by Suhani Adilabadkar

Varun Beverages (VBL) reported a more than 50% jump in net profit in the March quarter, but the scrip fell as the street wasn’t impressed with the bottom-line, which was supported by a tax write back, while seeing weak volume growth. Though the Q1CY20 setback seems to have been repaired, VBL stock has still lost more than 20% in share price since early March. 

A key player in Indian beverage industry and one of the largest franchisees of PepsiCo in the world (outside USA), Varun Beverages Ltd manufactures and distributes wide range of carbonated and non-carbonated drinks sold under Pepsi trademark, namely Pepsi, Seven-Up, Mirinda, Mountain Dew, Sting, Gatorade, Nimbooz masala soda and Slice in the carbonated soft drinks category along with wide range of Tropicana juices, dairy beverages and the Aquafina brand of packaged drinking water. Associated with PepsiCo since the 1990s, VBL operates across 27 States and 7 Union Territories in India as well as in Nepal, Sri Lanka, Morocco, Zambia and Zimbabwe.

Quick Takes

• VBL reported operating revenues of Rs. 1,676 crore rising 23% YoY with volume growth of 26% YoY at 114 million units in March quarter CY20.

• Operating profit growth moved 24% north from Rs. 218 crore in Q1CY19 to Rs. 271 crore in March quarter CY20.

• Product mix constituted 67% of colas, 7% juices and packaged drinking water at 26% of total sales volumes for March quarter CY20.

• The company has introduced value-added dairy beverages under the ‘Cream Bell’ brand in Q3CY19. 

March Quarter CY20 saw both exceptional items and tax writeback

VBL reported operating revenues of Rs. 1,676 crore in Q1CY20 against Rs. 1,359 crore in the same period previous year, rising 23% YoY aided by south and west territories consolidation. Volume growth was 26% YoY at 114 million units in March quarter CY20 against 90.3 million units corresponding quarter, previous year. Organic volumes for the March quarter declined by 13.7% in India and 9.3% on a consolidated basis due to Covid-19 lockdown restrictions. 

Operating profit growth grew 24% from Rs. 218 crore in Q1CY19 to Rs. 271 crore in March quarter CY20.  Operating margin came out at 16.2% expanding 10 basis points YoY in Q1CY20.

PBT was impacted by exceptional items of Rs. 66 crore during the quarter representing provision for impairment in the value of plant and equipment, glass bottles and plastic shells declining to Rs. 8 crore in March quarter CY20 against Rs. 62.5 crore in the same period last year. Supported by a tax write back of Rs. 52 crore, PAT stood at Rs. 60 crore in Q1CY20 compared to Rs. 40 crore in the corresponding March quarter last year. 

PepsiCo has steadily opened up more territory to VBL

VBL has a unique and agile business model, procuring raw material (concentrate) from Pepsi, manufacturing, bottling, packaging and managing the complete supply chain process while brand development and consumer marketing is done by PepsiCo. PepsiCo takes a specific percentage of net realization which has been standard for the last 25-30 years. Thus, with increasing prices of products, value accruing to PepsiCo has increased, though the percentage has remained constant. 

Over the past 28 years, this strategic association has resulted in VBL accounting for more than 80% of PepsiCo’s beverage sales volume in India with VBL’s sales volumes growing at a CAGR of 19.7% over the past four years (2015-19). In addition to this, revenue, PAT and EBITDA have grown at a CAGR of 21%, 53% and 23% over the past four years.  

Exhibiting faith in VBL management, PepsiCo has been divesting its sub territories in past few years, Delhi in 2013, Madhya Pradesh and Orissa in 2017, Jharkhand, Chhattisgarh and Bihar in 2018 covering north and eastern regions. Last year, the company covered south and western regions, Gujarat, Maharashtra, Karnataka, Telangana, Andhra Pradesh, Kerala, Tamil Nadu and five union territories and also prolonging its existing bottling agreement for a period of 20 years. Indian Subcontinent (India, Sri Lanka, Nepal) contributes about 85% to VBL’s total revenue mix and remaining 15% is from Morocco, Zambia, Zimbabwe with international business which grew 34% YoY in CY19. 

For the company as a whole as well, CY 2019 was a strong year with revenue growth of 40% and PAT rising by 58% YoY. According to VBL management, growth has been driven by under-penetrated sub-territories acquired in CY18 and 19 and expansion in rural markets with the improving power situation. Rural regions contribute roughly 30% of volumes, semi urban 20% and remaining 50% from urban areas. Product mix for VBL constituted 67% of colas, 7% juices and packaged drinking water at 26% of total sales volumes for the March quarter CY20. On the basis of realisation, juices score the highest realization followed by carbonated drinks and water. 

Gauging changing customer preference, the company is moving towards a healthier product mix and launched ambient temperature and value-added dairy beverages, under the ‘Cream Bell’ brand across three variants of Belgium Chocolate, Cold Coffee and Mango Shake in Q3CY19. Juice segment will also have a higher proportion with initiation of Pathankot facility in December quarter CY19.

Mr. Ravi Jaipuria, Chairman, Varun Beverages said, “The production has just recently started in the last quarter, last year and we expect full utilization of the plant this year”. The management is expecting asset turn between 1.9 to 2, which will further go on full capacity utilization expected in CY20. Pathankot facility is being equally used for juices and CSD along with recently launched dairy products. 

Covid-19 cooled scorching summers for VBL

January and February recorded 14% and 42% growth which later dwindled to negative 31% in the month of March. However, the June quarter will exhibit higher effects of Covid-19 as the company’s manufacturing facilities were completely shut for 15-20 days in the month of April. Though most of its facilities are back in action since May, the utilisation levels are low under essential commodities category. 

The June quarter typically accounts for about 40% of total annual sales for VBL. Speaking with respect to Covid-19 impact, Mr Jaipuria clarified, “We are in reasonably good shape and as markets are opening up, I don’t think people are shying away from having cold drinks. And as demand is improving on a day to day basis, volumes are going up and if we continue like this with Government opening territories and with additional margins as raw material prices are cheaper, we will not be in bad shape”. He further reiterated that the company is able to reach most of its distributors except in completely sealed red zones. 

VBL’s distribution network mainly comprises  kirana stores making up 70-75% of its volumes followed by 10% institutional sales (hotels, cafes, restaurants) and the remaining balance through modern retail. In the near term, the current situation looks challenging (especially keeping in mind the exodus by working class migrants from cities, a percentage of which would be working in these kirana stores and stalls).But recovery will be faster as CSD and juices are low value discretionary products and sales volumes will improve as lockdown restrictions are gradually eased. With respect to long term, strong growth potential is intact with full utilization of Pathankot facility in CY 2020, product mix change towards higher realization products, juices and dairy products, lower raw material costs, south and west sub territories contributing fully in the next 2-3 years, strong cash flows and robust international business.