Falling agriculture produce prices in an election year can lead to irrational decisions. The local dairy industry is staring at one. Some analysts fear that falling milk prices may force the government to intervene in the market.

Low prices will reduce the costs of milk-based value-added products makers. The expectation is reflected in the stock of Parag Milk Foods Ltd, which gained 23% in the last three months, compared to a 1.6% rise in the BSE 500 index. Last fiscal year, 66% of the company’s revenue came from value-added products.

The enthusiasm is not reflected in the shares of other dairy companies notably Heritage Foods Ltd, Hatsun Agro Product Ltd and Prabhat Dairy Ltd. The difference is these companies derive the majority of their revenues from commoditized products—liquid milk and milk powder combined.

Sure, the second set of companies’ vast procurement networks, processing centres and well- established brands are their competitive advantages and business drivers. But the current market situation will test them.

The worry is the current circumstances may put the companies in a tight spot. To obtain better realizations, farmers in some states are directly selling the milk to bulk consumers and same-day users (such as commercial eateries), says an analyst with a domestic broking firm. This not only threatens supplies but also hits the commercial or bulk business of the companies.

Concurrently, if state governments step in and ask the cooperatives to procure milk at higher prices, then the dairy companies will have no choice but to compete with them to maintain supplier relationships while protecting bulk consumers.

Of course, as the broking firm analyst cited above says, the price cuts by the organized sector did not last long in the recent past. Even then, given the weak demand conditions in overseas markets, companies will have to tread carefully.

According to Rabobank research, as production outstripped demand, inventories of skimmed milk powder reached record levels in India—50% more than normal stocking. Excess milk is stored in the form of skimmed milk powder. It is used in lean periods for producing milk or is exported. The dim export outlook, it is feared, will weigh on raw milk prices.

Dairy companies with a high share of branded consumer retail products can see good growth. Price declines are not anticipated for value-added dairy products. However, companies with high dependence on skimmed milk powder sales will face lower growth and pressure on margins, points out the report from Rabobank.

A report by Edelweiss Securities Ltd last year says that Parag Milk, Heritage Foods and Prabhat Dairy derive revenues from milk powder at varying levels. Given the diversified nature of the businesses, one cannot accurately gauge the impact. But if the situation worsens and the government intervenes, then the sector can see untoward consequences.

Source: Livemint