NSE dumps United Spirits, should you dump it?

The company has violated the listing agreement and the listing agreement very categorically states and there is a standard operating procedure which has been laid by Securities and Exchange Board of India (Sebi) which says that as soon as company does not come out with financials for two quarters, the company has to go into a trade-to-trade trade and following that with a penalty or then a suspension.

Menaka: All that is fine and good.

Sajeet: All that is fine.

Menaka: This is the shortest a stock has been in the Nifty.

Sajeet: Three months.

Menaka: Because it got included along with Tech Mahindra barely three months ago and now it is out.

Sajeet: March 28 is the day when it entered Nifty. Two quarters of results.

Menaka: Why is it that the company has not been able to file its earnings?

Sajeet: Two big things. The company has disclosed that it has not trying to enquire about the Rs 590 crore of receivables that it needs to get from distributors, debtors and all.

The second thing is the Rs 1350 crore loan which the company has given to United Breweries (UBHL) which is the holding company of Mallya Group.

Menaka: But both of these were items they cited for reasons for why they could not report their annual earnings. Since then an entire quarter has come and gone and they still have not been able to clarify just these two items.

Senthil: That is a question I would like to ask you, since you track the law. What stops him from filing the earning with notes to account for this?Menaka: No, because they must not have notes. An auditor has to agree to sign off on something, they don’t have enough information.Sajeet: Because the point is that even if the fourth quarter earnings are ready the annual audited numbers for FY14 cannot be done.Menaka: Till those don’t come you can’t report the subsequent quarters.Sajeet: Still the balance sheet is ready for FY14 they can’t come out with it and since FY14 balance sheet is not ready they can’t come out with quarter one.Menaka: But these are the two items that they cited for why they could not do the annual earnings.Sajeet: These are two items which they have disclosed so far.Menaka: This is what they said five months ago. They said we can’t report annual earnings, March ended FY14 earnings and they have not been able to report first quarter earnings results. So the last three months they have been investigating these two numbers.Sajeet: Not just that, there is another disclosure of USL which they had done as part of the postal ballot to the shareholders that they might have to take a hit of nearly Rs 4,000 crore which will take the entire net worth into negative. That is something again which is under scrutiny by the auditors. Remember the board of United Spirits is new. They don’t want to take any risk. They want clarification and information on the table before they go ahead and clear the financials. So that is one of the reasons why it is taking some time and I am told that the board meeting is not going to happen for another ten more days. So it will go into September.Menaka: So that is the background as to why USL was knocked out of the Nifty.Now let us get to our stock debate, should you dump your United Spirits stock. That is the question we are putting to both our experts in studio today. Jigar Shah and Vishal Jajoo joins in.Menaka: Should you dump the stock?Jajoo: I think so. I am in favour of the fact that if you take all the factors into account, maybe macros, micros and the company specific things the things work out that it has created one of the best wealth for the industry but the best time for this industry or for this sector and for this particular company is out. The argument started with the fact that when Diageo first was about to acquire United Spirits and then when the stock which was quoting in three digits zoomed past Rs 2,000 – 2,500 mark and every third person in the street was saying that it would be a Rs 5,000 stock over the next two years. The argument was that Diageo when it operates in overseas it operates at an EBITDA margin of 33 percent and United Spirits in India was operating at an EBITDA margin of 11 percent. So once Diageo takes it over there could be a threefold rise in its EBITDA levels but the fact of the case is there are a lot of ifs and buts in that.As Sajeet has mentioned there are two things which are being under debate, question also arises with regard to the Whyte and Mackay acquisition, how the accounting is to go through and the question also arises that if Rs 4,000 crore is an amount of hit that is being proposed upon then one has to look at that this company when it last reported its numbers then the nine months sales were Rs 9,000 crore, the profit after tax (PAT) figure was Rs 60 crore, all these are standalone numbers which have been reported to the exchanges, the debt figure was Rs 8,500 crore and we are debating whether there could be a Rs 4,000 crore hit coming or not. Forget the stock getting excluded from the NSE or not or whether this issue comes on or not the fact that stock had already started falling out from its peaks even before this announcement came in.So once you have these one offs coming and hitting it whenever the numbers get into public domain the figure or the impact would be much more disastrous than what it is or what we have seen till now.Shah: My view is that United Spirits is at the top of the alcohol beverage industry now led by Diageo and whatever they are doing with the cleaning up of the company has begun quite well although it is taking some time to get over but it will ultimately drive out all those issues which have been there for long time. Its board is reconstituted with some very eminent members and it is rightly taking its own time. I think auditors are also being very clear that probably we do not want to take any chance. So, when the next picture emerges it will be very clear and it will drive out whatever issues are there with the books. As far as investor is concerned he is concerned with the future of the company and he is concerned with the cash flow of the company which I think is only going to improve from here because you are slashing debt.Senthil: Two things that you mentioned, one, you said that the best time for the industry is over. How did you come to that conclusion because if you look at all parameters, per capita consumption, we are still very low. So, why do you say the best time for the industry is over? Two, the fact that as Jigar points out, it is a new management, so why punish it for past sins when you have got new a more dynamic hopefully a cleaner management in place?Jajoo: Coming to the volume growth part whether you talk of globally or what is happening in the Indian markets, I think the volume growth over the last several quarters have been answering the fact that this industry has not at all been growing.Secondly this has happened globally, this has happened in India. Stock on one side has become grossly expensive because of the developments that were expected to happen. Coming to the part that the new management is taking over the charge, I think they will take their own set of time because one cannot takeaway the fact that Vijay Mallya has created this empire right from scratch. He has created one of the best brands in this particular sector but then at some point of time because of valuations, because of what is happening globally and the logic that we apply in case of cigarettes industry that inspite of the fact that you have three out of five union Budgets hiking the duty, still the coinage or in terms of the change factor the industry continue to do well in terms of EBITDA margins in spite of the fact that number of sticks don’t increase. However in case of liquor that logic does not hold true. Menaka: Jigar I want you to respond to that. I also want you to respond to the fact that you might be saying that this is the end of the pain but are you comfortable as an investor being faced with a Rs 4000 crore write-off, are you comfortable with the questions being raised about the amount of write-off on the Whyte and Mackay acquisition which exceeds the amount of the acquisition in itself. So, I am just curious as to how you view all of this even if this is a cleaning up as you call it?Shah: Yes, it is very clear that after the money that Diageo pumped into United Spirits also the sale of Whyte and Mackay and with the cleaning up there will be cash. So I am not worried about the write off, because write off is in the books. It is not cash that the company is losing today. So I am not seriously worried about that although yes, from the point of view of books it is not good but if I am looking to the future it is not going to change or alter my position in the industry, it is not changing my profit margin, in fact it is only going to improve my return ratios as the balance sheet size shrinks because there was inefficiency in the capital allocation and the working capital management and everything that we know under the old management.Menaka: And yet this company has been investigating for the last six months or five months, two items that they are not able to identify or explain and have delayed the announcement of earnings.Shah: I am sure there are more than two.Menaka: Two that they have publicly informed us about, so I can’t speculate beyond that. Are you not worried that who knows what the numbers will throw up at the end of the day, is this a good time to stay in the stock even if you think this is a long term bet?Shah: Very much, because I am only looking at it this way that even in the downturn of the industry as Vishal pointed out the premium segment have been growing at 20-25 percent and that is where Diageo is focussing and now that Diageo is having a controlling stake in the company which earlier was not expected will go beyond that 50 percent so it is in a position to introduce new products and leverage the distribution network for which it bought United Spirits.Menaka: The stock is just Rs 2,400, where do you expect it to go?Shah: My target price is Rs 3,000; it is unchanged. I am maintaining that.Jajoo: I don’t think that over the next 15 to 18 months also the stock will breach the Rs 2,700 mark.Sajeet: Just to add there is a change in business model which is happening at USL. The second thing is today every fund manager is trying to see whether he should keep USL in his portfolio at least for the next three to six months because come next week it will be going off the derivates list and within next 15-20 days it will be into a trade to trade. So they won’t be able to trade much into it. So liquidity will dry up in USL for that. So there will be short term pressure on USL going forward.