United Spirits: Volume growth under pressure

United Spirits, the nation’s largest spirits maker, has been on investors’ radar for some time now. The stock has gained over 30% in the past three months due to expectations of strong synergies after its deal with the UK-based Diageo.

While Diageo’s acquisition of a controlling stake in United Spirits last November is likely to benefit the company in the long run, the operating woes in the near term will impact its financial performance.

Its March quarter results continued to show pressure on volumes due to a lower offtake in Tamil Nadu. This, together with volatile prices of extra-neutral alcohol, will limit the extent of revenue growth and improvement in profitability.

United Spirits' volume growth has slowed since the December 2011 quarter following a shift in the policy of spirits distribution in the southern state of Tamil Nadu.

The state’s contribution was estimated to be over 5% to total sales volumes before the change in the policy.

After the new policy was implemented, the growth in volumes fell to less than 5% from above 10% earlier. During FY13, volumes grew by 3%. The company has lost 13% market share in Tamil Nadu so far with a 15% drop in volumes in FY13 over and above the 22% fall in the previous year.

The management does not expect any major changes in the scenario in the near term. This means the overall volume growth may be under pressure even if the company improves volumes of its strategic brands.

On the positive side, the company is on course to gradually improve profitability.

Even though the FY13 operating margin fell 50 basis points to 11.2%, margin for the fourth quarter expanded by 90 basis points to 10.3%.

Besides, interest outgo reduced to Rs 157 crore during the March quarter compared with Rs 163.6 crore a year ago.

The volatility in the price of extra-neutral alcohol, a major input, will be crucial for the operating profitability of the company in the coming quarters apart from the growth in sales volumes.

The company reported net loss for FY13 due to higher foreign exchange loss. Hence, the price-to-earnings ratio will not be meaningful to evaluate the stock. It has increased substantially in the past three months on likely synergies from the Diageo deal.

But, investors need to wait to see signs of major improvement in the company’s performance before making fresh investments.