Ramp-up in capacity to keep fizz intact for Varun Beverages stock

Higher margins, asset turnover should boost return on equity; Street sees 15-20 per cent upside potential

Strong earnings visibility after the acquisition of PepsciCo India’s franchise rights has helped the Varun Beverages (Varun) stock gain about 20 per cent in the last six months, sharply outperforming the Nifty FMCG index.
 
The latter lost 1 per cent during the same period. On Wednesday, the stock hit its all-time high of Rs 969.9 apiece. Yet, the stock still has 15-20 per cent upside potential on the back of a likely improvement in return on equity (RoE).
 
This was expected, on account of an improvement in asset turnover and profitability, which should improve Varun’s RoE to 18-21 per cent by CY21 (calendar year), from 15.7 per cent in CY18.
 
Though the newly acquired low-margin franchise will cap Varun’s overall margin gains in the current year, ramping up of the franchise/facilities will help achieve better economies of scale and also add to the overall profitability and earnings of the company from CY20 onwards.
 

Among others margin levers are backward integration and a likely increase in the share of high-margin non-carbonated juices. Given the rising health concerns surrouding carbonated soft drinks, the share of juices in Varun’s overall product mix is likely to see a rise in future.
 
In fact, analysts expect strong internal accruals, coupled with additional equity issue through QIP (qualified institutional placement), to help reduce its debt burden.
 
In addition to revenue gains, the new franchise will also help improve capacity utilisation of Varun’s existing facilities.
 
This, along with a likely full capacity utilisation of the company’s new Pathankot facility, should improve the overall asset turnover — a key factor for RoE.
 
The management expects close to twofold asset turnover for the Pathankot unit, against status quo for the overall company.
 
Strong growth potential, with supportive macro factors such as population growth and lower per capita consumption of carbonated drink (44 bottles against 1,496 bottles in the US), among others, indicates the upside potential.
 
Analysts at ICICI Securities expect Varun Beverage’s revenue and net profit to grow 22 per cent and 34 per cent, respectively, over the next three years.
 
Expect this to reflect in shareholder returns over the medium term.