A lot of fizz left in Varun Beverages

Strong growth expectations, valuations should support the ongoing rally

While listed fast-moving consumer goods (FMCG) companies continued to outperform the benchmarks over the past month, one stock that gained the most among the Nifty FMCG Index constituents was Varun Beverages.

The bottler for Pepsico is up 22 per cent since August 1 as compared to the Nifty FMCG returns of 11 per cent during this period.

The company, which was among the worst impacted because of the lockdown and lack of out-of-home activity, reported good recovery (up 40 per cent YOY) in the first half of CY21. It is now expected to post strong growth, led by higher penetration, expansion in newly acquired regions in west and south India, and fresh launches.

Analysts led by Nihal Mahesh Jham of Edelweiss Research believe the company has multiple levers to achieve its 10 per cent organic volume growth target. Growth should be aided by the addition of visi coolers to existing outlets and distribution expansion, scaleup of recently acquired territories where its share is lower than India average, and an evolving product mix, they add.

Among the new products are Mountain Dew Ice, a lemon-based fruit drink launched earlier this year, and the energy drink Sting. The launch of Mountain Dew Ice opens up a new market for the company and lower goods and services tax is beneficial from the pricing/margin perspective. Analysts led by Vivek Maheshwari of Jefferies India say that Sting -- which was launched a couple of years ago -- has seen strong acceleration over the past two years and accounted for 5 per cent of India volumes year to date. The success, according to them, is attributable to attractive product pricing (sharp discount to Red Bull), packaging format (PET), and distribution reach (around a third of overall).

A better growth outlook and no near-term acquisition on the horizon may result in lower leverage and an improved return ratio. Analysts at Edelweiss Research expect the company to see a phase of strong cash flow generation, with net debt coming down from ~3,000 crore to ~1,200 crore over the CY20-23 period. The return ratio, which increased from 5 per cent in CY13 to 17 per cent in CY19, is expected to surge to 25 per cent by CY23, according to their estimates.

Besides these triggers, what may help sustain the rally in the stock is valuation. Oneyear forward valuation at 40 times earnings is at a substantial discount to FMCG peers. Given the sharp (45 per centplus) earnings growth over the next couple of years, the rerating of the stock should continue, while the valuation discount with peers should narrow. Investors can look at the stock with a medium-term holding period.