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Strong results; stretched valuations

Key takeaways from Q2FY22: (1) Hatsun registered strong revenue growth of 23.2% YoY and we believe it is largely volume led, (2) steady launches of new products and geographical expansion of HAP outlets continued during the quarter and (3) EBITDA margin declined 180bps YoY due to higher input prices, increase in freight costs and likely increase in ad-spend. Hatsun is on track to complete its expansion at its three plants, which are likely to be completed during FY22. Power purchase agreements with Swelect will lead to cost savings. We model Hatsun to report PAT CAGR of 24% over FY21-24E with: (1) high single-digit growth in milk procurement, (2) commencement of three plants and (3) lower effective tax rate in FY22E. We remain structurally positive on Hatsun due to its competitive advantages and strong growth opportunity in South India. However, post 97% stock price performance in past six months, we downgrade the stock to HOLD with a DCF-based TP of Rs1,450 (66x FY24E).

* Q2FY22 performance: Hatsun reported revenue, EBITDA and PAT growth of 23.2%, 8.1% and 24.8%, respectively. Milk products and Others (Oyalo, Cattle feed, power) reported revenue growth of 24.7% and 9.7%, respectively. Gross and EBITDA margins declined 98bps and 180bps YoY, respectively. We believe freight costs and ad-spend would have increased due to higher diesel prices and normalization of ice cream sales. However, with reduction in effective tax rate, PAT was up 24.8% YoY.

* New launches and geographical expansion: The company has launched new ice cream variant – Neapolitan Bar, with three flavors in one bar. It is available across retail and HAP daily outlets. It has also rolled out chocolates in select outlets. In Q2FY22, Hatsun expanded its HAP daily outlets presence by opening outlets in Indore (MP) and Kharagpur (WB).

* Investment plans for FY22: Hatsun plans to invest Rs4.5bn in manufacturing facilities as well as sales and marketing for ice-cream, milk, curd, milk products and cattle feed during FY22.

* Increase in milk procurement prices in FY22E: We model milk procurement prices to increase in FY22 from lower levels of FY21 and H1FY22. Anticipating likely increase in milk procurement prices, Hatsun has accumulated large SMP inventory which can partially arrest EBITDA margin decline in FY22E. We also expect the company to raise selling prices as most co-operatives have raised prices.

* Downgrade to HOLD: We model Hatsun to report PAT CAGR of 24% over FY21- 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 downgrade the stock to HOLD post 97% stock price rally in past six months.

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