Hold Varun Beverages; target of Rs 700: ICICI Direct

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ICICI Direct's research report on Varun Beverages

Varun Beverage’s Q2CY20 results were on expected lines with 41.6% sales fall and 46.4% volume de-growth. Realisation improved 8.9% with cut down in promotions & product mix change (decline in water business was even more severe). The results were impacted by lockdown with manufacturing, supply chain operations staying disrupted in April. Though the company started production quite early in April, demand conditions were slack with significant fall in ‘on the go’ consumption. Moreover, shutting down of restaurants, cafes, multiplex (comprising ~10% of sales) also negatively impacted volumes. Volumes were down 75% in April. They slowly improved in June with 25% decline with the start of unlocking phase. Operating margins were down 500 bps to 23% with employee spends & overhead spends up (percentage of sales) by 506 bps & 207 bps, respectively, largely due to negative operating leverage. However, some of this was mitigated by 212 bps gross margin expansion. The gross margin expansion was largely due to 12.5% decline in PET chip prices & 6% decline in sugar prices (in April, May). Net profit was down 64.7% to Rs 143 crore impacted by lower operating profit. Interest cost was down from Rs 84.4 crore to Rs 74.2 crore mainly due to reduction in debt from Rs 3246 crore to Rs 2932 crore.

Outlook

Carbonated drinks, juices & water businesses are discretionary in nature with ~70% of sales contributed by ‘on the go’ consumption with single serve pack selling the most. The current disruption has significantly curtailed ‘out of home’ activity impacting growth. Moreover, being the bottler, the company does not have A&P lever to reduce the cost to protect margins. We expect a full recovery only in Q1CY21 with sales returning to CY19 levels. We value the stock at 17x CY21 EV/EBITDA with a revised target price of Rs 700/share and HOLD rating.

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