Higher costs, lower volumes may sober up near-term cheer in USL

Ongoing strategic review to help improve volume, profitability in the long term

The stock of the country’s largest alcoholic beverage maker United Spirits (USL) was up 1.7 per cent in trade after the company indicated that the ongoing strategic review of its popular segment of brands will be completed by March 2022. The review of the popular segment, which is the entry-level and lower-priced brands of USL, was to be completed by December this year.

The review may lead to higher proportion of franchising, divestment or increased investments in a few of the 30 brands in the popular segment. The other categories based on pricing are prestige, premium, and luxury.

Since 2016-17, the company has been franchising (manufacture and distribution) some of its popular range of brands. This has helped it to concentrate on core or focus brands, while reducing the need for higher working capital. The strategic review is being undertaken with the aim of delivering sustainable long-term profitable growth.

One move as a part of this strategy has been to improve the share of prestige and beyond (higher margin), which is yielding results, given its share to the overall sales has improved from 27 per cent by volume in 2013-14 to around half now. Similarly, the share in value terms has increased from 43 per cent to over 65 per cent now.

While the Street will await the outcome of the review, the stock may not see much upward movement, given the pressures on raw material cost and expensive valuations.

Higher prices of extra neutral alcohol, inflation in glass prices, fuel, among others, are expected to exert pressure on margins, even as volumes are expected to be hit due to restrictions imposed by state governments.

In addition, any rise in excise duties by state governments could adversely impact volumes on the go.

While the strategic review could lead to improved sales and margins, brokerages believe the valuations - after a 40 per cent increase in prices since the beginning of August - are factoring in the positives. At the current price, the stock is trading at 58x its 2022-23 earnings estimates. Investors should await details of the strategic review and margin trajectory before considering the stock.

Analysts at Motilal Oswal Financial Services had downgraded the stock last month to 'neutral' due to headwinds (raw material costs, possible excise duty hikes) and higher valuations.