Varun Beverages Rating: Buy; poised for strong growth in earnings

VBL is witnessing steady recovery in volumes led by revival in on-the-go consumption. Normalisation of volumes, market share gain opportunity in South and West territories, stable RM environment, sustained cost savings and financial leverage benefits augur well for strong earnings growth over the next couple of years. We raise CY2019-21e volume CAGR to 6% from 3.6% earlier and increase CY2021/22e EPS by 10-11%. We like VBL’s execution prowess, market share gain and margin expansion opportunity. Maintain Buy; FV Rs 1,000 (from Rs 850).

Normalisation of volumes + operating/ financial leverage to drive 30% EPS CAGR (CY2019-22e)
We note that VBL reported 96% recovery in volumes in Q3CY20 (double-digit growth in the exit month) as rise in in-home consumption largely offset lower on-the-go consumption. Volume recovery continues and we expect 6% CAGR in volumes (like-for-like/organic) over CY2019-21E as against 3.6% earlier. We estimate 30% EPS CAGR over CY2019-22e led by:

Recovery in underlying demand and market share gains: Pepsi is under-indexed with 25% volume share in South and West (SW; territories acquired by VBL in May-19) versus 38% share in North and East. Further, Pepsi’s volumes in SW markets had declined to about 140 mn cases (CY2019) from a peak of 210 mn cases (CY2015/16). VBL eyes doubling of distribution in SW over the next 2-3 years and is augmenting workforce; efforts have resumed after a pause due to the pandemic. VBL is also confident of sustaining robust growth in international markets.

Stable/benign RM environment and cost savings to drive margin expansion: Lower crude price reduces VBL’s packaging cost (33% of RM costs and 15% of revenues) and aids GM expansion. Additionally, VBL has tightened slack in the cost structure. We expect 110 bps expansion in Ebitda margin to 21.4% (over CY2019-21e) led by improvement of profitability of the acquired territories (SW) and sustainable cost savings.

Financial leverage to drive higher earnings growth: VBL has adequate capacity and growth capex would be negligible until end of CY2022e. This, along with strong OCF, would result in reduction in net debt to Rs 12 bn in CY2022e from Rs 32.5/28 bn as at CY2019/20e.

CY2021/22 EPS estimates up 10-11%

We raise CY2021e/22e volumes to 617/669 mn cases from 590/640 mn cases and tweak margin assumptions. We raise our DCF-based FV to Rs 1,000/ share (from Rs 850), implying 27X March-23E PE and 13.5X EV/Ebitda (broadly unchanged).