Analysts retain 'buy' on Varun Beverages but cut target, earnings estimates on lockdown impact

The stock has gained 20 percent in the last one month following a recovery in market recovery. It was quoting at Rs 625.05, up 0.83 percent, on the BSE at 1230 hours.

While retaining the “buy” call on the franchise of PepsiCo with a price target at Rs 760 from Rs 860, JM Financial said Varun posted resilient numbers amid disruption led by COVID-19.

"Varun Beverages' Q1CY20 result was better than our expectations driven by higher volume contribution from acquired territories and resilient performance from International geographies. Organic domestic volume performance (declined 13.7 percent) was a bit disappointing, though, as COVID-19 related lockdown had an adverse impact in the month of March (accounts for disproportionately higher volume share)," it said.

The company maintained its operating margin on benign raw material costs and an easy base for the International business (last year Q1 margin was impacted by translation provisions).

The carbonated soft drinks and non-carbonated beverages maker reported a whopping 50 percent year-on-year growth in Q1 CY20 consolidated profit at Rs 60.06 crore, supported by tax writeback. Its revenue increased 23.3 percent year-on-year to Rs 1,676.4 crore, impacted by lockdown in the last 10 days of March.

Revenue growth lagged volume growth on higher salience of packaged water, characterised by lower realisations. Consolidated volume grew 26.7 percent aided by the acquisition of PepsiCo’s South and West territories and healthy performance in international geographies (7 percent volume growth).

On the operating front, its earnings before interest, tax, depreciation and amortisation (EBITDA) grew by 24.2 percent year-on-year to Rs 271.15 crore in the quarter ended March 2020.

"Operating performance was better than our estimates as weak domestic organic volume growth was offset by healthy contribution from newly acquired territories and resilient International business," said JM Financial.

EBITDA margin was flattish as sharp gross profit margin gains (up 281bps) on lower commodity prices was negated by adverse operating leverage (SG&A grew 32 percent).

The management withdrew its volume guidance for the year on demand uncertainties amidst the pandemic but was confident of maintaining operating margin, said JM Financial.

Benign raw material prices and reduction in trade/marketing spends would help negate the adverse impact from lower throughput, it said.

Net debt was largely maintained at Rs 3,200-3,300 crore sequentially and the management expects near-term debt maturities (Rs 450 crore) to be financed by operating cash flows. It also has unutilised credit lines of Rs 480 crore.

"This coupled with improved revenue trajectory post relaxation of lockdown recently should help navigate any liquidity related challenges in the near-term. Our confidence on business delivering healthy free cash flow to the firm (FCFF - Rs 1,000 crore) in CY20 and consequent net debt reduction drives our positive bias," JM Financial said.

Global brokerage house CLSA also maintained “buy” rating on the stock but reduced price target to Rs 745 from Rs 766 as it cut 2020 EPS estimates by 60 percent.

"There was sharp impact in India as lockdown extended, but there are multiple growth levers beyond 2020," said the brokerage, adding the company had 70 percent urban exposure and large OOH consumption (40 percent of sales).

However, ICICI Direct remained cautious and downgraded its rating to reduce with a revised price target at Rs 580 per share.

Unlike other FMCG companies, the company would be severely impacted by the lockdown, as manufacturing and supply chains were completely derailed, it said.

"Moreover, it also does not have advertising and promotion lever to reduce the cost at the time of crisis to protect margins. Though the management is confident of maintaining operating margins, we believe the recovery would be painful and prolonged," it said.

Moreover, higher interest cost was likely to impact earnings in CY20, it added.

In a conference call, compiled by JM Financial, the company said all plants were operational and Varun Beverages was meeting consumer demand. "Inventory pile-up at March-end has been largely cleared in April," it said.

"30-40 percent of beverage demand is on-the-go impulse consumption and 10 percent is institutional; contribution from which is expected to remain negligible in the near term."

International geographies like Nepal and Sri Lanka also witnessed lockdown in April, which would impact revenues in Q2CY20, the company said.

But EBITDA margin and EBITDA per case would be largely maintained in CY20. "Softening in commodity prices (pet chips, sugar), lower schemes and promotions and savings in administrative overheads will help in this regard,” it said.

Disclaimer: The above report is compiled from information available on public platforms. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.