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Acquired geographies to lead next leg of growth

Our analysis of Varun Beverages’ (VBL) CY20 annual report highlights the management’s efforts to improve its presence, product mix, and utilization levels. Key insights mentioned below:

Lower consumption due to COVID-19 pandemic affected overall volumes

* Over CY13-20, volume mix of carbonated soft drinks (CSD) has fallen by ~10pp to 73% in CY20 (309m units). However, corresponding volume has grown at 13% CAGR over the same period. The drop in volume mix is due to increased focus of the management towards diversifying its product portfolio through the introduction of newer products in NCBs (non-carbonated Beverages).

* Volume mix of Water increased by 11.6pp to 21% over CY13-20 (90m units), with corresponding volumes growing at 30% CAGR over the same period. Robust growth in Water volumes was due to higher mix of Water in the acquired territories by VBL in India and launch of Water in Sri Lanka and Morocco. Its international volume share saw a significant jump (700bp) to 21% over CY13-20 (88m units in CY20), with volumes growing at 23% CAGR over the same period.

* The mix of NCBs has marginally contracted by 120bp over CY13-20 (26m units in CY20). With the commencement of operations at the new Pathankot facility and higher focus towards NCBs, volume mix of NCBs is expected to improve.

* We expect overall volumes to grow at 28% CAGR over CY20-22E on the back of increased penetration in the newly acquired territories of South and West India, ramp-up of operations at its new facility (at Pathankot), and new product launches.

VBL’s share in PepsiCo’s India sales volume surged to ~85%

* In CY19, VBL accounted for 80%+ of PepsiCo’s India sales volume. Over CY15- 19, its volume share increased to 80%+ in CY19 from ~45% in CY15, through inorganic acquisition of new territories, increased penetration due to higher operational efficiency, and a robust distribution network.

* In CY20, VBL’s share (handling PepsiCo’s India business) further increased by 500bp and currently accounts for ~85%+ of PepsiCo’s India business.

Profitability affected due to COVID-19, better FCF on lower capex in CY20

* Revenue dropped by 9.5% YoY to INR64.5b on lower volumes. The same was affected due to COVID-led lockdown and slower ramp-up of operations from newly acquired territories.

* EBITDA margin contracted by 170bp to 18.6% and EBITDA/case dropped to INR28.3 in CY20 (v/s INR29.5 in CY19), which was due to lower volumes, leading to the absence of operating leverage.

* Gross debt decreased by 6% YoY to INR32b in CY20 due to repayment of longterm debt (which reduced by INR2b in CY20).

* Operating cash flow declined 23% YoY to INR10b in CY20 v/s INR13b in CY19. This was due to a reduction in operating profit by 17% YoY to INR12b, coupled with an increase in working capital to INR6.6b in CY20 (v/s working capital of INR5.8b in CY19). Working capital days increased by seven days due to a seven/five-day increase in inventory/debtor days. This was partially offset by an increase in the payables cycle by four days. Cash conversion (CFO/EBITDA) was 84% in CY20 v/s 90% in CY19. FCF increased by 25% YoY to INR7.2b in CY20. This was mainly due to lower capex outflow.

* RoCE/RoE contracted by 140bp/610bp YoY to 10.4%/11.5% in CY20, due to lower profitability amid COVID-19 pandemic.

* Standalone revenue/EBITDA/adjusted PAT decreased by 13%/29%/35% YoY to INR48.8b/INR8.6b/INR2.9b, respectively.

* Government grants decreased by 45% YoY to INR656m. As a percentage of consolidated/standalone revenue, government grants stood at 1%/1.3% in CY20 (v/s 1.7%/2.1% in CY19).

* Subsidiary revenue increased by 4% YoY to INR15.7b. This was due to significant revenue jump (28% YoY) to INR7.2b in its Zimbabwe’s subsidiary and amalgamation of Lunarmech Technologies Pvt in with Angelica Technologies Pvt (leading to increased revenue).

* Subsidiary EBITDA margin expanded by 570bp to 21.8% in CY20, whereas EBITDA jumped 40% YoY to INR3.4b. Adjusted PAT jumped 5x YoY to INR1b over the same period.

Valuation and view

* With the integration of new territories, VBL has adequate capacity in place to meet growing demand (utilization during peak season ~60%). With an increase in demand, we expect sweating of assets to increase, leading to the kicking-in of operating leverage, thereby improving margin. Surge in on-the-go consumption and increasing demand from HORECA segment (6-7% of sales) is expected to complement volume growth in the medium-term.

* We expect strong demand traction over the next few years due to: a) VBL is a monopoly play in PepsiCo India’s business, as the market increased to ~85%, b) increasing penetration in the newly acquired regions (South and West India) on the back of a robust distribution network, c) diversifying product portfolio, and d) greater Refrigerator penetration in rural/and semi-rural areas.

* We expect a CY20-22E revenue/EBITDA CAGR of 27%/35%. Based on future growth potential (namely acquisition of new territories in South and West India) and the return ration profile, we value the stock at 31x (in-line with its threeyear average P/E of 32x) CY22E EPS of INR36.7 to arrive at our target price of INR1,140, implying an upside of 15%. Maintain Buy.

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