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Better-than-expected results; lockdown leads to sharp EPS cut

* United Spirits (UNSP) reported in-line sales and significantly better-thanexpected EBITDA and PAT in 4QFY21. The key highlight of the result was the net debt declining to INR5.6b at end-FY21 (from INR20.7b at end-FY20) – the net debt has halved even over Sep’20 levels. While deleveraging has historically been a key success area for UNSP, it was particularly laudable in FY21 given the weak operating environment. Therefore, ROCE dipped just 50bp to 16.8% despite a ~42% EPS reduction in FY21. This gives us confidence that ROCE, which had been improving steadily in recent years, could reach the mid-20s levels from FY23E – once topline and earnings growth recover sharply.

* Lockdowns, as a result of the second COVID wave, have resulted in sharp earnings cuts. However, their impact, particularly with home deliveries being allowed in several key states, is unlikely to be as severe as the total lockdown seen last year. Faster-than-expected deleveraging strengthens the case for sharper earnings growth once normalcy is restored. We maintain Buy on likely strong earnings growth once the lockdowns are lifted and inexpensive valuations of ~40x FY23 EPS.

In-line sales; margins surprise positively

* UNSP’s reported standalone net sales grew 11.6% YoY to INR22.2b (inline). Underlying net sales – excluding the one-off sale of bulk Scotch in the prior year – increased 16.1% YoY.

* Overall reported volumes grew 8.1% (est. +14%).

* Reported gross margins expanded 180bp YoY to 43.9%, driven by benign commodities, a superior mix, and the management’s continued focus on productivity.

* Reported EBITDA grew 51.7% YoY to INR4.1b (est. INR3.7b).

* Reported EBITDA margins expanded 490bp YoY to 18.5% (est. 16.5%). As a percentage of sales, reported advertising costs and other expenses were down 140bp YoY and 170bp, respectively, while staff costs were flat YoY.

* On an absolute basis, ad spends were down 15.3% YoY.

* PBT grew 102.5% YoY to INR3.2b (est. INR2.8b).

* Adjusted PAT grew 124.1% YoY to INR2.4b (est. INR2b).

* FY21 net sales / EBITDA / adj. PAT was down 13.2%/34.5%/41.6% YoY.

* Net debt at end-FY21 was down 73% YoY to INR5.6b v/s INR20.7b at FY20- end.

* UNSP’s OCF and FCF grew 159% YoY each to INR17.3b and INR16.4b, respectively, in FY21.

Highlights from management commentary

* The management believes UNSP outperformed the competition in every quarter in FY21.

* The Scotch Whisky segment is faring very well as tax rationalization by various states has led to higher affordability. Additionally, the ongoing UKIndia FTA talks may also lead to lower import duty on scotch.

* Based on the current material cost trend, the management does not expect any major impact on GMs in either 1QFY22 or the full-year FY22.

* Diageo and UNSP would contribute INR350m and INR100m, respectively, toward COVID relief in FY22.

Valuation and view

* Changes to the model – due to the ongoing lockdowns amid the second COVID wave in India – have led to a ~35%/17% EPS cut in our FY22/FY23 estimates.

* Nevertheless, the impact of the ongoing second wave on sales and profits is likely to be less severe than in FY21 given that home deliveries are permitted and there is far lower supply chain disruption. Furthermore, the earnings rebound may be very sharp beyond the next few months, especially with a leaner-than-expected balance sheet. We had upgraded the stock to Buy in Jan’21 after adopting a cautious stance on Alcobev industry prospects for most of 2020. This is largely attributable to inexpensive valuations after the stock price underperformance seemingly factored in near-term risks.

* Valuations at ~40xFY23 EPS are at a sharp discount to the discretionary peer range (in our coverage) of 58–72x FY23 EPS. In the five years before COVID impacted FY21, UNSP reported a strong 18% CAGR in EBITDA and an over 30% CAGR on PBT/PAT.

* The outlook appears promising with (a) in-home consumption, which favors spirits over beer, benefiting from the on-going lockdowns (b) the ongoing strategic review of half the Popular portfolio to be concluded by Dec’21 – which would give further primacy to the Prestige & Above (P&A) segment, (c) success in the P&A segment in terms of both growth and margins (24–25% EBITDA margins already demonstrated by Pernod Ricard in India), (d) the new CEO (with a demonstrated growth focus) taking over from Jul’21, and (e) faster-than-expected deleveraging.

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