FY23 and (3) Hatsun plans to incur capex of Rs4.5bn to expand manufacturing capacities. We model it to report PAT CAGR of 25.3% over FY22-24E with: (1) high single-digit growth in milk procurement, (2) commencement of three new plants and (3) higher share of value-added products. We remain structurally positive on Hatsun due to its competitive advantages and strong growth opportunity in South India. We cut our earnings estimates to factor in delayed price hikes and weak Q2FY23. We maintain HOLD rating with a revised DCF-based TP of Rs975 (implied 54x FY24E EPS; prior TP: Rs985

Q2FY23 performance:Hatsun reported revenue growth of 6.9% YoY in Q2FY23. However, EBITDA and adj. PAT declined 15.5% and 48.3% YoY, respectively. Considering the price hikes, we believe the volumes were flat YoY. Gross and EBITDA margins contracted 266bps and 268bps YoY, respectively. Effective tax rate was at 26.5% in Q2FY23. PAT margin was 2.4% (down 259bps YoY) in Q2FY23

Inflation continues to hurt margins: Higher milk procurement prices, packing material and logistics costs continued to hurt EBITDA margin of Hatsun. We believe correction in freight costs, commencement of flush season and pricing actions by the company at end of Q2FY23 will likely improve profitability. We believe profitability is largely bottomed out in H1FY23 and expect margin recovery from H2FY23 onwards.

Reduction in working capital investments: Inventory days declined to 79 in Q2FY23 from 116 in Q2FY22. While debtor days were stable at 2 days, creditor days decreased YoY to 36 in Q3FY22 (40 in Q2FY22). We note reduction in working capital is largely attributable to sale of skimmed milk powder accumulated in FY21-22.

Maintain HOLD: We model Hatsun to report PAT CAGR of 25.3% over FY22-24E with RoE > cost of capital. While we remain structurally positive on Hatsun due to its competitive advantages and strong growth opportunity in south India, we need more comfort on valuations. We maintain HOLD with a revised DCF-based TP of Rs975 (implied 54x of FY24E EPS). Key risks - Increase in milk procurement prices and/or increase in competitive pressures may result in lower earnings than estimated. Strong economic recovery is a key upside risk

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