United Spirits – BUY says IIFL

Margin tailwinds gather more steam
Visibility of a sustained reduction in ethanol prices has improved with the first advance estimates of
the government projecting 17% YoY increase in sugarcane output. We estimate ethanol supply will
exceed demand by c400m litres in 2011, despite an increase in ethanol blending with petrol. Surplus
ethanol left over from 2010, would further add to supply. As a result, ethanol prices will likely remain
benign over FY11-12 driving 450bps EBITDA margin expansion for United Spirits (USL) over FY10-12.
An increase in marketing spends would only marginally offset the raw-material cost savings. We
increase our EPS estimates for FY11-13 by 4-6% and revise our target price to Rs1,705. Retain BUY.
Ethanol supply will exceed demand: We estimate ethanol production of 3,500m litres in FY11, as
compared to 3,000m litres in FY10. However, demand in FY11 is likely to be just over 3,000m litres, even
after factoring in 900m litres for blending with petrol (additional 500m litres over FY10). The surplus carried
forward from FY10 would also add to supply. USL’s cost of wet goods has already decreased from
Rs150/case in FY10 to Rs135/case at present. With the crushing season starting in November, this cost
could see further decline in the near term.
Sharp expansion in EBITDA margin over FY10-12, despite possible increase in marketing spends:
We expect EBITDA margin to expand by 450bps over FY10-12, despite a 50bps increase in marketing spends.
Cheaper brands will likely increase trade margins, thus forcing USL to also increase marketing spends.
2QFY11 results likely to be strong: We expect USL to report strong volume growth of c15% YoY in
2QFY11, driven by a volume bounce-back in Andhra Pradesh (USL’s largest contributing state). Volumes in
the state had declined in 1QFY11, on account of retail licence renewal. EBITDA margin will also significantly
expand, as the raw-material cost per case would likely be lower by c10% YoY.