Varun Beverages Rating: Add: Strong volumes for company in Q4CY20

Though peak quarter (Q2CY20) was impacted by lockdown, Varun has managed to arrest organic volume decline in CY20 at 20.8%. Recovery in economy and higher in-home consumption were key reasons for strong volumes in Q4CY20. Three pointers: (i) We believe when the business activity returns to normalcy, some consumers will still continue with higher in-home consumption.

This opens up new window of beverage consumption; (ii) Varun has initiated multiple cost-saving programmes and some of the savings are likely to be structural in nature; and (iii) the company has introduced Mountain Dew ICE, lemon fruit juice based drink in Feb’21. It competes in large market of lime and lemon based drinks (~600 mn cases p.a.). We model Varun to report PAT CAGR of 53.9% over CY20-22 with improving RoE. Maintain Add with TP of Rs 1,015 (33x CY22e).

Q4CY20 results: Varun reported revenue and Ebitda growth of 9.1% and 48.8%, respectively. However, adjusted PAT declined 86.6%. Volume growth was 5.7%. The company has managed to report volume decline of 9.5% (organic 20.8%) in CY20 even after its peak quarter Q2CY20 was impacted by Covid-led lockdown. Gross margins expanded 470bps due to change in revenue mix and lower input costs. Ebitda margin was up 350bps due to cost-saving initiatives.

Higher in-home consumption to drive growth: While out-of-home consumption is still lower, there is increase in in-home consumption of CSD. With re-opening of markets and transit points such as railway stations, bus stations, there is revival in out-of-home consumption. With better out-of-home consumption, rising in-home consumption will provide another growth opportunity in CY21-22.

Launch of Mountain Dew ICE: Varun has introduced a new variant as Mountain Dew Ice in Feb’21. It is lemon fruit juice based drink and is introduced in 250ml PET and 650ml PET SKUs. Lime and Lemon based drink is a large market with annual sales of ~600 mn cases. Mountain Dew ICE will have GST rate of 12% compared to 40% for carbonated soft drinks.

Rising share of PET bottles to save costs: Consumers are preferring to buy PET bottles instead of glass bottles as it is relatively safer. Hence, the share of PET bottles is rising. As company has already contracted the supplies of PET bottles for CY21, it does not expect material inflation even if crude oil prices increase. We expect company’s costs to be lower with higher share of PET bottles.

Maintain ADD: We model Varun to report revenue and PAT CAGRs of 25.4% and 53.9%, respectively, over CY20-CY22e. Varun continues to benefit from its relationship with PepsiCo, pan-India distribution, backward integration, and increased in-home consumption. Maintain Add with DCF-based unchanged TP of Rs 1,015 (33x CY22e). Key downside risks are sharp increase in competitive pressure and increase in raw material prices.