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Profitability to remain muted despite healthy volumes

* While UBBL’s 1QFY23 sales came in better than our expectation, the 410bp YoY and 440bp QoQ contraction in gross margin led to a miss of 9%/16% on forecasted EBITDA/adjusted PAT.

* When compared to pre-COVID levels, volumes are up by only 8% from 1QFY19 levels (14% when adjusted for the change in the Andhra Pradesh state government’s excise policy).

* As indicated in our Feb’22 note, rising commodity cost pressures for AlcoBev companies, given the lack of free pricing in a majority of states, is likely to negatively affect the pace of earnings growth, even in a strong demand environment.

* We retain our Sell rating on the stock, given its expensive valuation (~64.4x FY24E P/E).

Sales beat; input cost pressures adversely impact profitability

* Standalone net sales grew 117.9% YoY to INR24.4b (est. INR21b). EBITDA grew 196.1% YoY to INR2.8b. PBT/adjusted PAT grew 452%/424% YoY to INR2.3b/INR1.6b (est. INR2.6b/INR1.9b).

* Volumes grew 121% YoY in 1QFY23. The same was 8% higher than 1QFY20 levels. Record volumes were achieved, despite a number of supply-chain restrictions in the peak season.

* Gross margin fell 410bp YoY to 44.3% (est. 48.5%) due to inflationary pressures seen in the prices of barley, packaging materials, and crude oil.

* As a percentage of sales, lower other expenses (down 240bp YoY) and employee expenses (down 480bp YoY), adjusted for one-off severance payments, led to standalone EBITDA margin expanding by 310bp YoY to 11.6% (est. 14.8%).

Highlights from the management commentary

* The management is targeting 6-8% volume growth on a steady-state basis in coming years.

* In addition to input costs, margin in 1QFY23 was impacted by a weak state mix.

* Raw material (including packaging) inflation remains very high. Barley prices are up ~70%, while the cost of new glass bottles remains elevated.

* Consumer price increases have been in the 3-7% range, with Maharashtra and Karnataka seeing increases at the lower end of the range. Markets, where price hikes have been granted, account for two-thirds of UBBL’s countrywide volumes. States typically grant price increases in the first quarter of every fiscal.

* Higher input costs will impact 2Q, even more than 1Q, but the full extent of price hikes granted in 1QFY23 will offset some of that impact.

Earnings unlikely to see a strong growth; valuation stretched; retain Sell

Changes to our model have led to 6.6% and 2.4% cut in our FY23/FY24 EPS estimate owing to higher-than-expected material cost pressures, even as volumes are likely to remain healthy.

* Consequently, UBBL is likely to post an EPS decline at the end of FY23 v/s four years ago (FY19), even as sales are likely to exceed FY19 levels.

* The stock is expensive at 64.4x FY24E EPS and 34.5x FY24E EV/EBITDA.

* UBBL’s pre-COVID PBT CAGR for the five years ended FY20 stood at just 8.5%. Even as normalcy resumes, earnings are unlikely to witness strong growth. UBBL's return ratios were in the 18-19% range even during its best year (FY19), much lower than its Consumer peer average of over 30%. Even in FY24E, they are unlikely to exceed 15%.

* We maintain our Sell rating on the stock, with a TP of INR1,175 (targeting 25x Jun’24E EV/EBITDA)

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