Varun Beverages - PL INDIA Nimbooz, Tropicana Mazaa, Frooti, Real Water ... VBL’s distribution...

October 25, 2016

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Varun Beverages

IPO Note

Unique Play on Beverages; listing gains unlikely

Amnish Aggarwal [email protected] +91‐22‐66322233

Gaurav Jogani [email protected] +91‐22‐66322238

Rating Subscribe

Price Band Rs440‐Rs445

IPO Fact Sheet

Opening Date Oct 26, 2016

Closing Date Oct 28, 2016

BRLMs Kotak Mahindra, Axis Capital, CLSA

Issue Size Rs11.0 to 11.1bn

Fresh Issue Rs6.6bn

Offer for Sale 10,000,000 equity shares

Objects of the Issue

Debt Repayment Rs 540mn

Issue Details Pre‐issue equity (m shares) 166.95 mn

Post‐issue equity (m shares)* 181.95 mn

Post‐issue Market Cap (Rs bn)* 80bn

Share Holding (%) Pre‐IssuePost‐Issue*

Promoters 86.3 73.7

Public & Others 12.5 40.4

*Equity issuance calculated on higher band price

Varun Beverages offers a unique play on the Beverages segment in the Indian

Consumer space. The company has 44% of PepsiCo’s India sales and we believe

that the franchisee arrangement will continue beyond 2021 given long standing

relationship with PepsiCo and global focus of players like Coke and Pepsi to

operate with asset light models. Margin expansion from current levels looks

difficult (Margins up 450bps since CY13) given that VBL has already gained from

25% reduction in concentrate prices by PepsiCo and sugar prices have seen sharp

jump in past 2 quarters. However debt repayment will curtail interest costs and

enable strong profit growth in CY17 and CY18. The stock is being offered at

30xSept’18 EPS and looks fairly valued on PE basis although it compares favorably

with Manpasand Beverages (~35.8xFY18EPS and 25xCY16 EV/EBIDTA). We

estimate that VBL is offered at 13xCY16 EV/EBIDTA which is in line with global

peers (12‐15xEV/ EBIDTA) despite higher growth prospects and probability of

franchisee area expansion. We don’t expect significant listing gains at current offer

price; however the stock can offer decent returns over medium term.

44% share of PepsiCo’s India business: VBL has 44% share of the PepsiCo’s sales

of Soft Drinks in India (franchisee agreement). VBL can not only capture secular

mid teen’s growth in Soft drinks in India and its overseas territories, but can also

gain more territories from PepsiCo in future. Players like Pepsi and Coke are

moving towards an asset light model with focus on branding, concentrate

manufacturing and supply, which augurs well for franchisees like Varun

Beverages in the long term. We expect VBL to sustain mid teens sales growth in

existing territories, addition of new territory can provide upside.

Dependence on PepsiCo and Concentrate prices: Varun Beverages is completely

dependent on PepsiCo for innovations and concentrate (26‐34% of raw material

prices). PepsiCo has reduced the prices of concentrate from Rs31.2/case in CY14

to Rs22.8/case in CY15, which along with benign sugar and packaging material

costs has boosted the gross margins by 610bps in the past 2 years from 43.3% to

49.4%. We believe further expansion in gross margins looks unlikely given recent

upsurge in sugar prices and gradual increase in concentrate prices.

Contd…2

Key financials (Y/e Dec) CY12 CY13 CY14 CY15

Revenues (Rs m) 18,000 21,151 25,024 33,941

Growth (%) NA 17.5 18.3 35.6

EBITDA (Rs m) 2,280 2,910 3,845 6,341

PAT (Rs m) 251 (396) (202) 870

EPS (Rs) 9.4 NA NA 6.5

Growth (%) NA NA NA NA

Profitability & Valuation CY12 CY13 CY14 CY15

EBITDA margin (%) 12.7 13.8 15.4 18.7

RoE (%) NA NA NA 17.1

RoCE (%) NA NA NA 9.9

PE (x) 47.4 NA NA 68.4

P / BV (x) 6.9 27.6 17.4 8.9

Source: Company Data; PL Research

October 25, 2016 2

Varun Beverages

EBIDTA margins up 490bps since CY13, further expansion difficult: VBL has

seen sharp increase in EBIDTA Margins (490bps over CY13‐CY15) as steady sales

growth, lower material prices (concentrate, sugar and PET) and benefits of

adding significant territory in existing areas of North India provided economies

of scale and expanded margins. However we believe that the scope to increase

margins from the current levels seems limited. We believe that addition of new

territories beyond its existing catchments areas can be a risk to margins.

International Business turnaround to take time: VBL has international

operations in some of the high growth markets of Nepal, Sri Lanka, and Morocco

and has recently started in Mozambique, Zambia and Zimbabwe. IBD has EBIDTA

of Rs591mn but is losing money at PAT Level. We expect gradual increase in

sales and margins, although PAT breakeven is sometime away.

PAT growth to accelerate; ROE and ROCE to improve: Varun Beverages has high

capital intensity with sales/ Gross Block and Intangibles being 0.78. VBL is

looking at increasing the same to 2x over the coming few years, but it looks

unlikely given high competition and seasonal nature of business. VBL plans to

retire debt of Rs5.4b which will curtail interest cost at <Rs2b over the coming

couple of years thus accelerating PAT growth. We expect ROE and ROCE to

improve from 8.5% and 9.8% in CY16 to ~13.8% and 15% respectively by CY18.

Exhibit 1: Issue Details

Launch Date 25thth of October

Issue Period Opening date: 26th October; Closing date: 28th October 2016

Exchange Listing on both NSE and BSE

Issuer Varun Beverages Limited (“VBL”)

Offer Type Initial Public Offering / Reg S

Net offer Fresh issue of 15mn equity shares+ Offer for sale upto 10mn shares

Price Band Rs440 ‐445

Issue Split (No. of shares)

QIB Portion: Not more than 50% of the issue

Non‐Institutional portion: Upto 15% of the issue

Retail Portion: Upto 35% of the issue

Use of proceeds

Prepayment or scheduled repayment of a portion of outstanding indebtedness availed by the company

General Corporate Purpose

Current Shareholding Pre‐Offer Post‐Offer

Promoter & Promoter group 86.30% 73.70%

SCPE 7.70% 7.10%

AION 4.90% 4.50%

Others 1.16% 14.70%

Offer Structure (No of shares in mn)

Fresh issue 15

Offer for sale 10

Net offer for Public 25

BRLM's Kotak Mahindra Capital company ltd, Axis capital Ltd, CLSA India Pvt Ltd, Yes Securities

Source: RHP, PL Research

October 25, 2016 3

Varun Beverages

Varun Beverages: Leading PepsiCo franchisee globally

Varun Beverages Ltd (VBL) headquartered in Gurgaon and has emerged as one of the

largest franchisee in the world (outside USA) of carbonated soft drinks (CSDs), non‐

carbonated beverages (NCBs) and packaged drinking water sold under trademarks

owned by PepsiCo in India and internationally.

VBL produces and distributes a range of CSDs under the brands of Pepsi, Diet Pepsi,

Seven‐Up, Mirinda Orange, Mirinda Lemon, Mountain Dew, Seven‐Up Nimbooz

Masala Soda, Seven‐Up Revive, and Evervess. It also produces and distributes NCBs

under the brands of Tropicana Slice; Tropicana Frutz (Lychee, Apple and Mango); and

Nimbooz, as well as packaged drinking water under the brand Aquafina.

Exhibit 2: PepsiCo faces stiff competition from Coke across segments

PepsiCo Competition

CSD

Pepsi, 7‐Up, Mountain Dew, Mirinda, Evervess Coca‐Cola, Thumps Up, Limca, Sprite, Fanta

NCD

Slice, Nimbooz, Tropicana Mazaa, Frooti, Real

Water

Aquafina Bisleri, Kinley, Others,


October 25, 2016 4

Varun Beverages

VBL is associated with Pepsi Co since the 1990’s and has been consistently increasing

the number of licensed and sub‐licensed territories covered. As of June 30, 2016,

VBL has been granted franchises for various PepsiCo products across 17 States and

two Union Territories in India and also has franchise for various PepsiCo products for

the territories of Nepal, Sri Lanka, Morocco, Mozambique and Zambia. It is setting up

a Greenfield capacity in Zimbabwe in anticipation of Franchisee rights being granted

by PepsiCo Inc

Low utilisation due to seasonal business: As of June 30, 2016, VBL operated 16

production facilities across India and 5 production facilities in international licensed

territories. VBL has an estimated aggregate annual production capacity of 3,438.38

million litres (equivalent to 605.56 million unit cases) in India and an estimated

aggregate annual production capacity of 991.57 million litres (equivalent to 174.63

million unit cases) in our international production facilities.

Exhibit 3: Capacity Utilisation is low due to recent capex and seasonal business

Category Production in CY15 (in mn unit cases)

Capacity as of Jun'16 (In mn

unit cases)Capacity Utilization

CSD 195.8 646.6 30%

NCB 14.5 61.3 24%

Packaged Drinking water 29.5 72.3 41%

Total 239.7 780.2 31%


VBL capacities are underutilized to a great extent and with the acquisition of the

additional territories in Feb 2015, this will help it to achieve economies of scale and

also gain in operational efficiencies. VBL has backward integration facilities located

at Jaipur and Alwar which manufacture crowns, plastic shells, corrugated boxes and

pads and shrink wrap film. Backward Integration has enabled the company to

maintain uniformity in quality and reduce costs.

Creating last mile distribution a major challenge in Soft Drinks: As of June 30, 2016

VBL’s distribution network in India included 60 depots and 1,438 delivery vehicles

covering urban, semi‐urban and rural markets it also had 562 primary distributors

(i.e., distributors that recorded sales in excess of 0.5 million litres of PepsiCo

beverages in the 12 months ended June 30, 2016) in India. Its International

distribution included 20 depots and 518 delivery vehicles and 415 distributors.

It sells its products to retail outlets, including e‐commerce, supermarkets,

hypermarkets, convenience stores, bars, and restaurants, as well as to grocery stores

through distributors. We believe that last mile distribution is a big challenge in soft

drinks and would require steady investments for expanding reach and Visi Coolers

infrastructure in the coming years.

October 25, 2016 5

Varun Beverages

VBL: Carbonated Soft Drinks are 82% of the overall sales

VBL’s derived 82% of its CY15 volumes from CSD (Carbonated Soft Drinks), the

contribution over the last 5 years has remained in the same range (82‐84%); volumes

have grown at a CAGR of 10.7% during CY10‐15. Packaged drinking water

contributed 12% volume sales followed by Juices with 6% volume sales.

Exhibit 4: CSD volume sales has remained in the range of 82‐84%

84 83 84 82

8 7 7 6

9 10 9 12

0%

20%

40%

60%

80%

100%

CY12 CY13 CY14 CY15

CSD NCB Packaged Drinking water


VBL has reported sharp improvement in both Gross profit/ case due to reduction in

concentrate prices by PepsiCo and lower prices of Sugar and PET. However the costs

have bottomed out and sugar prices have started rising, any meaningful gross

margin expansion looks unlikely. EBIDTA margin expansion will be driven by rising

scale and economies and will come at a snail’s pace only.

Exhibit 5: Profit/case up sharply due to lower concentrate, sugar and Packaging costs

56.8 59.666.3

70.0

16.8 19.022.7

26.4

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

CY12 CY13 CY14 CY15

Gross Margin/Case EBITDA/Case

Source: PL Research

October 25, 2016 6

Varun Beverages

India is 84% of business; overseas business loss making at PAT Level

India accounts for 83.8% of sales even though VBL is adding new territories overseas.

It entered high growth markets of Nepal, Srilanka and Morocco post the

amalgamation of VBIL (Varun beverages International Ltd.) from 1st January 2016.

The contribution from India increased to 84% in CY15 due to the additional of new

territories in North India from 28th Feb 2015. Mozambique and Zambia have started

contribution from 1st January 2016, Zimbabwe territory has also been consolidated

with effect from 1st April 2016.

Exhibit 6: 80%+ of overall sales continues to be contributed by Indian region

100.0%

80.4% 82.0% 80.1% 83.8%

0.0%

19.6% 18.0% 19.9% 16.2%

0%

20%

40%

60%

80%

100%

CY11 CY12 CY13 CY14 CY15

India International


Exhibit 7: Overseas business is profitable at EBIDTA level

CY12 CY13 CY14 CY15

Net Sales 3,388 3,705 4,836 5,301

Growth (%) 9.4 30.5 9.6

Gross Profit 1,705 2,056 2,776 3,012

Growth (%) 21 35 9

Gross Margin (%) 50.3 55.5 57.4 56.8

EBITDA 389 635 638 591

Growth (%) 63.3 0.4 ‐7.4

EBITDA Margin (%) 11.5 17.1 13.2 11.1

Interest & Finance Charges 180 218 291 299

Financial Other Income 63 74 ‐67 0

Depreciation 389 499 580 548

Profit Before Taxation (117) (9) (301) (256)


While the International subsidiaries are profitable at the EBITDA level, they remain

loss making at the PAT level given high interest and depreciation charges. We believe

that the business will take time for full turnaround given high interest, depreciation

and lack of scale.

October 25, 2016 7

Varun Beverages

Soft Drinks; market moving away from carbonated drinks

The overall soft drinks market in India saw aggregate sales of 12,081 million litres,

worth Rs 524.3 billion in the year 2015. The main segments constituting the soft

drinks market in India are carbonates, juices and bottled water, which together

accounted for over 99% of the total volumes sold in 2015. The remaining is divided

among products such as ready‐to‐drink coffee and tea, concentrates and sports and

energy drinks.

Exhibit 8: Value share of CSD is highest, Water has high volume share

37.9%

14.9%

46.4%

0.8%

47.9%

25.1% 23.1%

3.9%

0%

10%

20%

30%

40%

50%

60%

CSD NCB Packaged

drinking water

Others

CY15

Volume Value


Exhibit 9: NCB and bottled water are expected to gain share in CY20

26.5%19.0%

54.0%

0.6%

34.6% 35.5%

26.8%

3.1%

0%

10%

20%

30%

40%

50%

60%

CSD NCB Packaged

drinking water

Others

CY20

Volume Value


CSD has the highest value share, but slowing growth

In the Indian soft drinks market CSD commands the Value leadership with 47.9%

share followed by NCB and packaged drinking water with 25.1% and 23.1% share

respectively. In volume terms however packaged drinking water has the highest

market share of 46.4% followed by CSD with 37.9% share and NCB with 14.9%.

Overall volumes in the soft drink market has grown at a CAGR of 17.9% during CY10‐

15, while the CAGR volume growth in CSD was only 10.7% during the same period,

Other category CAGR volume growth was 25% majorly contributed by packaged

drinking water which grew by 25.4% during the same period.

In value terms the soft drink market grew at CAGR of 18.7% during CY10‐15, even

here the growth in the CSD segment was the lowest with CAGR of 12.5%. Value

CAGR growth in Packaged drinking water has been the highest with 31.5% growth

followed by NCB with 26.3% growth during the same period

October 25, 2016 8

Varun Beverages

Exhibit 10: Volume growth across categories slowing down

13.1

8.6

24.019.7

29.0

22.8

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0


CSD NCB Others


Exhibit 11: Value growth is above 20% in CSD and NCB category

13.7

10.9

26.3 25.1

27.9

23.1

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0


CSD NCB Others


Average price increase during CY10‐15 in the CSD segment has been quite tepid at

1.75%, while in the NCB segment we saw average price increase to the tune of 4.5%

and 2.5% in the packaged drinking water segment. We believe that high competitive

intensity in the segment restricts the pricing power of the players in the category.

The price increase in all the 3 categories have been below the average inflation rate

VBL’s areas in East/ North east have low consumption

VBL has bottling rights for North, East (ex Bihar) and some parts of Maharashtra and

Madhya Pradesh, these are having low consumption levels and constitute 44% share

of overall PepsiCo’s sales volume in India. Growth rate across these regions have

been quite the same with North and East markets growing at CAGR of 18.2% and

16.2% respectively during CY10‐15

Exhibit 12: Consumption of Soft drinks is the lowest in East and North markets

9.4% 9.2% 9.0% 8.9% 8.8% 8.7%

33.5% 33.6% 33.7% 33.8% 33.8% 34.0%

23.0% 22.9% 22.7% 22.7% 22.7% 22.7%

34.1% 34.3% 34.5% 34.6% 34.7% 34.6%

0%

20%

40%

60%

80%

100%

1 2 3 4 5 6

East and North East North South West


October 25, 2016 9

Varun Beverages

The penetration in the states of East and North east is weaker and also the per

capita consumption is lower providing scope for VBL to increase distribution and

increase volumes however it will entail lot of investments in setting up the required

infrastructure and distribution network as the terrain in these regions is difficult

making transportation a cumbersome process.

The Coca Cola Co has the highest market share in CSD and Juices

The Coca Cola Co has enjoyed the highest Volume and value market of 56.5% and

59.9% in respectively in the CSD segment. Pepsi Co Inc has remained no.2 player in

the CSD segment with 31.1% Volume share and 33.2% value share. Over the last few

years Pepsi Co inc has lost ~300bps market share

In the Juices segment however Pepsi Co has been able to gain both Volume and

Value market share, Its volume share has increased from 22.8% in CY10 to 26.4%

while Value share has increased only from to 22.8% to 24.2%

Exhibit 13: Coca Cola is the market leader in CSD space

56.5 59.9

31.1 33.2

12.4 6.9

0%

20%

40%

60%

80%

100%

Volume Value

The Coca Cola Co PepsiCo Inc others


Exhibit 14: Pepsi Co has been gaining market share in Juices

30.1 22.3

26.424.2

15.112.1

8.413.6

20 27.8

0%

20%

40%

60%

80%

100%

Volume Value

The Coca Cola Co PepsiCo Inc Parle Real Others


October 25, 2016 10

Varun Beverages

Financials

Exhibit 15: Income Statement: 1HCY16 numbers can’t be extrapolated due to seasonal business; 2H usually has a loss

CY12 CY13 CY14 CY15 H1CY16

Revenue

Revenue from operations (gross) 19,861 23,512 28,111 39,059 30,110

Less : Excise duty 1,861 2,360 3,087 5,117 4,813

Excise duty % 9.4 10.0 11.0 13.1 16.0

Revenue from operations (net) 18,000 21,151 25,024 33,941 25,297

Expenses

Cost of materials consumed 9,732 11,503 13,162 14,253 12,041

Purchases of stock in trade 513 574 597 3,202 684

Changes in inventories 33 (85) 2 (290) (746)

Gross profit 7,722 9,159 11,263 16,777 13,318

Gross margin (%) 42.9 43.3 45.0 49.4 52.6

Employee benefits expense 1,524 1,830 2,168 3,238 2,108

Other expenses 3,917 4,418 5,250 7,199 5,168

Total 15,720 18,240 21,179 27,601 19,255

EBITDA 2,280 2,911 3,845 6,341 6,042

EBITDA margin (%) 12.7 13.8 15.4 18.7 23.9

Depreciation and amortisation 1,358 1,844 2,101 3,174 1,895

Finance costs 1,156 1,697 1,854 1,688 1,112

Other income 442 174 147 143 97

PBT 208 ‐456 38 1,621 3,132

Tax expense:

Current tax 102 59 187 530 734

Minimum alternate tax credit entitlement (89) 0 (121) (468) (516)

Deferred tax expense/(credit) (56) (111) 181 704 779

Net profit/(loss), as restated 251 (404) (210) 855 2,134

Add: Share of profit in associate 8.41 8.81 15.17 15.38

Less : Share of (loss)/profit transferred to minority interest 0 ‐0.01 0 52.16

Profit/(Loss) after tax 251 (395) (202) 870 2,097

Source: RHP

October 25, 2016 11

Varun Beverages

Exhibit 16: Balance Sheet (Rs m); High capital intensity and acquisitions have bloated debt


Equities and Liabilities

Shareholders’ funds

Share capital 268 1,338 3,338 5,838 5,857

Reserves and surplus 1,449 416 93 885 3,258

Total Networth (A) 1,716 1,754 3,431 6,723 9,115

Share application money pending allotment ‐ 400 ‐ ‐ ‐

Minority Interest 0 0 ‐ ‐ 0

Non‐current liabilities

Long‐term borrowings 13,628 16,952 16,302 15,795 18,375

Deferred tax liabilities (net) 725 638 812 1,512 2,292

Other long ‐ term liabilities 352 314 111 6,363 3,151

Long‐term provisions 138 176 259 440 533

Total (B) 14,843 18,080 17,484 24,110 24,351

Current liabilities

Short‐term borrowings 3,384 3,376 5,085 2,524 3,004

Trade payables 907 1,392 1,806 1,846 3,297

Other current liabilities 4,633 4,829 4,967 8,798 12,407

Short‐term provisions 65 63 176 374 781

Total (C) 8,988 9,660 12,035 13,542 19,490

Total (A+B+C) 25,548 29,894 32,950 44,375 52,955

Assets

Non‐current assets

Fixed assets

Tangible assets 16,838 22,157 22,132 31,057 34,405

Intangible assets 194 1,493 1,321 3,839 3,609

Capital work‐in‐progress 1,893 274 248 379 192

Goodwill on consolidation 95 95 95 95 2,367

Non‐current investments 0 9 18 33 48

Deferred tax assets (net) 13 38 34 27 28

Long‐term loans and advances 644 369 446 1,190 1,846

Other non‐current assets 25 21 68 50 53

Total (A) 19,704 24,457 24,361 36,670 42,547

Current assets

Current investments 0 0 3,020 0 0

Inventories 2,306 2,464 2,893 4,247 5,592

Trade receivables 907 652 973 979 1,479

Cash and bank balances 384 509 344 581 1,155

Short‐term loans and advances 2,198 1,709 1,251 1,804 2,024

Other current assets 50 102 108 94 159

Total (B) 5,844 5,436 8,589 7,704 10,408

Total (A + B) 25,548 29,894 32,950 44,375 52,955

Source: RHP

October 25, 2016 12

Varun Beverages

Exhibit 17: Cash Flow (Rs m); VBL has cash flow from operations of ~Rs10b in last 2 years


Operating profit before working capital changes 2,714 3,132 3,971 6,444 6,160

Cash generated from operations 2,911 3,013 4,416 6,031 7,641

Net cash generated from operating activities 2,804 2,971 4,309 5,598 7,329

Net cash used in investing activities (5,066) (5,736) (5,000) (2,916) (8,215)

Net cash (generated from)/used in financing activities 2,292 2,743 577 (2,490) 1,466

Net increase/(decrease) in cash and cash equivalents 31 (22) (114) 191 581

Cash and cash equivalents at the beginning of the year 157 187 165 52 243

Cash and cash equivalents at the end of the year 187 165 52 243 824

Source: RHP

October 25, 2016 13

Varun Beverages

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3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai‐400 018, India

Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209

Rating Distribution of Research Coverage PL’s Recommendation Nomenclature

26.1%

58.3%

15.7%

0.0%0%

10%

20%

30%

40%

50%

60%

70%

BUY Accumulate Reduce Sell

% of Total Coverage

BUY : Over 15% Outperformance to Sensex over 12‐months

Accumulate : Outperformance to Sensex over 12‐months

Reduce : Underperformance to Sensex over 12‐months

Sell : Over 15% underperformance to Sensex over 12‐months

Trading Buy : Over 10% absolute upside in 1‐month

Trading Sell : Over 10% absolute decline in 1‐month

Not Rated (NR) : No specific call on the stock

Under Review (UR) : Rating likely to change shortly

DISCLAIMER/DISCLOSURES

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