Price cuts may hurt USL's operating margins: Espirito Santo

Also read: SC's decision on USL-Diageo deal slightly positive: Angel

Below is the interview of Nitin Mathur of Espirito Santo with Reema Tendulkar and Ekta Batra on CNBC-TV18.

Reema: We understand that USL has cut prices for a couple of its spirits by 5 to 15 percent in a couple of states. How would this impact the total revenues? Do you expect volumes to go up because pricing has come down or net-net do you think it will have a negative impact on the revenues?

A: Surely we have seen volumes impact whenever these levels of price cuts have been implemented by any FMCG player. So, even in alcoholic beverages we would not be surprised to see some volume uptick. However what it means for operating margins expansion is that the speed it was building would probably not be the case now, because the biggest driver for operating margins expansion is the gross margins expansion, which is clearly not going to be the case right now.

For us what it means is essentially we were actually very below street estimates. We were maintaining a fair value of Rs 1,500 on USL, hence there will not be any material change to our estimates for the time being.

Ekta: What do you think has resulted in the cut that they have taken? What has taken place in the past when they have taken price cuts on two of their main products?

A: Clearly volumes impact as I mentioned earlier has been the case. From the strategy perspective this looks like a change of heart from what Diageo and USL management has actually focused on earlier. We have been arguing with our clients that economies of scale do not exist in this business hence focus has to be volumes as well to utilise the existing capacities.

So clearly from a strategy perspective we think it makes sense to focus more on volumes, however, what the street was factoring is probably more focus on gross margins expansions which is not going to be the case.

Reema: What would your margin assumptions be? Do you think that it is just going to takeaway the possibility of margin expansion or it might actually hurt margins and it could come down?

A: We were building up just 100 bps of margin expansion going into next three years and I believe that is the case right now because it is very early to decide on what is the volume impact going to be like.

Ekta: Is there a possible loss of market share that you would be assuming for USL considering the cut that they have taken?

A: What we saw in last few months is that other players in the industry were actually gaining market share because USL was actually vacating its focus on some of the mass market of whiskey, but clearly the things have changed suddenly. This move was quite unexpected. It caught us by surprise as well.

Regular whiskey segment was anyway facing price cuts and we are actually slightly concerned that this is actually spreading to prestige and premium segment whiskey as well. So it really depends what other players are actually going to do in terms of price cuts or price increases but that is a significant development from the industry-wise phenomena I would say.