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Getting into the spirit

Alcobev companies’ earnings have a higher leverage to economy normalization in a post Covid-19 world. Our channel checks as well as volume trends from six key states (50%+ of industry volumes) already reflect a sharp normalization curve – IMFL volumes are up 7% yoy, while beer volumes have reached 80%+ of pre-Covid levels in Oct/Nov. Secondly, the pandemic has offered a crash course on economics to state governments - they have quickly reversed excessive tax hikes to optimize revenues. We expect more benign taxation policy ahead. Lastly, margins have a tailwind from soft commodity prices. We expect revenues/earnings for our coverage to rise 7%/50% in H2FY21 vs. 39%/100% decline in H1FY21. Reaffirm Buy on RDCK, UBBL, UNSP.

Alcobev: arguably the best bet on economy normalization; volume recovery trends encouraging:

With the economy normalizing from the Covid shock at a faster pace, alcobev names are a good recovery play and offer strong upside potential. Channel checks and beverage corporation data of six key states (~50% of Beer/IMFL volumes) show that IMFL saw growth and beer saw good recovery mom in Oct/Nov. IMFL volumes grew in Oct in key markets (exRajasthan), while beer recovery rose to 80% in Oct from 60%/70% in Aug/Sep. Channel checks show further improvement in Nov on strong growth in Karnataka and beer’s recovery in the Eastern markets.

Excessive pandemic taxes prove ineffective; states on a reversal mode to optimize revenues:

Taxes account for almost two-thirds of the consumer price of alcobev products and are big revenue generator for states. Excessive tax increases were the sector’s major challenge – adversely affecting both affordability and pricing power. Most states that raised taxes sharply post the Covid outbreak suffered tax revenue losses and have now reversed it - either fully or in part - to improve volumes and tax revenues. While Delhi and J&K fully reversed 50-75% tax hike on IMFL/beer, Odisha and Andhra Pradesh did it partially. West Bengal has fully withdrawn 30% Covid tax on beer. Most states now have 0-10% tax increases, and consumers are likely to absorb it without much demand hit. Overall tax revenue recovery of most states and their realization of excessive alcobev tax impact to their own revenues keep us hopeful of a more benign tax environment ahead.

Soft input prices; cost-reduction measures offer room for margin surprise:

The steep input inflation in FY20 is behind us and key input prices have moderated. Stable sugarcane/maize/barley production vs a steep decline in demand from alcobev in H1 should keep prices of key inputs - ENA and barley - soft for more quarters. ENA makes up 40% of COGS for UNSP/RDCK, while barley is 20% of UBBL’s COGS. Benign ENA/barley prices should offset a moderate glass price inflation (35-40% of COGS) – in turn driving margin gains. In addition cost rationalization and savings from discretionary spending cuts should lead to higher operating margins as volumes fully recover. For FY20-23E, we estimate 100-200bps gross margin gains for UNSP/UBBL/RDCK which are still conservative vs FY19 and can see upsides.

Exciting recovery play; reaffirm Buy on RDCK, UBBL and UNSP:

We are constructive on the sector as volume recovery continues to show improvement and the tax-hike overhang is seen to be reducing. Better volume trends, benign input prices and moderate taxation should drive strong earnings recovery in FY22-23E - with likely upsides to our forecasts. We foresee a full volume recovery by Dec’20/Jan’21, driving earnings growth in H2FY21. Alcobev stocks have underperformed since Covid-19 outbreak. Current valuations are at a discount to their long-term averages and can see upsides as volume/earnings growth visibility improves. Reiterate Buy / OW in EAP on RDCK, UBBL and UNSP.

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