The industry had logged a 10% compound annual growth rate (CAGR) in the past decade.
Sales of VAP including ice cream, cheese, flavored milk, curd and yogurt, which are more profitable than liquid milk and account for more than a third of the organized dairy sector’s revenue, are expected to decline by 2-3% this fiscal, which would reduce operating profitability by as much as 50-75 basis points (bps).
CRISIL said a build-up of inventory due to surplus milk being converted to skimmed milk powder (SMP) and unsold VAP inventory will increase the working capital needs of dairies and test the liquidity of mid-sized ones.
The analysis is based on analysis of 65 CRISIL-rated dairies that account for slightly more than two-thirds of the revenue of the organized dairy segment, and assumes a return to normalcy in the second quarter.
The two-month-long closure of hotels and restaurants because of the nationwide lockdown halted institutional VAP sales, which account for almost 20% of the organized dairy segment’s revenue, CRISIL said.
It added that logistical challenges and apprehensions about consuming cold products (ice creams, flavored milk and yogurt) during the pandemic impacted sales in the first quarter, which is the peak-demand season.
However, steady liquid milk sales, comprising two-thirds of total industry sales, will prevent a bigger fall in revenue, the company said. The lockdown has not affected the supply of milk, since it is an essential product, and therefore it expects milk sales to rise 3-4% this fiscal.
Sameer Charania, director, CRISIL Ratings, said, “Steady demand for milk and higher VAP prices (hiked 10% in the second half of last fiscal) will help partially offset lower VAP volume, and arrest any decline in the dairy sector’s revenue. Further softer input prices will provide some respite and limit the fall in operating profitability to 50-75 basis points.”
The flush season (typically from October to March), which sees higher production, was extended by a couple of months, leading to oversupply of milk in April and May. Consequently, dairies, especially cooperatives that are better off in terms of liquidity and working capital, have converted excess milk into SMP. This means year-end inventory could rise 14% after dropping sharply in March 2020, resulting in higher working capital needs.
Rahul Guha, director, CRISIL Ratings, said, “While dairies reduce capital spending, tapered cash flows stemming from lower sales and higher working capital requirement will jack up short-term borrowings by about 20% this fiscal. While large dairies have better liquidity, mid-sized ones would feel the squeeze.”
Given higher debt and lower operating profitability, the average interest coverage ratio of the 65 CRISIL-rated dairies will touch a five-year low of this fiscal. Moderately-leveraged balance sheets will help absorb the drop in profitability and increased working capital debt.
Inherent sectoral resilience will ensure faster recovery in fiscal 2022, CRISIL said, assuming the pandemic abates. The duration of the pandemic, liquidity management and revival in VAP sales will be the monitorables in the road ahead, it noted.