A sharp reduction in skimmed milk powder (SMP) inventories and a slowdown in milk supply – which would lead  to a Rs 1-2 per litre increase in the domestic prices of milk over the next few quarters – are expected to improve the dairy sector’s operating profitability by 30-40 basis points next fiscal.

SMP inventories had begun reducing because of subsidy on exports offered by the government in the second half of fiscal 2019.

The dairy sector had a muted outing over the past two years due to flattish milk prices since June 2017, which was when the last price increase of Rs 1 per litre happened. Nevertheless, farm gate prices remained firm during this period.

Besides, the sector has been facing pressure because of weak global SMP prices and higher milk production in India, which has led to accumulation of inventories. To support, the central government announced a subsidy of 10% on export prices, while two major milk-producing states – Maharashtra and Gujarat – announced additional subsidy of about Rs 50 per kg of SMP for 6 months from July 2018.

Says Anuj Sethi, Senior Director, CRISIL Ratings, “The impact was immediately visible in the form of higher average monthly SMP exports of nearly 5,000 tonne between September and December 2018, a ten-fold increase compared with the same period in 2017.”

CRISIL has ratings outstanding on the debt of ~100 dairies, which account for ~60% of the organised dairy sector’s revenue.

Since January 2019, SMP prices have risen ~20% globally, from an average ~2,000 USD per tonne over the past two years, which has changed the dynamics of the dairy industry. The rise is attributed to a deceleration in global production leading to a correction in the demand-supply dynamics.

Consequently, CRISIL expects the current momentum in exports to sustain for another 2-3 quarters, allowing Indian dairies to liquidate their SMP inventory, which had surged over the past two fiscals. CRISIL believes a ~25% reduction in inventory is likely by March 2020 from ~3 lakh tonne at the end of March 2018.

Further, CRISIL expects domestic milk production to grow slower at 3-4% in fiscal 2020, compared with a compound annual growth rate of 6.5% in three fiscals through 2018. That’s largely because of lower investments in cattle – amid rising maintenance costs – by farmers, and no correction in farm gate prices. This constrained returns and led to lower cattle availability.

Consumption, however, will continue to grow at 6-7% annually, enabling dairies to raise milk prices.

Says Poonam Upadhyay, Associate Director, CRISIL Ratings, “Higher milk realisations and better profitability in fiscal 2020 will also bolster cash flows. Besides, falling SMP inventories will also ease working capital requirements, lower balance sheet pressure, and support credit profiles of dairy firms.”