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Alcoholic Beverages: Q2FY20 Preview - A weak quarter

Volume growth – Moderate demand and high base to impact volume growth

We expect Q2FY20E volume trend to moderate (from mid-to-high single digit to mid-single digit) after a weak Q1FY20 (election-led disruption), likely impacted by muted demand environment, adverse monsoons and a high base. We have factored in mid-single-digit volume growth (United Spirits (UNSP): 4%, Radico Khaitan: ~7%) for spirits players, driven by high single-digit to low double-digit growth in the Prestige & Above (P&A) segment while for United Breweries (UBL), we expect volume growth of ~3% for the quarter.

We attribute the expected qoq moderation in UNSP’s volume growth to a) weak demand scenario, b) liquidity issues in certain northern India markets, c) one-off supply disruption in scotch portfolio (BIO portfolio), and, d) channel disruption in AP/Telengana. We have factored in 4% volume growth (7% for P&A segment and flat for regular segment) for Q2FY20E.

For UBL, volume growth is likely to taper qoq due to weak consumer sentiment, adverse monsoons coupled with a high base (17% volume growth in Q2FY19). We believe while capacity constraint issues seen in Q1FY20 are now behind, adverse monsoons and gradual regaining of Q1 lost share have impacted performance in its key market, Karnataka. We estimate 3% volume growth for Q2FY20E.

ENA prices firm up further while prices of barley/glass remain stable qoq

We expect gross margins of spirits players to remain under pressure due to higher ENA prices. ENA prices, which were up by 10-11% yoy in Q1FY20, inched further in Q2FY20 and are now up ~5-6% qoq. Molasses-based ENA prices have been ruling higher than grain-based ENA. Further, the price hikes received over last few months are not enough to completely offset the impact of inflation in input costs.

For UNSP, input cost inflation and continued impact of absorption of excise duty in Maharashtra are likely to keep gross margins under pressure (estimated 260bps yoy decline in Q2FY20E). For Radico Khaitan, higher input costs (especially molasses-based ENA) will likely impact the company’s gross margin (330bps yoy decline in Q2FY20E) during the quarter.

UBL’s gross margin too is expected to remain under pressure due to inflation in barley prices (up ~15% yoy), higher glass prices and a high base. However, qoq input costs have remained stable, which coupled with better state mix compared to Q1FY20, could improve gross margin qoq (down 380bps yoy but up 150bps qoq in Q2FY20E).

Control on overheads unlikely to support EBITDA; corporate tax rate cut to aid PAT growth

Volume and thereby gross margin weakness have likely pushed alcoholic beverage players to keep a tight control on overhead costs. We estimate lower A&P spend for UNSP (~7.5% of sales compared with 9% in Q2FY19), with step up expected in the same in H2FY20E. We have factored in 200bps yoy EBITDA margin decline yoy, resulting in ~5% EBITDA decline for Q2FY20E.

For Radico, higher ENA prices and a weak mix will likely result in gross margin remaining lacklustre, causing EBITDA to decline ~2% yoy.

UBL’s EBITDA margin too is estimated to slide 410bps yoy, affected by lower gross margin and negative operating leverage, resulting in 14.5% yoy decline in EBITDA during the quarter.

PAT growth is likely to be higher for all the players, given the benefit of reduction in corporate tax rate (from 33-34% to 25.2%).

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Overall, we estimate Q2FY20E would be a weak quarter for alcoholic beverage players within our coverage, both on volume as well as operating front. From a medium to long-term perspective, UBL remains our top pick, as we believe near-term challenges are transient. For UNSP, we believe, consumption slowdown, uptick in ENA and rising competitive activity from Pernod Ricard provides limited scope for earnings upside.