Despite near-term pressure, investors find flavour in Varun Beverages

Besides good business recovery, improved margin outlook boost investor sentiment

Despite a 69 per cent year-on-year fall in pre-tax profit to Rs 181.9 crore in the June 2020 quarter (Q2), led by 46.4 per cent volume plunge, the stock of Varun Beverages has gained 15 per cent since the announcement of results versus a 1.7 per cent rise in the Nifty FMCG index. PepsiCo’s franchise, which follows the January-December accounting period, announced its quarterly results on Tuesday this week. Good business recovery and improved margin outlook boosted investor sentiment towards the stock.

Though out-of-home consumption is under pressure due to the pandemic, rising in-house consumption of carbonated soft drinks (CSD) is partly saving the overall volumes. From 25 per cent in April, domestic volumes as a proportion of year-ago level went up to 75 per cent in June and have further improved in July, the company says. This actually offers good hopes about Varun’s faster business recovery than anticipated earlier, though near-term volumes see some pressure with localised lockdowns. In fact, improved in-house consumption also points towards incremental business for Varun once the situation normalises.

For instance, according to analysts at ICICI Securities, “when the business activity returns to normalcy, some consumers will continue with in-home consumption and this opens up new window of beverage consumption.”

But what's more enthusing is Varun’s operating margin ability mainly led by structural cost control. The management expects, most of cost savings programs in Q2 would sustain going ahead. Thus, analysts at Kotak Institutional Equity estimate potential margin tailwind of 100 basis points in 2021 from these permanent cost savings.

Further margin cushion in the near term would stem from a likely improved product mix with lower share of low-margin packaged water. The latter attracts one-third realisation of CSD, which is likely to remain in relative better shape.

In Q1 also, volume share of CSD improved to 85 per cent from 74 per cent a year-ago and that of packaged water declined to 8 per cent from 18 per cent. This along with lower trade promotions, benign raw material prices and cost savings led to better than estimated EBITDA margin of 23 per cent, though down 500 basis points year-on-year. Some analysts had pegged Varun’s Q2 EBITDA margin at 17-18 per cent.

Thus, how the company’s operating margin pans out going ahead would be interesting to see.