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Heritage Foods Limited Q2 FY2019 Earnings Conference Call

This is the verbatim transcript of Heritage Foods management call with analysts.

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This is the verbatim transcript of Heritage Foods management call with analysts.

Moderator: Ladies and gentlemen, good day and welcome to the Heritage Foods Limited Q2 FY2019 Post Results Conference Call, hosted by Sunidhi Securities & Finance Limited. As a reminder, all participant lines will be in the listen-only mode. There will be an opportunity for you to ask questions after the presentation concludes. Should you need assistance during the conference, please signal an operator by pressing “*” then “0” on your touchtone phone. Please note that this conference is being recorded. I now hand the conference over to Mr. Shailesh Kumar from Sunidhi Securities & Finance Limited. Thank you and over to you!

Shailesh Kumar: Good evening ladies and gentlemen, on behalf of Sunidhi Securities, I extend a very warm welcome to all of you on post results conference call of Heritage Foods Limited. Management side is being represented by Dr. M. Sambasiva Rao, President; Ms. Brahmani, Executive Director; Mr. A. Prabhakara Naidu, CFO; Mr. Samba Murthy, Head Dairy Division; and Mr. Umakanta Barik, Company Secretary. Dr. Rao will brief us about the quarterly performance and then we may proceed with question and answer session. Now I would like to invite Dr. Rao to take the proceedings from him. Over to you Dr. Rao!

M Sambasiva Rao: Good afternoon Mr. Shailesh. I welcome all the participants to the Q2 earnings call of Heritage Foods. I will be happy to clarify the questions, doubts, suggestions, take the suggestions from you as we proceed with the call. I also thank Sunidhi Securities for hosting this call.

Coming to the Q2 performance of Heritage Foods, at consolidated level we have achieved Rs.619 Crores of topline, which is almost flat compared to the Q2 of the previous financial year though we have achieved 5% growth in the sale of liquid milk in volume terms. In revenue terms, we were not showing any growth because of certain reasons like reduced realization from the milk and products and reduction in the sale of bulk commodities during

this period, which we had significant quantities in the previous year when we acquired the business from Reliance Dairy.

Coming to the EBITDA, for the Q2 we have achieved Rs.50 Crores compared to the Rs.22.76 Crores of the previous financial year Q2. There is a significant improvement at the EBITDA level. Similarly PBT level, we have achieved Rs.34.45 Crores compared to Rs.9.65 Crores of Q2 of the previous year. PAT Rs.21 Crores compared to Rs.7.4 Crores of the previous financial year. The margin expansion happened for several reasons including the lower farm gate prices of milk and efficient inventory management having balanced the procurement of milk and sales of milk in terms of volumes, minimize the commodity business during this quarter. Keeping in view the glut scenario in the country and also lower prices for the commodities like milk powder, ghee and butter, this has enabled us to improve the bottomline significantly. Consciously we have taken this call as the countries going through the glut situation we thought we would wait for the situation to alter till the time we maintain the volumes and improve the margins. The growth can be considered post the flush season, which is now commenced from October to it will go up to February, from March month we can expect revival of the demand in the market, some were sets in from

end of February in these parts.

Coming to the standalone business, which includes dairy and renewable energy segments, the achievement is Rs.612 Crores out of which Rs.611 Crores is from dairy and Rs.4 Crores is from the renewable energy after netting of the intersegment, the net is Rs.612 Crores. EBITDA level it is Rs.49 Crores the standalone compared to Rs.24 Crores of the previous

year Q2 and PBT level it is Rs.33.5 Crores this year compared to Rs.11 Crores of the last year Q2, PAT level is Rs.20 Crores at standalone level compared to Rs.8.8 Crores in the previous financial year.

Coming to the milk volumes in terms of procurement, we have maintained similar volumes like Q2 of last year, it is 13.37 lakh liters per day, sales volume there is a growth of 5% the previous year Q2 was 10.92 lakh liters per day and now it is 11.44 lakh liters per day. The value added products revenue wise, which was Rs.122 Crores in the previous year Q2 has gone up to Rs.142 Crores, which is a 16.5% growth.

Coming to production capacities, we have reported chilling capacities, companies having 18.71 lakh liters per day in own premises and 2.86 lakh liters in the lease premises.

Coming to the processing capacity, this 25.7 lakhs in own premises and 1 lakh liters in the co-packers and packing of milk it is 17.15 lakh liters in own premises and co-packers we have about 50000 liters per day, as of now we have franchisee managed Heritage parlors 1500.

Coming to the capex, we have incurred an expenditure of Rs.15 Crores during the Q2 and debt position as of September 30, 2018 is Rs.170 Crores long-term and Rs.10 Crores working capital total Rs.180 Crores, so now we open for the discussion. Thank you very much.

Moderator: Thank you very much Sir. We will now begin the question and answer session. We have the first question is from the line of Sameer Gupta from IIFL. Please go ahead.

Percy Panthaki: This is Percy Panthanki here. Sir my first question is on the procurement strategy and if I can just break that into two parts if I can understand what has happened in the past let us say last two to four years and then how this pertains to the medium-term let us say March
2020 so firstly I understand that the procurement has been affected by this Rs.4, Rs.5 extra that Telangana is giving to the government so if you could just explain over the last three years for example what has been the contribution of Telangana three years back, what it is today and that will give us a sense to calculate how much has our overall procurement effort

suffered due to that one factor and secondly let us say by March 2020 what kind of targets you have in terms of milk procurement per day and versus where we are today how is that gap going to be bridged from which geography, I understand you are now expanding into North and West, so is that account for the bigger part of the growth in procurement or do you plan a significant growth in procurement in the existing geographies as well, so that is my first question Sir?

M Sambasiva Rao: Yes I think it requires at least one hour of time to explain.

Percy Panthaki: Sure Sir.

M Sambasiva Rao: I will try to minimize the time because there would be many participants seeking information related to that aspect. I would be glad to share with you more details later on a call or a meet because this is a very, very important topic and it requires elaboration, otherwise you would not get full feel of what I am saying. Having said that our strategy is to grow closer to the markets wherever we are marketing the milk our procurement would be within 200 kilometers preferably 150 kilometers distance from the markets, so we are expanding into different markets, we localized the milk procurement in that particular geography so that consumers get fresh milk, we do not move the milk long distance because we have procurement capacity in one milk shed, we cannot take the milk to other milk shed,

one is a freshness issue, second is cost of logistics and third is perishability of its impact on the quality so when we are offering the consumers fresh and pure milk, out strategy is to procure within 150 to 200 kilometers of any market where we are setting up.

We also set up the packing stations milk processing and packing stations closer to the markets and the outskirts of towns like we have one near Bengaluru, one near Chennai, one near Hyderabad like that every market we set up a processing station move the milk from the villages to the chilling center first and from chilling centers to the packing station and to the markets that is a movement plan. Coming to the volume growth impact of the governmental interventions over a period of last five years or 10 years various governments in different states and the national level also do intervene with their policies for price support to the farmers from time-to-time, they will ask for one season, two seasons, three seasons, some states are continuing beyond that, so certain states like Karnataka, Telangana have come with support price mechanism recently Maharashtra also started in a partial way compared to these states and some states like Rajasthan, Haryana have also implemented, but they have withdrawn after the season changes so every year we evaluate the local milk sale price, milk procurement price including the state support price and we price our sale of milk and value added product accordingly so that we balance the procurement volume, sale volume and the margins accordingly, so wherever this Rs.5, Rs.4, Rs.2 different states have got different input as a support price to farmers there we have maneuvered our milk procurement in such a way that we do not deny the farmers who are working with Heritage for marketing their milk, but we do not expand new farmers and we do not go to the new localities in that state, we go to the neighbouring state and move milk.

Just to elaborate this point in Karnataka when this additional support price of Rs.4 was introduced we have minimized our milk procurement in Karnataka state, but continued the sale in Bengaluru to support the volumes of sale in Bengaluru, we have moved milk from neighbouring districts

of Andhra Pradesh and Tamil Nadu where the price was relatively manageable compared to the Karnataka price.

Similarly, in Telangana when the price of milk was supported by the state with Rs.4 per liter, we have stepped up our procurement in neighbouring districts of Andhra Pradesh and Maharashtra, supplement of the milk to Telangana, so our mixed milk cost average cost of the blended milk from different geographies is within the manageable level. Same way we have been doing in Delhi also we have the differential prices in Rajasthan, Haryana and Punjab where we procure milk and bring it to the nearby markets depending on the prices of that state, we step up or step down the volumes in the neighbouring states without same time cautioning without hurting the farmers interest in that area we will try to maneuver.

The balancing act of procuring milk from the different milk sheds and meeting the market requirements is what we have been doing, we continued

to do the same, our ambition, our vision is to reach 28 lakh liters of milk per day procurement and sale by 2022 and currently we are handling 15 lakh liters of milk per day, this has to be doubled by 2022.

This requires investments in the backend for procurement at village level, chilling center level and the packing station level, similarly investments in the front-end for the marketing infrastructure like chillers, freezers, coolers, parlors, etc., so this growth is backed up by the investments in the back and front end and of late we have also realized the need for improving our brand communication marketing activities for the last one-and-a-half year, we have stepped up our activities, so brand building has to happen

simultaneously to match this disposal of the milk along with the procurement, so I try to address the questions you have raised, but there is much more to talk about it, I will hold on here and share with you a more information when we get a chance to discuss.

Percy Panthaki: Sir just two data points if you can give, one is what is the current procurement percentage from Telangana and secondly what is the closer term target this 28 million liters is three to four years away let us say 12 months or 18 months down the line how much do you think you can ramp up the procurement?

M Sambasiva Rao: Our strategy is to have prorata growth, every year we grow on a same rate of growth except this year we have slowed down a bit, but we will be assessing our market requirements and meeting it if I have to give 15 lakh liters in four years’ time I have to do it 4 lakh liters per annum or 3 lakh liters per annum incremental increase and the growth in Telangana area is a function of growth in the sales if you are able to grow at a particular rate in Hyderabad city, matching rate of growth we will ensure in milk procurement and more probably we will not step off our procurement significantly, here will step up in the neighbouring districts of Maharashtra and Andhra Pradesh where the prices are advantageous plus Hyderabad requires more of buffalo milk compared to other markets and buffalo milk is available mostly in Andhra Pradesh and Telangana area milk is mixed with cow and buffalo, so we have to step up procurement where buffalo milk is available to meet Hyderabad demand. It is not a state specific procurement policy it is a consumer and market demand oriented procurement policy we will pursue.

Percy Panthaki: I have more questions, but I will come back in the queue. Thanks.

Moderator: Thank you. We have a next question from the line of Prashant Kutty from Sundaram Mutual Fund. Please go ahead.

Prashant Kutty: Thanks for the opportunity. Just on the procurement particles you said that this year kind of moderated the procurement requirement, but you also highlighted that while you are

probably reducing procurement from let us say regions like Telangana or Karnataka, but stepping up on the other regions, but should not that in that case lead to some increase in the procurement number?

M Sambasiva Rao: Yes it will increase in the procurement number. Earlier some milk we procured during this period we used to convert as milk powder, butter and ghee. It was also a reasonable business, but now those areas have created problem, lot of inventory sitting in the country I happen to attend meeting with Government of India recently on the dairy sector. We realize there is a huge inventory sitting even at the end of season when flush is commencing inventory levels are very high with many companies and cooperatives in the country, so we have consciously avoided that commodity business and milk converting into commodities and selling, therefore we have not stepped up the procurement, that element of commodity business is not taken up this year.

Prashant Kutty: The question when comes to the fact that you said that you are looking 28 lakh liters for 2022 and typically you had this target at the start of the year as well, so does it still remain prorata when you are probably looking at the next year, so let us say for example 15 to 28 is about 12 odd, 13 odd liters to be added that is roughly about 4 lakh liters, so would that 4 lakh liters be achieved in the next year I am just trying to understand from that angle?

M Sambasiva Rao: That is a plan, but it is subject to market conditions like this year, like this year also we have planned to step up procurement, but we did not because of the current scenario, so our plan is one, implementation period we will do that tweaking, so we wish to do that, but if situation like this we encounter we would like to moderate or we would like to step up. It is basically balancing the growth with margins.

Prashant Kutty: Here is there a case that if you look at this particular year while you said there obviously has been a challenge in procurement because of the inventory in the system, what as per your assessment would this inventory probably stay on till because you said right now flush is like kind of already started, so to your assessment should this kind of situation, which is currently there what is your best estimate as to how long could this last?

M Sambasiva Rao: Expectation is still the March month the situation would be more or less same till the summer sets in and the Government of India has come out recently to help the industry and cooperatives to liquidate the stocks. They have announced all of you must have read 20% as export incentive for the milk powder if anyone exports and all the industries started exporting for the last couple of months after this announcement came. Certain state governments like Gujarat and Maharashtra have also announced additional incentive of Rs.50 subsidy per kg of SMP exported from India. Combining these two 20% export incentive of Government of India and Rs.50 per kg export incentive of Gujarat and Maharashtra. Maharashtra gave one more decision of Rs.5 per liter of milk procured in
Maharashtra if it is converted and exported as powder is also available now. With combination of all this support measures expectation is inventory gets liquidated in the next few months, three to four months time and we have to see how it functions because there will be reaction from other exporting countries too. I have read in the news recently someone is trying to put investigation from WTO that government is not supposed to subsidize exports, so I am yet to hear the response from WTO side or Government of India side there was some news appeared that certain countries are opposing these policies and trying to make a trade dispute in the WTO forum. We have to see how the outcome would be, but as of now estimated these inventories gets liquidated in the next three, four months’

time.

Prashant Kutty: What is the inventory in the system left as of now?

M Sambasiva Rao: An estimate given at the end of September by the Government of India in the meeting was 2 lakh tonnes of SMP.

Prashant Kutty: It still stays over there?

M Sambasiva Rao: I think last couple of months 30,000, 40,000 tonnes must have gone out and we have a meeting on November 5, 2018 again with Government of India with industry they would tell us what is the latest position on next Monday we would be able to know much detail.

Prashant Kutty: Another thing, which you are speaking about was obviously looking at the non-south markets in terms of growth rates we are looking in markets like Delhi and Mumbai, those are the markets you are looking at from a sale perspective, could you give us some assessment in terms of how has the growth rates been over there in terms of the sales side of it because you are saying that there is still a bit of procurement versus sales gap over there, so could you just tell us what is the growth in those markets?

M Sambasiva Rao: We are yet to pickup in these two markets particularly Maharashtra had a massive glut this year, maximum problem of milk disposal by farmers was held in Maharashtra and later in Punjab, Haryana side. These two markets have been hit by surplus, so there is nothing

positive in that area.

Prashant Kutty: So there has been nothing much to look at?

M Sambasiva Rao: We do expect from the next season the growth to come back.

Prashant Kutty: Assuming that the growth comes back in the next season, more steady state sales volume number for milk what would that be as per your estimate?

M Sambasiva Rao: Can I elaborate?

Prashant Kutty: No, when I am asking is let us assuming a normalized scenario as far as milk is concerned and in terms of pricing as well as in terms of supply what is the steady state volume, which one can actually estimate?

M Sambasiva Rao: At a national level if you see the data published and discussed last three, four years the sale growth was 10% per annum year-on-year and production growth was 4%. In this year the report says it is 7.5% is production growth, sales growth was 3.5%, so the things have been

reversed in this year to some extent there is a modification. This is what change I am saying. We look for the change in the coming season.

Prashant Kutty: This ideally you think because in sales of 3.5 we still do about 5% volumes, so typically it is a little more reasonable assumption to make the things improve in the next year, you should be able to get back to that 8%, 10% kind of a number is that a right assumption?

M Sambasiva Rao: That was trend of the last five years that 10% was average growth and this year it is reversed. It is a kind of national scenario, which was highlighted by the central government in its recent discussions.

Prashant Kutty: Thank you and sorry for taking this long. Thank you very much. I will come back in the queue.

Moderator: Thank you. We have a next question from the line of Keyur Shah from Emkay Global. Please go ahead.

Keyur Shah: If you can tell me what will be your market share in your key markets or key states that you are present in?

M Sambasiva Rao: It varies from 10% to 12% in the markets where we are operating in south whereas in west and north we are not even visible it is too tiny to measure also. We just entered those markets.

Keyur Shah: That is it. Thank you very much. All the best.

Moderator: Thank you. We have the next question from the line of Sameer Gupta from IIFL. Please go ahead.

Sameer Gupta: Just wanted to understand the thought process behind deferring the decisions on expanding into new areas and just correct me if I am wrong, but my thought process is let us say if in Maharashtra there is a oversupply situation and farmers are really desperate to dispose off their milk at some reasonable price, would not that be the right time to enter the market because it is easier to build up a procurement in that kind of scenario versus let us say if there were a supply shortage and then to go into a geography and sort of take procurement with already existing strong players there at that point of time it would be more difficult versus it is right now?

M Sambasiva Rao: Yes your proposition is perfect in a normal condition, but there is a distortion in Maharashtra right now. I will try to explain the distortion why we are not able to expand in Maharashtra because of that distortion. Government of Maharashtra offered Rs.5 per liter as a state support to all cooperatives, all private companies procuring milk in Maharashtra subject to two conditions. Condition one company shall be Maharashtra Company so we have been eliminated because we are not Maharashtra company, Maharashtra company means it should be registered in Maharashtra, based in Maharashtra, so we do not get that

Rs.5 reimbursement which Maharashtra government is offering to milk procuring companies.

Sameer Gupta: Not possible to make a subsidiary or something registered in Maharashtra?

M Sambasiva Rao: Coming to that. Second one is the milk procured shall be used for conversion as milk powder not sold as liquid milk. If you sell milk as milk this Rs.5 would not be given, if you convert milk into powder you get Rs.5 and three, this is available for only three months and extendable to another three months, yesterday they extended for another three months. So it was introduced in July now it is extended up to February, so you cannot base your procurement strategy based on these ad hoc decisions, which are only aimed at certain activities like powder making and by Maharashtra companies, so we are waiting for this glad scenario. If I procure more milk now that Rs.5 Company has to pay it is not level playing field for heritage now to build volumes and where do I sell that I procure with Rs.5 more and I will end up making huge losses. The margin on milk is less than Rs.2 and you have to fund further against the additional volume, so therefore having taken note of all the conditionalities prevailing in the market and the schemes of government, we felt it is a big disadvantage to go forward at the moment and wait for the change of the situation that is why I said I will explain to you later. There are too many details are involved in these

decisions and actions.

Brahmani N: In addition to that, the whole ethos of the business is based on having a long-term relationship with the farmer, not is based on price, but based on several other activities that we do for them and going to a newer set of farmers temporarily this does not work out to sustain the relationship with them, etc. We do several other welfare activities that we have elaborated upon in the past, which requires a lot of time, a lot of investment, so for three months, six months, we cannot expand a procurement base because that it is not sustainable.

Sameer Gupta: Completely understand, Sir are there any such sort of market distortions in North India because another market you wanted to expand is Delhi, so is there similar situations around that also?

M Sambasiva Rao: They have come and gone. Punjab also had recently there was massive disruption, three days we could not even get milk. Rajasthan also we did not get milk for two days. They all shut that is called gaon bandh, so they did not give milk actually for two days at the village level. So the government have come and offered certain supports and then they have
relaxed, so they are happening in multiple states and it is not first time it is happening over a period of long time, but this year it is so happened many things got converged at the same point in time, so that has created the pressure because at a national level production and demand equation altered, high sale low production to high production low sale situation has

come.

Brahmani N: In addition to that Mr. Sameer, there is also this distortion that typically when there is high supply of milk a lot of organized players also come into the market and what they start doing is they start offering predatory pricing, a lot of promotions in the market, a lot of discounts, etc, which are very short term in nature. So again from a margin sustainability

point of view, etc., it does not make sense for us to be growing in a scenario like that wherein there are several small players temporarily in the market.

Sameer Gupta: Understood and in your core South Indian markets that three of our states that you are present in, is there any change in competitive intensity there or is it the same as it was a year or two back?

M Sambasiva Rao: More or less same players, same strategies, all are growing and all are aspiring to grow and demand is also growing, urbanization is happening at a rapid pace, so we do not see any

significant difference.

Sameer Gupta: Just one house-keeping question, if I omit the fat sales and look at only sort of non-commodity sales I believe this quarter your sales growth would have been around 8%. Now on the back of this 8% what would be the corresponding volume growth because there might have been a sort of decline in the realizations, so this 8% sales growth would

correspond to what volume growth?

M Sambasiva Rao: It would be around 10%.

Sameer Gupta: That is all from me. Thanks.

M Sambasiva Rao: We have value added product growth 16%, milk growth 5%.

Sameer Gupta: Right. These are value numbers right, I was just asking if what would be the volume numbers, so you are saying 10%?

Brahmani N: Specific in milk like we had mentioned earlier, there has been a volume growth of about 5%. In curd, which is basically a largest value added product, which has seen 24% increase last year same quarter to this year Q2.

Sameer Gupta: That is helpful.

Moderator: Thank you. We have the next question from the line of Nitin Gosar from Invesco Mutual Fund. Please go ahead.

Nitin Gosar: I just wanted to understand you mentioned that the national level data denotes that there is drop in milk demand what could be the reason behind that?

M Sambasiva Rao: I did not say drop.

Nitin Gosar: Sorry slowdown.

M Sambasiva Rao: There is a 3.5% increase in the sale whereas production growth was 7.5%.

Nitin Gosar: While historically the demand used to be around 8% to 10%?

M Sambasiva Rao: Yes, it was shown as 10% in the earlier years, now the demand growth is only 3.5%.

Nitin Gosar: The slowdown is specific to any particular state in geography or any particular event?

M Sambasiva Rao: No, details were given provided to us, it was just a broad guidance statement they were made.

Nitin Gosar: And Sir second question is pertaining to the payment terms, in these kinds of situations when the supply is excess, do companies have levers to negotiate on payment terms with the farmers or is it difficult to go on that level?

M Sambasiva Rao: Usually we are driven by the cooperative prices, they are the reference prices and they also reduced prices and we also reduced. It would not be kind of one to one negotiation point, it is a broad industry trend like you are paying Rs.25 per liter of cow milk in one district or one part and cooperatives reduced Rs.1 we also go by that Rs.1. So there would not be much difference in procurement price between brands more or less all have to pay the same price, it depends on some quality policies like heritage space a bit higher price for the high quality milk. We attract farmers who deliver high quality milk in the sense of fat and SNF content in the milk, so we give Rs.1 more, some people give Rs.1 less for the low quality
milk half a rupee less, some people give same price for more or less high quality, low quality, so the quality parameter measurement accuracy is important. We have introduced our electronic testers where accurate measurement is possible, therefore we are able to give differential prices for high quality milk, which has higher fat and SNF we give higher price, low quality milk we give low, so low quality milk does not come to us. So the farmers’ value for milk they typically see as a liter price, we see as a liter with quality parameters, so they ended up getting little more. Farmer gives milk to different companies, but he will realize the higher price from us as a value for milk not for the price of the milk. Price of the milk appears same liter is so much, but value per liter will be different depending on the

quality parameters, different brands pursue.

Nitin Gosar: As there are trade payables your balance sheet for the last two years, they note trade payables for the companies somewhere between 10 and 12 days, the trade payables are the terms of payment with the farmers do they change in this kind of situation?

M Sambasiva Rao: Their cycles are same like we have three types of cycles in certain states milk bills are paid once in 15 days, in certain states it is 10 days, in certain pocket cities 7 days, so we pursue three cycles, so 7 days, 10 days, 15 days, average is coming to 9 days.

Nitin Gosar: Got it. Perfect Sir. Thank you.

Moderator: Thank you. We have the next question from the line of Dhaval Mehta from ASK Investment Managers. Please go ahead.

Dhaval Mehta: Good evening team and thanks for the opportunity. My question is pertaining to the inventory on our balance sheet, so we have reduced inventory where on Rs.96 Crores compared to March quarter, so does it mean that we have liquidated all our SMP stock or we are still holding some amount of SMP stock?

M Sambasiva Rao: Most of it was liquidated and we did not build it in the season, typically what happens is one side liquidation happens other side production happens, this year production of these commodities is slowdown and existing stock was consumed as sold and we entered the

flush season with almost negligible stocks when we entered October 1, 2018 with flush season commencing our inventory was very thin, it may be two, three weeks kind of production only, so we will carry, we will get into the flush season with least of the inventories.

Dhaval Mehta: So even in lean season should we expect that the inventory will be thin or you are planning to build up the inventory during this flush season?

M Sambasiva Rao: We will build again from January or so, so that we require it in the summer, the need based build up will happen from January.

Samba Murthy: On an average, the inventory period is going to be around 15 days and trade receivable two days, trade payable nine days, working capital cycle is around eight days as of now.

Dhaval Mehta: Sir my second question is with respect to the state of Maharashtra if you see the state is sitting on a lot of SMP inventory and apart from that government is giving subsidy of Rs.5 at least for the next few months I do not know whether it will be again renewed for another three months till the elections, but at least for the next few months government is giving subsidy, so do not you expect it till the first season ends the state will be sitting on a lot of SMP inventory, which can impact the next year?

M Sambasiva Rao: Yes that is the scenario, but with the incentive of central government offering 20% export incentive and this Rs.5 support price the industry should be able to dispose to a great extent.

Dhaval Mehta: But somehow that is not happening right because in the last three months it was around 20000 to 30000 tonnes of inventory has been liquidated we are still setting on to the extents of inventory?

M Sambasiva Rao: Some of the industry members were sharing with me, because the other end importers and buyers have already tied up their stocks for this quarter. So their intake capacity in this quarter was less already they have commitments. For the next quarter, they would not have

made commitments, so this movement will happen quickly when the international trade realizes the price scenario.

Brahmani N: There is a certain shelf life for milk powder also, so it only makes sense that it will be liquidated within the time, given the fact that there are different subsidies available given by Government of India and various state governments.

Dhaval Mehta: Right I understand that we need to liquidate the inventory, but there has to be a buyer also at the other end right, so the reason why we are not liquidating because we are not getting the right price and there is no buyer at the other end, so do you think that a few of the cooperators

might help to write off the inventory once its perishable life is over?

M Sambasiva Rao: It is too difficult for me to respond, let us wait and see.

Dhaval Mehta: That is it from my side Sir. Thank you and all the very best.

Moderator: Thank you. We have the next question from the line of Anirudh Joshi from ICICI Securities. Please go ahead.

Anirudh Joshi: Yes Sir, just one question, so in case of SMP, I believe the profit margin is significantly lower than the milk business, so can you please share what was the indicative margin on SMP that we get and the margin on the milk business because I believe despite higher sales the margin has increased, so in the pure milk business the margin is significantly higher?

M Sambasiva Rao: Yes, see for us milk margin is around 7%, 8% EBITDA and value added products would be around 13%, 14%, that is the range 7% to 8% in the milk and 13% to 14% in the value added products. We do not have much of the milk powder sales and milk powder last one year was in a difficult situation, there was no margin at all and with this support coming from government there would be some possibility depending on the quality of the powder, leftover shelf life or balance shelf life of the stocks available, if shelf life is less obviously the stockholder has to sell at even a lower price get it consumed faster, so there margin scenario is difficult to say, but in the period prior to 2015 the margins were significantly high. When the global price of SMP was hovering around $4600, $4800 per tonne, currently it is half of it, so it is difficult to say how it would be in future. This has become a problematic commodity at the moment.

Anirudh Joshi: Thank you.

Moderator: Thank you. The next question is from the line of Sameer Kapadia from Rockstud Capital. Please go ahead.

Sameer Kapadia: Can you please share your strategy towards the value added products and what has been the progress in regards with the setting of your yogurt plant?

Brahmani N: Yes for the previous quarter Q2 we have seen a revenue growth as mentioned of 16% from value added products and volume growth is much higher than that especially in curd, we did about 285 tonnes per day on an average and going forward we have a clearly stated machine that we have to increase the contribution of revenues from value added products to 40% in the next five years, so we were working towards that. Every year we are seeing that we are increasing the contribution from value added products towards revenues by about 3%, so if you looked at the last quarter itself the contribution of revenue from value added products was about 23.3%, which was an increase compared to the previous year, which was at about 20.8%.

Even for the first six months or half year of the current financial year we have seen that the contribution from the value added products had increased from 23.8% last year to 26.5% in the current year, so we are moving in that direction, we have seen positive traction in value added products and the idea is to reach 40% in terms of revenue contribution and margins are also looking healthy. Now specifically related to the JV with Novandie, the French company it is 50:50 JV and we are progressing quite swiftly on the project, we have a team placed. We are also working on our marketing plan. As we speak we are also building our facility in Maharashtra in a place called Manor for making the JV products fruit and flavoured yogurt and we expect to launch the product anywhere in the first or second quarter of the next financial year, so working towards that plan and things are moving smoothly.

Sameer Kapadia: What is the capex for the same?

Brahmani N: Around Rs.15 to Rs.20 Crores is what we expect in terms of capex.

Sameer Kapadia: Are there any new products, which are lined up?

Brahmani N: Right now we are actually looking at fruit and flavoured yogurt as a new product line, but apart from that very recently we also started long shelf life milk processing facility and with a capacity of 1 lakh liters per day and we have it in different variance, difference sizes of SKUs and we are seeing very good traction in that particular product especially in remote areas such as villages where refrigeration is an issue. We are almost at 50% capacity utilization of a processing facility already, so that is another new product where we are seeing good traction going forward.

Sameer Kapadia: In regards to the recently launched ice cream brand how is the rollout happening in the other metro cities, can you throw some light on that as well?

Brahmani N: We are currently focusing on our existing markets because it is frozen product and we have a processing facility in Hyderabad, so our intention is to build our volumes and our brand in existing markets before we look at other markets.

Sameer Kapadia: Currently how many markets you are present?

Brahmani N: In the states of states of Karnataka, Telangana, Tamil Nadu, and Andhra Pradesh, these are the four states where we are present.

Sameer Kapadia: You are as of now holding back your strategy in regards with expanding into the other metro cities?

Brahmani N: Yes. That has been a stated strategy for ice cream and frozen desserts that we will only focus on these markets currently till we build our volumes to about 50000 liters per day and perhaps later we will look at other markets given the fact that we have to invest into back end, we have to invest into frozen cold chain and we have to be investing into freezers, etc. We will just stick with these markets for the next few years.

Sameer Kapadia: As of now what is the capacity at present you said you would be waiting up till 50000 liters per day?

Brahmani N: The capacity of our processing facility is 20000 liters per day.

Sameer Kapadia: Lastly any views in regards with your animal feed business?

M Sambasiva Rao: We have started one own cattle feed making plant a year back in AP that has come to about 50% capacity utilizations, it is a 6000 tonnes per month capacity and that plant will be utilized for meeting the market requirements of parts of AP, parts of Karnataka, and parts of Tamil Nadu the junction of Rayalaseema around and we are also now setting up second plant in the coastal Andhra Pradesh near Vijayawada to serve the needs of the coastal Andhra districts. That also is same capacity of 6000 tonnes per month. We hope to reach 50% capacity in one year’s time here also and keep growing till we get 10000 tonnes putting both the plants together.

Sameer Kapadia: That is it from my side. Thanks a lot.

Moderator: Thank you. We have the next question from the line of Prashant Kutty from Sundaram Mutual Fund.

Prashant Kutty: Thank you for the followup. Just a couple of book keeping first one was the curd value sales I am sorry I missed that number?

Samba Murthy: Rs.116.27 Crores out of Rs.142.68 Crores of value added products.

Prashant Kutty: Rs.116.27 Crores?

Samba Murthy: Rs.116.27 Crores curd sales.

Prashant Kutty: Basically the value growth is about 22% is that right number versus volume growth of 24%?

M Sambasiva Rao: 22% will be the value.

Prashant Kutty: The reason for asking this specifically Sir because until last quarter we had a very high value to volume difference that number seems to have bridged down right now if I am not wrong until the last quarter we were almost having a 16% value versus the 25% to 24% kind of a volume number that seems to have kind of bridged, have you reduced your promotions or anything to the extent, which has been done, which is why the value volume ratio has gotten reduced?

M Sambasiva Rao: There are certain promotions, schemes offered during this year to push the volumes.

Prashant Kutty: Has that gotten reduced now is what I am asking?

M Sambasiva Rao: It will continue for this season. We are in the heavy flush season and consumption of these products would come down in this season because of the lower temperatures.

Prashant Kutty: Just one more thing Sir over here. In terms of the other expenditure number any one off over there Sir because if I look at it is about 15% to 17% down YoY anything to call out over here Sir specifically?

M Sambasiva Rao: Marketing?

Prashant Kutty: Marketing has come down you are saying?

M Sambasiva Rao: Because last year we had some additional activities of silver jubilee celebrations, awards and engagements program and we altered the logo on brand. We did the repackaging, new art works, whole packaging was changed. Marketing in the sense it is not on the communication side it is on the brand rejuvenation, brand art work change, consultants were engaged for altering art works, etc. Lot of changes happened and celebrations and engagement activities we have done close to some 100 events we have conducted with the farmers and consumers and channel partners, so that expenditure is not there this year.

Prashant Kutty: This is a little more steady state number is that a right way to look at it?

M Sambasiva Rao: Yes right.

Prashant Kutty: Just one last thing Sir in terms of you just highlighted that your milk margins are about 7% to 8%. At this point of time Sir is it for the entire operations of the milk sales, which you sell right now, is that entire portion at 7% to 8% margins because we also have the acquired entity of Reliance?

M Sambasiva Rao: This is at company level.

Prashant Kutty: This at company level is 7% to 8% margins you are referring to right now?

M Sambasiva Rao: Yes.

Prashant Kutty: The reason for that clarification over here Sir if I look at my company level margins for the quarter it was about 7.9% and you said milk margins is about 7% to 8% whereas my value added is about 13% to 14%?

M Sambasiva Rao: There will be fat losses. We have another way of accounting fat that would erode.

Prashant Kutty: What would that be for the quarter Sir?

Samba Murthy: EBITDA loss on fat products is 10%.

Prashant Kutty: EBITDA loss is 10%?

Samba Murthy: On fat products yes.

Prashant Kutty: What was the quantum of fat loss?

Samba Murthy: For the quarter EBITDA loss is around Rs.4.8 Crores.

Prashant Kutty: This was how much last year?

Samba Murthy: Last year same quarter Rs.4.98 Crores.

Prashant Kutty: It is almost a similar number?

Samba Murthy: Yes.

Prashant Kutty: Thank you very much.

Moderator: Thank you. We have the next question from the line of Aditya Agarwal from Indgrowth Capital. Please go ahead.

Kunal Pawaskar: This is Kunal Pawaskar here. Thanks for taking the question. Sir I wanted a specific data point for another six months from today March end, the procurement number for per day lakh liters per day how much do you expect that to be with the challenges that the company

is facing in procurement?

M Sambasiva Rao: I failed to communicate to you. We have no challenge in procurement. We have been moderating our procurement to match the sales because this is an year of surplus year and any additional milk getting converted into commodities without being sold as milk or products is going to hit our bottomline, so we have not stepped up our volumes deliberately,

so we have no challenge at all and we have just entered the flush season.

There will be a natural growth of milk by about 10% to 15% during this period, which we would be getting like another one to one and a half lakh liters minimum will come like currently we are getting let us say 14 lakhs, it will go to 16 lakh liters in this half year. The procurement is not a challenge in the current market situations for the last few months.

Kunal Pawaskar: Sir second question was in earlier earnings call you had mentioned about the marketing efforts that you are doing, so the way you have described how, at a level below the Heritage Parlors how you were trying to get additional sales through you parlor network can you please comment on that and how that is working?

M Sambasiva Rao: Yes we have taken certain initiatives to bring in noncompeting products into the parlor food products particularly so that the sale of parlor increases footfalls increases and the income of franchisee goes up that was the concept. We have been able to bring close to 40 SKUs
from Future Consumer Limited, the FRL Group Company. They have placed all their products and a couple of other companies also local companies have put their eatable products, etc., the sales increase is yet to be felt, but we see the momentum taking place. It may take time because consumers have to understand these parlors are offering products beyond dairy, then the traction will come, but the supplies have been tied up and distribution is taken care, now the offtakes have to improve, it will happen in course of

time.

Kunal Pawaskar: Thank you Sir. That is all from mine.

Moderator: Thank you. We have the next question from the line of Shan from Edelweiss. Please go ahead.

Shraddha: Good evening this is Shraddha from Edelweiss. I just wanted to understand in terms of competitive intensity in your respective states, Sir as you said all India demand as per the latest data would be somewhere around 3.5% and we have approximately grown particularly in our state do we tend to continue to outperform that particular states production, will it be fair to say that our volumes or how is the competitive intensity because of this oversupply situation because in the earlier call you had somewhere

highlighted that unorganized players are also getting aggressive in this scenario?

M Sambasiva Rao: That fluctuations are there, certain pockets there is excess milk within the South certain pockets is moderate, certain pockets are normal, so where the excess milk production is there the loose milk is entering urban markets at a lower price point, so certain shift happened where such excess is not there, the growth is felt. Certain pockets we are growing in spite of all this, so certain areas where growth is 14%, in certain areas it is 4%, so it is very uneven and not explainable to you in a short call, so we will see the situation continuing to be same in the next two to three months also may be more clarity will emerge by the end of February and beginning of March.

Shraddha: In terms of capex plans earlier as we had highlighted we are looking at around Rs.120 Crores of annual capex and you said in this quarter we have done around Rs.50 Crores so with this kind of a situation are we still continuing with that for this year or are we scaling down the same?

M Sambasiva Rao: Our half year expenditure is close to Rs.50 Crores Q1 and Q2 and we do expect Rs.50 Crores capex in the next half year.

Shraddha: Lastly on Reliance Dairy if you can just talk about it how that has scaled up and how the EBIT level we are seeing the breakeven?

M Sambasiva Rao: In terms of business acquired from Reliance it has become two parts. One part is in the northern states like Delhi around five to six states, other part is in South where we have more or less subsumed into our operations in terms of procurements and packing stations and distribution routes, agents, etc., so here it got fully merged into the regular Heritage business. It has lost its traceability to acquire business methodology so it has helped us in adding about some 30000 to 40000 liters in South India. In the northern states where we have acquired, there some amount of exclusivity is there, so we have small quantity of Heritage business there. There the growth is yet to pick up because of the reasons we
discussed so far. In terms of losses we have significantly brought it down in the full year of last financial year it was around Rs.23 Crores of loss we have incurred at PBT level in the previous financial year from those operations. First half year it has come down to Rs.5.5 Crores this year that too because of the scaling down of the sales because of the conditions, but we do hope this also will be wiped out in the second half year or at least in the Q4. It is

on a low key in terms of losses and growth is also on a low pace and we have stabilized our packing stations as we explained earlier. We have acquired one facility near Chandigarh and that is up and running now exclusively for us and we have also expanded our facility in Haryana to meet our growth requirement. We have recently shifted our third party operations out of one facility Reliance has handed over to us to another facility, which is much closer to Jaipur and much, much better. This also will be stabilized in another one month’s time. We recently moved a week back into the new plant near Jaipur.

Shraddha: Annually Sir or rather on half year what is the sales we have done in Reliance Dairy as part of the business?

M Sambasiva Rao: That is what I said it has now got subsumed in certain parts of the country into our business. What is possible to look at is in northern states where the revenue is close to around Rs.80 Crores in those states itself, but another Rs.30 Crores to Rs.40 Crores would have got

merged into Heritage in this area where separate monitoring is not feasible now anymore.

Shraddha: This is on the North side you are talking right?

M Sambasiva Rao: North side close to Rs.80 Crores was the revenue in six months in those five to six states. South side would be and I am just guessing it is Rs.30 Crores to Rs.40 Crores, which got merged into the normal operations and we stopped tracking and that data goes into SAP as

Hyderabad operations or Chennai operations or Maharashtra operations where it is splitting only, but that could be the ballpark number Rs.30 Crores to Rs.40 Crores.

Shraddha: Sure Sir. Thank you so much.

Moderator: Thank you. We have the next question from the line of Shailesh Kumar from Sunidhi Securities. Please go ahead.

Shailesh Kumar: Thanks for the opportunity. Just a housekeeping question this Rs.100 Crores capex if you could provide me with the breakup of what capacities we are adding that would be helpful?

Brahmani N: About 2 lakh liters of the milk procurement gets added and about 1 lakh liters of the milk packing, about 50 tonnes of curd will be added, about 4000 liters to 5000 liters of ice cream facility gets added and flavoured milk we are adding about 15000 bottles per day, 3000 liters per day of flavoured milk, and about 5000 liters of lassi. Various products get added in different clients and some debottlenecking and also certain ISO requirements are there and environmental requirements are there, they also will be met from that effluent treatment plants and things like that boilers, generators.

Shailesh Kumar: That is it from my side Sir. Thank you.

Moderator: Thank you. As there are no further questions, I now hand the floor back to the management for closing comments.

M Sambasiva Rao: Thank you very much for the interest shown in Heritage and the suggestions given. Certain questions help us to think again on the strategies we have been following. Thank you one and all for the participations and thank you Sunidhi Securities once again for hosting this call and facilitating this discussion. Thank you very much.

Moderator: Thank you. On behalf of Sunidhi Securities & Finance Limited that concludes this conference. Thank you for joining us. You may now disconnect your lines.
First Published on Nov 27, 2018 01:53 pm
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