United Spirits stock rated ‘Neutral’ by Motilal Oswal, says headwinds in the near term

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Published: July 3, 2017 4:15:18 AM

Highway ban to impact demand in FY18; ‘Neutral’ rating maintained owing to limited 8% upside; long-term potential is intact.

The ban on sale of alcoholic beverages along highways is likely to impact the business up to Q3FY18.

The ban on sale of alcoholic beverages along highways is likely to impact the business up to Q3FY18. A favourable hearing in July to a petition filed by the Restaurant Owners Association of Tamil Nadu could help mitigate the impact. UNSP is confident of an improvement in the long-term pricing environment. The longer term margin growth potential remains intact, mainly led by continued mix improvements. UNSP believes franchising of popular brands is a win-win situation for both parties. In our recent report on Alcoholic Beverages, we had pointed out the risks emanating from a host of factors like (i) the impact of GST implementation on profitability, and (ii) the impact of ban on sale of alcoholic beverages along highways and the prohibition decrees by various states on volumes. Our DCF-based valuation indicates a target price of Rs 2,415. Owing to limited 8% upside, we maintain our Neutral rating on the stock.

Impact of highway ban on demand unlikely to continue beyond FY18

The ban on the sale of alcoholic beverages along highways is impacting consumption as well as the pipeline. UNSP expects instability in demand up to Q3FY18, but does not expect sustained loss of demand beyond the current financial year. The Restaurant Owners Association in Tamil Nadu has appealed against the Supreme Court judgment that has brought on-premise consumption into the ambit of the highway ban; a hearing on this issue is expected in July.

GST effect not as high as feared

The impact of GST would not be as severe as feared initially, with ENA being kept out of the GST ambit. However, packaging and molasses would be subject to higher rates of taxation under the GST regime. UNSP should be able to provide clarity on the margin impact with a fair degree of accuracy in two weeks.

Company expects price hikes on a regular basis in medium term

UNSP took price increases in Karnataka, Maharashtra and Bengal in FY17. It is yet to be granted price increases in other key states like Andhra Pradesh and Telangana. The company intends to bargain for price increases after fully understanding the GST impact. In FY17, higher proportion of the gross margin increase was on account of price increases and not due to premiumisation, which is more sustainable. However, UNSP is not worried, as it expects price increases more regularly in the medium to long term.

Franchising to help arrest gross margin decline and free up working capital

In states where UNSP intends to retain its Popular brands (lower end brands), it is developing separate teams for the Popular and the Prestige and Above (P&A) segments. It already has such a system in place in Karnataka, which it plans to replicate in Maharashtra and West Bengal. In the 13 states where UNSP has exited the Popular segment by opting for the franchise route (to reduce negative impact on gross margin and free up working capital), it has adopted a strategy similar to Coke’s.

UNSP retains the intellectual property – if and when country liquor is banned in these states, UNSP would have an option to get back the business from the franchise partner after paying compensation. UNSP would continue to develop the brands in the states where it retains them and would share the benefits with the franchisees in other states.

Investors were concerned by a one-off `3.1 bn compensation to a third party in Q4FY17. While one-offs cannot be predicted, UNSP believes that such one-offs are highly unlikely going forward. Demonetisation dented UNSP’s asset restructuring plan. This is why the company is guiding for value unlocking over a 3-4 year period.

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