Varun Beverages: Good recovery, better margin outlook augur well for stock

Though out-of-home consumption is still under pressure due to the coronavirus pandemic, rising in-house consumption of carbonated soft drinks (CSD) is partly reducing the pressure on overall volumes

Even as Varun Beverages posted a 69 per cent year-on-year (YoY) fall in pre-tax profit to Rs 181.9 crore in the June 2020 quarter (Q2), led by a 46.4 per cent contraction in volumes, its share price has gained over 8 per cent since the announcement of results, versus a 2.4 per cent rise in the Nifty FMCG index.

PepsiCo’s India franchise, which follows the January-December accounting period, announced its quarterly results on Tuesday. 

Good business recovery and improved margin outlook have boosted investor sentiment towards the stock.

Though out-of-home consumption is still under pressure due to the pandemic, rising in-house consumption of carbonated soft drinks (CSD) is partly reducing the pressure on overall volumes. From 25 per cent in April, domestic volumes as a proportion of the year-ago level went up to 75 per cent in June and have further improved in July, the company says. This offers hope of a faster-than-anticipated recovery in Varun’s business, even as near-term volumes may see some pressure with localised lockdowns. Improved in-house consumption also points towards incremental business for Varun once the situation normalises.

 

 

According to analysts at ICICI Securities: “When business activity returns to normalcy, some consumers will continue with in-home consumption and this opens up a new window for beverage consumption.”

What is more encouraging is the company's operating margin levers, led by structural cost control. The management expects most of the cost savings programs in Q2 to sustain. Thus, analysts at Kotak Institutional Equities estimate potential margin tailwind of 100 basis points (bps) in FY21 from these permanent cost savings.

Further margin cushion in the near term would stem from an improvement in product mix with a lower share of low-margin packaged water. Realisation from packaged water is just a third of CSD, which is likely to remain in a relatively better shape.

In Q2 as well, volume share of CSD improved to 85 per cent from 74 per cent a year ago, and that of packaged water declined to 8 per cent from 18 per cent. This, along with lower trade promotions, benign raw material prices, and cost savings led to a better-than-estimated Ebitda margin of 23 per cent in Q2, though down 500 bps YoY. Some analysts had pegged Varun’s Q2 Ebitda margin at 17-18 per cent.

Thus, how the company’s operating profit margin pans out would be interesting to see.