W&M sale will boost United Spirits financials

It will not only reduce debt and improve working capital, but also provide money to fund future growth

United Spirits-Diageo deal hits yet another hurdle after the UK Fair Trade regulator raised concerns stating that the deal could result in lower competition in the UK market where the United Spirits’ wholly-owned subsidiary, Whyte & Mackay (W&M), operates. While Diageo (to address this issue) has offered to sell Whyte and Mackay (which came into its fold after the acquisition of United Spirits) which should help ease the UK regulator’s concern, the Street was nervous.

United Spirits Ltd’s (USL) shares fell 8.4 per cent in intra-day trade on Tuesday before closing with a loss of 1.52 per cent at Rs 2,581. However, contrary to the Street’s concerns, analysts do not think this as a big drag as many of them believe that this was known and Diageo was well prepared to deal with this. In fact, they say any move to sell W&M will be positive for USL.

“We see this as positive development which will sharply reduce debt and lead to significant interest cost savings. Also, this will improve working capital. The fund infusion will help bolster the capex plans (of USL),” said Abneesh Roy of Edelweiss Securities.

  In 2007, when USL bought W&M, it had led to additional borrowings for the former, which is one of the reasons that USL today has so much debt in its book. It has retired some debt out of the proceeds from preferential allotment of the shares to Diageo, but it still has a net consolidated debt of Rs 7,170 crore (of this Rs 3,455 crore is in standalone balance sheet). In Q2FY14, it incurred interest cost of Rs 136.4 crore, which was almost 47 per cent of its standalone profit before interest, depreciation and tax.

The market estimates that the sale of W&M could fetch about $1-1.5 billion, which at the current exchange rate is equivalent of Rs 6,244-9,366 crore. “If we assume that W&M assets are disposed of at a value close to the purchase price, USL would be nearly debt free. While impact on FY15 earnings estimates would indeed be small, reduced leverage and resultant lower finance costs would improve earnings visibility,” said Nillai Shah, who tracks the company at Morgan Stanley.

Assuming the entire money is used for the repayment of debt, the company will save interest cost of about Rs 740 crore (FY14 estimates), which is twice the amount of profits that the Street is expecting the company to earn in the current year. But, the benefits will largely reflect from FY15. Even after taking the impact of tax, this would still mean a 30-40 per cent positive impact on USL’s FY15 earnings.

Meanwhile, with Diageo coming on USL’s board and given the change in management, the Street is expecting that the company will benefit because of the common synergies, strength of balance sheet, and better governance.

Additionally, Diageo, because of its global practices, could add more in terms of efficient management of capital and operating performance driving improvement in the return ratios. The Street is expecting the return on equity to rise from 5.6 per cent in FY14 to 10.7 per cent in FY15. However, this does not include the benefit from the likely debt reduction which could take place in case W&M is successfully divested at a reasonable price. The latter too looks possible.

Roy says, “It is important to note that Scotch prices are up 60 per cent since USL acquired W&M, however, the investors’ appetite for such a large deal will also be a key factor.”