FREE

Alcoholic Beverages Q1FY20 preview: Challenges persist

Volume growth - High base and election-led disruption to impact volume growth

Election-led disruption continued to impact volumes during Q1FY20 (especially April & May), with business activities of alcoholic beverage players normalising in June. We have factored in mid-to-high single-digit volume growth (UNSP: 6%, Radico Khaitan: 7%) for spirits players, largely driven by high single-digit growth in the Prestige & Above (P&A) segment and some recovery in the popular segment. United Breweries (UBL), we believe, could achieve 7% yoy volume growth during the quarter, supported by strong summers.

Price/mix benefit inadequate to offset the impact of continuing inflationary input cost trend

The input cost environment remains challenging for both spirits as well as beer players. For spirits players, gross margins are expected to remain under pressure on account of increase in glass prices (up ~15% in H2FY19, after price hikes given to glass players) as well as firming of ENA prices. ENA prices which were already up ~8% yoy in Q4FY19, further inched up in Q1FY20 and are up ~10-11% yoy. Both molasses-based ENA (on account of higher molasses prices) and grain-based ENA (on account of weak grain harvest) have seen uptick in prices. While alcoholic beverage players, have received price hikes in UP, MP, J&K and some eastern markets over last few months, overall hike at the portfolio level is in low single-digit and not enough to completely offset the impact of inflation in input costs.

For UNSP, apart from input cost inflation, weak price/mix in a key market like Maharashtra (impact of absorption of excise duty for the full quarter) is likely to keep gross margins under pressure. For Radico Khaitan, continued mix improvement with strong growth in the P&A segment will curtail the impact of higher input costs on gross margins.

UBL’s gross margin too is expected to remain under pressure due to inflation in barley prices (up 20%+ yoy) and higher glass prices. Further, the base quarter has high gross margin, on account of better raw material sourcing and lower BTL activities/discounting due to supply constraints in certain markets.

Tight control over overheads to curtail impact on EBITDA

Given the inflationary trend in input costs, we expect alcoholic beverage players to keep a tight control over other overheads. For UNSP, EBITDA performance is likely to be healthy, given the higher overhead costs in the base quarter - staff cost (one off restructuring cost of Rs360m in Q1FY19) and other expenses (one-time investment in IT/factory safety standards) have one offs in the base. The same will not reflect in Q1FY20. Further, A&P spend in the base quarter was high (~10.5% of sales on account of investments behind brands in IPL/FIFA) and the same is expected to be muted in Q1FY20. Given the high cost base, we expect 27% yoy EBITDA growth; adjusting for one off staff costs, EBITDA growth should be in mid-single digit during the quarter.

For Radico, A&P spend is unlikely to moderate yoy, given the brand investments behind new launches; hence, we have factored in flat EBITDA margin yoy, which works out to 10% yoy EBITDA growth in Q1FY20.

For UBL too, we expect EBITDA margin decline (of 80bps yoy) to be lower than gross margin decline (of 260bps yoy), led by tight control over other expenses and relatively lower ad spends. As a result, we estimate 7%/6% EBITDA/PAT growth yoy, respectively, during the quarter.

View

Alcoholic beverage players ended FY19 on a weak note, despite healthy growth in 9MFY19, as election-led disruption, moderation in consumer demand and a high base impacted volume growth. Additionally, higher input costs impacted overall margins and earnings growth in Q4FY19. While we do not expect a materially different Q1FY20E in terms of volume performance, tight control over other overheads could aid in some earnings recovery. Election impact is now behind us and premiumisation trends remain strong for the sector, but we remain cautious in the near term, considering the challenging demand environment and higher input costs. Price hikes in major markets would be a key monitorable. From a medium-long term perspective, UBL remains our top pick, given its superior volume growth visibility and continued improvement in return profile.