Nikhil Vora, Managing Director & Head - Research, IDFC Securities strongly believes that change in management will not only rerate United Spirits (USL) but the scale of business also will look dramatically different over the next three years.
"Our sense is that USL with the new management and new promoters on board will be in a position to repay at least Rs 1000 crore of incremental debt over the next one year and then post that, the entire balance sheet will undergo a significant change. So we are fairly positive on the way the business will move." says Vora. USL right now operates at Rs 7000 crore of debt.
Diageo has completed the share purchase agreement and is now the single largest shareholder with 25% stake in United Spirits.
Vora also believes that USL's business will become at least three times more profitable than it is today and sees profits moving from Rs 400 crore to Rs 1200 crore in next three years.
Below are the excerpts of his interview on CNBC-TV18
Q: What is your view on how to approach a stock like United Spirits (USL) now with the new management on board?
A: It definitely changes the thought that one has had for the last one year that this business was getting extremely underpriced and change in management can only start to rerate this entire business. And what has happened in the last six months has got culminated. This was a business which was in lifestyle space and a market leader with over 50 percent market share but yet was making less than USD 50 million of profit in India.
Clearly, there is underlying profitability of the business which will start to look extremely robust over the next three-four year period and it is a management which has fair bit of competence attached to it. So this entire changeover of USL is an end of an era for the erstwhile USL management and a start for the new management coming in.
Q: The industry has grown by about the lowest in the past several years, the last numbers indicated a 3.5 percent year-on-year growth and USL itself in the previous revenues of Q1 didn’t have much to speak for itself in terms of revenue growth. So does it dip before it becomes a buy?
A: These are such small aberrations when you look at the lifespan of such a business. The fact is that globally cigarette businesses are less valuable than liquor businesses are. The fact that this business is now seeing change in board, change in management and change in strategic directions - all of these are tangible measures as you move forward. So if you look at the next quarter or two, in the time span that one is looking at for investments into a consumer business, I think this is possibly the best time to buy into such businesses.
One has seen Pernod Ricard operate in India, they operate at zero debt, whereas USL right now operates at Rs 7000 crore of debt. So there is a need to change this equation. Pernod Ricard makes Rs 600 crore of net profits despite being one fifth the size of USL. USL struggles to make Rs 400 crore of profit today. Therefore, the scale of this business will look dramatically different over the next three years than what one is seeing today and thereby the reason for investors to really get aligned to such a business today.
Q: Post this equity infusion the debt has come down to Rs 7000 crore like you mentioned but can you give us some numbers on how much further they can scale down their debt and how much further interest cost can go down because that was the big positive that we saw in the quarter gone by?
A: The EBITDA margins of Pernod Ricard are closer to 28-30 percent right now and that of USL is around 14-15 percent. So USL is at 50 percent EBITDA margins to that of Pernod Ricard. Moreover, the difference between EBITDA and profit before tax (PBT) margins of Pernod Ricard is zero which means that there is no depreciation; there is no interest cost. Whereas, the difference between EBITDA and PBT of USL is close to 1000 bps. So that is the entire correction that one can really look at. Moreover, if the EBITDA margin starts to scale up as debt starts to get dwindle out, you will start to see the EBITDA and PBT really start to converge.
Our sense is that USL with the new management and new promoters on board will be in a position to repay at least Rs 1000 crore of incremental debt over the next one year and then post that, the entire balance sheet will undergo a significant change. So we are fairly positive on the way this business will move.
In terms of profitability our sense is that this business will be at least three times more profitable than what it is today, it will move from Rs 400 crore of profit to close to Rs 1200 crore of profit in the next three years. And we are not really accruing for what may happen to Whyte & Mackay which is likely to be sold thereby the debt will get pared down further.