Regulatory hangover continues to take toll on United Spirits in Q3

Change in distribution impacted volumes; firm working to cut costs

United Spirits (USL), the producer and distributor of prominent liquor brands such as Royal Challenge, Antiquity, and Johnnie Walker, disappointed the Street with its December 2017 quarter (Q3) results.
 
In fact, the subsidiary of London-based Diageo — the world’s largest producer of spirits — lagged behind expectations on several counts.
 
The share price of USL fell over eight per cent intra-day on Wednesday before closing down seven per cent at Rs 3,489.
 
The regulatory environment continues to take a toll on the company’s performance. This time it was a change in norms (route-to-market; impact on distribution) in some states, which coupled with a residual impact of ban on liquor sales on highways, pulled down USL’s revenues.
 
Despite the low base last year (hurt by demonetisation), the Q3 results disappointed. Analysts say volumes declined 14 per cent against their expectations of a decline of eight per cent.
 
Net sales at Rs 22.6 billion was lower than Bloomberg’s consensus estimates of Rs 24.6 billion. The rise in marketing and other expenses, despite lower input and employee costs, led to an operating profit of Rs 2.96 billion, lower than Rs 3.86 billion expected. Net profit at Rs 1.47 billion was also way short of estimates of Rs 2.1 billion.
 

A subdued quarter suggests that caution is likely to prevail. The route-to-market changes seen in Haryana and West Bengal are likely to be seen in Uttar Pradesh and Punjab, too. This will keep analysts and the Street watchful. In fact, the near-term volatility is far from over, said analysts.
 
Himanshu Shah at HDFC Securities says USL remains exposed to vagaries of regulatory headwinds (excise hike, ban on sales, route-to-market changes, etc), which are its key concerns. Another analyst at a foreign brokerage said at current valuations, the risk-reward remained unfavourable. He has maintained an equal-weight (neutral) rating on USL due to low visibility on pricing growth (a key driver for earnings) and high stock valuations.
 
USL, however, continues with its efforts to grow the business, including expanding the premium segment sales, rationalising supply channels and outsourcing low-value production. It is also aiming at increasing the share of prestige and above segment (Antiquity, and Royal Challenge brands; a notch below premium segment) to 75 per cent. Over the past one year, its share has increased from 50 per cent to 63 per cent.
 
USL has also highlighted that underlying demand remains strong as it is achieving double-digit growth in markets with no route-to-market changes. The full impact of price hikes taken in Telangana is likely to reflect in its performance. Also, there is a possibility of similar raises in other states from April 2018. Any positive development will help drive up investors’ sentiment.