Varun Beverages outperforms index; territory acquisition to boost earnings

In the past five trading sessions, the stock of Varun Beverages — Indian maker of PepsiCo soft drinks — rose three per cent against a 1.4 per cent fall in the BSE FMCG (fast-moving consumer goods) index. The company recently approved the acquisition of PepsiCo India’s franchise rights in the southern and western regions. This turned investors’ sentiments positive on the stock, with expected traction in overall earnings as the deal is expected to be earnings accretive in the long term.

One of the major downsides for the business of Varun Beverages (Varun) is the seasonality factor. A major chunk of the business being from the northern region, the December quarter is the weakest season for the company and June the strongest. This is clearly visible in the December 2018 quarter (Q4) results, when the company posted net losses of Rs 70.8 crore. And, its overall volumes plunged by 41 per cent sequentially. However, volumes and net sales were up 39.4 per cent and 49 per cent, respectively, year-on-year.

The south and west have a comparatively supportive environment for the major part of the year. Thus, the development would mitigate the seasonality impact.

“The south’s and west’s seasonality is much smoother and much more stable than what it is in the North. So, after this year (CY19) our seasonality will change drastically, which is very good and healthy for the business,” said the company’s management during analysts’ call.

The south and west regions offer a large marketplace, where PepsiCo India’s market share is much lower than the company’s overall market share in other territories. Thus, there is much room for volume expansion and market share gains. 

The acquisition (including purchase of part of some states) would147 million additional unit cases, which is over 43 per cent of Varun’s total sale volumes in 2018. This gives a good picture of volume boost going ahead. Rough calculation shows that overall volumes could go up by 24 per cent annually over the next two years.

Varun’s market share in terms of selling PepsiCo India’s products would shoot up to over 80 per cent from 51 per cent earlier.

But, there could be some pressure on profits in the near term with an expected rise in debt levels and integration of facilities for the new acquisition, as the company expects the deal to be consolidated by 2019. A major part of the Rs 1,850-crore deal would be funded through debt, said the management.

The positives are in-house manufacturing of juices and likely stable raw material prices. Varun will start making Tropicana from May or April 2019 from its Pathankot plant, indicating potential cost savings.

The major improvement, however, is expected to come only next year. “The operating profit margin would remain at 18-19 per cent by 2020. But, overall earnings should see some boost in 2020 with expected volume improvement on the back of the acquisition,” says Kaustubh Pawaskar, an analyst at Sharekhan.

Overall, with its attractive valuation of 31 times 2020 estimated earnings, Varun is likely to be a good bet for long-term investors.