United Spirits Limited - Re-rating triggers in place - Upgrade to BUY - Antique

We believe that the initial improvement for United Spirits (UNSP) during the next 2 years would flow through its balance sheet on account, of 1) reduction in debt levels and 2) lower growth in loans and advances aiding efficient management of working capital. UNSP's debt levels during the last five years have increased from about INR14.8bn in FY07 to INR75.5bn in FY12. Post the acquisition by Diageo, as an impact of debt repayment and efficient management of working capital, particularly loans and advances, we expect debt levels of United Spirits to reduce to INR47.1bn by FY15. The medium to longer-term benefits would flow from higher level of premiumisation leading to better realisations and operating profitability.

We rollover our SOTP based target price to FY15 earnings, arriving at a fair value of INR2,428. We believe that the stock would witness a re-rating in the coming years with the actual drop in debt levels and reduction in working capital requirement. We therefore recommend a BUY on the stock at the current levels.

Loans and advances to be the focus area for management of working capital

In the first phase, we believe that Diageo's involvement will be instrumental in prudent management of working capital. We believe that the key improvement in working capital management would be through the control of loans and advances. Loans and advances had witnessed a steep increase particularly during FY11 and FY12 by about INR8.45bn and INR5.34bn respectively. This according to our understanding has been a higher increase when compared to growth in scale of UNSP's operations during the period. Loans and advances as percentage of sales witnessed a steep increase to 28.4% during FY11 from about 18.8% in FY10. This, we believe was one of the key reasons behind the rise in debt levels of about INR 8.75bn during FY11. Further the estimated contribution of tie up units and subsidiaries to UNSP's estimated consolidated sales has dropped during FY11 and FY12. Therefore any material addition to loans and advances from tie up units and subsidiaries can be ruled out which is also reflected in the loans to tie up units and subsidiaries.

Dominance in IMFL to aid medium to long-term premiumisation

Nevertheless, UNSP remains the dominant player in the IMFL industry backed by a comprehensive portfolio across key IMFL categories and a leading 43% market share (against the second biggest player, Pernod Ricard with a market share of about 9-10%). UNSP's large-scale operations and distribution strength would aid its premiumisation drive and improve profitability in the medium to longer term, though in the short term its large presence in the low margin 'Regular' category would restrict any margin expansion.

Source : Equity Bulls

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