We initiate our coverage on United Spirits with an ?overweight? rating and price target of R3,115. After the initial tailwinds, following the change in control, the next leg of stock outperformance will be catalysed by an increased confidence in higher long-term earnings growth.
Our in-depth analysis of tax structures and volume/pricing trends in key states suggest that USL has been overly focused on volume market share. Pricing for the regular liquor segment in India (~75% of industry volumes) is non-remunerative and likely unsustainable. With the change in management control, we expect a greater focus on profitable growth and consequent structural rise in profit pool for the liquor industry in India.
We see 24% ebitda CAGR for the company over the next seven years. Our conviction on this growth is anchored to our work on profit pool growth and likely increased focus on the prestige liquor segment (more than R350 per bottle). Based on current margins, a 5 percentage point overall shift in mix toward the prestige segment over FY13-16 would drive ~100 bps of operating margin expansion. In our base case, we estimate adjusted net profit to rise 12x over FY13-16, albeit off a low base, led by 31% operating profit CAGR.
USL is the top pick in our coverage as we find the risk-reward for the stock compelling even after a 2.7x increase in the stock price over the past 12 months. Diageo is set to acquire 27.4% of USL, following which current management is obliged to vote alongside Diageo on all board resolutions for a period of four years. However, we believe it is likely that Diageo may seek absolute control and look to increase its stake.