Strong volume growth and rich valuations for Varun Beverages' stock

Varun Beverages (VBL) reported reasonable results and saw the stock sold down sharply followed by a sharp recovery. VBL reported a revenue growth of 29 per cent year-on-year (Y-o-Y) in the April-June quarter (Q2) of CY24, (the company has a January-December financial year) while volume growth was up 28 per cent Y-o-Y. This was because of domestic volume growth of 23 per cent due to higher capacity and the heat wave. But international volume was flat with a transition to zero-sugar in Zimbabwe responsible for the poor results. Realisation was flat Y-o-Y at Rs 179 per case.

Guidance is for double-digit volume growth in the domestic market going forward, while the international market (mainly Zimbabwe) would rebound to healthy volume growth from Q3CY24. Cost optimisation and operating leverage may boost earnings growth.

Revenue grew 29 per cent Y-o-Y to Rs 7,330 crore which was below expectations. Volume grew to 402 million cases, up 28 per cent. The Carbonated Soft Drinks (CSD), juices and water volumes grew 32 per cent, 39 per cent and 7 per cent, respectively to 306 million cases, 32 million cases, and 63 million cases.

The consolidated Ebitda margin expanded 70 basis points (bps) Y-o-Y to 27.7 per cent due to better gross margin (up 220 bps Y-o-Y). This improvement was driven by timely procurement and storage of PET chips, an effort to minimise sugar content, and the adoption of lighter packaging. Ebidta per case grew by 3 per cent Y-o-Y to Rs 49.6. The Ebitda stood at Rs 2,000 crore, up 32 per cent Y-o-Y, again below consensus.

Adjusted PAT grew 26 per cent Y-o-Y to Rs 1,250 crore but there was higher depreciation, up 41 per cent Y-o-Y (due to an acquisition of BevCo and setting-up of new facilities), and increased finance costs, up 86 per cent Y-o-Y due to higher stocking of PET chips. Net debt as of June 2024 stood at Rs 5,880 crore versus Rs 4,730 crore in Dec’23. The Ebitda and revenues of subsidiaries grew 24 per cent and 49 per cent respectively to Rs 250 crore and Rs 1,530 crore but the adjusted PAT of subsidiaries declined 19 per cent Y-o-Y to Rs 100 crore.

VBL management expects healthy double-digit volume growth in CY24 led by double-digit domestic growth and volume recovery in the international market from July-Sep’24. The company has incurred a total capex of Rs 1,800 crore in CY24 so far, of which the company spent Rs 1,200 crore on assets to be capitalised in CY24 and Rs 600 crore on assets to be capitalised in CY25. Capex of Rs 1,000 crore is planned in the second half of CY24 for assets to be capitalised in CY25.

VBL has started commercial production of CSD and water at a greenfield facility in Congo. The country offers a big opportunity as it is a 100 million population region situated on the Equator with 12 months of heat.

The company can look at positives like increased penetration in Africa, higher acceptance of newly launched products, continued investment in capacity and distribution reach, growing refrigeration capacity and a scale-up in international operations.

The stock remains expensive in terms of valuations but the strong growth expectations have led to bullish analyst recommendations. According to Bloomberg, 14 of 15 analysts polled post results are bullish and one has a hold rating. Their average one-year target price is Rs 1,756.60 compared to Wednesday's closing price of Rs 1,577.70.