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Strong revival in volume growth

Q2CY21, peak quarter for Varun was impacted by covid wave-2 and lockdown but the company still managed to report strong revenue growth of 49.4% (Volume growth of 45.4%). Two year CAGR was -6.6%. We believe (1) stronger growth in urban markets, (2) higher in-home consumption and (3) favourable base were chief reasons for stronger revenue/ volume growth.

The company has done inventory up-stocking for packaging material for entire CY21. It will be net beneficiary as the crude oil/ packaging material prices are rising. Varun also need not raise prices and we believe it can gain market shares. We model Varun to report PAT CAGR of 55.3% over CY20-22 with improving RoE. Maintain ADD with target price of Rs840 (40x CY22E; Earlier TP-Rs733).

* Q2CY21 results: Varun reported revenue, EBITDA and PAT growth of 49.4%. 51.1% and 118.9%, respectively. Volume growth was 45.4% and net realizations improved 2.8%. Gross margins declined 130bps but EBITDA margin expanded 30bps due to cost savings. CSD, Juice and Packaged drinking water were 78%, 7% and 15% of company’s volumes in Q2CY21.

* Planned increase in working capital: The working capital days have increased from 20 in Jun’20 to 24 in Jun’21 primarily due to higher inventory. The company has done higher stocking of pet resin/ preform inventory due to lower input prices (crude oil and packaging material) at beginning of CY21.

* Revival in urban markets: In CY20, rural markets were outperforming the urban markets. However, in CY21, there is healthy growth in rural as well as urban markets. While there is strong revival in growth in urban markets, the growth rates in rural markets have remained strong.

* Increase in costs but no price hikes planned: While there is increase in raw material prices, the company has covered the raw materials for the full year. There is also increase in freight cost due to lockdown as well as higher diesel prices. However, Varun has not yet raised prices of its products and does not plan to raise prices in near term.

* Maintain ADD: We model Varun to report revenue and PAT CAGRs of 25.5% and 55.3% respectively over CY20-CY22E. Varun continues to benefit from its relationship with PepsiCo, pan-India distribution, backward integration, and increased in-home consumption. Maintain ADD with DCF-based target price of Rs840 (40x CY22E). Key downside risks are sharp increase in competitive pressure and increase in raw material prices.

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