Company update: Radico Khaitan (Outperformer) - Accelerating growth trajectory!

We believe Radico Khaitan (RKL) is at the cusp of a strong and sustained earnings growth trajectory over the next 3 years. A normalized growth environment, accelerated innovations and price increases in key states will result in Indian-made foreign liquor (IMFL) revenues posting 10.3% CAGR over FY17-20E, in our view. The benefit of price increases, benign Extra Neutral Spirit (ENA) prices and falling molasses prices will benefit EBITDA margins and we estimate a 290bp margin improvement to 15.5% over FY17-FY20E. We have upgraded earnings by 12%/9%7% for FY18/19/20E to factor in higher margins. Improving operating cash flows, stable working capital and no significant capex requirements will aid the company in reducing its debt by Rs3bn by FY20E, enabling 30% interest cost reduction over FY17-20E. We believe RKL’s strong 27% earnings trajectory over FY17-20E will narrow the company’s 60% valuation discount to market leader, United Spirits, on EV/EBITDA basis. We maintain Outperformer rating on RKL with a revised target price of Rs405.

Revenue growth to pick up: We estimate RKL’s IMFL volumes to register 5.6% CAGR over FY17-20E on the back of a normalized environment post GST, highway ban and demonetization. Price increases in key states and continued benefits from premiumisation will aid RKL’s organic revenues at 8% CAGR over FY17-20E. Successful product launches in the prestige and above segment can add to the revenue growth momentum, going forward.

Multiple margin expansion levers: We expect a boost in RKL’s profitability backed by price increases in key southern states in last 6 months (~45% of IMFL volumes), 75-80% crash in molasses prices over last 2 months and benign ENA prices. As a result we expect 290bp rise in EBITDA margin over FY17-20E. There is further room for upgrade to our EBITDA estimates if molasses prices stay at lower levels.

Debt reduction on track; Earnings estimates upgraded: We expect Rs3bn debt and 30% interest cost reduction over FY17-20E, and estimate 27% earnings CAGR and 540bp RoCE improvement over FY17-20E. The company’s improving financials will help narrow RKL’s steep 60% discount to market leader United Spirits (UNSP). We value RKL at 18xFY20E EBITDA; maintain Outperformer with a revised target price of Rs405. Key risk to our call is any adverse regulatory action for the alcoholic beverages sector.