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United Spirits (UNSP IN) Summary

Core Content

United Spirits (UNSP) is a prominent player in India's consumer staples sector, currently trading at INR3,568 with a target price of INR2,734, reflecting a 23% decrease. The company has been downgraded to a "SELL" rating due to its high EV/EBITDA valuation of 33.2x and the lack of immediate catalysts for growth. Despite a strategic shift to focus on premiumisation and compliance, the company expects earnings improvements to be delayed by 1-2 years.

Main Points

• Strategic Initiatives: UNSP is implementing a five-pronged strategy to drive long-term growth, which includes premiumisation through 15 focus brands, creating consumer pull, cost rationalization, improving industry image, and building a future-ready organization.
• Premiumisation Focus: The company is targeting 10% of its 150 brands (UNSP + Diageo) to be premium, with specific brands like Royal Challenge and McDowells being rebranded and relaunched. These efforts are expected to lead to double-digit growth in key states.
• Cost Rationalization: UNSP plans to reduce costs by rationalizing high-cost legacy manufacturing sites and improving efficiency. It is also exploring innovative packaging to reduce costs and pricing.
• Debt Reduction and Interest Cost: The company has reduced interest costs from 13% to 12%, and further reductions depend on credit rating improvements and debt reduction. It plans to reduce debt through stake sales and other divestitures.
• Growth Projections: The company aims for gross margin expansion of 300-400bps over the next five years and EBITDA margins in the high teens. These targets are ambitious given the rising input costs and regulatory pricing constraints.
• Industry Outlook: The liquor industry in India is expected to grow at a double-digit rate, driven by the prestige and above segment. The company believes that the entry of multinational companies will improve compliance and premiumisation.
• Working Capital Management: UNSP is targeting a 10-day reduction in working capital, focusing on inventory and creditors. It has already improved its management of debtors compared to peers.
• Capital Expenditure and Divestitures: The company plans to invest INR4-5b annually in capex for manufacturing upgrades and is divesting inefficient assets worth INR10b. It has already spent INR2b since the management change.
• Dividend Policy: The company maintains a consistent dividend policy with a net dividend yield of 0.1% and a payout ratio that is expected to decrease over time.
• Financial Performance: Despite a strong EBITDA margin in FY16, the company has faced challenges in achieving profitability due to high debt levels and interest expenses. Pretax profit has shown improvement, but reported net profit remains negative in some periods.

Key Metrics

Share Price and Performance

• Share Price Performance: The share price has shown a 53.7% growth over the past year, but the relative performance to the index is 37.8%.
• Valuation: The current EV/EBITDA multiple is 33.2x, which is considered high, leading to the SELL recommendation.
• Catalysts: While long-term catalysts are present, the short-term outlook is bleak, leading to a 25% reduction in target price and forecasts.

Strategic and Operational Highlights

• Five-Pronged Strategy:

  1. Premiumisation: Focusing on 15 key brands to drive growth.
  2. Consumer Pull: Enhancing product marketing and innovation to create demand.
  3. Cost Rationalization: Reducing high-cost manufacturing sites and improving efficiency.
  4. Corporate Citizenship: Promoting responsible consumption and improving industry compliance.
  5. Future-Ready Organization: Building a compliant, innovative, and efficient organization with new roles and processes.

• Industry Growth: The liquor industry in India is expected to grow at a double-digit rate, with the prestige and above segment leading the growth.

• Debt and Interest: The company is working on reducing debt and interest costs, with the current interest cost at 12% and plans for further reduction post-credit rating improvement.

• Working Capital: Targeting a reduction of 10 days in working capital through inventory and creditor management.

• Investment Plan: Planning to invest INR4-5b annually in capex for manufacturing upgrades and divesting non-core assets.

Conclusion

United Spirits faces a challenging regulatory environment but is implementing strategic changes to drive long-term growth. While the company is optimistic about its future, its current high valuation and lack of short-term catalysts have led to a SELL recommendation. The management is focused on premiumisation, cost rationalization, and improving industry standards, but the path to profitability is expected to be gradual.