Distribution gains to bolster volume growth for Varun Beverages

The impact of rising raw material prices is a near term concern

A strong performance in the December quarter and plans for distribution and manufacturing expansion are positive triggers for one of the largest global franchisees of PepsiCo outside of the US, Varun Beverages. 

Revenue performance for the bottler of PepsiCo’s range of carbonated beverages was much higher than estimates at 30 per cent. The gains were aided by a weaker base, easing of restrictions, higher mobility and international performance.

Volume growth at 28.5 per cent accounted for most of the revenue growth with the rest coming from higher realisations. Even on a two-year basis, volume growth for the company was at a robust 17 per cent, say analysts at Axis Securities. “Despite pandemic hitting the peak season over the last two years, VBL managed Covid-led disruption well. Distribution ramp-up, portfolio expansion (Sting, Mountain Dew Ice), strong push towards in-home consumption and robust growth in international markets aided the recovery,” they add. 

The volume growth and revenue outperformance is boosting sentiment for the stock given the upcoming peak season. Most brokerages believe that the company would deliver a good CY22 after two consecutive years of muted show due to the ongoing pandemic. 

What could aid the volume growth is the manufacturing and distribution expansion. While manufacturing facilities in Bihar and Jammu and Kashmir are expected to come online shortly, the company is expanding its reach in Africa through facilities located in Morocco and Zambia.
 

While the company added 40,000 visi-coolers during CY21, it plans to boost its network presence (2 million retail outlets) by 10-15 per cent over the next year. Himanshu Nayyar and Ankit Mahajan of YES Securities believe that continued retail outlet expansion is driving market share gains in carbonated soft drinks which coupled with success in categories like dairy and energy drinks should remain key growth drivers. They believe the company is a good compounding story for the long-term with a growth potential in the mid-teens coupled with stable margins and return ratios. 

While there was no change in net debt at Rs 3,000 crore at the end of December quarter, the company aims at bringing this down by 40 per cent on the back of higher free cash flow generation and lower capital expenditure. 

What could impact earnings however are raw material pressures. Gross margins dipped by 470 basis points y-o-y to 55.4 per cent due to an increase in prices of polyethylene terephthalate or PET used in making bottles and linked to crude oil prices. With crude oil prices hovering at around $100 a barrel, margin pressures are expected to stay in the near term. 

At the current price the stock is trading at 28.5 times its CY23 earnings per share estimates. Given the growth prospects, any weakness can be used to accumulate the stock.