United Spirits is likely to report another weak quarter as Q4 earnings are expected to contract 18% y-o-y. While there could be a sequential relief in extra-neutral alcohol (ENA) prices, the extent of correction would only be moderate from an all-time high levels of Q3. A sharp 34% y-o-y rise in interest costs would further exert pressure and we don’t expect any significant de-leveraging even in FY13.
The stock has run up 34% in the last one month and appears fully valued at 22x FY13 earnings. Therefore, we downgrade its rating to underperform. United Spirits? input costs (ENA) have shot up in the last few quarters. Q3FY12, in fact, had ENA prices touching an all-time high of R164/case. Q4 prices have seen limited corrections, which imply that the much-expected ENA price correction may not come through even in Q4. For UNSP, we now build an ~2% q-o-q correction during the quarter.
After reporting the lowest-ever volume growth of 0.7% in Q3FY12 due to regulatory issues (quota rejig in Tamil Nadu and sharp tax hikes in West Bengal), we expect stabilisation and build in a 7% volume increase during Q4. Ebitda should rise by 6%. Higher interest costs (+34% y-o-y to R1.4 billion; a flat q-o-q, though) would, however, result in an 18% y-o-y decline in (standalone) net earnings to R640 million.
United Spirits’ debt levels have been rising due to higher working capital requirement in the domestic business as well as to fund capex and acquisitions. Q3FY12 net debt rose to an all-time high of R77 billion and we do not expect any de-leveraging even in FY13 as we continue to build in high capex/working capital. The company is looking to raise $175 million (with an addition of $50million) through FCCBs, which should help, but uncertainty prevails on the time line.
The stock has delivered 34% returns in the last one month and appears to be fully valued at 22x FY13CL earnings in the context of high net gearing, weak cash flow generation and near-term earnings pressure. We downgrade the stock to U-PF, but raise target to R750/share (18x Mar-14 earnings). Resolution of group-level issues (Kingfisher Airlines) and potential de-leveraging are key risks to our negative call.