United Spirits Ltd. share price target

28 July 2020 United Spirits (UNSP) declared dismal 1QFY21 EBITDA/net loss (albeit lower than our expectations). Further, Premium & Above segment (P&A;) is likely to underperform (unlike previous years) leading to mix deterioration. Also, the full impact of the sharp excise hikes by various states would be felt 2QFY21 onwards. All these factors lead to weak earnings expectations though we do not expect EBITDA losses 2QFY21 onwards. Our DCF-based calculations and P/E multiples of 47x FY22E EPS indicate that valuations seem currently lofty given the uncertainty prevailing over earnings growth in the sector. We had downgraded the UNSP stock to due to rising concerns on the Alcobev sectors earnings growth in the COVID and immediate post-COVID era. After adjusting for one-time bulk Scotch sales last year, underlying net sales declined 51%. P&A; and Popular volumes declined 51.5% and 46.

UNSP's Q4FY20 was in-line but weak at operating level with volume decline of 13% YoY (P&A; 20%). Adjusted for one-off bulk sales, Revenue/ EBITDA/APAT were -14.8/-10.6/-28.2% YoY. Reported revenue/EBITDA/PAT were -11.4/-12.4/-14.6% YoY. Yet, UNSP's earnings print is impressive in backdrop of weak volume growth and decline in Gross margin of 433/220bps YoY/QoQ. Persistent cost controls in line-items below GP is enticing for second consecutive quarter. For perspective, below GP costs declined from...

1 June 2020 UNSPs 4QFY20 results were worse than expectations. If bulk scotch sales (that could be lumpy but not extraordinary) are excluded, then results would be even weaker. While UNSPs PAT CAGR for 5 years ending FY20 stood at 33%, FY21 and FY22E are likely to be the lost years for UNSP and other alcohol companies with negligible earnings growth. Impact of extremely sharp excise increases across states would only exacerbate the pressure on FY21 profitability. Further, we believe profitability is already sharply impacted by (a) the absence of any sales until 3 May, and (b) absence of sales from on-trade channel (20- 25% of sales), which is expected to last for a significantly large part of the year after the latest MHA guidelines. on UNSP on account of fair valuations. Standalone net sales declined 11.4% YoY to INR19.9b (v/s est. the one-off sale of bulk Scotch, declined 14.8%.

Increased technology in the delivery of alcohol brings a better experience for customer and also shifts consumer behaviour (more acquisition of new customers and lowering the social stigma attached to alcohol). Historically there had been 60-70000 outlets for liquor compared to a distribution reach of several millions for FMCG companies. E-commerce channel would help drive liquor penetration among the vast potential customer base in India. Expect normalisation of liquor sector from H2 onwards Post relaxation of lockdown, various state governments in light of stressed...

Diageo's global market leadership (17/40% share in spirits/scotch) and its dominance in premium segment drives our confidence on UNSP. India is a critical market for Diageo, given the scale (largest Whisky market), leadership position and opportunity to premiumise. UNSP's return to the premiumisation path (P&A revenue mix up 1180bps vs. FY17) aided by a deprioritisation of Popular. We remain believers in the co's ability to deliver consistent growth and benefit from the category expansion happening in the premium segments. UNSP posted healthy 8/3% rev/vol growth in P&A; in 3Q despite industry growth remaining sluggish (vol growth of 1.5/2.5% in 3Q/9M). Price hike and product mix has led to P&A; realisation growth of 5% (3% in 3QFY19 and -3% in 2QFY20). RM pressure continued and led to GM contraction of 421bps YoY to 44.4% (>400bps avg. dip in the last 4 qtrs). Co's sharp cost control initiatives continue to support EBITDA margin. We value UNSP on Dec-21E EPS, arriving at a TP of Rs 759. Maintain BUY.

28 January 2020 UNSP not only reported 8% sales growth in the Prestige & Above (P&A;) segment (mainly led by the return of mix improvement and despite a challenging base of 16% growth in 3QFY19), but also ended the quarter with healthy winter and Christmas/New Year eve sales. Despite significant pressure on the gross margin from ENA costs, the company (contrary to expectations of EBITDA margin pressure for FY20) reported ~120bp YoY operating margin improvement in 9MFY20 (adjusted for bulk scotch), including 210bp YoY expansion in 3QFY20. Premiumization trend returned with each sub-segment growing faster than the one beneath it. Despite significant gross margin compression, the EBITDA margin expanded operating costs and to a lesser extent by the lower marketing reinvestment rate (other expenses were down 390bp YoY, staff costs were down 150bp YoY and ad spends were down 100bp YoY).

Negative impact of raw material prices trimmed on EBITDA The management expects prices of key raw materials (ENA, glass) to have peaked off and do not expect further deterioration in gross margins from here on (contracted 421 bps to 44.4% in Q3FY20). Judicious management of employee and other overhead costs (by lowering bad debt provisions), lowered the impact of gross margin compression on the EBITDA front (grew 207 bps). The management has also actively de-prioritised in a few low margin products and in certain geographies (that exhibited higher cash...

1) USL's continued reliance on Pioneer Distilleries for raw materials: Pioneer Distilleries runs a zero pollution 160 KLPD ENA manufacturing plant (ENA from molasses: 100 KLPD and from grain: 60 KLPD), 12 KLPD malt spirit, 2 lakh cases per month bottling facility in Maharashtra. Other products include denatured spirit, commercial CO2 and other distillery by-products. The merger would ensure uninterrupted operations of PDL's plant and provide better nimbleness...

chase and sale of alcohol beverages. The company has a domestic as well as global operational presence. Through various tie up units and brand franchisee domestically and globally ,the company is engaged in producing, purchase and sale of beverage Alcohol (spirits and wines). There presence...

Diageo's global market leadership (17/40% share in spirits/scotch) and its dominance in premium segment drives our confidence on UNSP. India is a critical market for Diageo, given the scale (largest Whisky market), leadership position and opportunity to premiumise. UNSP's premiumisation journey is on track (P&A revenue mix up 800bps vs. FY17) supported by aggressive A&P spends and de-focus on popular brands (franchise model). Restructuring drive, richer product mix, WC efficiencies (80 days vs. 120 days in FY17) have led to strong FCF generation over the last 3 years (cumulative Rs 32bn). Thereby, co has been able to deleverage balance sheet (net debt is at Rs 25bn vs. 40bn in FY17). We expect more of the same over FY19-22E (Rs 33bn FCF generation and Rs 17bn debt repayment). UNSPs 2Q was weaker than expected. Liquor industry was impacted by slowdown, high base, flooding, liquidity stress in wholesale channel and stiff input costs. UNSPs restructuring drive is visible, supporting margins despite several headwinds. We believe UNSP will continue to tighten the screws on overheads and benefit from premiumisation. We cut EPS estimates by 4-5% to factor miss in 2Q and value UNSP on Sep-21E EPS, arriving at a TP of Rs 737. Maintain BUY.