Highlights:

- UNSP’s standalone net sales for 4QFY17 fell 1.1% YoY (est. of +6.4%) to INR20.1b, with volumes down 8.2% (est. of flat volumes). Management stated that adjusted for Bihar prohibition and operating model changes, sales rose 7% YoY. Gross sales grew 9.2% YoY to INR64.7b (Ind-AS), with excise duty as % of sales up 320bp YoY to 68.9% (increased tax/excise levies in MH/West Bengal).

- Overall 4Q volumes down 8.2% YoY to 21.4m cases: Popular volumes fell 15.1% YoY to 12.9m (sales down 16% YoY), while Prestige and above volumes rose 4.9% YoY (sales up 10% YoY) to 8.5m cases. For FY17, volumes fell 3.2% to 90.1m cases. Prestige and above volumes rose 7.6% to 36.8m cases (sales up 13% YoY), while Popular volumes fell 9.5% to 53.3m cases (sales down 9% YoY).

- Gross margin (excl. operating income) improved 330bp YoY to 43.9%. Ad spends fell 70bp YoY to 8.2% of sales. EBITDA margin (excl. other operating income) expanded 730bp YoY to 12.6% (est. of 10.9%), mainly led by gross margin expansion. Staff costs declined by 100bp YoY, and other expenses by 230bp YoY to 17.1% of sales. EBITDA (excl. other op. income) rose 132% YoY to INR2.54b (est. of INR2.48b).

- Other operating income increased 71.9% YoY to INR110m in 4QFY17. Interest costs fell 15.5% YoY to INR853m on debt reduction/favorable rates. PBT was at INR1.52b v/s estimate of INR1.65b. Tax rates were lower than expected. Reported PAT grew 204% YoY off a low base to INR1b (est. of INR937m).

- FY17 brand-wise performance: Signature grew volumes by 26% and sales by 29%. Royal Challenge net sales grew 16% YoY (15% volume growth). McDowell’s No 1 whisky volumes grew by 7% and net sales by 8%. Scotch portfolio in premium and luxury segment grew 29% by volumes and 32% by sales, driven by Johnnie Walker, Black Dog, Black & White and VAT 69.

- Conference call highlights: 1) There have been increases on indirect tax rates under GST on packaging and services. Management did not provide clarity on EBTDA margin impact for FY18 as they are awaiting final clarification on rates. 2) Capex for FY17 was INR2.2b and will be in INR2.2b-3b range going forward. 3) Debtor days increased as some states are witnessing financial difficulties.

Valuation and view: Longer-term margin growth potential remains intact, mainly led by continued mix improvements. Management reiterated target of mid-teen margins in the medium term. In our recent report on the alcohol sector, we had pointed out the risks emanating from a host of factors, such as GST, highway ban and a spate of prohibition of various degrees announced by a few states over past two years. There has also been substantial delay in the planned sale of non-core assets, which management cited will now happen over a 3-4 year period. Working capital is also increasing due to weak state finances. Our DCF-based valuation indicates a target price of INR2,150. We maintain our Neutral rating.