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Alcoholic Beverages: Q3FY20 Preview - Nothing to cheer

Volume growth muted – Demand environment remains challenging

We expect Q3FY20E volume trend to remain muted (low single digit), likely impacted by tough demand environment, liquidity challenges and disruption in certain markets due to nation-wide protests (Northeast and West Bengal markets).

In the spirits segments, we expect UNSP’s volumes to remain muted at mere ~2% yoy growth (mid-single digit growth in P&A segment and ~1% yoy decline in Popular segment). Volume growth for the quarter is likely to be impacted by a) Anti-CAA protests in India’s eastern markets, b) Liquidity challenges in the North markets, and, c) Company decision to de-prioritise low-profit popular brands in Karnataka, given the challenges in ENA availability. For Radico, we expect healthy volume trajectory to continue with double-digit growth in P&A segment and high single digit growth in popular segment.

We estimate ~4% volume growth for UBL for the quarter, with some recovery in Karnataka, Mumbai and Goa markets (impacted by adverse monsoon in Q2). This would be partially offset by disruption in eastern markets, Andhra Pradesh and a high base (16% volume growth in Q3FY19).

No signs of moderation in input costs, better price/mix to aid gross margins qoq

We expect gross margins of spirits players to remain under pressure, with ENA prices at levels similar to Q2FY20. ENA prices were up ~15-20% in H1FY20E. 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.

We estimate gross margins to decline yoy; however, with high input costs now starting to come in the base, the extent of contraction is likely to be lower compared to Q2FY20. Further, price/mix is likely to improve marginally, aiding qoq gross margins.

For UNSP, we estimate ~300bps yoy decline in gross margins in Q3FY20E. For Radico Khaitan, we have factored in ~100bps yoy decline in gross margins.

For UBL, we have factored in ~100bps yoy decline in gross margins due to inflation in barley (up ~11% yoy) and glass prices. However, on qoq basis, input costs have remained stable, which, coupled with better state mix should support gross margins.

Control on overheads to support EBITDA for spirits players, margin pressure for UBL to continue

We believe UNSP will continue to have tight control over staff costs and other expenses. While A&P spends might increase compared to H1FY20, we expect the same to be lower yoy, further aiding operating performance in Q3. We have factored in 170bps yoy EBITDA margin expansion, resulting in ~14% yoy EBITDA growth for Q3FY20E. For Radico, higher ENA prices will likely result in gross margin remaining lacklustre, resulting in EBITDA growth of ~4% yoy.

UBL’s EBITDA margin too is estimated to slide ~500bps yoy, affected by lower gross margin, higher staff costs (due to addition of capacities) and other expenses (negative operating leverage and higher taxes), resulting in 27% yoy decline in EBITDA during the quarter.

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Overall, we estimate Q3FY20E would be a weak quarter for alcoholic beverage players within our coverage, with volume growth remaining subdued and input cost pressures unabating. From a medium to long-term perspective, UBL remains our top pick, as we believe near-term challenges are transient. For UNSP, while the stock has corrected ~10% post Q2 results, we would await volume recovery and input cost moderation to change our Neutral stance on the stock.