A sobering reality for alcobev makers despite spirited volume gains

Raw material pressures, lack of pricing power key worries for Street despite spirited volume gains

The April-June quarter (first quarter, or Q1) of 2022-23 (FY23) performance of the alcoholic beverage (alcobev) sector was a mixed one - revenues came above expectations, margin performance was subpar. 

On a low base, the combined revenue growth of the three large listed players —  United Breweries (UBL), Radico Khaitan (Radico), and United Spirits (USL) — was 61 per cent.
 

Higher sales were driven by strong volumes. Growth was led by UBL, which reported a 121 per cent uptick over the year-ago quarter, followed by USL (up 25 per cent) and Radico Khaitan (14 per cent).
 

Assigning reasons for offtake in volume, Nirmal Bang Research says there was strong consumer demand in off-trade channels (shops, supermarkets). The on-trade channel (hotels, bars, restaurants) saw stirrings of recovery.
 

UBL’s volume growth, according to research analyst Vishal Punmiya of the brokerage, was ahead of estimates due to record volume in the summer season, leading to full recovery. 
 

USL’s volume delivery fell short of expectations, impacted somewhat by constraints in scotch whisky supplies. Lower excise rates, compared to the base quarter, supported revenue growth in Q1FY23. 

For Radico, gains in volume were 29 per cent year-on-year (YoY) in the prestige-and-above (P&A) category and 9.3 per cent YoY growth in the regular one. The share of the P&A category in value terms in the India-Made Foreign Liquor business increased to 50 per cent, compared with 47 per cent a year ago. This signals a focus on premiumisation, says Kotak Securities.
 

However, on a three-year average revenue growth trend basis, larger companies posted a growth of 2.6 per cent. This lagged behind discretionary sector peers, such as paint makers and quick service restaurants.

In addition to the pandemic, the alcobev sector, according to research analyst Ronak Soni of Equirus Research, faced multiple disruptions in the form of constant excise duty hikes across states, changes in route-to-market in some states, and a ban on selling liquor on highways, among others.

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

Gross margins of USL and Radico Khaitan fell by about 354-366 basis points (bps), while those of UBL were down 406 bps YoY due to sharp rise in input costs. 
 

On a three-year basis, the gross margin compression has been in the 400-640-bp range for the three companies. Radico fared the best among listed majors on sales growth and gross margins, compared to the pre-Covid period.
 

While the management of USL expects double-digit inflation in the near term, UBL highlighted that price increases have been taken in Q1 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 big worries, say research analysts Abneesh Roy and Anurag Lodha of Edelweiss Research.
 

Margins are expected to remain subdued for the July-September quarter before witnessing an uptick in the second half of the current financial year (FY23). Rising costs and pricing pressure have led to a cut in the earnings estimates by most analysts, and are likely to weigh on earnings growth. 
 

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 are likely to negatively affect the pace of earnings growth for alcobev makers. Brokerages have a bearish stance on the sector and recommend a ‘sell’ or ‘reduce’ rating in most cases; it is a ‘hold’ in the rest. 
 

Except for Radico, which is up 31 per cent over the past three months, the stock performance has been lukewarm for UBL (up 10 per cent) and USL (flat) over this period. 
 

Investors should await improvement in the margin trajectory before considering the stocks in this sector.