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Radico Khaitan:: Strong Sep Q marred by higher costs; Maintain Buy
Sep Q profit up 94% yoy but misses our est; PO cut to Rs230
Rs189mn profit was lower than our est of Rs289mn on 1) lower volume 2) lower
gross margin gain and 3) higher A&P spend. While investment on launch of new
premium whisky could take Radico’s earnings on a structural high growth path, in
the near term it will hit margins. We cut our earnings by 19%/8% in FY11/12E to
factor in 1) higher A&P spends and 2) push back of molasses price fall. We do not
yet factor in possible upside from new whisky launch due to low visibility. PO cut
to Rs230 but maintain Buy as our core thesis of strong volume revival, sharp
reversal in input cost cycle and margin gain from premiumization remains intact.
Launch of new premium whisky is a long term positive
Radico is currently test marketing premium whisky brands ‘After Dark’ and
‘Eagle’s Dare’. These brands are present in a category 15x bigger than the
premium vodka category in which Radico is a market leader. Even a relatively
small market share can be a significant push to Radico’s earnings growth. In the
near term we are however building in a 150bp margin hit on launch costs.
Volume growth to pick up; Molasses prices fall pushed back
Sep Q volume growth of 14% was below expectations as weaker growth in 8PM
during re-launch offset a huge 48% growth in Magic Moments. With launch now
completed, we expect 16-17% vol growth going onwards. However, as highlighted
earlier, molasses price fall could be pushed back on delay in cane crushing. We
revise molasses price fall est to 15%/12% (vs 20%/10%) for FY11-12E.
Maintain Buy on attractive valuations for strong growth
Radico is cheapest stock under our coverage at 14xFY12E. Expect re-rating with
strong EPS CAGR of 108% over FY11-12E led by strong volume growth, lower
input costs and with success of premium whisky providing upside potential.
Sep Q results strong but miss our est
Radico reported net profit of Rs189mn, up 94% yoy. Though the results were
strong, they missed our forecast of Rs289mn profit on 1) lower than expected
volume growth 2) lower than expected gross margin gain and 3) higher than
expected A&P spends.
Key results highlights:
Sales growth healthy: Sales came in at Rs3.1bn, up 19% yoy but 6% below
our estimates. The miss was led by lower than expected volume growth of
14% yoy. As re-launch of 8PM continued during the quarter, it missed our
expected growth target.
Premiumization going strong: The value volume gap in IMFL sales as
maintained at 10% of which more than 8% was contributed by
premiumization. Strong growth of 48% yoy for Magic Moments and weak
growth of low value smaller brands led to continuation of this trend.
EBITDA disappoints: Operating profit came in at Rs373mn, up 17% yoy,
much weaker than expected as margins declined 20bp vs our est of 350bp
gain. Key reasons for margin disappointment were lower than expected
gross margin gain and significantly higher A&P spends.
Gross margin gains muted: With a minor 30bp gain we are disappointed
with the gross margin gain. Molasses / ENA prices went up in key state of UP
during the quarter on anticipation of delay in cane crushing.
A&P spend rises sharply: There was 49% yoy jump in A&P spends. The
surge in spending is to support 8PM during its relaunch, push Magic
Moments vodka and most importantly to support launch of new premium
whisky brands – ‘After Dark’ and ‘Eagles Dare’.
Interest cost collapse continues: Interest costs fell 63% yoy, ahead of our
estimates on deleveraging through QIP proceeds and internal cash accruals.
Net profit growth is strong: In a seasonally weak quarter, Radico has done
well with net profit of Rs189mn which is up 94% yoy and also 10% up qoq.
Earnings cut on lower margins
We have cut our earnings estimates for Radico by 19%/8% for FY11/12E. This is
to factor in lower margins due to 1) higher A&P spends and 2) push back in
molasses price fall. Despite the cut, we expect a very healthy 108% EPS CAGR
over FY11-12E. Our new EPS estimates for Radico are Rs7.7 in FY11E and
Rs12.5 in FY12E.
A&P spend jump to hit margins near term
Radico is investing behind its key brands 8PM and Magic Moments vodka at this
point in time. Also, there has been additional cost in launching its premium whisky
brands ‘After Dark’ and ‘Eagles Dare’ which are being test marketed. As a result
we have taken up our A&P spend assumptions to 8% as a % of sales in line with
company guidance. This has resulted in a margin hit of 150bp to our estimates.
This margin hit has led to an earnings cut of 15%/11% in FY11/12E.
While the long term benefit of a successful premium whisky launch can be
massive (as discussed in detail in the following sections) we have not yet taken
this in our estimates due to a lack of visibility. If the launch is successful, it could
take up Radico’s growth to a much higher trajectory and recoup the current A&P
spends with a healthy return.
Molasses price fall could be back ended
Currently molasses prices fall is lower than expected (10% vs est of 20%) on
expectations of delay in sugarcane crushing and lower yield in U.P (~25% share
of production) due to floods. We are not concerned with this development as 1)
latest Gov’t of India estimates, sugarcane production in India has been again
revised upwards to 347mT, up 25% yoy 2) current trading volume of molasses is
negligible due to off season and 3) delay in crushing would lead to bunching up of
supply in Mar Q leading to sharper fall in prices, making up for lower fall in Dec Q.
However, to be on the conservative side we have revised our molasses price fall
estimates to 15%/12% decline in FY11/12E vs 20%/10% decline estimates
earlier. We recognize the possibility of price decline getting pushed back towards
Mar Q rather than in Dec Q due to delay in crushing and overhang of additional
demand from ethanol blending of fuel. However, with actual sugarcane production
expected to beat estimates and bunching up of excess supply in Mar Q, we
expect a sharper than expected fall in molasses prices, making up for the delay.
New whisky launch is a potential
game changer
Radico is currently in the final stages of launching a premium whisky at the
national level during 4QFY11. Premium whisky category between Rs300-
Rs600/bottle is a potential 40mn case category. This is 15x the Vodka category in
which Radico has made a mark with success of Magic Moments vodka. With
consumers trading up from entry level brands like 8PM, Bagpiper etc, this
category is set to witness a 20-25% growth over next few years.
Radico had been constrained by its JV with Diageo in terms of launching
premium whisky in India. As per the terms of the JV, a premium whisky in the
price range of Rs300-Rs600/bottle had to be launched only through the JV. Given
that the JV had been a disappointment till this point in time, Radico felt the need
to remove this clause. Post negotiations in Dec’2008, Diageo agreed to allow
Radico to launch premium whisky outside the JV.
Product details – mid priced and attractively packaged
Radico for last 18months has focused on developing blend and packaging that
would attract and retain consumers. As part of the exercise, post several
iterations to get the blend right, Radico has now test launched two brands – After
Dark and Eagle’s Dare in select markets. Packaging for both the brands is
attractive with special bottle printing technology giving them a premium look and
feel. Initial response is encouraging for both the brands and a decision will soon
be taken to continue with the launch of the more popular brand at a national level.
The whisky would be priced at Rs400-450/bottle - a price point in between the
two popular segments of Royal Stag (Rs320/bottle) and Blender's Pride,
Signature (at Rs550/bottle). Management expects to spend US$4mn on this
launch and breakeven is expected at sales of 350,000 cases. Despite the extra
spend, management would keep A&P/Sales ratio at ~8% of sales. This appears
achievable but upside from this launch is not part of our numbers yet.
Potential upside to earnings is immense
As of now we have not included push to earnings from launch of premium whisky
given visibility at this point in time is relatively low. Given below is a scenario
analysis of potential impact on earnings in a bear, bull and a most likely situation.
As is evident in a bull case scenario, the potential impact of premium whisky
launch is immense and as we get more visibility on the roll out, inclusion of
premium whisky sales in our estimates could provide a huge positive upside.
Strength of premiumization
With Magic Moments vodka and Morpheus brandy doing well for Radico, we
expect the product portfolio for Radico to continue its premiumization trend. As
per management, currently these brands contribute ~30% of sales and ~50% of
profits for Radico. Management expects continued success of these brands to
lead to 50% sales contribution from these brands within next 2-3 years.
Structural margin boost expected to be significant
We see premiumization as a strong margin driver for Radico. Magic Moments
contributes 3x-5x and Morpheus contributes ~7x of gross profit per case in
absolute terms vs an entry level brand like 8PM.
Our estimates forecast a more conservative 25% contribution currently which will
go up to 32% by FY13E. This we believe adds ~400bp to the margin on account
of higher contribution. However, if the contribution from higher end brands goes
up to 40% by FY13E, it would lead to margin gain of another 500bp.
International Brands Division – to support premiumization
Radico is in the process of setting up an International Brands Division. This
division will provide access to Radico’s distribution to some select International
brands. Key positives that we expect out of this initiative are:
Additional earnings stream: Though the scale of this division is likely to
be small given the luxury segment which it would target, there would be
additional income for Radico in the form of Distribution and Management
fees by sweating the existing resources.
Provides broader bouquet to premium outlets: With this broader
bouquet of brands, Radico’s clout with premium outlets would improve
significantly. This would help Radico in pushing its premium brands more
effectively to these outlets.
No threat of cannibalization: Given that these brands would be sold as
‘Bottled in Origin’, they would attract import duties, taking up their selling
price to above Rs2000/bottle. This would be significantly higher than the
premium brands of Radico and hence threat of cannibalization does not
exist.
Pernod Ricard’s strategy in India is a model to follow
Pernod Ricard in India is estimated to make operating profit of Rs5.5bn by selling
15mn cases of which 75% are in premium category. Radico on the other hand
made Rs1bn of operating profit in FY10 by selling similar number of cases of
which only 25% were in the premium category. By moving up the value chain,
Radico intends to emulate Pernod Ricard in terms of profitability.
Maintain Buy on strong growth &
attractive valuation
Radico at 14xFY12E is the cheapest stock under our coverage. Its current trading
multiple is at 40% discount to the FMCG sector multiple. Though, we agree that
some discount for Radico is warranted given its smaller business scale and lack
of market leadership, there is a clear case for discount to narrow down given 1)
earnings growth is set to surge 2) balance sheet health is now not a cause for
concern and 3) company is strategically improving its product / brand portfolio.
We have pegged our PO for Radico at Rs230 which implies a potential 29%
upside from current levels. This is based on our expectations of strong re-rating of
the stock to 18xFY12E supported by with strong EPS CAGR of 108% over FY11-
12E led by strong volume growth, lower input costs and with success of premium
whisky providing potential upside risk.
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