GST, not highways' sales ban, a concern for liquor stocks

United Spirits and Radico Khaitan could see margin erosion under GST, estimate analysts

The Supreme Court (SC) on Friday gave its nod to implement the ban on liquor sales within a 500-metre radius of national/state highways with effect from April 1. Although the SC gave some relief by reducing the distance to 220 metres for areas with a population of up to 20,000, this ban will impact the performance of spirit makers — United Spirits and Radico Khaitan, among others, believe analysts. "Our industry checks suggest the Supreme Court ban on liquor outlets near highways announced in January has affected about 30-40% of outlets," said Avi Mehta, analyst at India Infoline. Retailers have already started de-stocking their inventories in anticipation of this ban. However, analysts believe the impact is likely to be more short-term in nature.

Implementation of such a ban by the state governments will be crucial and a key monitorable. Most analysts believe the store owners will relocate near highways (slightly beyond the specified 500 m) in order to comply with the ban and thereby mitigate the impact. Consumers can still buy alcohol at stores located away from the highways and stock them during their journey, say analysts. Thus, the impact of the ban on alcohol companies will be transient in nature and likely to fade in a quarter or two. Though the liquor companies don’t share the percentage of revenues earned from outlets located on/near highways, anecdotal evidence suggests local/unbranded liquor's share of alcohol sales on these highways is on the higher side.

A bigger worry for alcohol companies, though, comes from the implementation of the goods and services tax or GST. These products are kept out of GST as they contribute significantly to the states’ revenue. Thus, while the inputs these companies use such as glass, ethanol, etc. will be covered under GST, these companies would continue to be taxed in the current form. This means they will no longer be able to avail input credit as they will be under a separate tax system. Analysts believe this will hit these companies’ earnings before interest, tax, depreciation and amortization (Ebitda) margins by 100-150 basis points. Companies are seeking price hikes from the state governments to pass on some of this pressure. If this happens, it will be a key positive for alcohol companies and their stock price.

Also, since liquor will be a state subject, there is a possibility of states raising tax on alcohol, which could then impact the companies’ profitability. Already, quarterly sales growth and profitability has been volatile for United Spirits in the first three quarters of 2016-17. For Radico Khaitan, while sales have grown at a brisk pace, the December quarter saw profits fall 22% year-on-year after growing over 25% in first half of FY17. 

Most analysts are cautious on these stocks and are awaiting clarity. Stock valuations, too, are not cheap. At the current levels, United Spirits trades at 67 times FY18 estimated earnings versus its  historical average one-year forward price to earnings ratio of 62 times; while Radico Khaitan trades at 18 times versus its average valuations of 15 times.