United Spirits: Premium brands aid Q4 show

Regulatory concerns, however, a key overhang and could cap upside from current level

Investors cheered a healthy operational performance by United Spirits Ltd (USL) in the March quarter (Q4) and pushed the stock up 11 per cent intra-day on Wednesday. Despite a fall in overall volumes and sales, higher value products grouped under the prestige and above segment (brands such as McDowell's No 1, Royal Challenge, Signature) grew at a healthy clip. This segment contributes 58 per cent to total revenue and has helped offset a decline in the entry or popular segment.

A host of factors, including prohibition in Bihar, demonetisation and the highway ban issue pulled down revenue of the popular segment. A strong show by the prestige and above segment reflects the continuing trend of premiumisation, which has helped operating profit. Even as revenue fell 1.1 per cent to ~2,014 crore, margins expanded 730 basis points (bps) to 12.6 per cent. Excluding one-offs, sales grew a decent seven per cent. Gross margin improvement and lower employee and other expenses aided profit. This, coupled with lower tax rates, led to a threefold rise in net profit to ~101 crore. A low base effect in the March 2016 quarter has helped.

However, there are some overhangs for the stock. Though alcohol for human consumption is kept outside the goods and services tax (GST), inputs such as glass and ethanol among others will be under it and could attract additional tax. The company is in talks with the central government to minimise the impact and is also considering higher prices. Two, the highway ban on liquor sales will continue to impact the popular segment in the coming quarters. And, a high valuation of 53 times the FY18 estimated consolidated earnings leave little room for error.

On the other hand, sale of non-core assets worth ~2,000 crore could be a positive surprise. "United Spirits can sell treasury shares worth ~800-900 crore, currently held by a bank under a legal dispute. The Debt Recovery Tribunal recently ruled in favour of the company. A final decision from the Karnataka high court is pending. USL could use these proceeds to reduce debt," says Anuj Bansal, analyst at Ambit Capital. Continued premiumisation is another long-term positive. Overall, though, continued regulatory risk could keep a lid on the stock.