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RM cost headwind to hurt near-term earnings, FY24 outlook better

Key takeaways from our meeting with the management of United Spirits (UNSP) to obtain an update on its medium-term and near-term growth prospects:

* Management remains clear that the recently concluded sale of popular brands was essential as the company did not have a right to win in this sub-segment. UNSP has retained McDowell’s No.1 and Director’s Special (DSP) in the popular segment. While McDowell’s No.1 can be premiumized to the P&A category. The management aims to capitalize DSP, which commands great brand equity, in several parts of India.

* Material cost outlook remains challenging in the near term. Neither glass costs nor ENA are showing signs of abating in the near term but FY24 outlook is likely to be better. Natural gas costs are rising, which would hurt glass costsfor now. Soda Ash costs are double of last year at the same time. However, non-glass packaging costs are gradually coming down. Raw material volatility and rollback of Delhi excise policy are likely to hit topline and earnings for the next few quarters.

* Potential benefits of the UK-India free trade agreement (FTA): Management elaborated on the potential benefits from the UK-India FTA that appears to be on the anvil. This will benefit both Bottled in Origin (BIO) and Bottled in India (BII), which are ~20-25% of P&A sales annually. The import duties currently comprise ~15% of the retail selling price (RSP) value chain on a national weighted average basis. Depending upon the contours of the eventual announcement, retail price of the imported scotch portfolio will come down by 6-7%. More reduction may happen if states also cut duty on this portfolio.

* Innovation and renovation: The management is happy with the progress on innovation and renovation. End-to-end renovation initiatives on “Signature” have been carried out and the renovated brand is now available nationally. The company is also happy with the response to “Royal Challenge American Pride Bourbon” initiative that has led to healthy sequential growth. “McDowell’s No.1” renovation has also been successful.

Valuation and view

* We have kept our forecasts unchanged.

* We had downgraded UNSP to Neutral in Nov'21 after the stock outperformed our Coverage Universe. Fair valuations post-outperformance, potential nearterm headwinds in the form of cost inflation (also highlighted in our Feb'22 AlcoBev note), and delays in price increases v/s earlier expectations are likely to keep near-term earnings growth and stock price performance under check even as the outlook in FY24E is projected to be better.

* While we appreciate the potential for growth led by various measures undertaken by the new CEO over the past year, fair near-term valuations lead us to maintain our Neutral rating and TP of INR880, premised on 50x Sep'24E EPS.

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