United Breweries not in high spirits due to increase in input costs

Inflationary environment also poses a risk to consumption and volume growth

The stock of India’s largest beer maker -- United Breweries (UBL) -- has shed over 8 per cent over the last week on a muted December quarter performance for the 2022-23 financial year (Q3FY23). This, coupled with worries on account of volumes as well as near-term profitability weighed on investor sentiment.

While the beer major’s sales in the quarter saw a growth of 2 per cent year-on-year (YoY), it was down 4 per cent on a sequential basis. The growth over Q3FY22 was led by a 4 per cent volume increase which was partly negated by a weak product mix. Volume growth, however, would have been in high single digits had it not been for the change in the route-to-market in Tamil Nadu (TN).

The bigger disappointment for UBL was on the margin front. Gross margins fell a steep 810 basis points (bps) YoY to 41.7 per cent. Consistently high packaging costs, coupled with a 40-45 per cent jump -- both on a YoY and sequential basis in barley costs -- led to the sharp miss on the gross margin front.

Margin fall at the operating level was limited to 623 bps YoY (829 bps on a sequential basis) to 4.8 per cent, given lower other expenses and employee costs.

Commenting on the operating profit margin performance, Krishnan Sambamoorthy and Aditya Kasat of Motilal Oswal Research say that margin performance in Q3FY23 was the lowest in any quarter not affected by Covid-19 since Q2FY14. Operating profit margins were dragged down by steep material costs, the impact of weak state mix, route to market change in TN and the impact of a change in excise policy in Delhi, they add.

UBL has indicated that price hikes have been taken in multiple states and that the company continues to pursue further hikes in prices to mitigate gross margin erosion. Gross margin pressures could continue for a couple of quarters more, until the new barley harvest will start arriving from April and will be consumed in June/July. Glass bottle prices too have seen an uptick of 10-15 per cent and pricing pressure on this account will continue as supply is lagging behind demand.

The other worry is on the volume growth front. Elara Securities expects volumes to grow at 7.2 per cent as there is a low likelihood of UBL outperforming average industry growth unlike in the past. In addition to distribution related issues in TN, high competitive intensity in the premium beer segment, which is UBL’s core focus, and overall demand environment for beer as a category due to inflationary headwinds could translate to lower on-premise consumption.

UBL does not have a strong recall in the premium beer segment, which is the fastest-growing category amid high raw material pressure, believe Karan Taurani and Rounak Ray of the brokerage. 

Most brokerages have cut their earnings estimates by14-22 per cent over the next two years to factor in the persistent raw material inflation. How demand pans out in the coming quarters, especially in the June quarter, will be critical as it accounts for over a third of the annual operating profit.

Despite the 18 per cent fall in stock price from its 3-month high in December, brokerages believe it is yet to factor in the headwinds.