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United Spirits Ltd
Exaggerated Response to
Results: Opportunity to Buy
Quick Comment: In our view, USL’s Q2F11 results
point towards structural factors that continue to drive
consumption of alcohol in India along with rapid
premiumization and improving product mix. Market
response (stock down 8%) to the results is exaggerated
in our view and presents a good entry opportunity. We
reiterate our OW rating on the stock.
What is the market missing – Key issues: 1) Rise in
Interest cost for the standalone business suggests
poor cash flow management: We disagree. The
company has refinanced the White and Mackay (W&M)
acquisition loans of over Rs10bn in 2HF10 and this,
combined with regular increase in working capital,
contributed to an increase in interest cost for the quarter.
According to management, consolidated interest costs
are down to Rs2.5bn in 1HF11 from Rs2.8bn in the
corresponding quarter last year.
2) Gross margin expansion driven by lower interest
costs; Spirit cost likely to soften further in 2H: We
disagree. The increase in gross margin in 2Q was driven
largely by a combination of price increase in various
markets and product mix improvement. According to
management, spirit costs during the quarter were only
marginally lower than the previous quarter, and the
trends for the rest of the year would be apparent post the
onset of the sugar crushing season in November. In our
view, the market is underestimating the impact of
implementation of the ethanol blending program on
alcohol prices in India.
3) Competitive pressures are forcing the company
to increase advertising expenses: We disagree.
Introduction of new products to encourage consumers to
up trade is a strategy that contrary to market perception
is already yielding results. Products at the top end of the
spectrum grew by 20% during the quarter. Under this
scenario, the underlying profitability of the business is
best judged after stripping out brand investments, which
can be considered as one-time expenses. Adjusting for
this investment, we estimate that EBITDA grew by 35%
during the quarter.
4) Market seems to be ignoring Whyte and Mackay
operating profit growth and improved visibility: W&M
operating profit grew 16% yoy in H1F2011, as against our
expectation of 39% decline for F2011. While this is a
seasonally weak period for scotch sales globally, W&M’s
management strategy of ending bulk supplies and focusing on
branded sales, along with sales to private label players is
yielding results faster than anticipated. We would also
highlight that H1F2010 had some benefit of bulk supplies to
Diageo.
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