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  • Stock Recommendation | United Spirits - REDUCE - Target price : 540

    Publish date: NOVEMBER 02, 2018

    Solid quarter drives estimate upgrades; REDUCE stays on valuations. reported a solid quarter on all fronts – volumes surprised, mix improved, and costrationalization measures took margins to multi-year-high levels. Management seemed pretty upbeat on the call but chose not to raise either revenue growth (‘double-digits’) or EBITDA margin (‘mid-to-high-teens’, 13-19%) guidance for the medium term. Our EBITDA and EPS estimates go up by mid-single-digits and DCF-based valuation gets revised up to ₹540/share. Retain REDUCE.

    UNSP reported strong results for 2QFY19 with EBITDA growing 36% off a good base (2-year CAGR stood at 46%). EBITDA margins came in at a multi-year-high 19.4%. Even as we were looking at a solid margin print, high base notwithstanding, the magnitude of yoy expansion (312 bps) was a surprise. Key driver of the strong earnings print was topline performance. Net revenues grew a healthy 14% yoy to ₹22.3 bn, 4% ahead of our estimate. Revenue outperformance flowed down the P&L driving a 14% EBITDA and a 19% recurring PAT outperformance. Quality of growth was healthy – it was volume-led (10.3% volume growth) and mix improvement trend continued with P&A segment delivering 19% revenue growth (very strong even as this was weaker than Pernod’s +34% yoy revenue growth print). The company has delivered 35% growth in EBITDA and 52% growth in recurring PAT in 1HFY19 – solid numbers.

    Sep 2018 quarter has been a strong one for the alcobev players going by the results of UNSP and peers reported thus far. Base was soft and aided yoy comps, of course. However, comps were strong even adjusted for the base. UNSP saw overall volume grow 10.3% yoy to 20.4 mn cases with P&A segment growing 15.4% (3rd consecutive quarter of 13%+ growth) and the popular segment arresting the trend of volume decline with 8% underlying growth. Realizations in P&A and popular segments moved up around 3% each suggesting benefits of mix improvement and favorable regulatory environment. Management called out ‘stable’ regulatory environment in the past 12 months as a key driver of strong performance.

    UNSP’s quarterly performance has been fairly volatile, especially on margin delivery. EBITDA margins have ranged 5.7-19.4% in the past 16 quarters and yoy EBITDA margin delta has also been in a fairly wide (640)-722 bps. Quarterly forecasting has been and remains a challenge. We say this not to dilute the 2Q outperformance but we do believe it is an important aspect to keep in mind. TTM (a slightly longer time-frame) growth smoothens quarterly volatility a tad. TTM EBITDA growth for 2QFY19 stood at 16% yoy.
    We raise EBITDA estimates for FY2019-21E by around 5% each. REDUCE stays on rich valuations.

    Highlights from concall
    ▶ Overall business performance. Management believes that regulatory challenges are now largely behind and normative trends of the business are clearly visible. Growth in 2QFY19 was broad-based across states as well as brands. In the run-up to the general elections, there should be some strong sales growth. However, they did caution that this is not always the case. They also believe that the governments are now much more receptive in terms of pricing and rational on tax issues; the governments do understand that an arbitrary increase in taxes leads to lower sales volume, thus impacting total collection. Secondly, management highlighted that there is still a lot of potential in the P&A segment and the premiumization story remains strong.
     Segment-wise takeaways. Prestige segment posted 19% yoy growth in revenues (aided by 15% volume growth) and now represents 51.5% of total volumes. Strong growth in the Prestige segment was led by robust growth in its scotch portfolio – Jonnie Walker and Black & White aided by activations. The first ever TV commercial of Black & White was created while Jonnie Walker saw a new visual identity. Other key brands like Signature and Royal Challenge also continued to deliver strong growth. The Popular segment posted 8% yoy increase in net sales due to 5% yoy increase in volumes – underlying net sales were up 10% yoy. The franchise income was also in line with expectations (expect annual income of ₹1.5 bn).
     Adspend guidance. Adspend in 2QFY19 increased 38% yoy (off a soft base) and stood at 9% of net operating revenues. Management highlighted that they expect adspends to remain in the range of 9-10% of revenues, which they believe is an essential investment to enhance the long-term potential of its brands.
     Comments on margin expansion. EBITDA margin for 2QFY19 expanded 313 bps yoy to 19.4%. After remaining weak for the past three quarters (11-12.6%), margins this time were in the range of the management’s medium-term guidance of mid-high teens. Management explained that they are relatively satisfied with the gross margins levels (some inflationary RM pressure likely going ahead) and are also rationalizing some of their overhead costs. However, bulk of the margin expansion going forward will be the back of higher volume-led operating leverage benefits. Due to the new ethanol blending policy, there has been some hardening of ENA prices. Management is closely watching this and believes that the flexibility to switch from molasses to grain based ENA (currently at 70/30% for grain/molasses) can also be used to mitigate any major impact; reduced attractiveness of ethanol blending due to lower crude prices could also help. Management believes that they do not expect any major cost inflation to impact them at least in FY2019.
     Other takeaways. (1) Company’s ambition remains double-digit topline growth and mid-to-high teens EBITDA margin in the medium term. (2) The state of UP continues to see good off take growth. (3) Strong focus on efficient working capital management – state limits have also been put for this and the company continues to take punitive actions against defaulting channel partners. (4) Company expects to complete sale of ₹15-20 bn worth of non-core assets in the next couple of years. (5) Salience of online delivery model is likely to increase going forward and several states are considering the same.

    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.

    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
    NM = Not Meaningful. The information is not meaningful and is therefore excluded.

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