Varun Beverages appears set for volume growth as consumer firms struggle

Gains expected on the back of rising out-of-home consumption after two years of sluggish performance

As most consumer majors struggle to improve volumes in the March quarter due to price, PepsiCo franchise Varun Beverages (Varun) seems an outlier.

Varun’s volume growth in Q4FY22 at 10 per cent—the sector growth is in lower single digits--is the highest in the consumer space. Its revenue growth of just under 14 per cent is the second highest (sector average at 7.9 per cent), according to IIFL Securities. Three- year compounded annual growth rate of revenues at 22 per cent is also the highest across the FMCG universe, believe analysts.

The volume gains are expected on the back of rising out-of-home consumption after two years of sluggish performance due to the coronavirus. Aided by acquisitions and organic growth, the company posted an annual sales volume growth of 20 per cent from 279 million unit cases in 2017 to 569 million unit cases in 2021.

The company’s product and capacity expansion could act as growth triggers. According to Devanshu Bansal and Ashit Desai, who work with Emkay Global Research, product and capacity are expected to come from a strong marketing push, portfolio expansion into lemon-based drinks (40 per cent of industry) and continued traction in energy drink ‘Sting’. New plants in Bihar and Jammu & Kashmir will help bring its products closer to customers, increase penetration, help gain market share and improve profitability.

While revenue growth is expected to be strong , the company will face commodity headwinds. Most brokerages expect an operating profit margin impact of over 120 basis points y-o-y in Q4FY22 to 15.9 per cent. The company, according to Kotak Institutional Equities, is facing inflationary pressure in PET chips, partly mitigated by low-cost inventory, operating leverage, and other cost saving initiatives such as light-weighting PET preforms.

Expansion in international geographies such as Congo, higher overseas contribution to overall revenues and net profits as well as reduction of debt are expected to support the stock. Motilal Oswal Research expects the company to generate a free cash flow of Rs 2,670 crore over CY22-23 with overall debt expected to come down to Rs 990 crore in CY23 from Rs 3,340 crore in CY21.

At the current price, the stock, which hit its 52-week highs on Wednesday, is trading at 36 times its CY23 earnings estimates. While growth prospects are strong, the stock (12 per cent higher over the past month) is trading near the target prices of most brokerages. Investors should wait for a better entry point to own the beverage maker and distributor.