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Performance below our expectations; outlook unclear

* UNSP’s 3QFY22 performance came in below our estimates. Unlike other Discretionaries, its weak two-year average sales, EBITDA, and PAT (6-8% range) was despite a near normal quarter.

* This is especially disappointing given the context of relatively softer input cost inflation, a highly favorable tax environment (no excise increases in the FY22 state budgets), and higher than usual realization led sales growth.

* It is fairly certain that these factors may not be as favorable going ahead. It is also important to note that any steep material cost increases cannot be passed on in large parts of the country without the approval of state governments, which usually comes with a lag. We maintain our Neutral rating on the stock.

Performance below our estimates

* Standalone net sales grew 15.9% YoY to INR28.8b (est. INR30.1b). Twoyear average sales growth was 6.1%.

* Reported volumes grew 3.7% (est. 12%). Two-year average volume growth was tepid at 1.5%.

* Reported gross margin contracted by 50bp YoY to 44.1%, led by input cost inflation, but was partially offset by favorable product mix and productivity savings.

* As a percentage of sales, higher advertising costs (+80bp YoY) and lower other expenses (-170bp) and staff costs (-130bp) led to a 160bp expansion in EBITDA margin to 17% (est. 17.6%).

* Reported EBITDA rose 27.9% YoY to INR4.9b (est. INR5.3b). Two-year average EBITDA growth was 9.1%.

* On an absolute basis, ad spends rose 26.3% YoY.

* PBT/adjusted PAT grew 29%/26.6% YoY to INR3.9b/INR2.9b (est. INR4.6b/INR3.4b).

* Sales/EBITDA/adjusted PAT grew 22.6%/84%/176% YoY in 9MFY22. Volumes grew 14.6% YoY in 9MFY22.

Highlights from the management commentary

* While on-trade sales have been impacted again in Jan’22 due to the ongoing third COVID wave, there is no panic among customers unlike that seen in the first and second waves.

* The realization part of sales growth will settle at 7-8% as compared to earlydouble-digits in recent quarters.

* Input costs are showing an increasing trend. Global shipping rates are at unprecedented highs. ENA and bottling costs are both trending upward. The former was flattish until recently, when OMCs offered price increases to ethanol producers.

Valuation and view

* Changes to our model have led to a 4.5%/7% impact to our FY23E/FY24E EPS estimate as we factor in a miss on our forecasts, the impact of the ongoing third COVID wave on demand in 4QFY22, and rising raw material costs.

* We had downgraded UNSP to Neutral in Nov’21 after the stock outperformed our coverage universe. Fair valuations, after the outperformance, and potential headwinds in the form of demand impact, cost inflation, and the risk of excise increases warranted a downgrade from our upgrade last year. None of these potential headwinds have abated so far.

* Unlike other Discretionaries, UNSP’s two-year average sales, EBITDA, and PAT growth are in single digits, despite a near normal demand environment in 3QFY22.

* We maintain our Neutral rating with a TP of INR920, valuing UNSP at 50x FY24E EPS.

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