NDR feedback: A strong proxy play on PepsiCo India
* We hosted investor meetings in Mumbai and Singapore with Varun Beverages Ltd’s (VBL) management. We maintain BUY on the stock with catalysts being launch of new products by PepsiCo India and improvement in VBL's return profile.
* Investors appreciated the fact that VBL's partnership with PepsiCo India goes beyond just bottling operations. VBL has end-to-end execution capabilities and presence across the entire beverage value chain.
* Investors focused on 3 discussion points: 1) new product launch in non-carbonates segment, 2) ROCE improvement on steady state basis and, 3) new acquisition strategy.
* Management also gave clarity on proposed product launches in juices, flavored water, energy drink and iced tea categories. ROCE could increase 200bps p.a. due to better capacity utilization, debt reduction and peeking out of depreciation. New acquisitions would be valued ~6x EV/EBITDA which we believe is reasonable.
Strong product launch pipeline to boost volume growth
VBL is confident of volume growth of more than 10% in the next few years based on new product pipeline. PepsiCo will soon launch new juice brand, flavored water, energy drink and iced tea products. All these products will be manufactured and distributed by VBL. In addition, PepsiCo is negotiating to acquire the world's largest coconut water brand, which will further improve VBL's portfolio in the non-carbonate segment.
Favorable plant economics
Investors were slightly concerned about VBL’s low ROCE, but the management explained this was because of sub-optimal utilization of consolidated capacities. VBL need not invest in new capacities for the next 4 years on steady state basis. Consequently, the asset turnover ratio will improve to 1.5x from current 1x. This will result in ROCE improvement to 18% levels. VBL is already making ROCE of 20% in matured plants.
New acquisitions to support high growth trajectory
VBL is looking to acquire more territories from PepsiCo and other franchise operators. The strategy is to acquire territories near existing areas which will immediately improve efficiency. VBL is not willing to shell out more than 6x EV/EBITDA, which in our view, is very reasonable.
Attractively valued dominant franchise partner
Current valuation of 11.9x EV/EBITDA CY18E is not expensive given the strong prospects for EPS growth. We have valued VBL on DCF basis due to strong visibility on cash flows.
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