Analysts remain bearish on liquor companies despite Q1 volume gains

Raw material pressures and lack of pricing power key reasons for this view

The June quarter performance of alcoholic beverage makers was a mixed bag, with revenues above expectations while margin performance was sub-par. On a low base, the combined revenue growth of United Breweries, Radico Khaitan and United Spirits--three of the largest listed players in this sector--was 61 per cent.

Higher sales were driven by strong volumes. Growth on this front was led by United Breweries, which reported a 121 per cent uptick over the year-ago quarter, followed by United Spirits (up 25 per cent) and Radico Khaitan’s 14 per cent.

Citing the reasons for the volume offtake, Nirmal Bang Research says there was strong consumer demand in off-trade channels (shops, supermarkets) while recovery was seen in the on-trade channel (hotels, bars, restaurants).
 

UBL’s volume growth, according to Vishal Punmiya of the brokerage, was far ahead of the estimate due to record volumes in the summer season, leading to full recovery. United Spirits’ volume delivery was short of expectations, impacted to some extent by constraints in scotch supplies. Lower excise rates compared to base quarter supported revenue growth in Q1FY23. For Radico, the volume surge was led by robust gains of 29 per cent YoY in prestige and above (P&A) category and 9.3 per cent YoY growth in the regular category. The share of the P&A category by value in the Indian Made Foreign Liquor business rose to 50 per cent from 47 per cent a year ago. This indicates a focus on premiumisation, says Kotak Securities.

However, on a three-year average revenue growth trend basis, the larger companies have posted a growth of 2.6 per cent which lags behind discretionary sector peers such as paints and quick service restaurant peers. According to Ronak Soni of Equirus Research, in addition to the pandemic, the sector faced multiple disruptions in the form of constant excise duty hikes across states, changes in route-to-market in some states, highway ban among others.

While volume growth in Q1 was strong and there are structural growth drivers such as low per capita consumption, the addition of over 15 million potential consumers annually above the drinking age and premiumisation, the sector faces profitability challenges that could offset the volume/price increase benefits.

Gross margins of liquor majors United Breweries and Radico Khaitan fell by about 400 basis points while that of United Spirits was down by 110 basis points YoY due to a sharp rise in input costs. On a three-year basis, gross margin compression has been in the 400-640 basis point range for the three firms. Both on the sales growth and gross margin fronts, when compared to the pre-Covid period, Radico fared the best among the listed majors.

While the management of United Spirits expects double-digit inflation in the near term, United Breweries highlighted that price hikes have been taken in the June quarter and there is limited scope to take further hikes.

High competitive intensity, inflation in glass, extra neutral alcohol (raw material for making alcoholic beverages) and low pricing power remain concerns, say Abneesh Roy and Anurag Lodha of Edelweiss Research.

Margins are expected to remain muted for the September quarter before witnessing an uptick in the second half of the current financial year. The rising costs and pricing pressure have led to a cut in earnings estimates by most analysts and is likely to weigh on earnings growth going ahead. Analysts led by Krishnan Sambamoorthy of Motilal Oswal Research believe that even in a strong demand environment rising commodity cost pressures and lack of free pricing in a majority of states is likely to negatively affect the pace of earnings growth for the alcoholic beverage makers.  

Brokerages have a bearish stance on the sector and recommend a sell or reduce rating in most cases while it is a hold in other cases. Barring Radico Khaitan which is up 31 per cent over the past three months, the stock performance has been muted for United Breweries (up 10 per cent), and United Spirits (flat) over this period. Investors should await improvement in margin trajectory before considering the stocks in this sector.