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Sustaining growth through new levers

We reinitiate coverage on Varun Beverages Ltd. (VBL) with BUY rating and target price (TP) of Rs705. Our view is pinned on the following arguments: (1)

Per capita consumption remains low(2) Capacity and distribution expansion will continue to support growth. (3) While Sting, stabilizes, growth expected to improve in Juices and Value-Added Dairy Products (VADP). (4) Africa offers potential for long-term growth. Per capita consumption remains low With a population of ~1.5bn and India predominantly being a tropical country, the nonalcoholic beverages (NAB) industry has grown at ~14.5% CAGR in volume terms and ~13.7% CAGR in value terms over the past decade as per the Indian Council for Research on International Economic Relations (ICRIER) report. Per capita beverage consumption of India is still mere ~21 ltrs as compared to ~359 ltrs in the US, ~198 ltrs in Saudi Arabia and ~102 ltrs in South Africa. Carbonated soft drinks (CSD) has the highest share within NAB followed by packaged water in value terms. Energy and sports drink remain the fastest growing sub segment in this space with a 45% CAGR over CY2010 to 2019. Despite CSD’s economic potential, the industry is limited by a tax structure that hinders growth & innovation. Currently, India imposes 40% tax on CSDs (28% GST + 12% compensation cess). It will be interesting to see the tax structure once compensation cess ends before Mar’26.

Expanding capacities and growing distribution network will continue to support growth

VBL has consistently build scale by adding capacities as well as acquiring new territories to capture growth. This is demonstrated by the rapid scale up of manufacturing facilities from 21 in CY16 to 48 as on 2QCY24. Moreover, the company now commands ~90% share of Pepsi volumes from 45% in CY17. The capacities are backed by strong distribution reach of ~4mn outlets (adding 0.3-0.4mn outlets every year) with installations of ~1.02mn visicoolers. VBL believes there is enough room for growth and new competition as there are 12mn potential outlets to be reached.

While Sting's stabilizes, growth is expected to improve in juices and value-added dairy

VBL introduced ‘Sting’ in CY17 at Rs50 in a 250ml can, but it couldn’t disrupt the energy drink market. However, in CY20, after relaunching at Rs 20/- 250ml PET bottle which (at par with a normal CSD bottle), the volumes of Sting skyrocketed and has now become >15% of the overall portfolio. While there is still a lot of headroom for Sting to grow as it reaches just >10% outlets out of VBL’s reach of ~4mn outlets but we expect growth rates to stabilize on high base. While on the other hand Juices, Gatorade and value-added dairy products are just a miniscule part of the company’s portfolio. With increased production capacity, we believe growth rates to pick-up in these businesses which are also margin accretive due to higher realization than the CSD.

Africa offers potential for long-term growth

International business has grown almost at the same rate in the last 5 years in volumes (21.5% CAGR) through addition of new regions and capacities. Through recent commissioning of numerous greenfield and brownfield facilities across strategic geographies, VBL plans to strategically diversify its operations geographically owing to seasonality of the core CSD business. In addition to existing portfolios, VBL has announced further snacking partnerships in the African market which complements their existing PepsiCo distribution.

View and Valuation

Company is on track to deliver healthy double-digit growth in CY24 as well. Pro-active capacity additions in domestic as well as international businesses along with long runway for distribution expansion, gives us good visibility on medium-to-long term growth. Over CY24E-CY26E, we build 25% earnings CAGR driven by 18% revenue CAGR and 40bps EBITDA margin improvement (led by scale & efficiencies). Re-initiate coverage on VBL with BUY rating and a TP of Rs705, as we assign a target multiple of ~54x on March’27E EPS.

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