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United Spirits (UNSP)
UW: Concerns outweigh the secular growth story
Key concerns: Raw material cost deflation overplayed, low
margins, weak balance sheet, competition, and high valuations
USL has disappointed on EPS delivery in the past; we expect
this to continue. Our estimates are c12% below consensus
Initiate at UW with EV/EBITDA-based SOTP TP of INR1,310
Industry growth unlikely to translate into shareholder value in the near term. The
Indian spirits industry is likely to grow at a rate in the low to mid-teens for the next few
decades, driven by volume growth and premiumisation. As it is the largest player, with a
c43% market share, United Spirits (USL) seems a natural way to play this story. However,
on a 12-month horizon we believe the stock may correct due to EPS disappointment (input
cost, interest cost, and ad spend likely higher than Street expectations).
Our key concerns. (1) We believe input cost deflation is likely to be lower than the
market anticipates. (2) USL’s EBIT margins are lower than peers’ and the benefits of
‘premiumisation’ are not visible on the bottom line – the ‘catch-up’ may therefore take
longer than expected. (3) Competition is a concern in the medium to long term, as Pernod
Ricard is now the second-largest player in India, with a 2006-09 volume CAGR of c17%;
(4) USL has high (and increasing) working capital and low ROE, which, in our view, call
for substantially lower valuation multiples than other consumer staples companies.
Initiate at Underweight. We value USL shares on a sum-of-the-parts (SOTP) basis – we
apply an EV/EBITDA multiple of 10x to the international business (in line with global
peers’ average) and 13x to the Indian business (at a 33% discount to Indian FMCG peers
to account for lower return metrics and poor FCF generation). Our target price implies
c20% multiple compression, which we believe is likely on the back of consensus misses.
Risks to our view would include higher-than-expected benefits of material costs, an
unexpected acceleration in permiumisation, slack competition, balance sheet improvement.
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