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Demand outlook challenging; material costs rising

* United Breweries (UBBL) reported strong results over a lockdown impacted 4QFY21. Nevertheless, they came in below our expectations on all fronts – as the pace of sequential recovery was slower than that seen in 3QFY21.

* Considering a) some impact from the lockdown in Maharashtra, Delhi, and Karnataka for a month during the key season for beer and b) the possible write-offs of perishable raw materials, we have cut our FY22 EPS forecasts by ~20%. However, we have not factored in any further risks from lockdown extensions, other states imposing lockdowns, and the possible impact of rising barley costs, all of which could have a significant impact – as 1Q contributes 35–45% to the company’s full-year EBITDA.

* Notably, the CCI hearings over the alleged price fixing by the top three beer players were held in Feb and Mar’21; post-hearing submissions were made by the company on 23rd Mar’21. This progress raises the specter of penalty to be paid by the top three players (last reported in news articles as USD250m). Such a development would further affect sentiment amid another likely weak year for UBBL. As we await the new initiatives defined by the new CEO (as highlighted in our corner office note), even if we were to assume recovery in FY23, EPS growth over FY19–23 is likely to be flattish and FY23 RoE would be just ~13%. Valuations, on the other hand, are expensive at 63x FY23E EPS. Maintain Sell.

Performance exceeds expectations

* Standalone net sales grew 8.4% YoY to INR15.4b (v/s est. INR16.6b). EBITDA was up 97.6% YoY to INR2.6b (v/s est. INR3.2b). PBT grew 277.1% to INR2.1b (v/s est. INR2.5b). Adj. PAT was up 286% to INR1.6b (v/s est. INR2.0b).

* Overall volumes grew 9% YoY in 4QFY21, but declined 39% for the full-year FY21.

* Gross margins expanded 110bp YoY to 52.0%, but fell 190bp on a sequential basis.

* With lower employee costs / other expenses as a percentage of sales (down 30bp/620bp YoY), 4Q standalone EBITDA margins expanded 760bp YoY (off a very low base) to 16.9% (v/s est. 19.0%).

* UBBL recognized exceptional expenses worth INR622m in 4QFY21 on account of:

* INR445m toward the impairment on property, plant, and equipment at their Bihar facility

* INR178m toward impairment on investments in its subsidiary

* FY21 results: FY21 sales / EBITDA / adj. PAT declined 34.9%/54%/64.7% YoY to INR42.4b/INR4b/INR1.5b. EBITDA margins contracted 400bp to 9.5%.

* Balance sheet and cash flows: Operating cash flows grew 22% to INR6.2b in FY21. Capex stood at around INR1.5b in FY21, significantly lower than FY20 capex of INR4b, due to a weak demand environment.

* The company declared a dividend of INR0.5/share for the year.

Highlights from management commentary

* With beer and its raw materials being perishable, there could be some write-offs on account of the impact from lockdowns in 1QFY22 – in addition to the loss of sales.

* Barley prices have recently reported an inflationary trend (up 15% v/s last year’s procurement levels), while glass costs remain benign.

* While there were no one-offs in 4QFY21 margins, advertising and promotion (A&P) expenses remain below the usual average even in 4QFY21.

* UBBL lost market share in the earlier part of the year, before returning to 52– 53% levels (the same as the last 2–3 years) by the end of FY21.

Valuation and view

* Changes to the model have resulted in a ~20%/~7% cut in FY22/FY23E EPS as a result of ongoing lockdowns in three key states. If the lockdowns are extended and/or implemented in other states, the impact could be much higher as 1Q (the summer season) has historically contributed 35–45% to the company’s fullyear EBITDA.

* Despite assuming recovery in FY23 and the second highest operating margins in the company’s history, valuations are rich at ~63x FY23E EPS – despite flat EPS over FY19–23E and RoE in the early teens. Progress on CCI investigations spells another overhang at an already challenging time.

* Maintain SELL, with TP of INR960, calculated at 24x FY23E EV/EBITDA.

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