Near-term margin hangover may put a lid on United Spirits' upside

Better-than-expected revenue and operational performance in the July-September quarter of 2022-23 (FY23), premiumisation trend after the recent rejig, and strong long-term outlook are positives for the country’s largest listed liquor maker, United Spirits (USL). Since its results on Tuesday, the stock has gained 6 per cent, outperforming the benchmarks.

Net sales for the quarter at Rs 2,880 crore saw a rise of 17.7 per cent, led by an estimated 8 per cent growth in volume.

Most brokerages had pegged sales between Rs 2,350 crore and Rs 2,500 crore. The reported number is about 25 per cent more than pre-Covid levels. Growth, according to the alcobev maker, reflects resilient consumer demand in the off-trade channel, rebound in the on-trade segment, and improvement in the product mix.

Sales were led by the prestige and above segment, which rose 23.1 per cent year-on-year (YoY) in the quarter and were the result of innovation and restructuring of its portfolio with focus on premiumisation. Volume gains of this portfolio on a sequential basis were the result of competitive pricing in certain states. Growth in the popular segment grew by a marginal 1.7 per cent.

By comparison, sales for the largest beer maker in the country, United Breweries (UBL) – which rose over 18 per cent - were lower than Street estimates. Even as volumes grew 23 per cent, pricing and an unfavourable mix (minus 5 per cent) pulled down the overall revenue performance. The premium portfolio of UBL saw a 48 per cent rise in the quarter. The segment accounts for 8 per cent of sales, compared with 6 per cent prior to the pandemic. 

“Favourable pricing in some states like Punjab, continuing premiumisation, and steady market share have been key positives for the quarter,” observes analyst Ajay Thakur of Anand Rathi Research.

The brokerage expects premiumisation and steady long-term industry volume growth outlook to lead to a healthy, 19 per cent annual revenue growth over 2021-22 through 2024-25 (FY25).

For USL, analysts Karan Taurani and Rounak Ray of Elara Securities (India) expect a healthy compound annual growth rate of 16.3 per cent in the prestige and above segment over FY23-25. The gains are on the back of consistent realisations and change mix. Realisations have grown 4-16 per cent YoY in the past four quarters, they point out.

The brokerage expects the second half to be better, aided by the festival season and the complete opening up of the on-premise segment. On-premise volume share for the luxury and upper prestige segments is as high as 40-60 per cent.

Even as brokerages are positive on the prospects of the two liquor majors, they face profitability challenges.

USL’s gross margins contracted 565 basis points (bps) YoY to its multi-year lows of 39.5 per cent, given the double-digit impact on costs. Prices of extra-neutral alcohol, glass and polyethylene terephthalate (or PET) bottles continued to remain elevated.

The management indicated that the challenges from double-digit growth in inflation will continue in the near term. The margin contraction at the operating level, however, was limited to 90 bps, given lower advertising costs, other expenses, and staff costs.

In contrast, UBL’s performance was better on the margin front. While it faced a 500-bp YoY gross margin contraction due to higher input costs, led by barley and packaging material, operating margins expanded 145 bps YoY (or 210 bps quarter-on-quarter), given operating leverage and cost efficiencies. Brokerages expect improvement in margin performance in the quarters ahead.

While some brokerages are positive on the USL stock, research analysts Krishnan Sambamoorthy and Aditya Kasat of Motilal Oswal Research had downgraded the stock last year after its market outperformance.

“Fair valuations after the outperformance, potential headwinds in the form of cost inflation, and delays in price increases are likely to adversely affect earnings growth. About 70 per cent of sales of USL accrue from markets where state governments regulate pricing,” they added.

Most brokerages are gung-ho on UBL. Analyst Vishal Punmiya of Nirmal Bang Research remains optimistic about the medium-term volume growth opportunity that the Indian beer industry offers, especially for market leader UBL. But factoring in target prices, analysts believe investors should await a better entry point into the stock, currently trading at 47x its 2023-24 (FY24) earnings.

USL is trading at 51-53x its FY24 earnings estimates. Given the near-term pressures on margins, investors should await improvement on this front, as well as steady volume growth, before considering the stock.