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Growth drivers intact; recent correction overdone

Varun Beverages has corrected c.30% from its peak – a function of weak demand and rise in competitive intensity with aggression from Campa on pricing, channel margins, media visibility and distribution expansion. As per our checks: a) Campa is targeting states with higher salience of mass-end consumer/regional brands, b) within carbonated beverages, Campa has seen traction in INR 10 SKU (OOH consumption); while in large packs (in-home consumption), PepsiCo/Coca-Cola remain preferred brands, c) impact is likely to be higher in mass/mid segment packaged water/soda segment where regional brands have higher play and consumer pricing/product availability is more important than brand, & d) driving profitability in INR 10 PET remains a challenge. In CSD, brand equity, taste/flavours and availability are key elements for success. The latter part, especially, requires a strong manufacturing and distribution capability that further strengthens the brand, and VBL has built the same over a decade. Hence, Campa’s execution on these parameters needs to be monitored. Overall, India remains a key ‘Anchor market’ for Pepsico Inc. We believe VBL has many levers for growth in the domestic business (capacity/distribution/portfolio expansion), and the Africa opportunity is large and well intact. Moreover, a strong summer augurs (link) well for both the segment and VBL. Hence, we believe the recent correction is overdone and the prevailing market pessimism should be used as an opportunity to Add.

* Competitive landscape of India beverage market: The Indian beverage market with a size of c.2.4bn cases is largely a duopoly with Coca-Cola/PepsiCo having market share of c.50-55%/30-35% and regional brands accounting for the balance c.15%. Competitive intensity in the domestic market has been increasing with the re-launch of Campa by Reliance Consumer Products in Mar'23. RIL, in its 3QFY25 concall, indicated that the brand is expected to cross INR 10bn in sales in FY25, which translates to c.60mn-70mn cases and low-single-digit market share as per our estimate.

* Campa pushing hard at mass end: Campa has focussed on certain states like Tamil Nadu, AP, Telangana, UP and West Bengal - the strategy is to target the mass-end consumer who is price sensitive and less brand loyal through aggressive pricing - INR 10 PET bottle (Campa CSD range on per ml basis is priced at c.30-40% discount vs. Coke/PepsiCo). Also, some of these states have a high salience of regional brands - for e.g., Tamil Nadu has regional players like Podaran and Kalimark who operate at mass price point and provide a wide portfolio of flavours. While, visibility wise, Campa has gained grounds in these markets, our checks suggest offtake is largely in smaller SKUs (OOH consumption where consumer is price sensitive, not brand loyal & where Pepsico/Coca-Cola didn’t have offering); in the large SKUs (750ml/2.25ltr), which are predominantly for home consumption, PepsiCo/Coca-Cola remain strong. Also, in our view, the impact at the mass end could be higher in packaged water (where pricing/shelf availability is important vs. brand) and soda (where local flavours/pricing is important).

* Incumbents responding through tactical promotions & remain strong in large SKUs: Both PepsiCo and Coca-Cola have responded through promotional offers (RGB sold at INR 10, 400ml (250ml+150ml free) SKU at INR 20 launched by both Pepsico/Coke, likely launch of Zero sugar variants at INR 10 price point), which is the right thing to do especially during upcoming summer season. Having said that, tactical promotions have been there in past also. Moreover, as per our checks, both Pepsico & Coca-Cola have higher saliences in 750ml/2,25ltr (we est. it to be c.60-70% of their domestic cola-carbonate volumes) and offtakes here remain intact considering the liking for the taste and higher brand loyalty.

* India remains a key growth engine for Pepsico & Coca-Cola, VBL will continue to focus on capacity, distribution & portfolio expansion to drive domestic growth: Both Coca-cola (SLMG Beverages Pvt Ltd, Coca-Cola’s biggest independent bottler in India said that it will invest up to $1 bn by 2030 for expanding the production facility in UP and Bihar) and Pepsico (India is a key ‘anchor market’ for Pepsico where it sees next five to seven years of incremental growth coming for PepsiCo globally) remain optimistic & will continue to invest behind domestic business. We believe VBL has levers in terms of portfolio expansion (Sting, sports drink, likely launch of jeera soda) and capacity/distribution expansion (targeting to add 300k-400k retail outlets and 0.1mn visi-coolers per annum, capex of INR 20bn in CY25 for setting up facilities at Prayagraj, Damtal, Buxar & Meghalaya) to drive growth in domestic business.

* Africa remains a large opportunity: Africa is a large beverage market, and Coca-Cola enjoys a formidable position in many markets in the region. As per our analysis, CocaCola's Africa unit clocked volumes of c.2.5bn cases in CY23 (c.7.5% of overall CocaCola's volumes). Within Africa, Coca-Cola Beverages Africa (one of the largest bottlers) does volumes of c.1bn cases (c.40% of Coca-Cola's Africa volumes). We believe Varun Beverages, with estimated volumes of c.0.4bn in CY25E, has enough headroom to grow sales (through capacity/distribution expansion in existing territories and also by acquiring rights for other African markets (for e.g. Nigeria)) as well as expand margins (through improving mix and backward integration). This apart, Africa offers opportunities in the food business (c. USD 800mn TAM in Zimbabwe, Zambia and Morocco) where VBL is building capacities (over CY25-1HCY26) and targeting USD 100mn sales (not built into our estimates).

* Risk-reward favourable, recent pessimism provides an entry point for long-term investors: We are currently building in low-double-digit sales CAGR for the domestic business and 42% CAGR (LTL c.30%) for the international business over CY24-26E. In the bear case, if we assume competition weighs on both volumes and margins in India - which means India business sales growth of 8% (vs. management guidance of double-digit volume growth) all led by volumes, margin compression of c.100bps over CY24-26E (factoring in higher brand investments) and a 38% CAGR in international business sales, we see c.5- 7% cut in our existing earnings estimate. At CMP, this will translate to valuation of c.42x on CY26E, which is still attractive considering the company's growth profile (c.22% CAGR over CY24-26E), which is much better vs. FMCG peers. We maintain our positive stance on the name - superior execution, large opportunity size & net debt free status provides confidence on the earnings growth (CAGR of 26% over CY24-26E). Maintain BUY rating with TP of INR 675 (55x CY26E EPS).

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