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Volume recovery to be prolonged…

VST Industries posted revenue growth of 9.4% but, net of excise, revenues saw 4.6% de-growth. Cigarette sales witnessed growth of 12% to | 347.4 crore with flattish YoY volumes. However, on a sequential basis, cigarettes volumes grew 15% during the quarter. Tobacco sales declined 45.3% to | 35 crore on account of adverse exports due to the non-availability of containers.

The company has not taken a price increase in last nine months and does not intend to make any price changes in the next six months. High priced cigarettes (at a price point of | 6, | 7, | 11) contribute ~45% of total volumes. On an annual basis, the company witnessed 17% cigarettes volume decline in FY21. Though cigarette volumes recovered considerably in the last three months, we believe state wise lockdowns would impact volumes in Q1FY22E. Operating profit increased 3.8% given the overhead spends were down 13.7% during the quarter. PAT increased 3.1% to | 72.8 crore. The company declared a final dividend of | 114 / share.

Lockdowns to slow recovery

VST saw 17% volume decline in FY21 on the back of supply problems due to lockdown in Q1FY21 and subsequent demand destruction due to reduced out of home activity. We were expecting volumes to recover significantly in FY22E but with the second wave of Covid-19, we believe recovery would be prolonged. We expect 6%, 3% volume growth in FY22E, FY23E, respectively.

We believe taxation on cigarettes would be stable for the next few years given the industry is facing stiff challenges. The company is looking to increase contribution from its high price cigarettes, which would help it grow through realisations, going forward. We expect 8.8% revenue CAGR for FY21-23E. With stable taxation and rationalisation of overhead spends, net profit is expected to grow at a CAGR of 8%.

Strong free cash flows; high dividend payout

Despite a beleaguered year, VST was able to generate | 286.2 crore of operating cash flows. It generated ~| 300 crore (on an average) free cash flow every year from FY18 onwards. The company declared a dividend | 114 per share for FY21 (56% dividend payout). Moreover, it has consistently paid ~50-60% dividend in last six years. We believe payout would increase to 65- 70% in coming years given it is holding more than | 800 crore of cash & equivalent and does not have any capex requirement in future. Despite expected subdued earning, we expect RoCE, RoE to improve to 48.2%, 36.1%, respectively, by FY23E.

Valuation & Outlook

VST maintaining its profitability despite severe volume challenges shows its ability to manoeuvre pricing & promotion to its advantage. We believe stable taxation would help it to recover volume in future, which would help it grow revenue, earnings trajectory for the next few years. However, localised lockdowns due to severe second wave of Covid-19 would restrict out of activity and, in turn, cigarettes volumes in H2FY22. We maintain HOLD with a revised target price of | 3600 (earlier | 4200), valuing it at 15x FY23E P/E

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