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Highlights from CY20 annual report – strong focus on growth to continue

Top five highlights: (1) Management remains confident on higher growth led by multiple tailwinds such as low per capita consumption, improving penetration in rural and semi-urban markets and rising in-home consumption, (2) Varun has increased investments in trade with the installation of 25,000+ visi-coolers in CY20, (3) there is reduction in trade discounts largely due to lower turnover. Most dealers were unable to achieve turnover targets, in our view, (4) there is increase in net working capital days due to lower sales but working capital in INR terms has also increased by Rs0.5bn YoY and (5) EVA creation remains negative with RoE (7.3% in CY20) < cost of capital. However, there is healthy FCF generation of Rs3.1bn in CY20. Maintain ADD with a target price of Rs1,100 (35x CY22E).

* Increase in trade investments: In-spite of covid and lockdown, the company has increased its investments in trade. The number of visi-coolers stands at 800,000+ in CY20 compared to 775,000 in CY19. Total reach also stands at 2mn retail outlets with 1,500 primary distributors in CY20.  Management confident on higher growth: The company believes the soft drink consumption to remain on a steady-growth trajectory. Tailwinds such as (1) rising young population, (2) low per capita consumption, (3) improving retail penetration across semi-urban and rural markets, (4) better agro-economics and (5) rising trend of in-home consumption make soft drinks an attractive growth market.

* Reduction in trade discounts: The company’s trade discounts to gross/ contracted revenues stood at 14.6% in CY20 compared to 16.3% in CY19. The savings in trade discounts were partly due to lower turnover target schemes to the trade, in our view.

* Increase in working capital and days: Varun’s net working capital days increased to 23 in CY20 compared to 18 in CY19. The key reason was lower sales. However, we note the working capital in INR terms has also increased from Rs3.6bn in CY19 to Rs4.1bn in CY20.

* EVA creation remains negative: Due to lower sales, the company’s RoE was lower than cost of capital even in CY20 resulting in negative EVA. However, as there was no acquisition, the company generated FCF of Rs3.1bn in CY20.

* Maintain ADD: We model Varun to report revenue and PAT CAGRs of 25.5% and 55.9%, 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 Rs1,100 (35x CY22E). Key risks: Sharp increase in competitive pressure and hike in raw material prices.

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