Premium segment may bring hard times for United Spirits

Lower volumes and a changing consumption pattern may pull down sales

The stock of United Spirits (UNSP) is up marginally, even as the firm posted a sharp drop in revenue and profit for the March 2020 quarter (Q4) last week.

Although positive news flow such as the permission for home delivery/online sale of liquor, re-opening of shops, and expectations of margin gains have supported the stock, which is up 30 per cent from its March lows, there are reasons for investors to be cautious.

To begin with, the management commentary on benign raw material prices and cost efficiency are supportive of margins, but there is uncertainty over near-term sales and profitability given the current situation. Subdued off-take in the more profitable premium portfolio (Prestige & above segment, or P&A) is also expected to weigh on overall profitability.

At a time when discretionary demand has taken a back seat, sharp hike in taxes (10-75 per cent) on spirits by many states has only added to the woes of firms such as UNSP, which have a large share of premium liquor sales. Due to excise duty hikes and impact on income levels, premium liquor sales are expected to be hit as consumers down-trade to cheaper options. “UNSP has around 70 per cent of its business in Prestige brands, and thus any down-trading into the popular (economy) segment will be a drag on revenues and margins in FY21,” according to Credit Suisse. The foreign brokerage, while estimating benign raw material prices and cost efficiency efforts to lift Ebitda margins in FY21, expects revenues to fall by 15 per cent.

Change in consumer behaviour in a bid to avoid public gatherings and social events for some time, even after the economy is unlocked indicates uncertainty in future volumes. This would hit a quarter of UNSP’S business as on-premise consumption (bars, restaurants) account for 20-25 per cent of overall business. Analysts at Motilal Oswal Securities expect absence of on-premises sales to last for a significantly-large part of the year, and foresee a 260 basis point (bps) fall in margins.

Even in Q4, about 20 per cent decline in P&A volumes (due to the lockdown) pulled down overall volumes by 13.5 per cent and net sales by 11.4 per cent year-on-year (YOY) to ~2,250 crore. Strong focus on cost optimisation since the past few quarters benefited UNSP. Despite a 430 bps YOY fall in gross margins due to high raw material costs, Ebitda margin was up 100 bps to 13.6 per cent.

Therefore, how volumes in the P&A segment along with home delivery and online selling support UNSP'S overall business would be interesting to watch.