Alcohol Sector Report

8/4/2019 Alcohol Sector Report

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Alcoholic Beverages Sector Report 16 December 2010

1

RCML: Winner of LIPPER-STARMINE broker award for Earnings Estimates in Midcap Research 2008 |Honourable Mention in Institutional Investor 2009 | Voted amongst Top 5 most improved brokerages by

Asia Money Poll 2009 | RCML Research is also available on Bloomberg FTIS and Thomson First Call

Varun Lohchab Gaurang Kakkad Bandish Mehta

(91-22) 6766 3458 (91-22) 6766 3470 (91-22) 6766 3471

[email protected] [email protected] [email protected]

Sector Report 16 December 2010

Recommendation snapshot

Company CMP Target Rating

United Spirits 1,421 1,650 BUYUnited Breweries 427 400 HOLD

Radico Khaitan 164 190 BUY

Stock performance

Returns (%) 1-mth 6-mth 1-yr 3-yr 5-yr

United Spirits 1.6 13.1 13.0 (28.1) 225.7

United Breweries 2.4 102.1 153.9 26.6 521.6

Radico Khaitan (6.0) 36.6 47.0 (8.7) 18.1

BSE FMCG Index (3.8) 13.9 26.3 56.4 121.1

BSE Sensex (3.3) 12.8 16.4 (1.9) 111.6

Sector performance relative to BSE Sensex

-

50

100150

200

250

300

350

Dec-06

Jun-07

Dec-07

Jun-08

Dec-08

Jun-09

Dec-09

Jun-10

Dec-10

RCML Research Alcobev index Sensex

2 years relative price performance

-

100

200

300

400500

600

Dec-08

Feb-09

Apr-09

Jun-09

Aug-09

Oct-09

Dec-09

Feb-10

Apr-10

Jun-10

Aug-10

Oct-10

Dec-10

RDCK UNSP UBBL Sensex

Alcoholic Beverages

In high spirits!

We initiate coverage on the Indian alcoholic beverages sector with a positivelong-term view on growth prospects and the potential for margin expansion. Weexpect strong topline growth in both the beer (2225% CAGR) and spirits (1720% CAGR) segments over FY10-FY13. Margins should expand 100300bpsduring this period due to stable input costs and strong volume growth.Moreover, corporate balance sheets have been fortified by the raising of equity,while free cash flows (FCF) are expected to strengthen, thus buoying ROEs.However, valuations for the sector are also rich relative to its cash flowgeneration and ROE profile, thereby largely factoring in the strong earningsgrowth expected through FY13.

We prefer Radico Khaitan (RDCK) over United Spirits (UNSP) in the Indian-made foreign liquor (IMFL) space due to the formers pure India exposure andlower debt burden. We also like United Breweries (UBBL) business profile butwould advise buying on declines given the rich valuations.

Strong volume growth potential: We believe both spirits and beer offer strongvolume growth potential in India over the medium to long term, with beerexpected to outpace the growth in spirits over the next couple of decades. IMFLwould continue to witness strong volume momentum driven by consumerupgrades from country liquor and positive demographics. Beer consumption isabysmally low in India due to taxation policies and should rise with greateracceptability of social drinking and improving affordability as income levels

move up. We model in an 1820% volume CAGR for beer and a 1215%volume CAGR for spirits over FY10-FY13 and beyond.

Margin expansion over FY10-FY13: Lower molasses/ENA prices, product miximprovement and stable glass costs would help spirits companies improvemargins over FY10-FY13. Stable barley prices and strong volume growth will alsolead to margin expansion for UBBL. Unlike the FMCG sector, alcoholic beveragecompanies would face lower input cost pressures over FY10-FY12.

Balance sheets have improved, FCF generation to pick up: Companies haveraised equity over the last 18 months, resulting in improved balance sheetsfollowing the FY08-FY10 period of low margins, high capex and rising workingcapital. UBBL is expected to show a marked improvement in FCF generation due

to lower working capital. RDCK should also report improvement on this frontgiven lower capex post-expansion of distillery capacity.

Valuations factor in most positives: Sector valuations have run up strongly overthe last 12 months and now factor in most positives, leaving limited room for afurther re-rating. Though valuations look reasonable relative to historicalaverages (mainly due to euphoric valuations in FY08), we find them high on anabsolute basis when compared with the ROE profile of companies and their FCFgeneration potential. However, given strong earnings growth over FY10-FY13and improving ROEs, we believe the current valuations could sustain goingforward.

Prefer selective buying at current levels, buy on declines: We prefer RDCK

(rated BUY) over UNSP (BUY) in the IMFL space given lower valuations and pureIndia exposure. We would advise buying on declines in UBBL (rated HOLD) toplay the beer market growth potential.


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Contents

Section Page No.

Indian alcobev market 3

Spirits the dominant form of alcohol consumption 3

Indian alcobev market growing well; trend to continue 4

Liquor heavily regulated and a state subject 5

Pricing: Beer and wine relatively more expensive 6

Growth potential 7

Sector financials 10

Appendix I 12

Global spirits industry 12

Appendix II 14

Manufacturing process of IMFL 14

Companies

United Spirits - Domestic business to drive growth 16

United Breweries - Compelling long-term story but pricey 30

Radico Khaitan - Premiumisation holds the key 42


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3

Indian alcobev market

Spirits the dominant form of alcohol consumption

Spirits dominate alcohol consumption in India. In contrast, beer is the primary alcoholicbeverage consumed in most parts of the world. This is primarily due to lower taxationon beer and wine as governments the world over seek to promote consumption of thesebeverages over spirits given their lower alcohol content (and hence lower risk to health).

The Indian market, though, differs in the following key aspects:

a) The drinking pattern in India is skewed towards binge drinking as against socialdrinking (the prevalence of drinking is more concentrated considering that only~30% of the male and ~5% of the female population consume alcohol).

b) There is no differential taxation in case of beer due to which beer gets priced out(in terms of price per gm of alcohol).

c) Availability of beer and wine is as controlled as that of spirits, whereas in mostcountries, beer and wine distribution is not regulated.

Fig 1 -Broad structure of Indian alcoholic beverage industry

Beer(181mn cases)

Rs 130bn

Strong(127mn cases)

Alcohol content :5.25-15% v/v

Alcohol Industry(660mn cases)

IMFL(236mn cases)

Country Liquor(242mn cases)

Distilled Spirits(478mn cases)

Wine

Mild(54mn cases)

Licensed

Brown Spirits(226mn cases)

White Spirits(10mn cases)

Whisky

(136mn cases)

Gin

(5mn cases)

Brandy(50mn cases)

Vodka(5mn cases)

Rum(40mn cases)

Rs 566bn Rs 240bn

Rs 806bn

Rs 942bn

Rs 6bn

Alcohol content :Upto 5.25% v/v

Alcohol content :30% v/v


Alcohol content :42.8% v/v

Beer(181mn cases)

Rs 130bn

Strong(127mn cases)

Alcohol content :5.25-15% v/v

Alcohol Industry(660mn cases)

IMFL(236mn cases)

Country Liquor(242mn cases)

Distilled Spirits(478mn cases)

Wine

Mild(54mn cases)

Licensed

Brown Spirits(226mn cases)

White Spirits(10mn cases)

Whisky

(136mn cases)

Gin

(5mn cases)

Brandy(50mn cases)

Vodka(5mn cases)

Rum(40mn cases)

Rs 566bn Rs 240bn

Rs 806bn

Rs 942bn

Rs 6bn

Alcohol content :Upto 5.25% v/v



Alcohol content :42.8% v/v

Source: RCML Research | Industry size in volume terms is denoted in brackets within the boxes

Absence of differential taxation impliesthat milder drinks like beer get priced

out


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4

Indian alcobev market growing well; trend to continue

The Indian alcobev market has been growing at a 1011% volume CAGR over the lastfive years and we expect the healthy growth momentum to continue, given thefavourable demographics. Within the alcobev market, country liquor is the slowest

growth segment (~23% volume CAGR), while IMFL is growing at ~1213%, beer at~15% and wines at ~30% CAGR, albeit from a low base.

Fig 2 -Indias alcoholic beverages market (value breakup)S pirits

85%

Beer

14%

Wine

1%

Source: RCML Research, Industry data

Fig 3 -Favourable demographics

58.6

60.9

64.165.7

66.4

54

5658

60

62

64

66

68

1991 2001 2011E 2021E 2031E

Percentage of population in India between15-64 years of age

(%)

Source: RCML Research, Businessworld Marketing Whitebook 2010-11

We believe the consumption of spirits (country liquor plus IMFL) in India is at par withthe global average (with a high preference for whisky in particular; refer Fig 16 & 17).However, due to extremely low per capita consumption of wines and beer as comparedto other countries and the global average, the overall per capita consumption ofalcoholic beverages in India appears dismal. A comparison of pure alcohol consumptionwithin the penetrated population (i.e., average consumption per alcohol drinker) showsthat India is almost in line with the global averageimplying that Indians (who drink)actually drink alcohol at par with their global peers.

Fig 4 -Per capita consumption of drinks

0.0 0.11.3 1.2 1.8

40.5

44.2

7.9

15.7

22.1

3.2

21.9

29.130.6

37.4

3.9

05

10

152025

303540

4550

Fruit

Beverage

Bottled

Water

Beer

Distilled

Spirits*

Coffee

CSD

Milk

Tea

India Global(litres /p.a.)

Source: All India Brewers Association, RCML Research |* Includes Country Liquor for India

Fig 5 -Penetration of alcoholic drinksPenetration Adult males Adult females

India 30% 5%

China 80% 30%Source: RCML Research, Industry

Rising drinking-age population to drive

healthy growth in the sector

Per capita pure alcohol consumption

among drinking population is in line

with the global average

Only ~30% of men and ~5% of women

consume alcohol in India


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Fig 6 -Per cap consumption of pure alcohol (15 yr + popln)12.9

10.48.5

5.34.5 5.0

1.5

0

2

4

6

8

1012

14

Germany UK USA Brazil China World India*

(Litres p.a.)

Source: RCML Research, WHO |* Includes Country Liquor consumption

Fig 7 -Per cap consumption of pure alcohol among drinkers

13.6 12.9

11.8 11.08.7

7.7 7.2

02468

10121416

Germany

USA

UK

Brazil

China

World

Average

India*

(Litres p.a.)

Source: WHO, RCML Research | *Includes Country Liquor consumption

We believe the volume growth potential in spirits will be mainly led by consumers

upgrading to IMFL from country liquor (as big a market as IMFL) and illicit liquor(estimated to be as big as IMFL and country liquor combined). Positive demographics,with the drinking-age population (18yrs+) growing at ~3% CAGR, and greateracceptance of social drinking remain the other vectors of growth. However, we believethat given the quantity already being consumed per user, there is little potential for afurther increase and we could in fact see a decline as social (and not binge) drinkingbecomes more prevalent.

Volume growth potential would appear to be structurally higher in beer, due to(a) increasing social drinking; (b) possible deregulation of distribution; and(c) improving affordability with rising income levels.

Liquor heavily regulated and a state subjectThe liquor industry is heavily regulated with restrictions on both manufacturing andretail sales (licences needed to set up facilities and to sell alcohol), resulting incontrolled availability. About 65% of Indias states have strict regulations (governmentcontrols both wholesale/retail channels and buys directly from liquor companies,usually at an annually negotiated price). Only 20% are free markets (sales throughdistributor/retailer, free pricing), while the remaining 15% are auction-controlled(government appoints 12 central distributors in a state).

Taxation structure no differentiation due to alcohol contentThe taxation structure in India does not differentiate between lower-alcohol (beer, wine)and higher-alcohol content (country liquor, IMFL). In fact, the taxation is quite similar

and is more a function of pricing of the product rather than alcohol content.

Liquor taxation is a state subject and hence duties vary across states. In addition, withineach state there are different types of levies/taxes such as excise, VAT, import fee, exportfee, permit fee and annual licence fee, which serve to make for a complex structure.Inter-state movement of liquor involves additional taxation, thus requiring the use ofown distilleries located in the state or resort to contract bottlers, which further pushesup costs.

Volume growth potential higher for

beer than spirits

Liquor industry in ~80% of Indian states

government-controlled in some form


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Fig 8 -Taxation structure on Alcobev in the union territory of ChandigarhAlcohol Type Excise duty VAT Import fee

Country Liquor* Rs 6/- per PL 12.5% Rs 2.25/- per PL

IMFL (60 degree) Rs 6/- per PL 12.5% Rs 2.25/- per PL

IMFL (75 degree) Rs 20/- per PL 12.5% Rs 2.25/- per PLWines, Champagne, Cider,RTD and Liqueurs

Rs 10/- per BL 12.5% Rs 3/- per case

Beer

- Bottled Beer havingalcoholic content upto5.25% v/v

Rs 6/- per bottle of650ML

12.5% Rs 2/- per case

- Bottled Beer havingalcoholic content exceeding5.25% and upto 8.25% v/v

Rs 10/- per bottleof 650ML

12.5% Rs 2/- per case

- Draught Beer havingalcoholic content upto5.25% v/v

Rs 10/- per BL 12.5% Rs 0.25/- per BL

- Draught Beer havingalcoholic content exceeding5.25% and upto 8.25% v/v

Rs 15/- per BL 12.5% Rs 0.25/- per BL

Denatured Spirit Rs 0.75/- per BL 12.5% -

Source: Chandigarh Excise department, RCML Research | *Export fee of Rs 0.20/- per PL is also charged on Country Liquor

Fig 9 -Global alcohol taxation structureCountry % Sales tax/VAT Tax as a % of Retail price

Beer Spirit

India 4 to 12.5 45.0 40.6

Nepal 25.0 40.0 40.0

China 17.0 8.0 25.0

Japan 5.0 46.5

South Africa 14.0 18.4 26.3

Russia 20.0 4.0 35.0

France 16.9 8.8 33.2

Germany 16.0 6.6 13.8

Italy 20.0 11.0 20.0

Source: WHO, RCML Research

Pricing: Beer and wine relatively more expensive

Owing to higher taxation, the relative prices of beer and wine in India are higher thanthat of spirits. Wine is the most expensive relative to global averages while beer comes

next and spirits are the least expensive.

Fig 10 -Relative price* of per gram of alcohol in India vs global median500ml beer @4.5% alc/vol

750ml wine @12% alc/vol

750ml spirits @40% alc/vol

Pure alcohol content (gm) 22.5 90 300

Relative prices in India 11 53 29

Relative price of per gram alcohol India 0.489 0.589 0.097

Global Median 0.156 0.097 0.044

Source: WHO, RCML Research ** the ratio of the price of pure alcohol to the price of GDP per capita (local currency)

Globally, there is differential taxationwith beer usually taxed lower than

spirits

Globally, the typical price ratio for

beer: wine: spirits is 1:2:4 while the

same for India is 1:5:3


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Fig 11 -Relative price* of alcoholic beveragesBeer Wine Spirits

Country500ml 750ml 750ml

Brazil 1.51 5.35 9.42

Canada 0.37 1.62 5.75

Mexico 1.47 8.11 22.36

France 0.28 0.95 4.90

Germany 0.32 1.19 2.15

Russian Federation 2.41 12.05 14.45

United Kingdom 1.00 2.12 7.27

India 11.00 53.00 29.00

Australia 0.64 2.80 7.01

Iceland 0.76 5.32 9.97

Republic of Korea 1.61 2.03 45.52

United States 0.21 0.85 1.82China 6.63 26.52 26.52

Spain 0.41 0.46 5.53

World median 3.50 8.70 13.20

Source: WHO * the ratio of the price of alcoholic beverages to the price of GDP per capita (local currency)

Growth potential

IMFL: Volume potential due to upgrades from illicit and country liquorIndias IMFL market size is estimated at 236mn cases, growing at a 1213% CAGR overthe last five years. In FY10, the industry grew by 14.2% in volume terms. Whiskydominates the IMFL segment with a 58% market share, while brandy (21%) and rum

(17%) are other dominant forms. The white spirits segment is small (~4% of IMFLvolumes) but growing rapidly due to its preference among the younger generation,especially for vodka.

Fig 12 -IMFL volume breakup, 2009

Whis ky

58%

Brandy

21%Rum

17%

Gin

2%

Vodka2%

Source: Euromonitor, International Wine and Spirit Research, Industry data

Fig 13 -IMFL volume growth rate, FY10

6.8

12.014.3

16.8

29.7

14.2

7.0 7.7

0

510

15

20

25

30

35

Rum

Whisky

Vodka

Gin

Brandy

Total

IMFL

Country

Liquor

Beer

(%) FY10 Grow th rate s

Source: Radico, Euromonitor

IMFL continues to gain market share from country liquor, a trend we expect to continuegiven the relatively low price differential (country liquor sells at ~Rs 90100/bottle vs.the starting price of ~Rs 140150/bottle for IMFL). In terms of regional trends, SouthIndia (four states put together) dominates IMFL, accounting for ~5560% of total sales.

Rum the slowest growing segment;

vodka the fastest

Brandy and rum more popular in the

south and west, while whisky dominates

the north and east


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Fig 14 -Rising share of IMFL in total spirits sales in India

68 6660 61 57

53 51

32 3440 39

4347 49

0

10

20

3040

50

6070

80

FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10

Country Liquor IMFL(%)

Source: RCML Research, Company

Fig 15 -Region-wise sales of IMFL

82

47

7358

27

8

2

42718

24 19 20

6572

8

10

0

20

40

60

80

100

North S outh Eas t Wes t CS D

Whisky Others Brandy Rum(%)


Whisky: Growth all-roundWhisky, unlike in the rest of the world, remains the favourite spirit among Indians. Itconstitutes 58% of the total sales volume in India as compared to the global average of25%. Consequently, all of the worlds top 10 fastest growing whisky brands are Indian,with Old Tavern from UNSPs stable leading the pack.

Fig 16 -Whisky the clear favourite* among Indians compared to RoW

25

5815

21

13

17

48

4

0

10

20

30

40

5060

70

80

90

100

World India

Whis key Rum Brandy White S pirits(%)

Source: UNSP presentation * In terms of total sales voulume

Fig 17 -Worlds top 10 fastest growing millionaire whiskies

6.8

10.212.0

2.01.1

2.3

8.4

4.8

13.5

2.7

05

101520

2530354045

OldTavern

Original

Choice

Officers

Choice

DSPBlack*

Signature

Blenders

Pride

RoyalStag

Imperial

Blue

McDowells

No.1 G

old

Riband

0

2

4

6

8

10

12

14

16CAGR 2005-09 Volume-RHS(%) (mn cas es )

Source: RCML Research, Drinks international |*CAGR (2006-09)

Whisky the favourite spirit among

Indians

All of the worlds top 10 fastest growing

whisky brands over 200509 have been

Indian


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Fig 18 -Growth rates of leading whisky brands in India

Bagpiper McDow ells No 1

Off icers Choice

Original Choice

Royal Stag

Old Tavern

Directors Special

Hayw ards

8PM

Blenders PrideGreen Label

Gold Riband

Royal Challenge

Signature

(10)

0

10

20

30

40

50

(5) 0 5 10 15 20 25 30 35 40CAGR 2005-09

%c

hange09-08

Source: RCML Research, Drinks international | Labels colored red are brands of UNSP, Colored blue are brands of Radico; Colored green are brands of Pernod Ricard India; Colored black arebrands of Other IMFL players


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Sector financials

Fig 19 -Sales growth trend

(20)

(10)

0

10

20

30

40

50

60

FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Radico Khaitan United Spirits United Breweries(%)

Source: RCML Research

Fig 20 -EBITDA margin trend

0

5

10

15

20

25




Fig 21 -D/E ratio trend

0.0

1.0

2.0

3.0

4.0




Expect a steady 1520% topline CAGR

for the sector over FY10-FY13; UBBL to

deliver highest topline growth

Margins on an uptrend for IMFL led by

gross margin improvement due to lower

molasses prices

Leverage ballooned in FY09equity

issuances in FY09/10 by all players have

helped improve capital structures


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Fig 22 -Net working capital-to-Sales trend

0

20

40

60

80

100




Fig 23 - ROE trend

(10)

(5)

0

5

10

15

20

25

30




Fig 24 -Sector Valuation matrixMCap EPS CAGR EBITDA M (%) ROE (%) Adj. D/E (x) P/E (x) EV/EBITDA (x) P/B (x)

CompanyCMP(Rs)

Target(Rs)

Reco(Rs mn) FY10-13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E

United Spirits 1,421 1,650 Buy 171,471 49.5 19.1 19.0 14.8 15.9 1.2 1.0 26.2 21.2 15.4 13.4 3.6 3.2

United Breweries 427 400 Hold 102,000 63.4 13.7 14.5 22.8 25.6 0.6 0.4 39.0 29.1 21.1 16.7 8.2 6.8

Radico Khaitan 164 190 Buy 21,620 42.2 16.9 17.2 15.4 17.6 0.3 0.3 20.1 15.5 14.1 11.5 2.9 2.6

Aggregate - - - 295,091 16.6 16.9 28.4 21.9 16.9 13.9 4.9 4.2


UBBL has best working capital control.

Companies to improve working capital

turns

Expect ROEs to trend up after dismal

FY09; UBBL has the highest ROE


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Appendix I

Global spirits industryThe global spirits industry, which witnessed volume growth of 2.6% in 2009, is

estimated at over 2.1bn cases. Regional spirits like Japanese shochu (~130mn cases) andSouth Korean soju (~110mn cases) dominate global sales volumes with a 46% share(~990mn cases). White spirits (vodka and gin) form the next dominant category with a23% share (~470mn cases).

Fig 25 -Global spirits market breakup (volume)

White s pirits23%

Whis key

12%Rum

7%

Brandy &

Cognac

6%

Liqueurs

5%

Tequila

1%

Other s pirits

46%

Source: RCML Research, Drinks International

Fig 26 -Global consumption of spirits in 2009

222 880 1,182 1,3972,396 4,252

8,900

19,228

-

5,000

10,000

15,000

20,000

25,000

Tequila

Liqueurs

Brandy

Rum

Whiskey

White

spirits

Other

spirits

Total

(mn litres )


Fig 27 -Alcohol preference (in volume terms) across continents

0%10%20%30%40%50%60%70%80%90%

100%

Whiskey Cognac/Brandy White spirits Rum Tequila (&Mezcal)

Liqueurs Other s pirits

Asia Pacif ic Aust ra las ia Eas tern Europe Latin America ME and Afr ica North America Western Europe

Source: RCML research, Drinks international

Fig 28 -Worlds top 10 largest selling Vodkas in 200976.1

24.3

54.2

- (1.6)(0.6)2.210.7

22.53.0

0

5

10

15

20

25

30

S

mirnoff

Zelenaya

Marka

Khlibniy

Dar

Absolut

Khortytsa

N

emiroff

PyatOzer

C

zystade

Luxe(ZG)

Absolwent

Grey

Goose

(10)0102030405060708090

Vodka Sales - 2009 CAGR 2005-09-RHS(mn cas es ) (%)

Source: RCML Research, Drinks international

No Indian brand among the top 10

largest selling vodkas, indicating lower

preference for white spirits in India


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Fig 29 -Worlds top 10 largest selling Rums in 2009

19.8

5.79.0

(1.6)

5.6

(4.3)

0.0(1.9)

6.3

14.7

02468

101214161820

Bacardi

Tanduay

MCDNo.1

Celebration

Captain

Morgan

Havana

Club

Contessa

OldCask

Montilla

Cacique

OldPort

Rum

(10)

(5)

0

5

10

15

20

25

Rum Sales - 2009 CAGR 2005-09-RHS(mn cas es ) (%)


Fig 30 -Worlds top 5 largest selling Brandies in 2009

14.9

65.1

29.0

17.5

2.7

0

1

23

4

5

6

78

9

10

McDow ells

No.1

Mans ion Hous e

Brandy *

Honey Bee Dreher Old Admiral(5)

5

15

25

35

45

55

65

75

Brandy Sales - 2009 CAGR 2005-09-RHS(mn cas es ) (%)

Source: RCML Research, Drinks international | * CAGR 2006-09

Fig 31 -Worlds top 6 largest selling Gins in 2009

(4.3) (2.1)(0.8) 2.3 -

3.2

0

1

2

3

4

5

Gordons Gin S eagrams

Gin

Beef eater Bombay Tanqueray Blue Riband

Gin

(15)

(5)

5

15

25

35

45

55

65

75

Gin Sales - 2009 CAGR 2005-09-RHS(mn cas es ) (%)


3 Indian brands in top 10 largest selling

rums in the world

All (except one) of the worlds top 5

largest selling brandy brands are Indian


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Appendix II

Manufacturing process of IMFLRectified Spirit

(Strength-94-95% v/v)

Redistilled in Extra NeutralAlcohol Plant ( Total Deooxidice

Copper plant)

Reduce withDemineralized

Water


Water

Denatured withDenaturet

Blending with Color& Essences for C&L

Denatured Spirit/SpecialDenatured Spirit (Not for

Human Consumption

ENA (Extra Neutral Alcohol)-95to 96% v/v

Reduced with D.M.Water

Blending with Color &Essence / Malt Spirit etc. (for

IMFL)Bottling (Procedure)

Empty Bottle

Washing / Rinsing

Filterisation (Liquor)

Bottle Filling

Sealing

LabelingPacking (Finished

Goods)

Rectified Spirit(Strength-94-95% v/v)

Redistilled in Extra NeutralAlcohol Plant ( Total Deooxidice

Copper plant)


Water


Water

Denatured withDenaturet

Blending with Color& Essences for C&L

Denatured Spirit/SpecialDenatured Spirit (Not for

Human Consumption

ENA (Extra Neutral Alcohol)-95to 96% v/v

Reduced with D.M.Water

Blending with Color &Essence / Malt Spirit etc. (for

IMFL)Bottling (Procedure)

Empty Bottle

Washing / Rinsing

Filterisation (Liquor)

Bottle Filling

Sealing

LabelingPacking (Finished

Goods)


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Companies


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United Spirits Ltd Initiating Coverage 16 December 2010

16


(91-22) 6766 3458 (91-22) 6766 3470 (91-22) 6766 3471


Profitability and return ratios

(%) FY10 FY11E FY12E FY13E

EBITDA margin 16.2 16.9 19.1 19.0

EBIT margin 14.7 15.5 17.7 17.6

Adj PAT margin 3.5 6.0 8.0 8.6

ROE 7.2 10.4 14.8 15.9

ROIC (1.3) 7.6 9.6 10.3

ROCE 2.0 8.2 10.4 11.3

Financial highlights

(Rs mn) FY10 FY11E FY12E FY13E

Revenue 63,623 69,145 81,518 94,128

Growth (%) 16.4 8.7 17.9 15.5

Adj net income 2,218 4,118 6,551 8,081

Growth (%) (907.2) 85.7 59.1 23.4

FDEPS (Rs) 20.0 34.1 54.3 67.0

Growth (%) (850.7) 70.4 59.1 23.4

United Spirits Ltd

Domestic business to drive growth

We initiate coverage on United Spirits (UNSP) with a BUY rating and aSeptember 11 price target of Rs 1,650. We like the companys domestic IMFLbusiness given its dominant market share and expected pick-up in profitabilityover FY10-FY13. UNSPs focus on strengthening the back-end by raising primarydistillation and bottling capacities should help improve its profitability profile.However, Whyte & Mackays (W&M) numbers are likely to remain lacklustre inthe near term given the discontinuation of bulk scotch sales in order to focus onbranded salesalbeit a positive move from a longer-term perspective. The stockis currently trading at 26.2x FY12E and 21.2x FY13E earnings. Our SOTP pricetarget of Rs 1,650 comprises 15x September 12 domestic EBITDA, 8x subsidiary(including W&M) EBITDA, and W&Ms scotch inventory value at 50% discount.

Dominant market position a key advantage: UNSP is a clear leader in the domestic

spirits sector with 43% market share, and continues to widen its lead over its nearestcompetitor. Given the entry barriers raised by regulatory constraints, this competitivelead looks sustainable and will enable the company to capture the longer-termconsumption shift from country liquor to IMFL, resulting in healthy volume growth.We expect a 18.3% topline CAGR over FY10-FY13 from domestic operations.

Domestic business to show improved profitability: Lower input costs (molasses)along with continuing product mix improvement should aid a 350bps expansionin domestic business margins over FY10-FY13. In our view, the key to significantvalue creation over the longer term would be a product mix shift to premiumspirits where UNSP has a relative weaker portfolio and tends to face toughercompetition from foreign players selling aspirational brands.

W&M performance to be weak in the near term: Following its takeover by UNSPin FY08, W&M has enhanced its focus on the branded scotch business rather thanon bulk sales. While this strategy should pay off in the longer run, we expect a45% drop in W&Ms EBITDA in FY11 (GBP 31 mn) given discontinuation of bulksales. Post this one-time adjustment, we expect W&M EBITDA to grow at ~ 14%CAGR in FY11-13 driven by growth in branded and private label sales.

Improvement in balance sheet but modest free cash flow generation: Followingthe QIP and treasury stock sales, UNSPs balance sheet has improved, with D/Ecoming down (3.1x in FY09 to 1.3x in FY11E). However, considering theexpected EBITDA contraction in W&M and rising capex trajectory for thedomestic business, free cash flows are unlikely to pick up significantly.

Initiate with BUY: We initiate coverage with a BUY rating and a September 11

target of Rs 1,650. Key risks for the stock are an increase in input prices, ahardening of interest rates, and disappointments on growth at W&M.

CMP TARGET RATING RISK

Rs 1,421 Rs 1,650 BUY MEDIUM

BSE NSE BLOOMBERG

532432 MCDOWELL UNSP IN

Company data

Market cap (Rs mn / US$ mn) 171,471 / 3,777

Outstanding equity shares (mn) 121

Free float (%) 70.9Dividend yield (%) 0.2

52-week high/low (Rs) 1,688 / 1,057

2-month average daily volume 271,976

Stock performance

Returns (%) CMP 1-mth 3-mth 6-mth

United Spirits 1,421 1.6 (11.7) 13.1

BSE FMCG 6,537 (1.8) 13.7 17.0

Sensex 19,648 (3.3) 0.7 12.8

Valuation matrix

(x) FY10 FY11E FY12E FY13E

P/E @ CMP 70.9 41.6 26.2 21.2

P/E @ Target 82.4 48.3 30.4 24.6

EV/EBITDA @ CMP 23.3 20.6 15.4 13.4

RCML vs consensus

FY12E FY13E

Parameter RCML Cons RCML Cons

Sales (Rs mn) 81,518 80,168 94,128 89,703

EPS (Rs) 54.3 58.3 67.0 72.1


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Investment rationale

Domestic business Growth intact, margins to move up

UNSPs business comprises two segments: domestic IMFL and the Whyte & Mackay(W&M) scotch business (acquired in 2007). However, domestic operations stillcontribute a bulk of consolidated revenues and profits and remain the key value andstock price driver.

Fig 32 -Revenue break-up

0%

20%

40%

60%

80%

100%

FY08 FY09 FY10 FY11E FY12E FY13E

Standalone W&M


Fig 33 -EBITDA break-up

0%

20%

40%

60%

80%

100%

FY08 FY09 FY10 FY11E FY12E FY13E

Standalone W&M


Domestic volume growth to remain strongUNSP is the dominant market leader in IMFL with ~43% market share. The companyhas been improving on its market share through higher-than-industry growth, therebywidening the gap to its nearest competitor (now Pernod Ricard, earlier Radico Khaitan).

We expect UNSP to hold onto its market share going forward and grow in line with theindustry at a 1213% volume CAGR over the next three years.

Fig 34 -IMFL industry sales vs UNSP

133

190214

236

59 66

158

74

88 100

45

42

39

4143

0

50

100

150

200

250

FY06 FY07 FY08 FY09 FY10

34

3638

40

42

44

46

IMFL industry sales

UNSP sales

UNSP's market share-R

(mn cas es ) (%)


Fig 35 -UNSPs volume growth ahead of industry

18.820.3

12.610.3

12.511.3

19.5

13.5

0

5

10

15

20

25

FY07 FY08 FY09 FY10

IMFL Industry vol. growth rate UNSP's vol. growth rate(%)


Domestic operations remain key value

and stock price driver

IMFL business expected to deliver

1213% volume CAGR over FY10-13


18/50


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Focus on backward integration steps in the right directionUNSP is currently deficient in primary distillation, meeting only ~11% of its total spiritsrequirement in-house through primary distillation (molasses to ENA), 33% throughin-house secondary distillation (rectified spirits to ENA), and the balance 56% throughpurchased ENA. Thus, the company has been unable to capture the full value in the

entire chain given that ENA prices have tended to be less volatile than molasses andprimary distillers have captured the upside. The management is looking to plug this gapin the value chain, which we believe is a step in the right direction. UNSP intends tospend ~Rs 6bn7bn over the next 24 months to bring the proportion of in-house primarydistillation to 37%.

The company is also looking to augment its in-house bottling capacity (62% currently),to save the mark-up paid to bottlers, which will further aid profitability. It intends tospend ~Rs 1.5bn in capex on the same. This apart, it will expand on in-house malt spiritcapacity (65% currently) with a capex of ~ Rs 1bn1.25bn.

Fig 36 -Expansion of ENA manufacturing capacity

11

37

89

63

0

10

20

30

40

50

60

70

80

90

100

Current After 2 years

Conversion of RS to ENA / Sourcing of ENA from other players

Own ENA manufacturing

(%)

Capex of Rs 6-7bn


Raw material costs trending down; positive for margins in FY11 and FY12Molasses (a byproduct from sugarcane crushing) is the primary raw material forpreparing rectified spirit, which is in turn processed into extra neutral alcohol (ENA), akey raw material for distilled spirits. Since UNSP is deficient in its own primarydistillation capacity, it directly purchases ENA instead of molasses. The price ofmolasses, and consequently of ENA, went up sharply during FY08-FY10 due to lowersugarcane production, resulting in pressure on gross margins. But prices have softenedin FY11 YTD due to strong sugarcane production in the last season. We expect molassesprices to stabilise around current levels (~5% below peak) given the strong sugarcanecrop expected in the upcoming season (DecemberMarch) as well.

The key to a raw material cost decline for the company would be lower ENA costs. Thiswill come through when the company increases primary distillation capacity in FY12and FY13, potentially leading to savings of ~Rs 10/case on a blended basis, implying~20% higher PBT.

Glass, the other key input cost for the company, has seen stable pricing of late.However, the rising crude rates could put pressure on glass prices in FY12. We expectstable raw material costs (per case) over FY10-FY12 while packaging cost per case willinch up gradually given the 45% CAGR inflation in glass prices.

Expanding primary distillation, bottling

and malt spirit capacities to lower

COGS

Key for raw material cost decline is ENA

cost which would come down with

increased primary distillation in FY12.

Rs 10/case saving on blended basis

could lead to ~ 20% increase in PBT


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Fig 37 -Molasses price trend for UNSP

4.0

4.9

2.5

3.9

4.8

6.6

-

20

40

60

80

100

120

140

160

FY05 FY06 FY07 FY08 FY09 FY10

-

1

2

3

45

6

7

Molas s es quantity consumedCost/litre-R

(mn kg) (Rs /kg)


Fig 38 -Spirits (ENA) price trend for UNSP

3133 33

31

4745

-

50

100

150

200

250

FY05 FY06 FY07 FY08 FY09 FY10

-

10

20

30

40

50

Spirits quantity consumedCost/litre-R

(mn litres ) (Rs /litre)


Fig 39 -Soda ash prices relatively stable

0

200400

600

800

10001200

1400

1600

Dec-

06

J un-

07

Dec-

07

J un-

08

Dec-

08

J un-

09

Dec-

09

Jun-

10

Dec-

10

S oda As h prices(Rs /50 kg)

Current : 950


Fig 40 -but crude oil prices steadily inching up

0

20

40

60

80

100

120

140

160

Mar-07

Aug-07

Jan-08

Jun-08

Nov-08

Apr-09

Sep-09

Feb-10

Jul-10

Dec-10

Brent Crude oil prices in London(US$/barrel)

Current : 90.4

Source: RCML Research, Company | *CAGR (2006-08)

Fig 41 -Raw material price per case of own unit sales

158170

140

193 201 200 191 193

-

50

100

150

200

250

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

RM per case(Rs/case)


Fig 42 -Packing material price per case of own unit sales

158 161169 179 166 174

183 192

-

50

100

150

200

250

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

PM per case(Rs/case)



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Fig 43 -Economics of UNSP on a per case* basis(Rs per case) FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Gross Realisation 1,080 1,164 1,290 1,337 1,344 1,438 1,510 1,585 1,633

Excise duty 395 538 573 603 636 697 732 768 791

Net Realisation 685 626 717 734 708 741 778 817 841Raw Material 146 158 170 140 193 201 200 191 193

Packing Material 151 158 161 169 179 166 174 183 192

Gross Profit 389 310 386 425 336 374 403 443 456

A&P* * 17 38 44 41 39 47 54 56 58

Conversion costs** 360 237 278 303 226 250 262 280 291

EBITDA* * 12 36 64 81 71 77 88 106 108

Source: RCML Research | *1 case comprises 12 bottles of 9 liters each **Includes tie-up unit cases

Product mix uptrading key for longer-term margins

UNSPs portfolio spans across various price segments of the IMFL market, with a bulk of

the sales volume coming upper regular and deluxe segments, which would help in termsof capturing the uptrading potential from country liquor to IMFL. However, over thelonger term, the primary profit pool for the industry will come from the premiumsegment, as the current tax structure leaves little to be made at the mass end. This willbe a key metric to monitor when looking at the longer-term value creation potential forUNSPs business model, which is currently high on volumes but low on profits.

The management plans to augment the premium end portfolio in brandy and vodka. Inaddition, McDowell Platinum has been launched in the whisky segment to competewith Royal Stagwhisky at the Rs 300 price point. We believe these steps augur well formargin expansion of the company over the longer term.

Bulk of current sales volume coming

from upper regular and deluxe (Rs. 200-300 per bottle) segment

Taking steps to beef up portfolio at top

end in vodka, brandy and whisky


21/50


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Fig 44 -Price pyramid of UNSP brands and volumes for each of themSegment

Price Range (Rsper 750ml bottle)

BrandsType ofIMFL

Volumes in2009 (mn cases)

Economy 100-120 Old Adventurer Rum 1.23

Regular 150-200 White Mischief Vodka 1.9

Haywards Whisky 4.06

Gold Riband Whisky 2.68

UpperRegular

200-250 Honey Bee Brandy 3.6

John Exshaw Brandy 1.48

Blue Riband Gin Gin 1.09

McDowells No.1Celebration

Rum 11.17

Old Cask Rum 2.21

Romanov Vodka 1.25

Bagpiper Whisky 16.26

Old Tavern Whisky 6.84

Directors Special Whisky 4.39Directors Special Black Whisky 2.03

McDowells Green Label Whisky 1.99

Deluxe 250-300 McDowells No.1 Brandy 13.52

McDowells No.1 Whisky 13.52

Prestige 300-400 - -

Premium 400-550 Royal Challenge Whisky 1.27

Signature Whisky 1.14

Super-premium

>550 Antiquity Rare Whisky < 1

Antiquity Blue Whisky < 1

Pinky Vodka < 0.1

Black Dog Scotch < 0.2


Wines and IPL Small but interesting

UNSP also operates in the wines business through its 100% subsidiaries, Four SeasonsWines and Bouvet Ladubay. The Four Seasons business caters to the mass- and mid-endsegments (prices range from Rs 200 to Rs 700/bottle) and offers home-grown productswith wineries in Maharashtra. The Bouvet Ladubay portfolio was acquired by UNSP in2007 and provides a presence at the top end of the imported wines market. We believethe wines segment in India offers strong growth potential over the long term and UNSP

has positioned itself well to capture the opportunity. However, given the relatively smallsize of the business, we do not see a significant impact on the companys financials overthe next five years.

UNSP also owns IPL franchise, Royal Challengers Bangalore, through its 100%subsidiary, Royal Challenger Sports. Via this entity, the company has obtained perpetualrights to the Bengaluru IPL team, involving annual payments to Indias cricket board, theBCCI. Revenue streams for the company include sponsorship rights, stadium tickets andmerchandise. The entity is only just breaking even and we do not expect a meaningfulcontribution to earnings in the near future. However, given the recent bids for two newIPL teams, we believe the franchise has created value for UNSP shareholders. Apart fromeconomics of the IPL team, this move also helps build brand equity for its key offering atthe premium end, Royal Challenge, given restrictions on advertisement in the sector.

Limited volumes in segments upward of

deluxe; absent in premium/super-

premium brandy, rum, vodka and gin

Wines business and IPL franchise

provide option value in distant future;

near-term impact to be limited


22/50


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Whyte & Mackay Lacklustre in near term

W&M amongst top 5 scotch players globallyUNSP acquired a 100% stake in W&M in FY08 in an all-cash deal valuing the companyat 595mn. The company produces ~8% of global scotch whisky consumption withsingle malt brands such as Dalmore and Isle of Jura and blended scotch brands such as

Whyte & Mackay,John Barrand Claymore.

Fig 45 -Scotch whisky growing at a faster rate in EMs

58 59

20

47

020

40

60

80

100

120

1988 2008

Mature Markets Emerging markets(mn cases )

20 years

CAGR: 4.4%

20 years

CAGR: 0.1%


Fig 46 -Growth trend in Scotch whisky in key EMs33

21 20

13

5 5

05

10

15

20

25

30

35

China Rus s ia* India Africa Brazil Korea

CAGR (2004-08))(%)

Source: RCML Research, Company | *CAGR (2006-08)

Fig 47 -Product pyramid of W&M

Source: Company

W&M produces ~8% of global scotch

consumption


23/50


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Fig 48 -More focus on branded sales by W&MSegment At the time of acquisition Currently

Bulk and private label sales as a %of total sales

56 50

Branded sales as a % of total sales 44 50

Coverage of Duty Free channels(nos)

5 30

Source: Company

Proportion of bulk scotch sales to dip further near-term negativePost-acquisition, W&M has enhanced its focus on the branded business. W&Msnumbers will take a hit in FY11 as the company has decided to cut back on bulk scotchsales (post-expiry of the Diageo contract), which will likely result in sales declining to110mn and EBITDA falling ~45% to ~32mn in FY11.

Fig 49 -Category-wise split of W&M sales (volume)

13

50

13

50

73

0%

20%

40%

60%

80%

100%

FY10 FY11E

Matured bulk spirit Branded sales Pvt. Lable sales


Fig 50 -Volume and EBITDA per case for W&M FY10

9.5

1.7 1.682.7

9.3 9.4

0

2

4

6

8

10

Bulk Private Label Branded

0

2

4

6

8

10

Volume (mn cases ) EBITDA per case-RHS(mn cases ) (GBP)


Fig 51 -W&M financials

34.3

32.3

33.1

0

20

40

6080

100

120

140

160

180

200

FY08 FY09 FY10

30

31

32

33

34

35

Sales EBITDA EBITDA Margin - R(GBP mn) (%)

Source: Company, RCML Research

Building branded business longer-term gain, near-term pain

W&M has a clear strategy focusthat of building its branded scotch business (whichoffers ~4x the sales value of the bulk segment) and utilising its bulk inventory for thesame over a period of time. The bottled business has grown at a 20% CAGR since the

acquisition in FY08, while bulk sales (net of the Diageo agreement and UNSPrequirements) have fallen at a 28% CAGR.

Greater focus on branded over bulk to

cause ~50% EBITDA drop in FY11

Emerging markets (incl India) remain

the best opportunity for W&M to tap

into for branded scotch


24/50


24

In order to generate greater visibility for its branded business, the company hasenhanced coverage of duty-free channels from 5 to 30 key locations. It has alsoestablished new importer/distributor tie-ups in China, Taiwan, South Korea, Middle Eastand South Africa. Further, distribution of scotch brands in India has been scaled up40%, a move which is integral to UNSPs rationale for taking over the business.

The Indian scotch market, albeit small at ~1.2mn cases p.a., is growing at a heady3040% CAGR, making it imperative for UNSP to build its presence here. Overall,though, we believe a ramp-up of branded scotch sales, beyond scale up potential inselect emerging markets, would prove an uphill task given the strong competition fromglobal scotch majors.

Financial overview

Overall topline CAGR of 13.9% over FY10-FY13Growth in the domestic business would be largely volume-led. W&M is expected to seea decline in FY11 topline due to the discontinuation of bulk scotch sales.

Fig 52 -Consolidated sales* growth trend

6.1

37.9

56.2

18.2 16.48.7

17.9 15.5

72.7

--

20,000

40,000

60,000

80,000

100,000

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

0

10

20

30

40

50

60

70

80

Consolidated Sales Growth-R(Rs mn) (%)

Source: RCML Research | *Includes other operating income

Fig 53 -Standalone sales* growth trend

7.8

32.8

16.6

28.920.5 20.6 18.7 15.6

77.2

-

20,000

40,000

60,000

80,000

100,000

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

0102030405060708090

Standalone Sales Growth-R(Rs mn) (%)

Source: RCML Research | *Includes other operating income

EBITDA margins to expand led by domestic businessWe expect strong margin expansion in the domestic business over FY10-FY12 due tolower input prices and continued volume growth momentum. Consolidated marginswould mirror the growth trend of standalone operations as W&Ms margins are expectedto remain steady at 28%.

Fig 54 -Consolidated EBITDA and margin trend

5.1

14.7

23.1

14.116.2 16.9

19.1 19.0

9.0

--

5,000

10,000

15,000

20,000

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

0

5

10

15

20

25

Consolidated EBITDA Margins-R(Rs mn) (%)


Fig 55 -Standalone EBITDA and margin trend

5.5

15.7

18.8

15.3 15.716.7

19.3 19.2

10.2

-

3,000

6,000

9,000

12,000

15,000

18,000

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

0

5

10

15

20

25Standalone EBITDA Margins-R(Rs mn) (%)


Domestic growth to be strong but W&M

weak in FY11


25/50


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Fig 56 -Free cash flow

--

2,000

4,000

6,000

8,000

10,000

12,000

14,000

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

FCF(Rs mn)


Fig 57 -D/E ratio

--

0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

3.5x

4.0x

FY0

5

FY0

6

FY0

7

FY0

8

FY0

9

FY1

0

FY11

E

FY12

E

FY13

E

D/E ratio


Fig 58 -Net capex

--

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Net Capex(Rs mn)


Free cash flow generation improving,

but just enough for W&M debt

repayment

Capital structure has improved after

equity issuances but still on the higher

side.

100 bps increase in interest rates could

lead to PBT decline of ~8 %

Capex trajectory shifting up due to

planned backend investments in India


26/50


26

Valuation

Trading at middle of historical band; initiate with BUYThe stock is currently trading close to the average of its historical band, especially onEV/Sales and EV/EBITDA which are the best metrics to look at given the capital structureand earnings volatility. Historically, UNSP has traded in a forward EV/EBITDA band of1017x and current valuations at 15x forward are near its historical averages. We alsolook at trailing multiples since forward multiples based on actuals could be misleading.Given the ROE profile of the business and growth prospects, we believe the stock shouldtrade at 1315x forward EV/EBITDA.

We value W&Ms scotch inventory of 102mn litres at a 50% discount to the lastreported independent third party valuation of 425mn. Our discount aims to capture thevolatility in bulk scotch prices and is on a post-tax basis. We don t value IPL separatelyas we include the revenues and costs of the same in our subsidiary numbers. We initiatecoverage on the stock with a BUY rating.

Fig 59 -1-year forward EV/Sales

--

1

2

3

4

5

6

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

1yr fwd EV/Sales Average

+1Std Dev -1Std Dev(x)

Current : 3.0x


Fig 60 -Trailing EV/Sales

--

1

2

3

4

5

6

7

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Trailing EV/Sales Average


Current : 3.0x


Fig 61 -1-year forward EV/EBITDA

--5

10

15

20

25

30

35

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

1yr fwd EV/EBITDA Average


Current : 15x


Fig 62 -Trailing EV/EBITDA

--10

20

30

40

50

60

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Trailing EV/EBITDA Average


Current : 17.0x


Barring FY08, UNSP has usually traded

in a forward EV/EBITDA band of

1017x

Our SOTP price target of Rs 1,650

comprises 15x September 12 domestic

EBITDA, 8x subsidiary (including W&M)

EBITDA, and W&Ms scotch inventory


27/50


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Fig 63 -1-year forward EV/Sales

0

100,000

200,000

300,000

400,000

500,000

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

EV 0.4x 1.6x

2.8x 4x 5.2x(Rs mn)


Fig 64 -1-year forward EV/EBITDA

0

100,000

200,000

300,000

400,000

500,000

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

EV 7.2x 13.5x 19.9x26.3x 32.7x

(Rs mn)


Fig 65 -SOTP valuation(Rs mn) September 12Domestic EBITDA 14,622

Target Multiple 15

W&M and other Subs EBITDA 1,620

Target multiple 8

Total EV 232,290

Add: W&M Inventory 15,088

Less: Net debt 49,256

Equity value 198,122

Rounded off September 11 Price Target (Rs) 1,650


Global distillers, on average, are trading at ~12x forward EV/EBITDA and 15x P/E. Giventhe higher sustainable growth rate of UNSPs domestic business and higher ROCE(domestic business ROCE ~30%), we believe a 2030% premium to global peers iswarranted for the domestic business. On the other hand, we believe W&M deserves a1520% discount to global peers given its relatively weaker market position.

Global peer valuation

Company MCap DividendEPS

CAGREBITDA Margin

(%)ROE (%) P/E (x) EV/EBITDA (x)

($ mn) Yield (%)FY11-13E

FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13E

Constellation Brands 4,516 - 10.7 25.9 26.3 13.5 13 11.4 10.6 9.2 8.6

Brown-Forman Corp 9,975 2.5 8.7 25.0 25.0 25.5 24 19.2 18.0 12.2 11.7

Davide Campari-Milano Spa 3,664 1.6 11.5 26.7 27.2 14.3 14 15.2 13.4 11.2 10.3

Jinro Ltd 1,315 4.3 2.3 21.2 21.7 16.7 17 13.5 13.5 11.8 11.1

Diageo Plc 46,569 0.0 9.5 32.6 33.4 38.9 35 13.8 12.5 10.9 10.1

Pernod-Ricard SA 23,921 2.1 11.8 28.7 29.2 12.1 12 14.5 12.8 12.8 11.9

Remy Cointreau 3,319 2.7 14.4 22.5 23.7 11.2 12 19.3 17.1 14.1 12.5

Average 93,278 9.8 26.1 26.7 18.9 18.2 15.3 14.0 11.7 10.9

Source: RCML Research, Bloomberg


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Consolidated financials

Profit and Loss statement Balance sheet

Y/E March (Rs mn) FY10 FY11E FY12E FY13ERevenues 63,623 69,145 81,518 94,128

Growth (%) 16.4 8.7 17.9 15.5

EBITDA 10,315 11,696 15,582 17,915

Growth (%) 33.9 13.4 33.2 15.0

Depreciation & amortisation 950 979 1,173 1,383

EBIT 6,778 9,365 10,717 14,409

Growth (%) - 38.2 14.4 34.5

Interest 6,069 5,475 5,682 5,704

Other income (1,597) 934 1,027 1,130

EBT 1,700 6,176 9,755 11,958

Income taxes 1,932 2,057 3,204 3,877

Effective tax rate (%) 113.6 33.3 32.8 32.4

Extraordinary items - - - -

Min into / inc from associates (13) - - -

Reported net income (227) 4,118 6,551 8,081

Adjustments (2,445) - - -

Adjusted net income 2,218 4,118 6,551 8,081

Growth (%) (907.2) 85.7 59.1 23.4

Shares outstanding (mn) 120.7 120.7 120.7 120.7

FDEPS (Rs) (adj) 20.0 34.1 54.3 67.0

Growth (%) (850.7) 70.4 59.1 23.4

DPS (Rs) 2.8 3.4 5.4 6.7

Y/E March (Rs mn) FY10 FY11E FY12E FY13ECash and cash eq 7,686 6,036 5,577 4,921

Accounts receivable 13,401 14,550 16,511 19,249

Inventories 17,462 18,869 20,762 23,862

Other current assets 11,029 12,028 14,156 16,360

Investments 1,265 1,265 1,265 1,265

Gross fixed assets 18,474 22,126 26,086 30,121

Net fixed assets 12,260 14,933 17,720 20,372

CWIP 943 943 943 943

Intangible assets 47,435 47,435 47,435 47,435

Deferred tax assets, net 715 715 715 715

Other assets 1,861 1,861 1,861 1,861

Total assets 114,058 118,634 126,944 136,982

Accounts payable - - - -

Other current liabilities 14,912 15,275 16,808 19,316

Provisions 2,819 3,397 4,390 4,783

Debt funds 55,062 55,062 55,062 55,062

Other liabilities 3,529 3,529 3,529 3,529

Equity capital 1,207 1,207 1,207 1,207

Reserves & surplus 36,529 40,165 45,949 53,085

Shareholder's funds 37,735 41,372 47,156 54,292

Total liabilities 114,058 118,634 126,944 136,982

BVPS (Rs) 312.7 342.9 390.8 449.9

Cash flow statement Financial ratiosY/E March (Rs mn) FY10 FY11E FY12E FY13E

Net income + Depreciation 723 5,097 7,723 9,464

Non-cash adjustments 19,768 5,475 5,682 5,704

Changes in working capital (4,577) (2,614) (3,456) (5,138)

Cash flow from operations 15,914 7,959 9,948 10,030

Capital expenditure (2,866) (3,652) (3,959) (4,035)

Change in investments - - - -

Other investing cash flow (853) - - -

Cash flow from investing (3,719) (3,652) (3,959) (4,035)

Issue of equity - - - -

Issue/repay debt - - - -

Dividends paid - (482) (766) (945)

Other financing cash flow (8,999) (5,475) (5,682) (5,704)

Change in cash & cash eq 3,196 (1,651) (459) (656)

Closing cash & cash eq 7,686 6,036 5,577 4,921

Y/E March FY10 FY11E FY12E FY13E

Profitability & Return ratios (%)

EBITDA margin 16.2 16.9 19.1 19.0

EBIT margin 14.7 15.5 17.7 17.6

Net profit margin 3.5 6.0 8.0 8.6

ROE 7.2 10.4 14.8 15.9

ROCE 2.0 8.2 10.4 11.3

Working Capital & Liquidity ratios

Receivables (days) 64 74 70 69

Inventory (days) 201 196 189 183

Payables (days) 165 163 153 148

Current ratio (x) 3.3 3.4 3.4 3.3

Quick ratio (x) 0.9 1.0 1.0 1.0

Turnover & Leverage ratios (x)

Gross asset turnover 3.5 3.4 3.4 3.3

Total asset turnover 0.5 0.6 0.7 0.7

Interest coverage ratio 1.5 2.0 2.5 2.9

Adjusted debt/equity 1.5 1.3 1.2 1.0

Valuation ratios (x)

EV/Sales 3.8 3.5 3.0 2.6

EV/EBITDA 23.3 20.6 15.4 13.4

P/E 70.9 41.6 26.2 21.2P/BV 4.5 4.1 3.6 3.2


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Quarterly trend

Particulars Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11

Revenue (Rs mn) 10,801 13,468 12,521 14,630 13,542

YoY growth (%) 19.7 30.8 37.9 17.8 25.4

QoQ growth (%) (13.0) 24.7 (7.0) 16.8 (7.4)

EBITDA (Rs mn) 1,821 2,212 1,813 2,811 2,191

EBITDA margin (%) 16.9 16.4 14.5 19.2 16.2

Adj net income (Rs mn) 662 996 622 1,219 830

YoY growth (%) (28.1) 158.4 1.7 15.3 25.4

QoQ growth (%) (37.4) 50.5 (37.6) 96.0 (31.9)

DuPont analysis

(%) FY09 FY10 FY11E FY12E FY13E

Tax burden (Net income/PBT) 8.7 130.5 66.7 67.2 67.6

Interest burden (PBT/EBIT) (46.8) 18.1 57.6 67.7 72.3

EBIT margin (EBIT/Revenues) 12.4 14.7 15.5 17.7 17.6

Asset turnover (Revenues/Avg TA) 49.6 54.7 59.4 66.4 71.3

Leverage (Avg TA/Avg equtiy) 493.8 377.4 294.1 277.4 260.2

Return on equity (1.2) 7.2 10.4 14.8 15.9

Company profile

United Spiritss (UNSP) business comprises two segments: domestic

IMFL and the Whyte & Mackay (W&M) scotch business (acquired

in 2007). UNSP is the dominant market leader in IMFL with ~43%

domestic market share. The company has been improving on its

market share through higher-than-industry growth, thereby

widening the gap to its nearest competitor.

Shareholding pattern

(%) Mar-10 Jun-10 Sept-10

Promoters 29.1 29.1 29.1

FIIs 49.3 47.3 48.9

Banks & FIs 6.8 5.3 4.5

Public 17.8 18.3 17.5

Recommendation history

Date Event Reco price Tgt price Reco

16-Dec-10 Initiating Coverage 1,421 1,650 Buy

Stock performance

1,300

1,400

1,500

1,600

1,700

Sep-10 Oct-10 Nov-10 Dec-10

Buy


30/50

United Breweries Ltd Initiating Coverage 16 December 2010

30


(91-22) 6766 3458 (91-22) 6766 3470 (91-22) 6766 3471


Profitability and return ratios

(%) FY10 FY11E FY12E FY13E

EBITDA margin 10.3 12.9 13.7 14.5

EBIT margin 5.7 8.9 9.9 10.8

Adj PAT margin 3.9 7.5 7.6 8.5

ROE 9.1 22.4 22.8 25.6

ROIC 4.3 10.6 11.1 14.0

ROCE 6.8 13.6 13.7 16.4

Financial highlights

(Rs mn) FY10 FY11E FY12E FY13E

Revenue 22,755 31,739 37,876 45,220

Growth (%) 17.9 39.5 19.3 19.4

Adj net income 895 2,377 2,877 3,834

Growth (%) 96.1 165.7 21.0 33.3

FDEPS (Rs) 3.4 9.0 10.9 14.7

Growth (%) 113.7 166.9 21.8 34.3

United Breweries Ltd

Compelling long-term story but pricey

We initiate coverage on United Breweries (UBBL) with a HOLD rating and a

September 11 price target of Rs 400. While we find the structural growthpotential in the Indian beer market coupled with the companys marketdominance compelling from a longer-term perspective, we believe currentvaluations already capture in most positives. We therefore advise buying thestock on declines below Rs 350/sh to ensure a favourable risk-reward.

Topline growth to remain in high-teens: Indias per capita beer consumption isabysmally low at 1.3 litres versus the global average of 22 litres, which is partlydue to a high taxation policy and resultant high pricing relative to income levels.We believe the beer industry will continue to grow at a 1215% volume CAGR(1518% value CAGR) on a long-term basis with an upside bias (if lower taxationor distribution deregulation materialises).

Relative market share improving: UBBL now enjoys a 51% value market sharewhile its nearest competitor (SAB Miller) holds a 25% share. The company hasbeen growing ahead of the industry and has improved its relative market sharefrom ~1.28x in FY05-FY06 to ~2x in FY10. This would allow it to fully capturethe volume growth potential given its superior brand equity.

Portfolio premiumisation; potential improves with Heineken: The addition ofHeineken (local production to start in April 11) complements UBBLs productportfolio well as it strengthens the premium end, which will aid margins over thelonger term and protect market share.

Margins to inch up gradually: UBBL has recently taken initiatives to reducebottle costs over the medium term. This along with stable raw material prices and

strong topline growth in the near term will help improve EBITDA margins. Weexpect margins to expand from 10.3% in FY10 to 14.5% by FY13 and potentiallyto 18-19% over the long term as scale benefits (fixed-cost efficiency and lowerA&P/Sales) kick in.

Cash flows to strengthen with lower working capital: UBBL has been able to loweroperating working capital days by ~30% with a greater focus on paring debtor andincreasing payable days. The company plans to incur annual capex of Rs 2bn2.5bn over the next few years which can be easily funded via internal accruals.

Valuations full; initiate with HOLD: We initiate coverage on UBBL with a HOLDrating and a September 11 price target of Rs 400 based on 18x September 12EBITDA. Since we are positive on the longer-term attractiveness of the business,we would recommend buying on declines below ~Rs 350 levels.

CMP TARGET RATING RISK

Rs 427 Rs 400 HOLD MEDIUM

BSE NSE BLOOMBERG

532478 UBL UBBL IN

Company data

Market cap (Rs mn / US$ mn) 102,000 / 2,247

Outstanding equity shares (mn) 240

Free float (%) 25.0

Dividend yield (%) 0.2

52-week high/low (Rs) 495 / 143

2-month average daily volume 142,479

Stock performance

Returns (%) CMP 1-mth 3-mth 6-mth

UBBL 427 2.4 (2.2) 102.1

BSE FMCG 6,537 (1.8) 13.7 17.0

Sensex 19,648 (3.3) 0.7 12.8

Valuation matrix

(x) FY10 FY11E FY12E FY13E

P/E @ CMP 126.9 47.5 39.0 29.1

P/E @ Target 118.9 44.5 36.6 27.2

EV/EBITDA @ CMP 46.9 26.7 21.1 16.7

RCML vs consensus

FY11E FY12EParameter

RCML Cons RCML ConsSales (Rs mn) 37,876 39,508 45,220 47,806

EPS (Rs) 10.9 12.7 14.7 14.0


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Investment rationale

Strong volume growth potential for beer

Per capita beer consumption very low in India

India stands much below the global average (and even below similar per-capitacountries) in terms of beer consumption. This is mainly due to high taxation levels andlow affordability. Beer taxes in India, at ~45% of MRP, are much higher than the globalaverage of ~2025%.

Fig 66 -Per capita consumption of beer158.6

110.0 104.7 99.0 95.083.8

68.3 60.0 58.9 51.8 51.3 47.6

1.3

30.0

81.6

05,000

10,000

15,00020,000

25,000

30,000

35,000

C z e c

h R

e p

u b

l i c

G e r m

a n y

A u s

t r a

l i a

U n

i t e

d K

i n g

d o

P o

l a n

d

S p

a i n

U n

i t e

d S

t a t e

s

C a n a

d a

S o u

t h A

f r i c

a

R u s s

i a

M e

x i c

o

J a

p a n

B r a

z i l

C h

i n a

I n

d i a

020

406080100120140160180

Total annual consumption Consumption per capita (RHS)(mn litres) (litres)

Source: Wikipedia, RCML Research

Fig 67 -Per capita consumption of beer v/s Per capita GDP


Fig 68 -Tax on Beer as a % of retail price46.5 45.0

40.0

22.018.4

11.0 8.8 8.0 6.6 4.0

0

10

20

30

40

50

Japan

India

Nepal

Global

Average

South

Africa

Italy

France

China

Germany

Russia

(%)


Beer highly taxed vis-a-vis spirits; hence priced outGlobally, beer is taxed at a 50% lower rate than spirits (on a pure alcohol basis), so as toencourage consumption of beer given its lower alcohol content. However, India has nosuch differential tax structure. On the contrary, beer taxation is higher than that onspirits (on a pure alcohol basis), with ~60% differential in certain states. We believegrowth in the beer market could reach inflection point if taxation and consequentlyaffordability issues are addressed. As the country adjusts to the concept of socialdrinking, people might prefer lower alcohol products such as wine and beer.

Indias annual beer consumption low at

1.3 litres per capita

Owing to high taxes, beer gets priced

out due to much lower kick per rupee


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Fig 69 -Relative price* of alcoholic beveragesBEER WINE SPIRITS

500 ml 750 ml 750 ml

Brazil 1.51 5.35 9.42

Canada 0.37 1.62 5.75

Mexico 1.47 8.11 22.36

France 0.28 0.95 4.9

Germany 0.32 1.19 2.15

Russian Federation 2.41 12.05 14.45

United Kingdom 1.0 2.12 7.27

India 11.0 53.0 29.0

Australia 0.64 2.8 7.01

Iceland 0.76 5.32 9.97

Republic of Korea 1.61 2.03 45.52

United States 0.21 0.85 1.82

China 6.63 26.52 26.52Spain 0.41 0.46 5.53

World median 3.5 8.7 13.2

Source: WHO, RCML Research | *Derived as a ratio of the price of alcoholic beverages to per capita GDP of the country*10,000

Distribution regulations on par for beer and spirits; deregulation a possibility

Another impediment to growth of the beer industry has been regulated distribution, withlicence requirements being the same as that for spirits. Overall, alcoholic beverages inIndia sell through ~65,000 licenced outlets. Globally, wine and beer are usually freefrom distribution regulation and hence available even in supermarkets. We see apossibility of beer being de-linked from spirits over a period of time in India, resulting inimproved availability. For instance, the state of Maharashtra has introduced separate

licences to sell wine and beer which are available at much lower licence fees.

Indian beer industry now at ~200mn cases; 12% CAGR over last 5 years

The domestic beer market has grown in line with the spirits segment despite the relativeunder-consumption due to the factors mentioned above. However, over the nextdecade, we believe beer will outgrow the spirits market.

Fig 70 -Indian beer market

91

181.4

0

20

40

60

80

100

120

140

160

180

200

FY05 FY10

(Rs bn)

CAGR: 14.8%

Source: Company

Indias beer industry has grown in line

with the spirits market so far


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Strong beer dominant and growing much faster

Strong beer (7.5% alcohol content vs 4.5% for lager) remains the dominant form of beerconsumption in India and is growing ahead of the lager market. Lager (mild) beer, infact, registered a decline over FY08-FY10, returning to positive growth only in FY11.This is primarily due to taste preferences for heavier bodied strong beer comparedto lager.

UBBL has improved its market share in the strong beer segment over the years whereSAB Miller was traditionally the stronger player. In the mild segment, the company haslost some market share to top-end foreign players such as Carslberg and Heineken.

Fig 71 -Indian beer market segmentation

0

10

20

30

40

50

60

70

80

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Current

Mild S trong(%)

Source: Company

Fig 72 -UBBLs beer portfolio

30

80

70

20

0

20

40

60

80

100

Current 10 years back

Lager Strong(%)


Fig 73 -UBBLs market share within beer segments

70 71 66 65

35 39 3845

0

20

40

60

80

100

FY05 FY06 FY07 Current

Mild Beer S trong Beer(%)


UBBL the clear market leader in Indian beers with ~51% share...

UBBL is a strong leader in the overall beer market in both volume and value terms. Inthe case of individual brands, the gap is even higher with Kingfisherbeing a very strongbrand versus nearest competitor Haywards.

Strong beer now 70% of the total beer

market versus ~50% five years ago

UBBL has ~47% volume and ~51%

value share in Indian beer market


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Fig 74 -Sales volume and volume market share of beer companies in FY10Company

Volume (mnhecto litres)

Vol. Marketshare (%)

Brands

UBBL 6.747.3

Kingfisher, Zingaro, SandPiper, UB Export,London Pilsner, Kalyani Black Label, Turbo,Guru, Charger, Bullet, Marco Polo,

SABMiller 428.3

Haywards, Knock Out, Royal challenge, Foster's

Mohan Meakin 0.85.7

Golden Eagle, Black Knight

Mount Shivalik 0.453.2

Cobra, Thunderbolt

Carlsberg India 0.42.8

Carlsberg, Tuborg, Palone

Leelasons 0.211.5

Khajuraho

Anheuser-Busch Invev

0.181.3

Budweiser, Armstrong

Other 1.4110.0

Total 14.15 100

Source: IWSR

Fig 75 -All-India value market share (%)

Others

24%S ABMiller

25%

UBBL

51%


Fig 76 -All-India market share of beer brandsOthers

50%

Haywards

13%Kingfisher

37%


...and still growing ahead of market and improving market shareUBBL has improved its overall market share and also increased its lead over the No. 2player over the last five yearsa notable achievement given the rising competitiveintensity in the sector with the entry of top foreign brands such as Carslberg, Heinekenand Budweiser.

Fig 77 -Movement of value market share

46 48 50 4751

31 3132 33 25

6 55

4

17 16 13 13

620

0

10

20

30

40

50

60

70

80

90100

FY04 FY05 FY06 FY07 Current

UBBL SABMille r Mohan Meakin Other(%)

Source: Company, RCML Research

Higher A&P spends instrumental in

helping UBBL beat back competition


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Market share lead a key competitive advantage

We believe UBBLs improved market share in the last few years and the recentintroduction ofHeineken under its portfolio will help the company reap the benefits of astrong and profitable market. The company has invested significantly in A&P (A&P/Salesratio up 600bps in the last five years), which has paid off handsomely by way ofincreasing its lead over peers in terms of brand equity and recall.

Strong portfolio straddling the price pyramid to help, especially at top end

UBBL has a strong portfolio of brands straddling the price pyramid and the company isworking further to address all the segments of the beer market. At the lower end, UBBLhas brands through its joint venture, Millenium Alcobev (which is in the process ofbeing merged with the company post-acquisition). In the mid-end, it has Kingfisherwhich enjoys strong brand equity. UBBL is looking at further market segmentation viathe launch of variants such as Kingfisher Blue at a 1015% premium (~1% higheralcohol content), Kingfisher Ultra at ~50% price premium (~0.5% lower alcoholcontent), and Kingfisher Redan all-season variant. We believe these are interestingmoves, especially Kingfisher Ultra in the premium segment.

Now with Heineken N.V. holding 37.5% in UBBL (following the acquisition of Scottish

& Newcastle which had the same stake), Heineken brands, which currently have a 2%market share in India, will be sold in the country through UBBL. This is a key positive asit helps the company fill the void at the top end of the beer market. Heineken will bemanufactured in India starting April 11 and re-launched aggressively to compete at thetop end.

Overall, we expect 23% topline CAGR over FY10-FY13We expect UBBL to maintain its topline growth trajectory with volume g

Documents

Alcohol Sector Report