Retain ‘buy’ on Varun Beverages, Target price at Rs 1,000 – Axis Capital

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Published: February 26, 2019 2:19:09 AM

VBL’s acquisition of franchise rights of South and West regions from PepsiCo gives it near control of pan-India operations of PepsiCo (80%+).

Retain our ‘buy’ rating with revised target price of Rs 1,000 (from Rs 840) as we bake in acquired territories consolidation and roll-over to Mar-21 (based on 13x target EV/EBITDA).

While Q4CY18 is seasonally weak, VBL reported strong performance beating our estimates on account of robust performance in India business led by strong festive season and timing shift.

However, the action was beyond results – VBL’s acquisition of franchise rights of South and West regions from PepsiCo gives it near control of pan-India operations of PepsiCo (80%+). Reasonable deal valuations and VBL’s impeccable track record to scale up acquired territories (both in terms of share/margins) is likely to make the deal EPS accretive in CY20; we expect VBL to become FCF positive in CY20 and RoCE to inch up to ~20% in CY21.

Retain our ‘buy’ rating with revised target price of Rs 1,000 (from Rs 840) as we bake in acquired territories consolidation and roll-over to Mar-21 (based on 13x target EV/EBITDA).

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During the quarter, VBL acquired franchise rights to parts of Maharashtra, Karnataka and MP from SMV (12-13 mn cases, Rs 1.8-2 bn revenues – at Rs 2 bn payout payable in parts). It also entered into binding agreement to acquire franchise rights to South (ex-Andhra) and West regions from PepsiCo (deal likely to be completed by March-end; entails total volume of 135 mn cases, Rs 16-18 bn revenues – at Rs 18.5 bn payout).

Our calculations suggest both the acquisitions have been done at reasonable valuations of 1-1.2x sales and 5-6x normalised EBITDA (in line with company’s stated acquisition guidelines).

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The management plans to fund the acquisitions through a mix of internal accruals, debt and equity dilution (targeting 5% dilution).

The deal catapults VBL into control of ~80%+ of PepsiCo’s India volumes (from 51% currently) with presence in 27 states and 7 union territories. Apart from significant leverage/scale benefits, the acquisition is likely to reduce VBL’s dependence on summer season due to lower seasonality drag in South & West. Assuming entire deal is funded via debt, we expect the deal to be EPS accretive in CY20, RoCE to improve to 16-17% levels in CY20 (from current 14%) and VBL to become FCF positive (assuming normalised capex) by CY20.

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