Highlights:
- Overall volumes were higher by 7 percent despite domestic slowdown
- One-time sale of bulk scotch boosted top line and bottom line
- Advertising and marketing spends were lower during the quarter
- Operating margin expanded due to cost control measures
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Liquor manufacturer United Spirits (USL) delivered a strong set of earnings in the first quarter of FY20. The top line growth was steady despite liquor restrictions during the general elections season. Operating profit nearly doubled as the margin got a boost from one-time sale of scotch and reduced discretionary and non-discretionary spends.
Quarterly earnings highlights
- USL’s top line increase of 10 percent to Rs 2,218 crore was driven by a combination of volume growth across its product categories and one-time benefit from sale of bulk scotch to Diageo UK. The revenue growth on a like-for-like basis stood at 6 percent.
- The overall volume growth for the quarter stood at 7 percent, led by higher sales from its premium segment - Prestige & above. Popular segment returned to growth in Q1 FY20 and reported 5 percent increase in volumes on a low base while the premium segment growth was much stronger at 8 percent on a high base of 13 percent.
- Hardening of key raw materials (extra neutral alcohol and glass bottles) continued to put pressure on the gross margin, which came in at 47.3 percent and resulted in a margin contraction for the third consecutive quarter. Besides, absorption of excise duty hikes in Maharashtra, along with an adverse state mix, weighed on the gross margin.
- Operating profit was much stronger in comparison to the top line growth as USL reported an expansion in EBITDA margin despite the inflationary cost pressure. Lower employee costs, along with decline in advertising and marketing spends as well as other expenditures, aided the operating performance. Furthermore, USL garnered Rs 57 crore of profit before tax from one-time sale of scotch of Rs 97 crore.
- The employee costs were much higher in the base quarter due to one-time restructuring charges of Rs 36 crore. Overall staff expenditure of Rs 136 crore in Q1 of 2019-20 was 19 percent lower YoY after adjusting for the restructuring changes.
- Given the subdued demand environment and the election season, the advertising and promotion spend for the quarter was much lower in comparison to the previous year. June quarter marketing spends was around 8 percent of revenues. However, the same is expected to normalise around 9-10 percent over the course of the year.
- Interest expenses came down as a result of debt reduction. The leverage ratio has improved as the company has been monetising its non-core assets.
- The packaging costs appear to have stabilized, but the prices of extra neutral alcohol are on an uptrend due to the ethanol blending policy. Inputs costs are anticipated to inch up further and could affect gross margin in coming quarters.
- The new government in Andhra Pradesh (AP) has decided to gain operational control over the liquor retail store operations in the region. AP contributes around 4 percent to USL’s top line and therefore, the management is contemplating rejigging its supply chain in the region of Andhra Pradesh on the back of this latest development.
Outlook and Recommendation
- Demand prospects seem very exciting from a medium to long term perspective, but near-term challenges such as slowdown in consumption, excise duty revisions, liquor ban in Andhra Pradesh loom as the sector continues to be under the regulatory ambit of the government.
- Diageo-led United Spirits offers an interesting investment proposition in the consumption space owing to its strong brand recall (McDowell’s No1, Royal Challenge, Black Label, Signature, Smirnoff etc.) and widespread distribution reach. However, the current valuation (56 times FY20 projected earnings) appears fairly expensive, considering that the business is facing a challenging operating environment, both on the demand and cost front.
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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here
