Focus on the premium segment will be a boost to United Spirits' margins

May help mitigate downside risk from tax increases

For United Spirits (USL), 2018 was a dismal year, with the stock declining 13.5 per cent in comparison to a 27-37 per cent rise for two of its peers — United Breweries and Radico Khaitan. The reason for USL’s stock performance was decline in volumes to the tune of 13 per cent in FY18, while the other two reported a growth of 7-11 per cent.

However, USL’s dismal volumes were mainly in the non-premium segment, with the firm’s focus shifting to the premium portfolio. This should boost margins. Despite the fall in overall volumes in FY18, premium segment volumes grew 1.3 per cent. The higher premium segment share helped USL’s gross profit margin expand by 465 basis points to around 48 per cent.

In fact, the premium portfolio has been growing 13-15 per cent year-on-year, in volume terms, since the last three quarters up to September 2018. The share of premium products moved from 40.9 per cent in FY17 to 47.4 per cent in FY18 and stood at around 52 per cent during April-December 2018.

With changing lifestyle, USL’s premium product is expected to see good traction. According to Nirmal Bang’s report, ‘drink less but better’ is the new consumption pattern seen across the millennial population and they believe the share of P&A (prestige and above category, or premium products) will grow even further.

Given the inclination of the improved product mix towards the P&A segment, gross margin is expected to expand 300 basis points during the FY18-FY21 period. During April-September 2018, the company’s gross margin was around 49 per cent. In addition, with higher operating leverage, USL will see close to a 440-basis-point expansion in its operating profit margin.

Moreover, focus on premium segment will also help mitigate downside risk from an expected tax increase as demand for premium products is relative price inelastic, says an analyst at domestic brokerage. However, the upsides could be capped due to high valuations of 45 times its FY20 estimated earnings.