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Sharp volume growth on strong recovery and lower base Earnings above estimates

* Varun Beverages (VBL) reported strong volume/revenue growth on the back of demand recovery across product segments and a lower base. It reported a stable operating performance, albeit gross margin contraction, owing to sustainable cost optimization measures implemented last year.

* 2QCY21 revenue/EBITDA/PAT came in above our estimates. We increase our earnings estimates for CY21/CY22 by 29%/8%, on the back of (a) better realization on an improving product mix, (b) an increase in volumes on strong demand recovery, and (c) increasing traction in newly launched products. We maintain our Buy rating, with TP of INR920.

Sharp volume recovery, marginally offset by second wave

* Revenue increased 49% YoY to INR24.5b (est.: INR21.3b), primarily led by (a) robust volume growth across segments, coupled with the lower base of the previous year, and (b) a 3.2% YoY increase in realization per case. Overall volumes increased 45% YoY to 152m cases. Gross margins contracted 130bp to 53.5% (est.: 52.5%) on a change in the product mix and a marginal increase in raw material prices.

* EBITDA/unit-case rose 4% YoY to INR37.6/unit-case on a better product mix v/s the same period last year. The EBITDA margin expanded 30bp YoY to 23.3% (est.: 21.5%), and EBITDA stood at INR5.7b (up 51% YoY). Adj. PAT increased 2.2x YoY to INR3b (est.: INR1.9b).

* Subsidiary (consolidated less standalone) sales/EBITDA grew 2x/70% YoY to INR4.9b/INR1b in 2QCY21. Adj. PAT surged 3.7x YoY to INR701m.

* CSD volumes increased 33% YoY to 118m unit-cases. Performance was driven by strong growth in Apr’21 (v/s the low base of the previous year) and steady recovery in Jun’21 (despite the second COVID wave and related lockdowns).

* NCB volumes grew 38% YoY to 11m unit-cases, driven by the recently launched ‘Sting’ beverage as well as Tropicana juices.

* Water volumes surged 2.9x YoY to 23m unit-cases on the back of higher growth in the International segment. Water volume share jumped 750bp to 15.1%.

Highlights from management commentary

* Realizations: VBL did not take any price hikes during the year. Improvement in the product mix (higher volumes recorded in juices, ‘Sting’, and ‘Mountain Dew-Ice’) has led to an increase in realization. International realization per unit case stood at INR180, whereas domestic realization was recorded at INR156/unit-case.

* Working capital: Working capital days increased marginally to ~24 days (as of Jun’21) from 20 days (as of Jun’20), primarily owing to the higher stock of pet resin / preform inventory – to capitalize on lower pricing at the start of the year.

Valuation and view

* We expect robust demand going forward, driven by a) the resumption of services, with the impact of the lockdown gradually subsiding; b) a pickup in volumes in the southern and western regions; c) strong demand traction in newly launched products; d) the growing penetration of refrigeration in rural/semi-rural areas; and e) the growing discretionary spending among the populace.

* 2QCY21 revenue/EBITDA/PAT came in above our estimates. We increase our earnings estimates for CY21/CY22 by 29%/8% – on the back of (a) better realization on an improving product mix, (b) an increase in volumes on strong demand recovery, and (c) growing traction in newly launched products.  We expect a revenue/EBITDA/PAT CAGR of 25%/33%/79% over CY20–22E. We value the stock at 35x Sep’23E EPS. Our TP of INR920 implies a 17% upside. Maintain Buy.

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