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Focus on sustainable growth path

Varun Beverage (VBL) in the CY22 annual report highlighted its efforts to grow sustainably in a high-potential business segment through its strong manufacturing and distribution capabilities, which give an edge to the company.

Favorable industry outlook aids revenue growth

* The Indian beverage industry is expected to witness significant growth opportunities going ahead on the back of favorable climatic conditions (hot, dry, or moderate), growth in per capita income, accelerated urbanization, an expanding demographic profile and a rising middle-class population.

* Rural electrification and increasing fridge penetration should further fuel growth in rural and semi-urban areas, which account for ~60% of revenue. (Refer our latest report)

* In order to tap into the vast opportunity, VBL has expanded its distribution network to over 3m retail outlets in CY22 (v/s over 2m in CY21) and ~2,400 primary distributors (v/s ~2,000 in CY21) along with over 9.25 lakhs visicoolers (v/s 8.4 lakhs in CY21), over 2,500 distribution vehicles and over 110 depots. This robust network is backed by VBL’s 37 state-of-the-art manufacturing facilities spread across India and international locations (31 in India and six in international territories).

* VBL’s robust supply chain, along with backward integration facilities (including newly commissioned J&K facility) for production of preforms, crowns, plastic closures, corrugated boxes, corrugated pads, plastic crates and shrink-wrap films, provides an edge to the company in an expanding market. The company’s newly commissioned J&K facility will provide an opportunity to enter into this territory.

* Banking on its strong capabilities, VBL is confident of delivering sustainable and healthy volume growth across all product categories and further strengthen its market position in the beverage industry.

* By strengthening its 31-year strategic association with PepsiCo, VBL has set up a manufacturing line in UP for the production of Kurkure Puffcorn for PepsiCo and entered into an agreement for sales and distribution of Lays, Doritos and Cheetos in Morocco.

Benefits of improved distribution reflecting in volume growth

* Revenue grew 49% YoY to INR131.7b in CY22 (27% CAGR over CY17-22), aided by robust volume growth (up 41% YoY; 24% CAGR over CY17-22), higher realization (up 6% YoY to INR164/unit case) and a favorable product mix.

* Domestic volumes grew 44% YoY, led by the post-pandemic recovery in demand, the expansion of the distribution network and robust demand for new products, with Sting emerging as a key growth driver (Refer report)

* To address the cost pressures faced in CY22, VBL increased prices of select SKUs and rationalized discounts and schemes. This, along with a prudent raw material sourcing strategy, limited the impact of a surge in preform prices (over 30% YoY) on gross margin (down 180bps YoY).

* EBITDA grew 69% YoY to INR27.9b (27% CAGR over CY17-22), led by operating leverage. EBITDA per unit case rose 20% YoY to INR34.8.

* PAT grew 2.17x YoY to INR15b (48% CAGR over CY17-22), aided by high revenue, better margins and the transition to a lower tax rate in India (down 250bps YoY).

* Government grants under different industrial promotion tax exemption schemes stood at INR1.85b in CY22 v/s INR1.4b in CY21. However, it stood at 1.4% of consolidated revenue in CY22 v/s 1.6% in CY21.

* Capex for CY22 stood at ~INR13.5b v/s INR8.6b in CY21 and v/s the average of INR6.4b in the last five years.

* As of 31st Dec’22, VBL had CWIP of ~INR6.1b for further Greenfield expansion in Rajasthan and Madhya Pradesh and for brownfield expansion at six existing plants in CY23 in India.

* CFO/EBITDA stood at ~64% in CY22 (down 10pp YoY) due to an increase in working capital requirement. Strong cash flow generation helped VBL sustain its Net Debt at INR34.1b as on 31st Dec’22; however, Net Debt increased from INR30.1b as on 31st Dec’21 on back of high capex during the year.

* Subsidiary’s Revenue/EBITDA/PAT grew 16%/28%/11% YoY in CY22 to INR25.7b/INR6.1b/INR2.3b.

Building the growth path.….sustainably

* VBL aims to improve the dietary habits of its consumers with its nutrition-based portfolio. Accordingly, it is offering health-based fruit-pulp and juice-based drinks, energy/sports drinks, and dairy-based beverages.

* The product mix of low and zero-sugar products improved to 36.2% in CY22 from 34.7% in CY21.

* Considering environmental sustainability, VBL recycled ~80% of PET used in finished products (PET bottles, shrink film, plastic closures, labels and laminates) in CY22 v/s 70% in CY21 and intends to recycle ~100% by CY25.

* Accordingly, it has collaborated with GEM Enviro Management Private Limited, a Central Pollution Control Board (CPCB) recognized organization specializing in collection and recycling of packaging waste and promotion of recycled green products. It makes T-shirts and bags by recycling used PET bottles.

* VBL has also entered into a joint venture with IDVB Recycling Operations Pvt. Ltd. for the recycling of used PET bottles.

* Further, VBL successfully reduced its water usage ratio to ~1.7x in CY22 from 1.89x in CY21 (It needs 1.7 liter water for 1 liter of final production). However, its water recharge ratio stood at ~2.02x in CY22 v/s. ~2.28x in CY21.

Valuation and view

* We expect VBL to maintain its earnings momentum, underpinned by 1) high demand due to the early onset of summer, high temperature and further possibility of an El Nino event, 2) increased penetration in newly acquired territories in South and West India, and 3) higher acceptance of newly launched products

* The increasing penetration of refrigerators in semi-urban and rural areas bodes well for VBL’s products, as the customer base is expanding at a rapid pace in these regions.

* Further, to capture the growing market, VBL is increasing capacities by 20%, which are likely to be operational before the summer (except for the dairy beverage facility that will be operational by Jul’23).

* We expect a revenue/ EBITDA/PAT CAGR of 16%/18%/27% over CY22-24. We value the stock at 44x CY24E EPS to arrive at a TP of INR1,620. Maintain BUY.

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