Q1 results: United Spirits high on strong margin gains, stock falls 1.6%

Operating efficiency to drive profitability, but there are some near-term headwinds

United Spirits' June quarter (Q1) results, announced on Monday after market hours, were above expectations with standalone net sales growing 10.4 per cent year-on-year (YoY) to Rs 2,218 crore and net profit rising by over two times to Rs 197.4 crore. According to the Bloomberg Consensus, analysts had pegged these numbers at Rs 2,152 crore and Rs 120.2 crore, respectively.

The stock, however, fell 1.6 per cent to Rs 589.4 on Tuesday due to the weak sentiment in the market and profit-booking, given it has outperformed the Sensex in the past three months.

Though dry days and restrictions on keeping the liquor stores open during the general election weighed on the company's offtake, absence of tax hikes in Karnataka, which usually happens in April every year, and one-time sales of old scotch stock of Rs 97 crore pushed the top line.

What is more enthusing is the sturdy margin performance. Despite a 291 basis-point YoY contraction in gross profit margin to 47.3 per cent due to inflationary pressure and excise duty hike in Maharashtra, United Spirits' Ebitda (earnings before, interest, tax, depreciation and amortisation) margin zoomed 772 bps YoY to 17.8 per cent in Q1. The margins gain was due to the company's strong traction of the premium portfolio (prestige and above products) and operating efficiency measures.

The prestige and above category products grew 8.4 per cent YoY in volume terms and about 9 per cent in value terms in the June quarter. The one-off sale of old scotch was from the popular category - non-premium segment.

According to the management, gross profit margin gains will moderate but operating efficiency will push up the Ebitda margin. It added each of the premium categories was growing at a faster pace. Extra Neutral Alcohol (ENA), which forms around 40 per cent of the company's cost of raw material consumption, is seeing some upward movement since June-end and restricting gross margins. 

"The company is structurally going in the right direction. Premiumisation and operating efficiency are likely to give margin benefits to the company," said an analyst at a domestic broking house. Analysts at Edelweiss, who have a hold rating on the stock, estimate the Ebitda margin to increase by 30 bps in FY20 and by another 40 bps in FY21. Aided by single- to low-teen digit increase in top line, the company's earnings are expected to increase over 20 per cent annually in the next two years.

The savings in operating costs are expected to accrue on the employee and operating expenses (other than marketing spends) front. This is because, after a sharp fall in Q1, the management expects advertising and sales promotion expenses to normalise. Going by the trend in the past two years, advertising and sales promotion costs could go up to 9-10 per cent of net sales from 7.7 per cent in Q1.

Yet, investors should be mindful of the near-term headwinds, which could weigh on margins and overall earnings.

According to analysts at Edelweiss Securities, who think United Spirits is a good long-term bet, an expected increase in taxes, competitive intensity, and a likely liquor ban in Andhra Pradesh could hurt near-term growth. 

The current political situation in Karnataka, which contributes around 20-30 per cent of United Spirits' revenue, is another worry.