United Spirits Q1FY18 Concall Summary

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 GST Impact

  • The implementation of GST happened effective 1st July and this resulted in additional taxes on the input materials and services which will result in some stranded taxes that will impact margins
  • Company ensuring start off 1st of July with respect to the system and processes geared up for the GST changes which has happened
  • Company ensured that has gone smooth and the entire ecosystem for United Spirits Diageo India has been working perfectly now
  • While the GST rates are now clear has been notified and have an understanding with respect to the various input costs going up and also engaging with the various state governments to clearly understand on the ground executions of the GST's notificationwhich is the fact
  • While some of the states have upfront de-notified, some of the local taxations, company is still engaging with many state governments to understand the overall implications
  • LBT is a combination of various taxes, some of those are very highlighted – there could be entry tax, it could be OCTROI or local, state taxes which have been de-notified
  • Some of the states also expecting increasing excise components which is a combination of various moving parts
  • Various state governments are also seeking in turn clarification on many of the state specific taxes
  • Company would like to have a stability across the various taxes before opening up and giving a very specific answer on the particular state tax

 Financial Highlights

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  • With the operating model changes, the prestige and above segments now accounts for more than 60% of net revenue and in this quarter, 61% to be precise
  • Overall, input cost inflation has remained around 3% during the quarter and this has been largely mitigated by the efforts taken on productivity
  • Company generally expects an inflation of 3% to 4% on an annualized basis for this company but because it has putted together a complete productivity initiative, is in a position to actually mitigate almost like 75% of the cost implications
  • Able to get a positive price momentum happening especially in the states of Maharashtra, West Bengal, Karnataka that have called out earlier
  • Investors has witnessed a Q-o-Q moderation in interest costs which is recommendable
  • Company have been working on a capital structure for United Spirits for a 12-month period now
  • A substantial movement have been witnessed in terms of annualized improvement in the interest, interest rates between Q1 F17 and Q1 F18
  • Company’s interest rate profile has improved or interest rate has come down close to 230 bps points which is largely because have moved into commercial papers
  • Company able to renegotiate down the overall interest rate across the various banks and brought a very positive momentum in terms of the finance cost reduction
  • For prestige and above is up about 1.7% y-o-y and at the same point had significant mix worsening during the quarter because investors had called out a scotch
  • The decline was much more than the rest of the portfolio and there is a big difference in the revenue per case depending on the state because prestige and above is minus eight for the quarter and popular is also minus eight for the quarter, that's how the numbers really stack up
  • In the current quarter, company has a royalty income about Rs 25 odd Crores coming from new franchise operating model, which corresponds to an NSV of about Rs 142 Crores in the last corresponding quarter, which would mean a net impact of 117
  • For the 13 states franchised in the last whole year, company had a corresponding net sales of about Rs 640 odd Crores and would get reflected in the subsequent quarters for a setting
  • The corresponding full year volumes for F17 for the 13 states, have franchised are about 10 Million cases
  • As this year company has done 25 Crores,there are 3 dimentions- The volume impact for the full year of the last year was about 10 Million, net sales was Rs 650 odd Crores, the royalty depending upon the states and also expecting fine-tuning post of the GST, could be anything in the Rs 140 Crores to Rs 160 Crores
  • Rs 25 Crores of royalty per quarter which will basically annualize out to about Rs 100 Crores, is sitting right now in the sales line
  • The annualized royalty income could be in the range of Rs 140 Crores to Rs 160 Crore
  • There was a very small provisioning of Rs 7 Crores which is related to provisioning for receivable from one of company’s very old outstanding parties which is a part of the business as usual
  • While negotiating with the vendor for the sake of accounting prudence, company provided for it and lapping cost about Rs 6 Crores
  • To reiterate on the staff cost of Rs 13 Crores, there were some factory closures also a part in the current quarter which is largely to do with the factory closures debentures
  • Company have been investing Rs 200 Crores to Rs 300 Crores in CAPEX every year, so it should increase in the overall depreciation rate, but on a q-o-q, there would be a variation happening and overall kind of a flattish trajectory that had shown so far

Impact of Highway Ban 

  • The performance as expected was impacted by the highway ban, which has certainly created confusion and some concerned across the trade that has led to a reduction in the number of outlets, are currently open to service consumers
  • As a result, the underlying net sales declined by 7% if we separate out the impact of the operating model changes
  • Company observed shrinkage of about 30% of outlets after the highway ban came into existence and out of 30%, another about 10% of stores reopening thereafter
  • Now many states have still not actioned the recent Supreme Court clarification
  • There are still about Rs 15,000 odd stores that are closed and out of which, about two-thirds are on-trades of bars, restaurants and about one-third are off trade
  • With each successive week or month, either the stores are beginning to reopen, some fresh licenses being issued by State Governments as Karnataka has just done to make sure that their revenue does not get impacted or ultimately consumption moving to the stores that exists
  • Company should get back to normative performance levels and growth levels which had prior to the highway ban happening
  • There is a volume impact in the state of Maharashtra
  • Working with state governments to seek clarity on some of the specific taxes and also approaching for price increases where appropriate
  • The Karnataka government had actually wrote to the Ministry of Road Transport and Highways and was enquiring to denotify the national highways whichgoes through the large urban center in Karnataka and the Ministry of Road Transport and Highways has sought clarification from the Supreme Court
  • The supreme court has to an extent, "softened" its stand when they have given the clarification that they are not against de-notification of State and National Highways within urban centers
  • State patrol impacted from April, one of the bigger impacted states is Maharashtra actually where there is a material number of stores are closed in Maharashtra,Maharashtra happens to be a state, where there is a very significant on-trade as well, in addition to off-trade,Maharashtra volumes are under pressure

Key Operational Highlights

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  • In addition to the operating model changes, have also witnessed a material down-stocking that has happened during this quarter
  • Company’s estimate of the value of the down-stocking is about 3% to 4%
  • Pointing at Prestige and above, net sales were down at v8%
  • Although, sales is partly impacted by down stocking but also has materially impacted by the fact which the highway ban has been more prevalent on trade channel so, the bars, restaurants and hotels where the premium prestige and luxury brands are actually consumed
  • Company continued the renovation journey this quarter and in the past, had renovated Royal Challenge, McDowell's and Signature
  • In Q3FY17 , company had started rolling out the relaunch of Antiquity and the early signs, both was from the point of view of the consumer and the trade is positive
  • Company managed to deliver a material improvement in gross margin and while part of it is due to the business model change and there is a 116 bps underlying gross margin improvement
  • Despite having a difficult quarter on topline, continued to invest behind the brand to fuel future growth and the long-term growth story remains intact
  • The absolute A&P in Q1FY18 is almost the same as it was in the same quarter of the previous year
  • As company has more or less protected A&P, the normal reaction would have been to trim A&P quite sharply with the kind of a drop in topline, but has confidence of future growth would come and therefore, have stayed invested behind the brand
  • In spite of observing an underlying de-growth of 7.5% in the NSV, witnessed a substantial step-up in thegross margin profile
  • The reported gross margin profile has improved by 265 bps, but the underlying has improved by 116 bpswhich is a combination of largely around two factors this time
  • Some flow are witnessed through price increase happening even in this quarter which is near about 150 bps point tha have gained because of the price improvement
  • The company has taken productivity initiatives
  • While price improvement brings in 150 bps improvement in company’s GM margins net off inflations, the negative impact is also about 50 bps points which gives an overall gross margin improvement of 116 bps points in the current quarter
  • While getting into the first 25 days, in the next couple of weeks, will have a complete clarity coming in
  • Investors would wait for the full year to observe ETR movements between y-o-y rather than observing at just quarterly numbers
  • Tax profile range would be in between 30% to 34% in full year
  • Company has a combination of about 19 subsidiaries it consol and besides RCB, which is an operating company and also have Pioneer Distilleries, which is an operating company
  • Company has a small wine company called Four Seasons Wines which are the operating companies and would have 16, 17 non-operating companies
  • On Nielsen, company had an improvement in market share, both in the last quarter, but also over the last year
  • This quarter, it's very tough to read brand wise performance because the overall underlying performance has been significantly impacted by the regulatory changes
  • Signature has performed well and grown despite a quarter of the kind and is because of the relaunch of Signature
  • The company expects Royal Challenge to continue to grow not just in line with market, but grow share in coming periods and will be making investments both in terms of money and activities with the objective of delivering that kind of performance
  • The changes started somewhere in the announcements in first quarter of '17, that are going for restructuring of organization and as there would be a big project which are taking and have been now incurring severances costs q-o-q to bring down on staff costs
  • Staff cost actually includes about Rs 13 Crores of severance that have to take, for severances happening largely around factories, around white collars, blue collars and that's the program which is initiated a year backand as a result, a staff cost overall improvement happening q-o-q as well
  • Started receiving ENA, molasses based ENA, in the last week and was some uncertainty in the beginning but in the last week so far, nothing was alarming
  • Some correction are going to witness in the longer-term trend of margin progression which has planned and will happen for the next two years and is current estimate, but appreciated Latika, therewere seriously moving parts
  • At the current quarter, about Rs 142 Crores of NSV in the previous quarter was sitting in sales, have gone away now and has been franchised which is replaced by royalty income
  • As part of innovation the company has launched new product offers like Captain Morgan Rum, which announced started extending and making national
  • Company did some franchising in January’ 17, something in April and also did some franchising in May and June of 2017
  • Experimented about a year and half or two years ago by increasing prices for Haywards hoping that the rest of the industry would follow. However, the company lost market share at the point of time and lost volume which took many months to get the prices reduced again and receive the approvals for them done
  • Since, there has been a recovery trajectory that had on Haywards, the good news is company is back on track in terms of market share, but because ofcontinuously improving trend, is always lapping a little bit of a softer base 

 Future Strategy

  • Despite the short-term regulatory challenges observed,  the company remains confident about the long-term consumer opportunity on the business and the demand for alcoholic beverages and spirits
  • Company has medium-term ambition to grow topline by double digit and improve margins to mid-to-high teens
  • Company expect the impact of the highway ban in which one quarter is done and therefore, expect to a decreasing extent, an impact over the next two quarters
  • Presently, conpany is working through the mitigations and since that time, have a full implementation of this in the ground, also expect margins impact from the GST in F18
  • Company will definitely have a better clarity in the next few months as the work on the various measures to mitigate the overall GST impact
  • Engaging with company’s large vendors to understand their cost implications and how best can work together to really mitigate many of the tax implications
  • In two to three years, there will be any permanentmargin impairments to use invetsors words again
  • One of the things are going to continuously be doing, is to witness how many factories could close which are legacy factories, high cost and are not necessarily strategic from the point of view of a destination footprint
  • Must continue to expect selectively, would witness at exiting certain locations in terms of high cost factory and therefore, the factory closure costs would come into part of the results
  • Company has cost implications, intention would be to approach the state governments to seek a price increase
  • If company expects some margin improvement between FY18 and FY20, then should be able to compensate for GST and receive back to the margin trajectory which originally had