Revenue growth of the Indian dairy industry will be flat this fiscal because of weak sales of value-added products (VAP), a problem that got aggravated because of the Covid-19 pandemic-driven lockdown. The industry had logged a 10% compound annual growth rate (CAGR) in the past decade.

Sales of VAP like ice cream, cheese, flavoured milk, curd and yoghurt among others, which are more profitable than liquid milk and account for over a third of the organised dairy sector’s revenue, are expected to de-grow 2-3% this fiscal. That would reduce operating profitability by as much as 50-75 basis points (bps).

Further, a build-up of inventory – on account of 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 (revenue below Rs 500 crore).

The analysis is based on analysis of 65 CRISIL-rated dairies that account for slightly more than two-thirds of the Rs 1.5 lakh crore revenue of the organised 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 organised dairy segment’s revenue. Moreover, logistical challenges and apprehensions about consuming cold products (ice creams, flavoured milk and yoghurt) during the pandemic is impacting 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 lockdown has not affected the supply of milk since it is an essential product. Overall, therefore, milk sales should rise 3-4% this fiscal.

Says Sameer Charania, Director, CRISIL Ratings, “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, got 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 such excess milk into SMP. The upshot will be that year-end inventory could rise 14% after dropping sharply in March 2020, resulting in higher working capital needs.

Says Rahul Guha, Director, CRISIL Ratings, “While dairies reduce capital spending, tapered cash flows stemming from lower sales and higher working capital requirement will jack up short-term borrowings by ~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 ~4 times 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, assuming the pandemic abates. The duration of the pandemic, liquidity management and revival in VAP sales will be the monitorables in the road ahead.