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MOSL: UNITED SPIRITS: Weak numbers given complete on-trade normalcyl

• United Spirits (UNSP)'s 1QFY23 result was disappointing given complete on- trade normalcy for the quarter with 2% sales decline over 1QFY20 and around 5% P&A CAGR adjusted for some one-offs.
• As highlighted in our , escalating material cost pressures, especially in the absence of requisite price increase from state governments, are putting immense pressure on profitability. Management has not indicated any respite over the next couple of quarters.
• While we are enthused by the structural implications of the strategic refresh, UNSP's earnings outlook appears challenging. Maintain Neutral.

Sales/gross profit below our estimates, other expenses led EBITDA beat

• Standalone net sales grew 34.3% YoY to INR21.7b (est. INR25b) in 1QFY23.
• Overall, UNSP reported a 17.9% growth (est. 27.4%) in volumes in 1QFY23.
• Reported gross margin contracted 370bp YoY to 40.9% led by input cost inflation; however, the same was partially offset by favorable product mix and productivity savings.
• As a percentage of sales, higher advertising costs (up 130bp YoY), lower other expenses (down 330bp), and lesser staff costs (down 510bp) - adjusted for a one-time special payout - led to a 340bp expansion in EBITDA margin to 13.8% (est. 15.6%).
• Adjusted EBITDA grew 78.4% YoY to INR3b (est. INR3.9b). On an absolute basis, ad spends rose 67.4% YoY.
• Exceptional items included: 1) INR384m towards the ongoing business restructuring expenses in the form of employee separation costs (a voluntary separation scheme) covering permanent workmen at four factories, and 2) a one-time special payout to employees.
• PBT/adj. PAT grew 135%/217% YoY to INR2.4b/INR2.7b (est. INR3.2b/ INR2.4b), respectively. There was a tax credit because of recognizing deferred tax asset due to the certainty in utilization of carried-forward capital losses.

Highlights from the management commentary

• Adjusted for one offs, the three-year P&A CAGR is likely to be around 5% in 1QFY23.
• Double-digit cost inflation is expected to sustain for the next few months.
• About 65% of COGS is glass and ENA. Crude-based derivatives account for a large part of the remainder portion of COGS. All the costs are seeing high inflation with no signs of respite. Hence, margins are likely to be under pressure in 2Q and 3QFY23 as well.
• Uttar Pradesh, Haryana, Madhya Pradesh, Rajasthan and Punjab governments have approved price increases with the former two received in 1QFY23. However, the same is not yet enough to combat double-digit inflation. Management is hoping for the mix to play a positive role in protecting its margins.