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Strong outlook ahead as premiumization drive and margin improvement continues

Result summary

* Standalone performance – Revenue grew 15.9% YoY in Q3FY22 and 14.3% adjusted for prior year one‐off sale of bulk scotch led by underlying volume growth of 3.7%. Gross margin down by 49bps to 44.1% owing to RM inflation partially offset by superior mix and improved productivity. EBITDA margin up by robust 159bps driven by lower employee and other expenses partially offset by higher A&P spends. PAT increased from Rs2,299mn to Rs2,911mn on account of lower interest and tax expenses. Revenue grew by 22.6% YoY and 21.9% adjusted for one‐off sale of bulk scotch with 14.6% underlying volume growth, EBITDA margin improved 544bps owing to gross margin improvement, positive operating leverage while PAT stood at Rs36,340mn in 9MFY22.

* Prestige & Above segment – Revenue up by 20% led by 7.9% increase in volume, accounted for ~74% of the total revenue in Q3FY22 vs 71% in Q3FY21. The strong performance was driven by premium and luxury portfolio growing faster than Prestige portfolio. While for 9MFY22, volume/revenue grew 16.7%/26.9% led by strong double‐digit growth in Scotch portfolio, Johnnie Walker, Black & White, Black Dog and J&B.

* Popular segment – Revenue down by 1.7% owing to 1.1% drop in volume, (flat growth in priority states) accounted for ~23.5% of the total revenue in Q3FY22 marginally down 4.1% over Q3FY21. While for 9MFY22, volume/revenue grew 12.2%/11% primarily driven by 10% growth in priority states.

* Other highlights – A&P spend as % of sales increased from 9% in Q3FY21 to 10.3% in Q3FY22 implying 32% growth to strengthen renovated Black Dog Scotch, Signature Whiskey and innovation offering of Royal Challenge American Pride Whiskey. It also launched In.thebar.com, a digital platform to drive consumer engagement. Employee expenses/other expenses were down from 7.6%/1.2% in Q3FY22. Interest expense of Rs 34cr includes one‐off non‐debt related charge of Rs 18cr.

Management con call takeaways

* Quarter commentary ‐ Operations remained broadly normal for the quarter with sentiment gradually inching up seen in improved mobility and strong festive which helped demand, input cost pressures continue, global supply chains remain disrupted with port congestion and container availability issues, ramp up of innovation and renovation agenda, premiumization trends continue, launched digital platform In.thebar.com during the quarter, Delhi and WB new policy operationalized, tax rationalization on BIO spirits continued in Maharashtra and WB.

* Financial summary ‐ Revenue up 16% and underlying growth up 14%, P&A up 20% and 2% decline in Popular, off—trade resilience continues, recovery in on‐trade footfalls which is now reversing somewhat in 4Q, product mix and efficiencies helped mitigate inflation impact, marketing costs up 10%, EBITDA Margins at 17% up 160bps led by operating leverage, became debt‐free in December, PAT up 27%.

* Outlook ‐ Aiming to retain current demand momentum despite challenging near‐ term environment, expanding on new productivity initiatives, renovated portfolio well placed to benefit from ongoing premiumization, final stages of strategic review of popular brands

* Pernod launching own EBOs – Was done in some African markets, but will wait for now before taking a call on opening own outlets, focus will remain on accelerating luxury and premium portfolio.

* Home delivery ‐ Excited about the home delivery opportunity which can at a future date be integrated with own digital platform In.thebar.com, currently active in 6 states with strong traction seen in WB (3‐4% share).

* A&P spends outlook  ‐  Spends brought back with on‐trade coming back to normalcy, will retain 8‐9% spends on A&P despite ongoing material inflation.

* Volume and realizations – 12% realization and 8% volume growth in Prestige and Above, second consecutive quarter of strong jump in realizations, favorable regulations and muted foreign travel has supported increase in realizations, expect realization increase to sustain at 7‐8% on an annual basis with efforts on premiumization.

* Material cost inflation – Both ENA and glass prices witnessing an upward trend, inflation in upcoming quarters could be in the range of 4‐5%, accelerating productivity increases to offset that, also engaging with state governments to give some price increases in the ongoing inflationary environment.

* Regulatory environment – Overall changes very positive on the RTM side especially on the BIO segment, recently got an increase from Assam and expect more in the next few months.

* Industry positives and challenges – Key positives  ‐  Positively surprised with pace of premiumization and positive developments in 4 states which reduced BIO prices; Challenges ‐ more work needs to be done on productivity, gaining pricing flexibility with the government and further manufacturing footprint optimization (already reduced from 100 to 50).  

* Near‐term outlook ‐ Expect quick normalization of business post the ongoing moderation (in key markets like Delhi) once the ongoing restrictions in a  few markets are lifted, do not expect much impact of the pandemic.

* Margin outlook ‐ Got benefit of seasonality and operating leverage in the quarter, will plan further margin improvement measures after reaching a sustainable high‐teens margins from the 16.5‐17% range currently.

* BIO salience and margin outlook – Overall scotch salience (BIO +BII) at about 22‐24% split equally, looking at aggressive growth so salience should continue to increase, currently make around 10% EBITDA margins on Diageo brands (distribution margin dependent on global transfer pricing regulations so non‐negotiable), will be dilutive for percentage margins but accretive on an EBITDA per case basis, also ROCE accretive with no investments on fixed assets or working capital.  

* Premiumization/realizations – Overall market is witnessing premiumization trends, P&A portfolio now growing ahead of Popular for past many quarters, all new launches accretive for price/mix pace to increase to 7‐8% from 4‐5% earlier.

* Capex and dividends – Will remain an asset‐light model going forward as well in line with limited capex as in the last few years, will be able to start dividend payout post wiping out accumulated losses in the next 3‐4 quarters.

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