United Spirits -Near term pain for long term gain; Buy:: BofA ML

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United Spirits
Near term pain for long term
gain; Maintain Buy
􀂄 Sep Q disappoints on higher costs; PO cut to Rs1800; Buy
PAT of Rs746mn was up 7% yoy and 46% below our est despite strong sales
growth of 26% yoy. Key surprises were 1) huge surge in A&P spends 2) lower
gross profits 3) higher interest costs and 4) forex loss. Though Sep Q has been a
massive disappointment, we maintain our Buy rating as our core thesis of strong
sales growth and a sharp fall in molasses prices remains intact. We have cut our
EPS estimates PO by 28%/12% in FY11/12 for negative surprises of higher A&P
spends, push back in molasses price fall and interest costs. Valuation at P/E of
18x FY12E prices in such weakness. New PO of Rs1800 implies 21% upside.
A&P spends appear to be on a structural uptrend
Over the last three quarters, UNSP has invested Rs4.4bn behind A&P spends (up
by Rs2bn or 77% yoy). This is led by increased exposure in IPL and spends on
new launches. While its ability to find opportunities to ramp up A&P in a restrictive
environment is encouraging, the benefit of such substantial investments is not yet
visible. In the near term this impacts margins and hits deleveraging plans.
Rising interest costs are a near term concern
We believe UNSP will not be able to deleverage as much as our earlier estimates.
Its free cash flow is likely to be hit by higher A&P spends and lower profits.
Though we are still building in Rs4-5bn reduction in debt by FY12E, we raise our
overall debt estimates by 8-13% impacting earnings by 7-11% over FY11-12E.
Sales growth robust; Margin gain could be back ended
Rebound in sales led by improved volume growth and higher premiumization
benefit is a positive. We have raised our sales est by 1% by cutting down volume
growth and taking up realization gains. Also, we have marginally pushed back
gains from lower molasses prices to FY12E on delay in sugar crushing season.
We are now building in a 15%/12% decline in FY11/12E vs 20%/10% earlier.