Dodla Dairy IPO: Nothing much to milk

The retail portion of IPOs being oversubscribed much before other categories, is a typical example of retail investor behaviour in a bull market. The day 1 subscription numbers of the Dodla Dairy IPO is one such instance. However, if you are still waiting on the sidelines and are yet to make up your mind, here are reasons to skip the offer.

Fall in PAT & high valuation

Dodla Dairy processes and sells fluid milk as well as dairy-based value added products (VAPs) such as curd, buttermilk, lassi, flavoured milk and ghee. Over FY18-20 revenues grew 16 per cent to ₹2,139 crore. But during the same period, net profits dropped by 6.3 per cent (CAGR) to ₹49.8 crore. FY19 recorded the best operating margin of 7.7 per cent, while the other two years clocked 6 - 6.5 per cent. Debt to equity ratio stands at 0.17 as on Dec 31, 2020.

The company is raising ₹50 crore (fresh issue) to repay borrowings (₹32 crore) and for capex (₹7 crore), alongside an offer for sale from promoter/promoter group totalling ₹462-470 crore.

Jump in operating margin

What catches the eye is a huge jump of 14.5 per cent operating margin for the nine months ended December 2020 and ₹116 crore of profits clocked in this period, aided by tailwinds such as low milk procurement prices and high realisations from customers due to price increases effected. Factors such as negligible presence in modern trade channel (retail stores which VAPs are dependent on) and low institutional exposure (hotels, restaurants, caterers) also became a blessing for Dodla during Covid.

Also read: Dodla Dairy raises ₹156 cr from 18 anchor investors

Annualising the nine months earnings based on this performance values the issue 15 times its FY21 earnings, somewhat comparable to its peer, Heritage Foods. Parag Milk Foods which has higher focus on value added products, trades at over 50 times.

However, a question arises on the sustainability of this earnings. Though VAPs bring in higher margins than milk per se, its share at 27 per cent now, it is expected to go up to only a maximum of 30-32 per cent in the near term according to the management. Unlike premium products such as whey, cheese or even ice creams, curd constitutes 70-80 per cent of Dodla’s VAP basket. Hence margins are likely to revert to mean, sooner than later.

Also, the company particularly enjoyed low milk procurement prices as well as skimmed milk powder prices in FY21 due to supply glut arising from Covid-related closure of hotels and eateries as well as retail stores. This advantage may be fleeting.

Assuming FY20 to be a normal year, the company’s valuation shoots up to 47 times based on FY20 earnings. However, this year saw a rise in employee costs, interest and depreciation charges due to addition of new units, which depressed the earnings in comparison with FY19.

The company has negligible market share in VAPs across its key markets - the southern states. In milk, it has 11 per cent market share in Andhra, 9 per cent in Karnataka, and 3-4 per cent each in Tamil Nadu and Telangana in the organised sector, including co-operatives.

Investors can skip the offer and wait for sustainability of earnings before taking the plunge, considering the highly raw material intensive nature of the industry. Raw material to sales ratio for the company stands at 70-80 per cent, and it is similar across the industry.

Value added products bring high profitability but at the same time require capex which may weigh on the earnings from time to time. Despite earning 70 per cent of revenues from VAPs, Parag Milk Foods who’s IPO came out in 2016, clocks only single digit margins. It trades below its IPO price band of ₹220 -227 now. Prabhat Dairy which debuted a year prior to Parag, sold out its core business and delisted.