A strong blend

SPECIAL REPORT

United Spirits and Tata Tea get a high on the bourses, but for bang opposite actions.

Be it water or whisky, it is party time on the bourses for companies which make drinks. While the United Spirits stock has gained 28.38 per cent after gulping down international scotch whisky maker Whyte and Mackay, Tata Tea is getting a thumbs up for selling off its stake in Glacéau to Coke making a quick buck.

Soon after United Spirits announced the acquisition of W&M on May 16, leading foreign broking house CLSA recommended a 'buy' on the stock with a target price of Rs 1,185.

Citigroup and SSKI are even more optimistic with a target price of Rs 1,250 and Rs 1,400, respectively.

And as for Tata Tea, the stock has gained over 18 per cent over the past one month probably because the market got a whiff of Tata Tea's opportunistic move to sell its stake in Glacéau to make a quick buck. And the party on the bourses is likely to continue if analysts are to believed.

High spirits
Home-grown United Spirits acquired Scotland-based whisky maker Whyte and Mackay (W&M) last week propelling itself to the number two spot after Diageo.

After intense negotiations for nearly one year, United Spirits agreed to pay £595 million (approximately Rs 4,797 crore), roughly 50 per cent higher than what it offered when talks began.

W&M is the world's fourth largest scotch manufacturer with sales of nine million cases over the past year, earning an estimated £160 million (Rs 1,290 crore). It has a strong brand portfolio including Whyte and Mackay, Isle of Jura, Dalmore and Vladivar.

W&M produces its scotch at its four malt distilleries in Scotland which have a capacity of 12 million litres.

Besides, the acquisition also bestows United Spirits with the world's largest grain distillery with a capacity of 40 million litres, a bottling unit, and a bulk scotch inventory of 115 million litres. This inventory alone is estimated to be worth £380 million (Rs 3,064 crore).

Globally, consumption of branded liquor, especially scotch whisky, is increasing, which is reflected in the prices too. While the demand for scotch whisky rose by around 10 per cent globally, the rise in demand from emerging markets like China, India and Russia has been more than 20 per cent over the past 12 months.

And as more people are drinking scotch, prices have increased around 75-120 per cent over the past one year. "The hike in the price offered for W&M from £400 million to £595 million hints toward the rise in whisky prices, considering the value of scotch inventory of W&M," says Rohan Gupta of Emkay Shares and Stock Brokers.

Last year, whisky sales in the country crossed 75 million cases, clocking a growth of over 20 per cent.

Going forward, the demand for scotch whisky is likely to grow around 35-40 per cent per annum, considering that imports of scotch into the country have been growing at thrice the rate of growth of locally made whisky.

Currently, United Spirits sources scotch from players like Diageo and W&M to blend with its domestic whisky in order to make premium whisky. Last year, it sourced about 18 million litres of bulk scotch mainly from Diageo and Pernod Ricard.

With the acquisition of W&M, the company is assured of steady supply of bulk scotch which may have been difficult otherwise considering the shortage of scotch. United Spirits now plans to look beyond India and enter other fast growing markets, especially China where scotch consumption grew by 115 per cent. Initially, United Spirits plans to launch five of its alcohol brands in China.

The company also has a joint venture with liquor-maker Russian Standard to distribute and sell its liquor brands in the Russian markets. Back home, United Spirits dominates the market with a 60 per cent share. The company recently acquired French winemaker Bouvet Ladubay for $16 million (about Rs 65 crore). 
 

IN HIGH SPIRITS
Rs crore	FY07	FY08E
Revenues	2711.90	3525.50
Operating profit	491.40	634.60
Net profit	497.50	317.30
EPS (Rs)	52.60	33.50
P/E(x)	22.00	34.40
Note: FY07 net profit includes a non-recurring income of Rs 265.7 crore

Valued at a shade less than 4 times its FY06 revenues, and 12 times EV/EBITDA (enterprise value/earnings before interest, taxes, depreciation and amortisation), the W&M acquisition is viewed as a good deal by most analysts.

The deal is financed entirely through debt. United Spirits has raised £325 million from ICICI Bank (without recourse to United Spirits' balance sheet) and £310 million from Citibank at an average cost of Libor plus 220 basis points.

Although the deal appears debt-heavy, with a debt-equity ratio of approximately 3.4, analysts feel that the company would be in an position to service the debt.

The company holds 10.3 million treasury shares effectively (post-group restructuring) and this could raise about £150 million. If this money is used to retire debt, the debt burden could reduce by 20 per cent and this could bolster earnings by 3 per cent by next fiscal, according to estimates by CLSA.

Further the company's existing scotch inventory ensures its earnings for the coming four-five years. Going forward, the company plans to list W&M on the British bourses.

At Rs 1149, United Spirits' stock is valued at 22 times its FY07 earning and about 34 times estimated FY08 earning (See table: In high spirits). According to analysts, there is still plenty of upside potential in the stock, considering the strategic fit of W&M with United Spirits.

"The stock has recently seen a run up of approximately 25 per cent post the deal closure, which captures the near term favourable impact from this acquisition," says Gupta of Emkay.

"However, given the robust growth expected in the liquor industry and aggressive management, the stock looks attractive," he adds. Despite the surge in price recently, the stock is worth accumulating for the long term.

A steamy brew
Within ten months of acquiring a 30 per cent stake in Glacéau, Tata Tea has sold off its holding to Coke for a consideration of $1.2 billion thus making a pre-tax gain of $523 million (approximately Rs 2,108 crore). Tata Tea acquired 25 per cent in Glacéau for $677 million in August 2006.

The net impact of the deal, which will take effect in November, is not clear because of the potential tax implications. Even though the Glacéau acquisition entailed Tata Tea an entry into fast growing water and energy beverages market with Glacéau's strong brands, the stock market gave it a thumbs down due to the financial implications of the deal.

Ever since rumours of Coke's plan to buy out Glacéau spread, the Tata Tea stock has been rising steadily, gaining over 18 per cent over the past one month to hit the 52-week high of Rs 941.25, demonstrating the predominant market view that Tata Tea would only stress its financials further in the event of an inevitable bidding war with Coke if it did not forgo its stake in Glacéau.

Tata Tea is currently valued at 10 times its estimated FY07 earnings. Analysts see a significant upside from this level with some pegging their 12-18 month target price at Rs 1,200. While the deal has the potential to transform Tata Tea into a debt-free company with cash surplus, it would strive to re-enter the health drinks market to bolster growth and reduce dependence on tea.

The group is also believed to be in talks to acquire Dadi Balsara's Himalayan water brand.

Recently, the company hived-off its plantations business, thus de-risking Tata Tea from the vagaries of commodity cycles and focusing on the trading and retail branding business more.