Expansion, product mix to fizz up Varun Beverages' volumes and margins

Energy drink Sting help drive realisations of Pepsi bottler in Q3CY22

The stock of Varun Beverages was up 13.6 per cent over the past three trading sessions on better-than-expected July-September quarter (third quarter, or Q3) performance in calendar year 2022 (CY22) and strong outlook.

Given the strong showing, brokerages increased their earnings estimates for the PepsiCo franchisee by 6-11 per cent for CY22 and 2023 (CY23).

Expansion of capacity, increased distribution, and rising levels of refrigeration in smaller towns are expected to help the company maintain the growth and earnings momentum.    

The immediate trigger is the sharp outperformance in Q3CY22. Aided by strong volume and growth in realisations, the Pepsi bottler posted a 32 per cent increase in revenue on a lower base of the year-ago period. The gains on the sales front primarily came from a 24 per cent increase in overall volumes to 190 million cases.

While volumes in India saw a 22 per cent increase, international volumes rose 31 per cent.

Realisations per case, too, saw 7 per cent increase, led by price hikes and better product mix. The company indicated that the increased realisations were on account of a higher mix of smaller packs, especially of energy drink Sting. The realisations of the product are 65 per cent higher than the rest of the portfolio.

The share of Sting in the volume mix has been on an uptrend, gaining from 5 per cent in 2021 (CY21) to 8.5 per cent for the nine months ended September CY22.

Sting accounted for 12 per cent of India’s market volumes in Q3CY22. The company expects volumes to grow in double digits, led by expansion of its distribution network and higher sales per outlet.

While revenues were higher, the operating profit, too, was 15 per cent above what the Street was working with.

Notwithstanding increase in raw material costs (polyethylene terephthalate bottles due to higher crude oil prices), gross margins improved 90 basis points (bps) to 53.7 per cent, while margin expansion at the operating level was 140 bps to 22 per cent. This was aided by higher realisations and improved leverage.

Analysts Devanshu Bansal and Jigisha Kapoor of Emkay Research expect normalisation of raw material costs to drive operating profit margins of the company. The brokerage has a ‘buy’ call on the company and expects a higher mix of brownfield capital expenditure to drive its return on invested capital (RoIC) to 26 per cent by 2024 (CY24). 

“Potential share gains, best-in-class efficiencies, and improvement in the RoIC profile keep us positive,” says the brokerage.

At the current price, the stock, which has gained 20 per cent since mid-October, is trading at over 43 times its CY23 earnings estimates. Investors can consider it on dips.