United Spirits stock is back on investors' radar; gains 13% in last two months

After months of consolidation, investor interest in United Spirits has been increasing. The United Spirits (USL) stock, which was the darling of the Street in late 2012 and 2013, lost steam in the first half of 2014 as it delayed the announcement of financial results a couple of times, raising concerns over its accounting of items related to debtors and a loan given to its promoter, UB Group.

But with those concerns behind and some growth drivers ahead, the stock is back on the investor radar, gaining 13% in the last two months, despite modest numbers in the past two quarter results.

“This is not a story of 1-2 quarters, but a multi-year growth story. The synergy that will be created from Diageo’s global portfolio and United Spirits Indian business has a huge potential. With Diageo taking the majority control and bulk of the balance sheet clean-up behind, the underlying earnings growth story should commence,” said Gautum Duggad, senior analyst with Motilal Oswal.

This may make sense if one has to look at the way India’s largest cigarette company ITC has created value for its shareholders. ITC’s market capitalisation has grown from Rs 30,000 crore to Rs 3 lakh crore in the last 10 years.

United Spirits, the world’s thirdlargest spirits company and the country’s largest, has a market capitalisation of Rs 39,500 crore. Mcaps of other MNC consumer companies such as Nestle, Colgate and GSK Consumer have risen over 10-fold in the last 10 years.

India’s favourable demographics, lower per capita consumption (0.9 litre per annum), increasing social acceptance of drinking and rising consumption of Indian manufactured foreign liquor (IMFL) among women are the key long-term growth drivers. With a more than 40% market share in a high growth industry characterised by a plethora of entry barriers, USL is in a very unique position.

With Diageo taking over, there are expectations that USL would undergo a transformation in a phased manner over the next few years which, in turn, could have a knock-on impact on USL’s profits through various restructuring and deleveraging plans. The new promoter has already begun the portfolio premiumisation agenda and expects brands to grow in mid- to high-teens. The MNC intends to drive value growth even if it comes at the cost of volumes.

Its peer Pernod Ricard’s numbers generate confidence. Diageo has indicated the possibility of margins of up to 20%. Recently, Diageo proposed manufacturing and distributing of its brands Bailey’s, VAT69, Smirnoff, Johnnie Walker, Captain Morgan and a few more.

Diageo has come out with two open offers in past years. With higher margins, lower working capital and lower debt, USL’s return ratios and earnings are likely to grow at a CAGR of 50% from FY15 to FY17. According to analysts, the company is likely to post a profit of Rs 450 crore in FY15 and Rs 1,050 crore in FY17. Assuming this, the stock is trading at FY17E earnings multiple of 37, which is not very expensive, given the kind of spot it is in. On Friday, the company's stock closed at Rs 2,765.