United Spirits on a high on margin gains

Improving profitability with pick-up in premiumisation of products, cost controls, reducing debt reinforce confidence

United Spirits’ shares gained five per cent on Tuesday to close at Rs 3,432.15 apiece on the BSE, as the company’s operational performance for the quarter ending September 2015 came better than Street expectations. While the firm has been doing its bit to streamline its operations and cut down debt, improvement in profitability and pick-up in premiumisation trend are key earnings catalysts.

The Street sentiments got a boost as earnings before interest, tax depreciation and amortisation (Ebitda) at Rs 318 crore was way ahead of Rs 258 crore indicated by Bloomberg consensus estimates. Margins at 14.8 per cent improved over 11.5 per cent in the year-ago quarter. With this, the reported net profit came in at Rs 929.30 crore including exceptional gains of Rs 799.45 crore, arising from the sale of United Breweries shares. Adjusted for extraordinary items, the profits would still have been higher than Rs 86.4 crore estimated by analysts. United Spirits had reported an exceptional loss of Rs 74 crore in the year-ago period.

Apart from operating gains, positives from exiting non-core businesses have been accruing and there is a reduction in debt, too. The company’s interest costs have been falling from Rs 155 crore in the year-ago quarter and Rs 128 crore in the previous quarter to Rs 110 crore now. The company has reduced debt by Rs 1,000 crore and the management expects a similar reduction in next 12-18 months that will accrue more benefits. Currently, its debt stands at about Rs 4,000 crore.

While margin expansion has been driven by some decline in advertising and sales promotion spends, growth in prestige (premium) and above IMFL segments has also helped. Prestige and above segments marked a growth of 16 per cent during the first half of the current financial year. This segment category formed 39 per cent of the total volumes in the first half and must have contributed 50 per cent to imputed net sales growth, say analysts. Diageo’s brand portfolio is also seeing increased contribution with sales from these at Rs 140 crore in the quarter against Rs 42 crore in the June 2015 quarter.

Challenge, too, has benefited from the re-launch and registered 49 per cent year-on-year volume growth in the first half. All this is positive for United Spirits’ margins. Thus, the popular segment growth of only one per cent during the quarter did not bother the Street since margins are also lower. The company is focusing on margins and not on volumes much, as is the trend seen in the industry.

Moving forward, the sustained trend of margin expansion is key for further gains in the stock price. Market sentiments in the recent past have gone upbeat on liquor majors in the country. One reason is expectations of lower prices for extra neutral alcohol (ENA), the by-product extracted during production of sugar. With increasing production year after year, ENA prices are likely to remain subdued.

Also, some analysts feel looking at low petroleum products prices, blending with petrol will also remain limited. Hence, raw material costs should remain under check for United Spirits as well as other companies. Since liquor producers have not been able to resort to price hikes for a few years now, some price hikes are anticipated. If that happens, it will act as a positive trigger for liquor majors including United Spirits.

The consensus Bloomberg estimates polled during October (prior to the results) stand at Rs 3,595. After the good results and visibility of a better second half, target prices might see some upward revisions. Analysts at Motilal Oswal Securities in their result preview had said United Spirits was their top pick in the large-cap consumer space. They expect the benefits of premiumisation and cost cutting, led by the new management, to help drive margins in the medium-term.