Healthy balance sheet to help sail through tough times

The quarter has seen strong growth of 18.9% in gross sales led by dealer stocking before Budget 2020 and price hike after the budget. The company paid excise duty of | 58.2 crore against | 22.6 crore in the corresponding quarter, mainly due to a sharp increase in excise duty in Budget 2020. Net of excise duty, sales increased 6.9%. Operating margins expanded 272 bps to 32.5% led by favourable change in product mix towards high priced cigarettes. With higher EBITDA & cut in corporate tax rate, net profit increased 33.2%. Our estimate suggest ~10% volume growth during the quarter with ~9% price hike & product mix change. In the last two years, the company has increased its volume contribution of high priced cigarettes (| 5, | 6 & | 10) to more than 50%. We believe the price gap between the company & leader in low end cigarettes helped former gain market share.

Double whammy of excise, lockdown to impact FY21 PAT

Though the March quarter was largely unaffected by lockdown given prestocking by dealers, we believe Q1FY21 would be significantly impacted by 45 days production halt as well as shutdown of most retail shops in the country. We expect loss of sales during this period, which is likely to result in volume decline by 8% in FY21. Moreover, price increase due to the hike in excise duty in February 2020 would also lead to realisation growth to the tune of ~22% (including the mix change due to higher contribution from high priced cigarettes). This would help in more than absorbing the excise increase in Budget. In FY22, we believe the company would be able to recoup lost volumes (assuming normal operations). We estimate 16% volume growth along with 10% price hike/mix change. We expect revenue & earnings CAGR of 6.4% & 4.8%, respectively, during FY20-22E.

Strong balance sheet with steady cash flows

The company has a strong cash flow from operations to the tune of | 300 crore every year (FY21 would be exceptional). Further, VST has been maintaining ~65% dividend payout every year. It holds more than | 700 crore as liquid investments. We believe the consistent earnings growth & limited capex requirement may further increase the dividend payout in future. The company would be able to maintain its healthy return ratios (FY20 RoCE – 52.6%, RoNW – 38.6%).

Valuation & Outlook

With a wide presence at lower price points and strong distribution of 1 million retail outlets, VST’s brand has been especially popular in West Bengal, Bihar, Uttar Pradesh, Andhra Pradesh and Telangana contributing ~60% of volumes. The company is also expanding its reach in western India. Though FY21 numbers would be largely impacted by 45 days lockdown in April-May, we believe operations would return to normal by Q2FY21. Further, the possibility of curbs on illicit cigarettes and expectation of increasing taxation on non-cigarettes tobacco could help drive the volume growth for VST in future. We retain our positive stance on the stock with a target price of | 4,000/share and BUY recommendation.

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