Diageo may make higher provision for loans given by United Spirits

Spirits major Diageo is planning a clean-up of United Spirits Ltd (USL) accounts. This comes ahead of Diageo's move to integrate the Indian firm with its global operations and might lead to a higher provisioning in USL's balance sheet.

The integration, expected to start from July 1, is likely to place USL under heightened risk of write-offs and impairment, as Diageo continues its sweeping changes in how USL signs off its 2013-14 balance sheet.

USL had recently said it was awaiting certain information from promoter and UB Group's holding company, UB Holdings, to determine the treatment of a loan of Rs 1,350 crore in the company's accounts. USL had also said it was making certain enquiries on nearly Rs 600 crore of loans provided to certain trade debtors.

When contacted on Friday, a spokesperson for Diageo declined to comment. The top management of Diageo, led by CEO Ivan Menezes, had made a presentation on future plans on June 16 at a Deutsche Bank conference in Paris.

Industry analysts tracking USL said there were risks of a possibly high write-offs or impairment, as USL became a Diageo subsidiary. This includes a likely write-down of inventories, the Indian Premier League asset and a longer-than-expected period for working capital improvement.

"We believe a large proportion of loans and advances - approximately 20 per cent sales, or 80 days of working capital - are likely stuck as non-core advances and realisation could take five years or even longer," Deutsche Bank wrote in a report to its clients on June 14. The Deutsche Bank analysts said there might be an "unexpected and unexplained" increase in working capital as part of the 'clean-up' process of USL's profit & loss accounts.

On account of these and various other operational risks, Deutsche Bank has cut USL's earnings per share (EPS) estimates for 2014-15 by 27 per cent and for 2015-16 by 25 per cent. This is to factor in a reduction in its assumptions for earnings before interest, tax, depreciation and amortisation (Ebitda) margin from 13.1 per cent to 10.7 per cent for 2014-15 and from 14.1 per cent to 11.8 per cent for 2015-16.

Diageo has maintained its Rs 18,000-crore investment for 54 per cent control of USL will be earnings-positive in 2021-22, the seventh full financial year after completion of investment (EPS-accretive) in the year that ends on June 30, 2016. This, according to industry analysts, might be at risk.

These risks compound the pain at USL weeks after the company said it would be forced to provide as much as Rs 4,200 crore for another loan given to its London unit. USL had to provide for this sum because sale of its Scottish subsidiary, Whyte & Mackay, will not be enough to meet the sum loaned to acquire the unit in 2007. As a result, USL had said, its net worth would be reduced by as much as Rs 3,500 crore.
RISKS GALORE

• High write-offs/impairments, including a likely write-down of inventories and longer-than expected period for working capital improvement, as USL becomes a Diageo arm
• A large proportion of loans and advances, at around 20% of sales (or around 80 days of working capital), are likely stuck as non-core advances and realisation might take 3-5 years
• Unexpected and unexplained increase in working capital, which Deutsche Bank believes is part of the "clean-up" process
• Higher-than-expected ENA prices due to the ethanol-blending programme that negated the gross margin expansion due to premiumisation
• Deutsche Bank has lowered USL's EPS estimates by 27% and 25% for FY15 and FY16, respectively, to factor in a reduction in their assumptions for Ebitda margins for the years