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To sizzle on greater penetration, launches

Varun Beverages (VBL) manufactures, sells, bottles, and distributes PepsiCo’s beverages in pre-defined territories in India.

Robust recovery in volumes: VBL saw strong volume growth across segments and markets. During the pandemic, VBL witnessed strong growth from 'in-home' consumption. With the lifting of restrictions, 'on-the-go' consumption is also growing and is expected to cross pre-COVID levels over the next few months. However, while VBL has seen a sharp increase across raw material prices, it is able to pass on the surge in RM prices and has also taken a price hike, which helps in protecting margins.

New product launches gain sizable traction: Recent launches, such as Sting and Mountain Dew – Ice, are supporting volume growth and are expected to gain sizable mass over the medium term. VBL recorded volumes of 10m units in the Sting energy drink in 1HCY21, more than double that of CY20 volumes. In 3QCY22 as well, Sting (+700% YoY volume growth) outperformed the market and the overall portfolio. Contribution from Sting has increased to more than 5% of overall volumes, owing to the higher acceptance of energy drinks in urban/rural areas – primarily on account of its lower price point v/s other energy drinks. The new variant – Mountain Dew – Ice’ (a lemon fruit juice-based drink) –launched to compete with Limca is performing well. The management aims to capture a major chunk of the 600m unit case market of lime drinks going forward.

Expect southern and western India to flourish from CY22E: In May’19, VBL acquired the franchisee rights to seven states – Gujarat, parts of Maharashtra, parts of Karnataka, parts of Telangana, parts of Andhra Pradesh, Kerala, and Tamil Nadu – from PepsiCo in southern and western India. Before the acquisition, PepsiCo’s market share had dropped over CY16–19, and penetration levels in the region were low, which the management aims to improve. However, its expansion plans were hampered due to the onset of the COVID-19 outbreak. With an increase in vaccine distribution and the revival of out-of-home consumption, CY21 is expected to record volume growth of 29% (v/s a 24% volume CAGR over CY14–19). Going forward, volumes in the southern and western regions are expected to contribute significantly over the next few years. VBL managed to add a substantial number of visi-coolers and new vehicles in 1HCY21, leading to sharp volume growth.

New plant setup underway: VBL plans to set up a new plant in the state of Bihar as it was unable to service the market in the region, leading to lower market share. Earlier, products were transported to Bihar from neighboring states to meet the requirement. With Bihar being one of the most populous states in India, VBL aims to capitalize on the growing demand in the region. The new plant is expected to be commercialized over the next 6–8 months (in CY22) at capex cost of INR2.85b. Furthermore, VBL is setting up a new plant in Kutwa (close to the Pathankot facility) to manufacture PET bottles and closures. The new capacity is expected to be operational by Mar'22.

Valuation and view: We expect the strong recovery to continue going forward as well, led by (a) growing ‘out-of-home’ consumption with the opening up of offices and traveling activity, (b) a volume uptick in new territories, (c) robust growth in newly launched products, and (d) growing refrigeration in rural/semi-rural areas. We expect a revenue/EBITDA/PAT CAGR of 22%/27%/59% over CY20–23E. Maintain Buy, with TP of INR1,210 (40x CY23E EPS).

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