GM Breweries Q1 FY20 review: Margin pressure to continue

- Sharp jump in key input prices (rectified spirits and packaging) impacted gross as well as operating margins in the quarter gone by. Gross profit declined 14 percent YoY while operating profit decreased by 24 percent YoY in Q1 FY20. The margins, however, recovered sequentially (quarter-on-quarter) due to cost rationalisation measures.

- The demand for ethanol has increased due to new orders from oil marketing companies and Maharashtra has allowed co-generation plants attached to sugar mills to produce ethanol from sugarcane juice. Ethanol policy has an inflationary impact on both ethanol as well as rectified spirits. Further, poor rainfall in cane growing areas leading to a decline in sugarcane production last year (2018-19) has further amplified the situation in Maharashtra.

- As a part of its cost rationalisation strategy, the company has changed it bottling mix towards PET bottles to reduce the packaging expenses. The manufacturing cost of PET bottles is lower in comparison to glass bottles and it currently supplies 70 percent of its output through the same.

- The management has indicated that higher input prices will continue to impact gross margins for the next two quarters. Change in demand-supply dynamics has resulted in a surge in prices of rectified spirit, which are hovering at lifetime highs at this point of time. Raw material costs were higher by nearly Rs 8 crore in Q1 in comparison to last year and will continue to remain at elevated levels until the arrival of the new sugarcane crop in October-November.

- Country liquor market in Maharashtra has been growing at a steady pace of 5-7 percent in the past few years. GM Breweries has been expanding at a similar rate and has clocked volume growth of 6 percent and 4 percent in the each of the two fiscal years.

Outlook and recommendation

- The company is operating at a capacity utilisation of nearly 50 percent and has sufficient headroom to scale up the business without incurring capital expenditure. However, competitive landscape as well as regulatory risks need to be monitored closely.

- Shares of GM Breweries are down nearly 18 percent since the reporting of Q1 earnings, reflecting a weak start to the year, especially on the margins front. At the current market price of Rs 421 per share, the stock is trading at trailing 12-month price-to-earnings multiple of around 10.2x.

- Valuation multiples have turned reasonable, post the recent correction and investors should keep an eye on the stock for accumulation on dips as the business has strong intrinsic fundamentals (debt-free balance sheet). The recent margin pressures may continue to exist throughout FY20, but its profitability remains poised for a revival on the back of good monsoon season and commencement of new ethanol plants.