Organic growth, expanding distribution reach add fizz to Varun Beverages

One name which is catching investor attention in the consumption space is Varun Beverage — PespiCo’s India franchise. The stock has surged 45 per cent rise in the last one year, mainly led by acquisition of PepsiCo’s south and west territories in India. However, with a strong improvement expected in return ratios, the stock is likely to see further upsides.

As per Bloomberg poll of analysts, the return on equity (RoE; a profitability indicator) of Varun Beverages is likely to go up to 19 per cent by CY2021 from 15.5 per cent in CY2018, led by a strong improvement in margins. The company follows January-December accounting period. 

Firstly, despite the ongoing slowdown, the company has posted strong organic growth in the past couple of quarters, including 17.5 per cent in September 2019 quarter (Q3CY19). It is also expanding its distribution reach, mainly in under-penetrated rural areas to overcome the sagging consumption scenario.

Moreover, Varun Beverages is ramping up the newly acquired territories, which in turn would give good margin traction with better operating leverage amid economies of scale. Q3CY19 also saw the company post strong volume growth of 59 per cent year-on-year to 124 million cases, pointing to the increasing operating scale post acquisition of new territories. This along with benign input cots led to a 60 basis point year-on-year expansion in Ebitda (earnings before interest, tax, depreciation and amortisation) margin to 18.7 per cent in Q3.

Notably, the company is also focusing on non-carbonated drinks, which enjoy higher margin. After commencing Tropicana juice facility in Pathankot, Varun Beverages launched three diary beverages in Q3CY19. Analysts expect the volume share of juices to increase over the next two years from 6.5 per cent during January-September 2019. 

“The company’s focus on healthier options would help drive incremental volumes and margins,” analysts at ICICI Securities explain in their report last month.

Lastly, the improving debt position (debt to equity at 0.9 times in Q3CY19) and attractive valuation are likely to lend further support to the stock, which is trading at 34 times its CY2020 estimated earnings versus over 40 times in case of many FMCG players.