Varun Beverages Rating: Buy- CY22 likely to be a good year for firm

After missing the peak summer season due to Covid-19, we expect better trends in 2022 for Varun Beverages, the PepsiCo bottler. While Covid continues to disrupt, a likely stability by March would help VBL to see a strong season, along with share gains in south & west (acquired territory). Balance sheet would continue to deleverage, RoE is set to expand to c.24% by CY23 and we forecast c.40% CY21-23 EPS CAGR. We retain High Conviction Buy with Rs 1,215 PT (+45%).

Covid disruption: VBL was among the most impacted companies in our coverage by Covid-19 disruption due to higher out-of-home consumption along with the timing of restrictions during the peak season (Apr-May) in CY20 as well as CY21. Both years saw a strong H2 recovery, despite the lost sale during the peak season.

Pick-up in CY22: Covid related restrictions will likely weigh during Jan/Feb, but we expect a strong pick-up from March which marks the start of busy season for VBL. Assuming no major disruption during season, CY22 could see a strong season, and we forecast VBL to report >20% volume growth in India.

Distribution: Distribution expansion was impacted in CY20 (& H1CY21). VBL added c.25k visi-coolers in CY20 and we expect this to accelerate to c.40k p.a. going ahead. Distribution expansion is an opportunity, especially in South & West, which contributes a third to the overall 800k coolers, providing strong growth headroom even while existing territory also presents this opportunity.

South share gain: VBL acquired the south & west territory from PepsiCo in May-19. Our checks indicate PepsiCo lost market share in the territory in the preceding few years. VBL, post acquisition, was expected to focus on the execution driving market share gains. However, curbs in the past two years delayed the share gain story, which should happen now, in our view.

Better shielded against rural: Weak rural demand has emerged as a major near-term concern for FMCG companies. With only 30% of its revenues coming from rural, VBL is better placed.

Margins: While RM inflation has been a challenge for the sector, VBL has managed it well and saw just 50bps y-o-y margin decline in the September quarter. Initiatives such as strategic sourcing, packaging interventions should continue to help, and we expect CY22 margins to expand back to c.20%.

Beyond CSD: Among the new launches, energy drink brand, Sting continues to ramp up well and already contributes c.5% to India volumes. Our checks also indicate the brand has been helping drive the portfolio penetration in several places, a key positive.

High Conviction BUY: We forecast VBL to report c.22% Ebitda and c.40% EPS Cagr over CY22-24e, which is the strongest growth in our coverage. We maintain a high conviction Buy on stock.