Varun Beverages: Wait for clarity on lockdown, demand before investing

As sales in the peak June quarter are impacted, analysts have cut sales growth to sub-4 per cent from over 20%

From being one of the top performers in the fast-moving consumer goods (FMCG) basket delivering 36 per cent returns in 2019, Varun Beverages — the India franchise of PepsiCo — is seeing its fortunes reverse in 2020.

Last year’s gains were aided by the acquisition of south and west territories of PepsiCo in May, which improved the growth prospects of Varun Beverages. Investors now may have to significantly tone down their expectations for 2020 as the coronavirus disease (Covid-19) pandemic is impacting the company’s peak season sales. The company follows a January-December accounting period.

The stock, up over 13 per cent in April, has shed around 24 per cent over the last two months, underperforming the 6-per cent fall in the Nifty FMCG during this period.

The 40-day lockdown and the expected delay in normalising business cycle will take a toll on the company’s top line in the June quarter. This crucial quarter contributes around 40 per cent of the company’s annual revenue. While the company will restart its operations after May 3, major concerns are prevail on the demand front.

 

 

Varun Beverages is the second-largest franchisee in the world (outside the US) of carbonated soft drinks and non-carbonated beverages sold under trademarks owned by PepsiCo. Most of them fall under discretionary products.

A likely cut in discretionary product portfolio, deferment or cancellations of social and public events are expected to keep demand subdued for the company. Analysts at IIFL have sharply cut their 2020 sales growth estimates for Varun Beverages to sub-4 per cent, from 22 per cent earlier, mainly due to demand uncertainty for discretionary and out-of-home consumption products.

Since a large part of Varun Beverages’ business is seasonal in nature, recovery of lost business is likely to be difficult.

According to industry sources, the demand for the company’s products is below normal levels. This is also due to shutdown of multiplexes, restaurants, and hotels, which collectively account for 10 per cent of its sales volumes.

The impact on the top line will also percolate through the operating and bottom-line levels. But, benign prices of key inputs and a larger share of variable costs may help cushion the impact somewhat.

Overall, investors should await clarity on the lockdown and demand before considering the stock, which is currently trading at rich valuations of 40x its CY20 estimated earnings.