Amid strong growth expectations, more fizz left in Varun Beverages' stock

While listed fast moving consumer goods (FMCG) companies continue to outperform the benchmarks over the past month, one stock which has gained the most among the Nifty FMCG Index constituents is Varun Beverages. The bottler for PepsiCo is up 22 per cent since August 1 as compared to the Nifty FMCG returns of 11 per cent during this period.

The company, which was one of the worst impacted due to the lockdown and lack of out of home activity, has reported a good recovery (up 40 per cent y-o-y) in the first half of CY21. Going ahead, it is expected to  post strong growth led by higher penetration, expansion in newly acquired regions in West and South India and new launches. 

Analysts led by Nihal Mahesh Jham of Edelweiss Research believe the company has multiple levers to achieve its 10 per cent organic volume growth target. Growth would be aided by addition of visi coolers to existing outlets and distribution expansion, scale up of recently acquired territories where its share is lower than India average and an evolving product mix, they add.

Among the new products are the Mountain Dew Ice, a lemon based fruit drink launched earlier this year and energy drink Sting. The launch of Mountain Dew Ice opens up a new market for the company and lower goods and services tax is beneficial from the pricing/margin perspective. Analysts led by Vivek Maheshwari of Jefferies India say that Sting which was launched a couple of years ago has seen strong acceleration in the last two years and accounted for 5 per cent of India volumes year to date. The success, according to them, is attributable to attractive product pricing (sharp discount to Red Bull), packaging format (PET) and distribution reach (around a third of overall). 

With growth outlook improving and no near term acquisitions in the horizon could result in lower leverage and improve its return ratios. Analysts at Edelweiss Research expect the company to see a phase of strong cash flow generation with net debt coming down from Rs 3,000 crore to Rs 1,200 crore over the CY20-23 period. Return ratios which have increased from 5 per cent in CY13 to 17 per cent in CY19 are expected to increase to 25 per cent by CY23, according to their estimates. 

In addition to these triggers, what could help sustain the rally in the stock are valuations. One year forward valuations at 40 times earnings are at a substantial discount to FMCG peers. Given the sharp (45 per cent plus) earnings growth over the next couple of years, the rerating of the stock would continue while the valuation discount with peers should narrow. Investors can look at the stock with a medium term holding period.