USL: Street sees positives in cleaning-up moves

Lean balance sheet and premiumisation efforts seen as long-term positives

The new management of Diageo after taking over United Spirits' (USL) business not only continues streamlining the operations but is also cleaning the books. The March quarter standalone results reflect this, with USL making provisions for doubtful debt/advances/ deposits amounting to Rs 1,013 crore (reported under expenses) and additional provisions worth Rs 4,322 crore, leading to a net loss of Rs 5,380 crore. The additional provisions comprise Rs 3,616 crore largely due to an intra-USL group loan (taken for White & Mackay) and another Rs 700 crore on account of diminution in value of investments made in Palmer Group and Montrose International. Thus, for FY14, the consolidated loss was Rs 4,489 crore.

The massive loss, however, failed to deter the Street. After falling 3.7 per cent in intra-day trade on Thursday, the stock closed almost flat at Rs 2,390. The reason: Market participants have been anticipating write-offs and also the weak operational performance in the backdrop of a subdued business environment. Analysts feel the stock after its fall from a 52-week high of Rs 2,941 factors most of the concerns and, hence, can rebound in a few quarters.

And, that's even as they expect some more write-offs and provisioning. Of the Rs 1,422-crore loans to UB Group, only Rs 330 crore has been provided for. While the management expects to recover the rest of the amount, analysts feel more will need to be provided for on this front.

Meanwhile, due to the overall industry slowdown, USL's revenues during the quarter could just grow 2.7 per cent year-on-year to Rs 1,917 crore. Margins are reeling under pressure as price hikes remain muted, whereas costs are on an increase. Employee costs surged (83 per cent year-on-year), the ENA (extra neutral alcohol) price per case also continued to surge while molasses prices are also increasing (up 10 per cent year-on-year). Adjusted for doubtful provisions and one-off business expenses of Rs 253 crore, Ebitda at Rs 116 crore declined 46 per cent year-on-year and margins at six per cent were down by 553 basis points.

The company, however, is taking steps such as premiumising the portfolio so as to improve profitability. It is said to have withdrawn low-price brands of rum from some markets. All these initiatives have led analysts to remain positive on the stock.

Analysts at Kotak Institutional Equities observe Diageo is carrying out a comprehensive restructuring of USL's balance sheet. Post restructuring, USL will emerge as a much leaner and more efficient company. Analysts at Edelweiss say, "We expect Diageo's control to bring in better focus and lead to steady sales and margin improvement in the longer term." They have a 'Buy' rating on the stock from a longer-term perspective.

Analysts expect USL's EPS to rise to Rs 40 in FY15 and further to Rs 56 in FY16.