Management Speak: United Spirits (Neutral) - Navigating business and operating model changes
Key takeaways of our meeting with United Spirits (UNSP) management:
Impact from route to market (RTM) to recede in Q4FY18: The primary volume growth was impacted in 3QFY18 due to route market (RTM) changes (states moved to a corporation model as compared to private distribution earlier) in Haryana (which accounts for ~7-8% of volumes saw de-growth of 40-50% in 3QFY18), West Bengal and expected change in Punjab. As the management continues to focus on mitigating credit risk over sales risk, it expects the impact of the same to continue in 4QFY18, though at a relatively lower extent compared to 3QFY18.
Franchise benefits to accrue through March 2018: In the franchised states, UNSP has so far been focussed on maintaining profitability (and not chasing market share), thanks to the fixed income model of its franchise business. However, the company recently set up a team to track volume and market share metrics over the long term in its franchise markets to ensure salience of its brands. For the balance 10-15% of its popular business, which can potentially be franchised, the company continues to look for a credible franchise partner. In terms of franchising led cost savings, the overhead cost correction is complete and a leaner balance sheet will be visible in the FY18 annual results.
Lower molasses prices to benefit near term margins: Nearly one-third of UNSP’s IMFL (Indian made Foreign Liquor) portfolio is molasses based (it buys molasses-based ENA (Extra Neutral Alcohol) from UP, Maharashtra and Karnataka). As price of molasses has fallen sharply in UP compared to Maharashtra and Karnataka, we expect the benefit of the price decline to reflect positively in Q4FY18 gross margins. However, management has reiterated its guidance of mid-single digit inflation in ENA for FY19.
Valuations factor in strong growth outlook: UNSP has corrected 19% from its recent peak due to steep valuations and a tempered near-term revenue growth outlook. We remain positive on UNSP’s broader premiumization and return and margin-accretive growth strategy. However, muted near-term revenue growth outlook coupled with fair valuations at 27.5xFY20E EBITDA leave little room for upside from current levels. We await a better entry point to turn positive and maintain our Neutral rating on the stock.
United Spirits is engaged in the business of manufacture, purchase, sale and distribution of alcoholic beverages, mainly, whiskey, brandy and rum. Co. is the flagship company of the UB Group Spirits Business. Co. conducts its activities in the Indian Made Foreign Liquor (IMFL) industry segment through Tie-up manufacturing/brand franchise. Co. maintains a portfolio of 60 brands, sourced through its manufacturing network which comprises 12 owned distilleries and 27 contracted sources of supply. Co.'s brand names include, Black Dog, Single Malt, No. 1 McDowell's brandy, Caesar, Red Riband, White Mischief, Celebration XXX, Old Cask, etc.
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