Varun Beverage (VARBEV) 512

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1 Initiating Coverage Rating Matrix Rating : Buy Target : 590 Target Period : 12 months Potential Upside : 15% Key Financials Crore CY16 CY17E CY18E CY19E Revenue 3,852 4,360 4,900 5,460 EBITDA ,003 1,181 Net Profit EPS( ) Valuation Summary CY16 CY17E CY18E CY19E P/E Target P/E Div. Yield Mcap/Sales RoNW (%) RoCE (%) Stock Data Particular Amount Market Capitalization ( Crore) 9,334.4 Total Debt (CY16) ( Crore) 1,368.8 Cash and Investments (CY16) ( Crore) 65.7 EV ( Crore) 10, week H/L 573 / 340 Equity capital crore Face value 10 FII Holding (%) 12.8 DII Holding (%) 1.2 Price movement Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Research Analysts Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Share price ( ) Nifty 50 Sanjay Manyal Nov November 28, 2017 Varun Beverage (VARBEV) 512 Territory consolidation to spur growth Varun Beverage (VBL), a part of RJ Corp group, is the second largest PepsiCo franchisee globally (ex-us). VBL is engaged in the business of manufacturing and distributing PepsiCo s CSD and NCB products across licensed territories in India, Nepal, Sri Lanka, Morocco and Zambia. It enjoys end-to-end execution capabilities across the value chain and currently owns 22 production facilities, 74 depots, 2,024 vehicles, 469,500 visi-coolers and 1,378 distributors. In CY16, India business contributed 77% to total revenue while international business contributed the rest. Due to consolidation of newly acquired territories, new product launches and higher growth potential in operating regions, we expect VBL to report revenue CAGR of 12.4% in CY16-19E with EBITDA margin of 21.6% in CY19E. With huge growth potential in sight on account of a) low per capita soft drink consumption and b) increasing penetration through territory acquisition, we initiate coverage on VBL with a BUY recommendation at a target price of 590/share. Leveraging strong brand name of PepsiCo VBL enjoys over 25 years of strategic association with PepsiCo and today accounts for ~47% of PepsiCo s beverage sales volume in India (as on Q3CY17). In addition to India, it is present in five other countries - Nepal, Sri Lanka, Morocco, Zambia. With the strategic franchisee partnership with PepsiCo in licensed areas, VBL takes care of the demand delivery for PepsiCo while PepsiCo owns the trademark and takes care of demand creation through R&D and brand development. VBL s presence in low per capita soft drink consumption countries (e.g. 9.4 litre for India against world average of 91.9 litre), supported by strong brand name of PepsiCo provides VBL huge growth opportunity through a) penetration in existing markets and b) growth via additional territory acquisition from PepsiCo. Health consciousness among consumers to aid NCD growth India is witnessing a shift from carbonated soft drinks (CSD) to noncarbonated drinks (NCD) on account of increasing health consciousness among consumers. To tap this opportunity, PepsiCo is focused on innovation and launch of new drinks in the non-carbonated space. In the recent past, it has launched Masala Nimbooz, Tropicana Frutz, 7 Up Revive & Sting. We believe VBL is strongly placed with a extensive distribution channel to tap the upcoming opportunity in the NCD space. We expect NCD segment to clock revenue CAGR of 25.8% in CY16-19E (increase in revenue contribution from 7.4% in CY16 to 10.3% in CY19E). Strong proxy play for soft drink industry in India; initiate with BUY We expect the revenue and PAT to grow at a CAGR of 12.3% and 39.2%, respectively, in CY16-19E with an operating margin of 21.6% in CY19E. With the comfort of earnings visibility and expected improvement in return ratios, we initiate coverage on the stock with a BUY rating and a target price of 590/share. Exhibit 1: Varun Beverage key Financials (Consolidated) Particulars CY15 FY16 FY17 FY18E FY19E Net Sales ( Crore) 3, , , ,90 5,459.6 EBITDA ( Crore) , ,180.7 Net Profit ( Crore) EPS ( ) PE (x) EV/EBITDA (x) RoCE (%) RoE (%)

2 Shareholding pattern (as on Sep 2017) (%) Shareholding Pattern (%) Promoters 73.6 Institutional Investors 14.0 Others 12.4 Source: bseindia.com, ICICIdirect.com Research Institutional Holding Trend (%) % Q4CY16 Q1CY17 Q2CY17 Q3CY17 FII DII Source: bseindia.com, ICICIdirect.com Research Company background Varun Beverage (VBL), a part of the RJ Corp group (a diversified business conglomerate with interests in beverages, quick-service restaurants, dairy and healthcare) was promoted by Ravi Kant Jaipuria. The company was incorporated in 1995 and began commercial operations in VBL is the second largest PepsiCo franchisee for carbonated soft drinks (CSDs) and non-carbonated beverages (NCBs) in the world (ex-us) after Tingyi Cayman Island Holdings Corp of China. The company has 22 production facilities and 276 million cases (CY16) of annual sales volume. VBL is engaged in the business of manufacturing and distributing PepsiCo s CSD and NCB products across licensed territories in India, Nepal, Sri Lanka (including Ole brand), Morocco and Zambia (it exited the Mozambique business early this year given the small scale of business operation). The company enjoys end-to-end execution capabilities across the value chain and currently owns 22 production facilities, 74 depots, 2,024 vehicles, 469,500 visi-coolers and 1,378 distributors (578 in India and 800 in the international market) reaching ~1 million (mn) retail outlets (India). In CY16, India business contributed 77% to total revenue with international business contributing the rest. On account of new territory acquisition domestically and new region acquisition globally, the India business of VBL reported 18.4% volume CAGR in CY The international business clocked 20.4% volume CAGR in the same period. On a segmental basis, CSDs dominate revenue with 85.6% share as on CY16, followed by NCDs and packaged water with 7.4% and 7.0% contribution, respectively. Strong proxy play for soft drink industry growth supported by relationship with PepsiCo VBL enjoys over 25 years of strategic association with PepsiCo. Today the company accounts for 47% of PepsiCo s beverage sales volume in India (as on Q3CY17) and is present in five countries (Nepal, Sri Lanka, Morocco, Zambia, India), globally. With the strategic franchisee partnership with PepsiCo in licensed areas, VBL takes care of demand delivery for PepsiCo through manufacturing, distributing, in-outlet management and consumer push (at the sales point). PepsiCo is the trademark owner liable for demand creation through R&D and brand development. VBL has a 10-year agreement with PepsiCo with auto renewal. Further, it procures the key raw material, i.e. concentrate, from PepsiCo at a mutually agreed price (at start of each year). Also, to access brands, strong relationship with PepsiCo provides VBL access to best operational & manufacturing practices and experienced professionals. Exhibit 2: Symbiotic relationship with PepsiCo VBL Demand Delivery Investment in Production Facilities manufacturing plants Sales & Distribution Vehicles In-outlet Management Visi-Coolers Market Share Gains ConsumerPush Management PepsiCo Demand Creation Owner of Trademarks Investment in R&D Product &Packaging innovation Concentrate Supply Brand Development Consumer PullManagement Capitalising on strong brand name & diverse product portfolio VBL has successfully leveraged the diverse & strong product portfolio of PepsiCo over the years. This is reflected in the company s strong growth over the years. As per the agreement, VBL is licensed to use PepsiCo s brands. However, it has to pay a 5% royalty for using trademark Lehar comprising Aquafina (bottled water) and Evervess (club soda). Volume CAGR of CSDs, which includes brands Pepsi, Diet Pepsi, Seven-Up, Mirinda Orange, Mirinda Lemon, Mountain Dew, Seven-Up Nimbooz Masala Soda, Seven-Up Revive and Evervess, was 18.4%, followed by Page 2

3 Exhibit 3: Product portfolio NCDs (Tropicana Slice, Tropicana Frutz & Nimbooz). Packaged water (Aquafina) clocked highest volume CAGR at 32.1% over the same period. Fizzy* Juicy Packaged Water *Available in Glass bottles of 200 ml, 250 ml, 300 ml and 400 ml; PET bottles from 250 ml to 2250 ml; Cans of 250 ml and 330 ml and post-mix bags Exhibit 4: Licensed products and respective territories Licenced product Territories Pepsi India, Nepal, Sri Lanka, Morocco, Zambia Seven-Up India, Nepal, Sri Lanka, Morocco, Zambia Mountain Dew India, Nepal, Sri Lanka, Zambia Mirinda India, Nepal, Sri Lanka, Morocco, Zambia Evervess India, Nepal, Sri Lanka, Zambia Tropicana Slice India, Nepal Nimbooz India Tropicana Frutz India, Sri Lanka Aquafina India and Sri Lanka Page 3

4 Changing product mix in line with consumers preference CY19E CY18E CY17E CY16 CY % 20% 40% 60% 80% 100% Exhibit 5: Revenue to grow at 12.3% CAGR over CY16-19E 9.0 Carbonates NCD Packaged water Investment Rationale Healthy revenue growth in sight on account of territory consolidation VBL reported strong revenue CAGR of 22.8% in CY12-16, led by strong 19.4% volume CAGR and 3.3% blended realisation CAGR in the same period. This strong volume growth was due to various acquisitions done by the company, both in India and international markets. Segment wise, carbonates contributed 85.6% of total beverage sales whereas juices and bottled water contributed 7.4% and 7.0%, respectively, in CY16. Going forward, considering a) consolidation of newly acquired territories, b) growth opportunity in the international market (expected growth in per capita soft drink consumption in operational territories), c) new product launches from PepsiCo, mainly in the non-carbonated segment, we expect the revenue to grow at 12.3% CAGR in CY16-19E. We expect the revenue mix of the company to change in line with changing consumers preference towards healthy drinks CSDs at 81.2%, juices at 10.4% and packaged water at 8.4%. Also, we expect the revenue CAGR of the CSD segment in CY16-19E to moderate to 10.5%. However, juices and packaged water are expected to clock higher revenue CAGR of 25.8% and 19.5%, respectively, over the same period. Further, EBITDA has grown strongly at a CAGR of 36.7% in CY12-16 on backward integration, economies of scale and consolidation of new territories. The EBITDA margin has expanded 8 pps over the same period to 20.6% in CY16. Going forward, we factor in 14% EBITDA growth in CY16-19E led by a) some saving in freight cost post GST implementation, b) profitable international business on account of economies of scale, c) blended realisation growth (2% CAGR in CY16-19E) and d) commissioning of new PET bottle plant in Goa (further strengthening the backward integration of company). Additionally, with increasing share of NCDs, alone with aforementioned positives, we expect EBITDA per case to improve to 31.8 in CY19E from 28.8 in CY16. Exhibit 6: EBITDA to improve to 31.8/case* CY13 CY14 CY15 CY16 CY17E CY18E CY19E 5.0 Revenue ( crore) % growth CY13 CY14 CY15 CY16 CY17E CY18E CY19E ; *1 case = litre Capitalising on strong presence of PepsiCo brand in Indian market PepsiCo is the second largest player after Coca Cola in India with 31.1%, 26.4% and 11.6% volume share in carbonates, juices and bottled water, respectively. In value terms, it has 33.2%, 24.2% and 10.8% market share in the carbonates, juices and bottled water market, respectively. The total carbonates industry grew at 10.7% CAGR by volume in and is expected to grow at 6.8% CAGR in E. Additionally, North India is expected to grow faster compared to other regions both in volume and value terms during the same period, providing the company Page 4

5 strong growth potential as it has a strong presence in the region post acquisitions in With rising health consciousness and changing food habits, the juice industry has grown at a faster rate than carbonates at a volume CAGR of 21.6% and value CAGR of 26.3% in The industry is further expected to grow at a volume CAGR of 19.6% in E. Additionally, growing health consciousness has also driven the bottled water segment strongly at a volume CAGR of 25.4% and value CAGR of 31.2% in This segment is also likely to witness strong volume growth of 19.8% during CY16-21E. The strong foothold of the PepsiCo brand in these segments with a bright growth outlook and Varun s increasing contribution to PepsiCo s total soft drinks volume sales in India (~47% in Q3CY17 from 26.5% in CY11), positions the company strongly to increase volumes through increasing penetration. Exhibit 7: Market share details in India for CY15 (%) Volume Carbonates The Coca Cola Co Sprite Thums Up Coca-Cola Limca Fanta PepsiCo Inc Pepsi Up Mountain Dew Mirinda Evervess Others Packaged juices Maaza (The Coca-Cola Co) PepsiCo Inc Slice Tropicana Frooti (Parle Agro Pvt Ltd) Réal (Dabur India Ltd) Others Bottled water Bisleri (Parle Bisleri Ltd) Kinley (The Coca-Cola Co) Aquafina (PepsiCo Inc) Others Value The strong track record of VBL to grow in the acquired business and PepsiCo s intention to exit operations from India (strategy to become asset light) gives VBL a huge opportunity to acquire and expand further in Indian territory Strategic expansion through franchisee acquisition VBL has a track record of effectively utilising the retained earnings for inorganic growth through acquisition of new territories. For the past many years, acquisitions have been a key component of the company s growth strategy that has successfully resulted in accelerated revenue growth and profitability. The company has expanded its operations in India (mainly North and North East India) through the acquisition of additional territories from PepsiCo in the last few years. As on date, VBL accounts for ~47% of PepsiCo s sales in India (as on Q3CY17) and is the second largest PepsiCo franchisee in the world (ex-us). We believe the strong track record of VBL to grow in the acquired business and PepsiCo s intention to exit manufacturing operations from India (strategy to become asset light) gives VBL a huge opportunity to acquire and expand further in Indian territory. As per media reports, PepsiCo is planning to sell its Page 5

6 bottling operations to franchisees in the south and west, thereby divesting the beverage business nationally. Till February 2015, licensed sub-territories in India included Delhi, Rajasthan, West Bengal, Goa, Arunachal Pradesh, Assam, Meghalaya, Manipur, Mizoram, Nagaland, Tripura and certain designated parts of Madhya Pradesh (MP), Uttar Pradesh (UP), Uttarakhand, Haryana and Maharashtra. With effect from February 28, 2015, the company successfully acquired franchises for Punjab, Himachal Pradesh, Chandigarh and remaining parts of Haryana, Uttarakhand and UP. Acquisition of these franchisees resulted in a significant increase in sales volumes for the company resulting in an increase in its share from 26.5% in 2011 to 44.12% in 2015 to PepsiCo s total soft drinks volume sales in India VBL, in September 2017, acquired PepsiCo India s previously franchised territories of Odisha, parts of MP along with two manufacturing units at Cuttack, Bargarh and Bhopal on a slump sale basis at a derived EV of 170 crore Upon completion of the latest acquisition, VBL enjoyed a presence across 18 states and two union territories, which are highly under-penetrated and provide a huge opportunity for increasing volumes and gaining market share. This move is in line with the company s strategy to expand into contiguous territories to garner better operating leverage and asset utilisation through economies of scale. Earlier this year (February 2017), in the international market, VBL increased its stake in its subsidiary, Varun Beverages (Zambia) from 60% to 90% post the first year of encouraging operations. Also, the company is in the process of setting up a greenfield facility in Zimbabwe in anticipation of franchise rights being granted by PepsiCo. On the other side, it divested its 41% equity stake in Varun Beverages Mozambique, owing to small scale of operations and losses. The PepsiCo International agreements are automatically renewed for successive five year terms if neither party provides notice of termination. We are not factoring in any new territory acquisition in our estimates; Presence of PepsiCo in fastest growing beverage markets, viz. India, Nepal, Morocco, Sri Lanka (source: RHP), gives VBL a huge opportunity to penetrate newer markets that would be a key driver for volume growth. Acquisition criteria adopted by VBL: The consideration for the target territory/sub-territory shall be up to 1.0x revenue (net of GST) ± 20% The investment will be made such that consolidated debt/ebitda ratio remains under 3x post acquisition Acquisition of any territory/sub-territory shall be at an EV of under 6x o EV = Volume* EBITDA* 6 o Volume = last one year proforma volumes of target territory/sub-territory o EBITDA = VBL s last one year EBITDA per unit case Any M&A related to PepsiCo franchise in target territory/sub-territory shall be through VBL only Source: VBL Analyst Presentation Page 6

7 Exhibit 8: Contribution of international franchise (CY16) Exhibit 9: Volume CAGR expectation in key franchise market (%) Sri Lanka 5% Morocco 5% Zambia 3% Others 2% Nepal 8% India 77% India Nepal Sri Lanka Morocco Zambia ; * Exhibit 10: Acquisitions Year CY12 CY13 Description Goa and North-East sub-territories merged with VBL; subsidiaries holding franchisee for Nepal, Sri Lanka and Morocco territories consolidated with VBL Acquires territory of Delhi from PepsiCo Acquires PepsiCo business of Uttar Pradesh (excluding certain territories), Uttarakhand, Himachal Pradesh, Haryana (excluding certain territories) and Union territory of Chandigarh, Punjab CY15 Acquires entire shareholding of Arctic International Pvt Ltd in Varun Beverages Mozambique, Ltd Incorporates Varun Beverages (Zimbabwe) (Pvt) Ltd (VBZPL) CY16 Acquires 85% of shareholding of VBZPL CY17 New manufacturing unit set up in Hardoi, Lucknow Increases stake in Zambia subsidiary to 90% Acquires franchisee of Odisha and MP VBL owns 21 production facilities, 71 depots, 2,024 vehicles, 458,000 visi-coolers and 1,378 distributors (578 in India, 800 in international market) reaching ~ 1 mn retail outlets (India) Strategically located production units, integrated distribution network The company s production facilities across India are strategically located to serve the various target markets at lower transportation and distribution expenses enabling it to leverage economies of scale. It owns 22 production facilities, 74 depots, 2,024 vehicles, 469,500 visi-coolers and 1,378 distributors (578 in India and 800 in international market) reaching ~1 mn retail outlets (India). The company s estimated annual production capacity is crore litre (~to 60.6 crore unit cases) in India and 99.2 crore litre (~17.5 crore unit cases) in international production facilities. Currently, its peak season utilisation is at 70%. It can serve 50% more volumes with the existing capacity. The capacity along with proximity to market and well connected distribution network across India and international territories provide the company the benefits of a) effective market penetration and b) effectively response to competitive pressure and consumer demand in a short time. VBL distributes through a hub-and-spoke model either directly or through distributors. There are no wholesalers involved in the process. Additionally, to keep logistics costs under control, VBL prefers to distribute in a radius of 200 km. Page 7

8 Exhibit 11: VBL s presence Source: Analyst Presentation, ICICIdirect.com Research Exhibit 12: Volume and realisation growth Changing trend towards NCD consumption to be potential driver in future With the shift happening from carbonated soft drinks (CSD) to noncarbonated drinks (NCD) on account of health consciousness, PepsiCo is also focused on launching new drinks in the non-carbonated space. In the recent past, it has launched Masala Nimbooz, Tropicana Frutz (fruit juice in Lychee, Apple, Mango, Mix Fruit and Orange flavours) and 7 Up Revive (hydrotonic drink). To tap the fastest growing segment of juices (expected 26% value CAGR), PepsiCo is continuously investing in innovation. In line with the trend, we believe VBL is strongly placed with an extensive distribution channel to tap the upcoming opportunity. We expect the NCD segment to clock revenue CAGR of 25.8% supported by 18.3% volume CAGR and 6.3% realisation CAGR in CY16-19E. Further, the revenue contribution of NCDs in VBL s overall revenue, is thus, expected to increase form 7.4% in CY16 to 10.4% in CY19E. Exhibit 13: Sales growth of NCDs CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY13 CY14 CY15 CY16 CY17E CY18E CY19E Sales Volume (crore litres) Realization ( per litre) Sales Value ( crores) % Increase Lower per capita consumption of soft drinks to provide huge opportunity The soft drink market comprises primarily of carbonates, packaged juices or non-carbonated drinks (NCDs), packaged drinking water and ready-todrink (RTD) tea and coffee. The Indian soft drink market is highly under penetrated with per capita consumption of only 9.4 litre in 2015, much lower than the world average of 91.9 litre and vis-à-vis 367.5, and litre for Mexico, US and Germany. In India, there is a huge potential for the company to tap the under penetrated of soft drinks given the low Page 8

9 per capita consumption. The Indian soft drink industry has grown at 17% CAGR in volume terms in to 2391 mn cases ( 60,000 crore in 2016) and is estimated to clock 15.1% volume CAGR in E to 4839 mn cases. The bottled water category leads the volume market (47.3%) followed by CSDs (36.3%) while the rest is contributed by juices (15.6%) and others (0.8%) for However, in value terms, the carbonates category is the leader with 47.9% contribution, followed by juices and water with 25.1% and 23.1% contribution, respectively (for 2015). Over E, bottled water is expected to grow at 19.8%, followed by juices at 19.6%. However, due to increasing health consciousness, carbonates are expected to grow at a lower CAGR of 6.8% over the same period. However, we believe the under-penetrated market provides a huge opportunity in the CSD segment as well. Overall, we believe that on account of the strong brand name of PepsiCo and strong presence in all the categories provides VBL a huge opportunity to grow. Page 9

10 Soft drink industry The soft drink market primarily comprises carbonates, packaged juices or non-carbonated drinks (NCDs), packaged drinking water and ready-todrink tea and coffee. The Indian soft drink market is highly under penetrated with per capita consumption of only 9.4 litre in 2015, much lower than the world average of 91.9 litre and vis-à-vis 367.5, and litre for Mexico, US and Germany. The global soft drink industry has grown at a volume & value CAGR of 3.4% & 3.1%, respectively, over , with per capita consumption of 91.9 litre, led by developed countries. However, the per capita consumption of soft drinks in Asian and African countries is much lower than mature markets. Further, as per industry reports, the per capita soft drink consumption of mature markets is expected to decline. In contrast, countries where VBL is present i.e. India, Sri Lanka, Zambia, Morocco and Nepal are forecast to grow at a much faster rate than the world average of 2.3% in E. Exhibit 14: Per capita consumption of soft drinks (in litre) Exhibit 15: Volume CAGR estimate over E (%) Mexico USA Germany Brazil China Morocco Zimbabwe Mozambique Nepal India Zambia Sri Lanka India Nepal Sri Lanka Morocco Zambia Indian soft drink Industry estimated to clock 15% volume CAGR The Indian soft drink industry has grown at 17.0% CAGR in volume terms in to 2391 mn cases ( 60,000 crore) and is estimated to clock 15.1% volume CAGR in E to 4839 mn cases. The three major constituent of the soft drink market i.e. CSD, NCD and bottled water together form over 99% of the market volume. Exhibit 16: Soft drink volumes to grow at 15.1% CAGR over E (mn cases*) E 2021E ; 1 case = litre Page 10

11 In volume terms, the bottled water category leads the market (47.3%, 1132 mn cases) followed by CSDs (36.3%, 868 mn cases) while the rest is contributed by juices (15.6%, 373 mn cases) and others (0.8%, 18 mn cases) for However, in value terms, the carbonates category is the leader with 47.9% contribution, followed by juices and water with 25.1% and 23.1% contribution, respectively (for 2015). Over E, bottled water is expected to grow at 19.8%, followed by juices at 19.6%. However, due to increasing health consciousness, carbonates are expected to grow at a lower CAGR of 6.8% over the same period. Others (concentrates, ready-to-drink tea/coffee & sports and energy drinks) are in a nascent stage with negligible share of overall volumes in Exhibit 17: Segmental contribution bottled water leads volume (%) Carbonates Juice Bottled water Others* P ; *Concentrate, RTD tea/coffee, energy drinks Exhibit 18: Volume CAGR estimate over E (%) Carbonates Juice Bottled water Others* Total Urban India contributed 75.7% of total soft drink volume sales while rural contributed the remaining 24.3%. With increasing awareness and brand loyalty in rural areas, companies are focusing on penetrating the rural markets In terms of distribution, channels, the soft drinks market is divided into off-trade (sales at retail outlets like grocery stores, hypermarkets, super markets, etc) and on-trade (sales at food service outlets, restaurants, bars, clubs, etc). The on-trade channels generally have a price advantage as they charge higher prices for the same product. However, as per industry reports, over the next five years, off-trade is estimated to grow at a faster rate due to their easy accessibility and penetration. Further, North & West India contribute the most to soft drink sales with 34% contribution each in volume terms supported by increasing disposable income among the middle class, coupled with rapid urbanisation and changing lifestyles. South India contributes 23%. This region witnessed more sale of juices and energy drinks due to health conscious customers. However, on account of lower disposable income and less priority by leading soft drink players (due to less favourable income group and difficulty in transportation), East & North East contributed only 9% to total soft drink sales volumes. Exhibit 19: On-trade & off-trade contribution in volume & value (%) Exhibit 20: Region-wise sales volume contribution West 34% East and Northeast 9% North 34% 0 Volume Value Off trade On trade South 23% Page 11

12 Exhibit 21: Demand drivers and concerns for growth for various segments Segment Volume CAGR* Demand drivers Concerns Carbonates 6.8 Widespread availability of carbonates in all retail channels Low advertisement reach and a lack of cold storage facilities in rural regions Sustainability to be used as mixers with alcoholic drinks drive lemonade/lime based carbonates Awareness of ill effects of sugar-based carbonates among consumers Juices 16.9 Rising health consciousness and changing food habits of consumers Availability of affordable fresh juice in local kiosks may restrict conumers to move to packaged branded juices, which contain preservatives Bottled water 19.8 Lack of access to safe drinking water in many regions ; * CAGR over E Increasing health consciousness among consumers Page 12

13 Competitive landscape of Indian soft drink industry The Indian soft drink industry is dominated by two MNCs PepsiCo and Coca Cola in both carbonates and juice categories. However, bottled water is dominated by home grown Parle Bisleri. In the carbonates segment, Coca Cola dominates the market with 57% market share with five brands (Sprite, Thums Up, Coca Cola, Limca and Fanta). Pepsi is the second largest player with 31% market share (Pepsi, 7 Up, Mountain Dew, Mirinda and Evervess) Exhibit 22: Market share of various brands in carbonates segment Evervess* 1% Mirinda* 6% Fanta 6% Mountain Dew* 6% 7 Up* 6% Limca 8% Others 12% Coca Cola 8% Sprite 19% Pepsi* 12% Thums Up 16% ; * Pepsi Brands Exhibit 23: Juice segment Coca Cola leads market Others 20% Pepsi (Tropicana & Slice) 26% Juice segment is dominated by Coca Cola s Maaza (31% market share), followed by Pepsi s Slice & Tropicana (26%). Parle s Frooti & Dabur s Real enjoy market share of 15.1% and 8.4% (2015) Exhibit 24: Bottled water segment Parle Bisleri dominates market Parle Bisleri 25% Dabur 8% Parle Agro 15% Coca Cola 31% Others 50% PepsiCo 12% Coca cola 13% Page 13

14 Exhibit 25: Market share trend for PepsiCo in carbonated segment (%) PepsiCo s stature in Indian soft drink market PepsiCo is the second largest brand in the Indian soft drink market with 31.1% volume market share in carbonated drinks and 26.4% volume market share in the juice segment. In the bottled water segment, it is No. 3 player with 11.6% market share. It operates in India with nine company-owned manufacturing facilities in the south & west PepsiCo enjoys 31.1% market share in the carbonated drinks segment at 8336 crore (2015). In terms of volume sales, it has grown at 8.6% CAGR over at 1424 mn litre Exhibit 26: Market share of key for 2015 (%) Others 12% PepsiCo 31% Pepsi Coca Cola 57% Exhibit 27: Market share trend for PepsiCo in juice segment (%) In the juice category, PepsiCo has two brands, Slice and Tropicana. Collectively, they have 26.4% volume market share, only next to Coca Cola s Maaza (30.1% volume market share). Slice (the mango based drink enjoyed a market share of 20.9% while Tropicana had a market share of 5.5% in 2015 In the bottled water category, PepsiCo s Aquafina is the No. 3 player in volume terms with 11.6% market share. Parle Bisleri dominated this category with 25.3% market share (as on 2015), followed by Coca Cola s Kinley that has 13% market share Exhibit 28: Market share trend for PepsiCo in bottled water (%) Pepsi (Tropicana & Slice) Aquafina (PepsiCo Inc) With the shift happening from carbonated drinks to non-carbonated drinks on account of health consciousness, PepsiCo is also focused on launching new drinks in the non-carbonated space. In the recent past, it has launched Masala Nimbooz, Tropicana Frutz (fruit juice in Lychee, Apple, Mango, Mix Fruit and Orange flavours) and 7 Up Revive (Hydrotonic Drink). In order to tap the fastest growing segment of juices (expected value CAGR of 26%), PepsiCo is continuously investing in innovation Page 14

15 Financials Territory acquisition to continue accelerating company s revenue VBL reported a strong revenue CAGR of 22.8% in CY12-16, led by strong 19.4% volume CAGR and 3.3% blended realisation CAGR over the same period. This strong volume growth was on account of various acquisitions done by the company, both in India as well as international markets. It acquired part of the Delhi sub-territory in CY13 and large size of neighbouring sub-territories in CY15 from PepsiCo and also acquired Mozambique and Zambia in CY16. Segment wise, carbonates contributed 85.6% of total beverage sales whereas juices and bottled water contributed 7.4% and 7.0%, respectively, in CY16. Exhibit 29: Revenue contribution (%) Exhibit 30: Geographical mix for CY16 (%) Zambia Morocco 3% 5% Sri Lanka 5% Nepal 8% Others 2% CY12 CY13 CY14 CY15 CY16 India International India 77% Going forward, considering a) consolidation of newly acquired territories, b) growth opportunity in the international market (expected growth in per capita soft drink consumption in the operational territories) and c) new product launches from PepsiCo, mainly in the non-carbonated segment, we expect revenues to grow at a CAGR of 12.3% over CY16-19E. Exhibit 31: Revenue Exhibit 32: Volume & realisation growth (%) CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY13 CY14 CY15 CY16 CY17E CY18E CY19E Revenue ( crore) % growth Volume growth(%) Realisation growth(%) Carbonates to dominate revenues but share of NCDs & water to increase On a segmental basis, the carbonates segment has been dominating revenues of VBL at ~86%. Mountain Dew is the star of the segment clocking fastest volume CAGR of 33.4% in CY12-16, largely driven by the consumption trend of non-cola carbonates. PepsiCo has been leveraging the trend and recently launched Masala Nimbooz in the non-cola carbonate segment, which has been received well by customers. VBL along with PepsiCo is involved in developing more such products. Page 15

16 Overall, the carbonate segment has clocked revenue CAGR of 23.4% in CY12-16 led by 18.4% volume growth. Exhibit 33: Break-up of CSD segment in volume terms (CY16) Exhibit 34: Mountain Dew fastest growing brand (% CAGR - CY12-16) Mirinda 18% Other CSDs 4% Pepsi 22% Seven-Up 10% Mountain Dew 46% Pepsi Seven-Up Mountain Dew Mirinda Other CSDs Going forward, we expect the segment to continue its domination in the revenue contribution. However, we expect the non-cola carbonates contribution to increase. We estimate 10.5% revenue growth from the CSD segment in CY16-19E with a volume CAGR of 8.3%. With increasing health consciousness among consumers for healthy drinks and companies adapting the same in their offerings, we expect NCDs and drinking water segments to clock higher volume growth rate. The NCD segment is expected to clock revenue CAGR of 25.8% supported by 18.3% volume CAGR and 6.3% realisation CAGR in CY16-19E. Similarly, the packaged water segment is expected to report 19.5% revenue CAGR in CY16-19E supported mainly by 18.3% volume growth. We do not estimate any substantial increase in realisation for the category. However, with increasing share of packaged water in the mix, there would be marginal saving on the raw material cost and increase in royalty. Exhibit 35: Volume contribution of NCD & water to increase (%) Exhibit 36: Value contribution of NCD & water to increase (%) CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY13 CY14 CY15 CY16 CY17E CY18E CY19E Carbonated Products NCD Drinking Water Carbonates NCD Drinking Water GST impact: The impact of GST implementation on the company is neutral as it is similar to what VBL was paying under the excise regime. Exhibit 37: Market share of various brands in carbonates segment Segment Excise GST Carbonates 38-39% 28% + 12% cess Juice 12% 12% Water 24% 18% Page 16

17 Exhibit 38: EBITDA to grow stronger EBITDA margin to remain range bound, going forward VBL s EBITDA has grown strongly at 36.7% CAGR in CY12-16 on the back of backward integration, economies of scale and consolidation of new territories. Its EBITDA margin has expanded 8 pps over the same period to 20.6% in CY16. Going forward, we factor in EBITDA growth of 14.1% in CY16-19E led by a) some saving in freight cost post GST implementation, b) profitable international business on account of economies of scale, c) softness in sugar prices due to expected all time high sugar production of million tonnes in and d) commissioning of new PET bottle plant in Goa (further strengthening the backward integration of company). Additionally, VBL has divested its stake in the loss making small scale business in Mozambique. We believe that would aid to profitability. For CY17E, we estimate some decline in the EBITDA margin to 19.7% on account of higher sugar prices in first half on CY17. However, with cooling down of the same and benefit realisation of GST in freight cost, we expect the margin to be at 20.5% and 21.6% in CY18E and CY19E, respectively. Additionally, with increasing share of NCDs, along with aforementioned positives, we expect EBITDA per case to improve to 31.8 in CY19E from 28.8 in CY16. Exhibit 39: EBITDA margin to expand going forward 1,50 1, , , CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY13 CY14 CY15 CY16 CY17E CY18E CY19E EBITDA ( crore) % growth Raw material as % of sales EBITDA margin (%) Raw material (%) Others* 32% Pet chips 9% Sugar 35% Concentrate 24% ; * includes filter paper, CO2, Pulp, Label, bottle cleaner etc. Key costs for VBL a. Concentrate It formed ~24% of total raw material for the company for CY16. VBL buys concentrate form PepsiCo India at a mutually decided price (at the beginning of every year) taking into account the net realisation for the company. Additionally, at times, PepsiCo provides discount on the concentrate price, which is effectively neutral. The discount to VBL on concentrate price is more in the competitive market scenario. VBL needs to pass it on in promotions and discounts in the supply chain b. Sugar Sugar was the largest component of total raw material for VBL at ~35%. VBL procures it directly from the local suppliers who meet the quality standards of PepsiCo. VBL keeps a sugar inventory of about six months c. Advertisement VBL takes care of the local area and store level marketing. It was 1.7% of sales for CY16. All other bulk brand building advertisement is done by PepsiCo d. Royalty VBL pays PepsiCo royalty on the use of brand Lehar and sells two products under it Aquafina (packaged water) and Everess (soda) e. Freight cost VBL has strategically placed manufacturing units, which aid it to serve the neighbouring areas. As a strategy for cost effectiveness, the company prefers to supply products over a radius of 200 km. For CY16, VBL s freight cost was at 5.3% of sales. With GST coming in, and acquisition of new territory, VBL would be able to rationalise the freight cost Page 17

18 Exhibit 40: Sugar cost hovering at higher cost ( /quintal) 4500 Exhibit 41: PET chips price pegged at crude cost ($/barrel) Nov-15 Feb-16 With the expected all time high sugar production in , sugar prices have started falling from oct onwards. Any substaintial dip in future could benefit VBL as sugar remains biggest RM cost May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 Nov Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Jul-17 Nov-17 Exhibit 42: Interest cost Interest cost reduction to directly flow to company s profitability The company s debt peaked when it acquired new territories in India and globally in H1CY16. The company had a significant debt of 2,138 crore on its books (H1CY16) ( 600 crore interest free debt from PepsiCo). Post a successful IPO, VBL s debt came down to crore (including short-term and long term). Debt/equity for the company successfully came down to 0.7x in CY16. We expect it to further decline to 0.5x by CY19E. Led by healthy EBITDA growth and decline in interest outgo, we expect VBL to report PAT CAGR of 39.2% in CY16-19E. Additionally, with an improvement in profitability, debt reduction and improving working capital management, return ratios of the company are expected to improve significantly. We expect the RoE and RoCE to increase to 16.9% and 18.9% in CY19E from 8.0% and 13.2% in CY16, respectively. Exhibit 43: Declining debt/equity CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY13 CY14 CY15 CY16 CY17E CY18E CY19E Interest ( crore) Debt/Equity (x) ; * Interest coverage (x) Lower interest cost to drive profitability The company s debt peaked when it acquired new territories in India and globally. The company had a significant debt of 2,138 crore on its books (H1CY16) ( 600 crore interest free debt from PepsiCo). Post a successful IPO, VBL s debt came down to crore (including short-term and long term). Debt/equity for the company successfully came down to 0.7x in CY16. We expect it to further decline to 0.5x by CY19E. Led by healthy EBITDA growth and decline in the interest outgo, we expect VBL to report PAT CAGR of 39.2% in CY16-19E. Page 18

19 Exhibit 44: Supported by lower interest outgo, profit to grow at 34.7% CAGR over CY16-19E CY12 CY13 CY14 CY15 CY16 CY17E CY18E CY19E PAT ( crore) ; * Pepsi Brands With investment slowing down, FCF to increase substantially VBL has incurred a total capex of ~ 2500 crore in CY13-16 to purchase new territories in India and globally. It has acquired two new territories in India (parts of MP, Odisha) for an amount of 170 crore. Going forward, we expect the company to consolidate the operations. Hence, we do not factor in any new acquisition. Thus, we estimate a nominal capex of 200 crore each for CY18E and CY19E. On account of improving operating profitability and lower capex, we expect the FCF of the company to grow significantly for the same period Exhibit 45: Capex ( crore) Exhibit 46: FCF ( crore) CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY12 CY13 CY14 CY15 CY16 CY17E CY18E CY19E With a) improvement in profitability, b) debt reduction, c) improving working capital management and d) improvement in asset turnover, the return ratios for the company would improve significantly. We expect the RoE and RoCE to increase to 16.9% and 18.9% in CY19E from 8.0% and 13.2% in CY16, respectively Page 19

20 Exhibit 47: Asset turnover Exhibit 48: Return ratios to improve, going forward CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY13 CY14 CY15 CY16 CY17E CY18E CY19E Asset turnover (x) ROE ROCE Page 20

21 Risk & concerns Relationship with PepsiCo: Termination of agreements, or less favourable renewal terms, if any, could adversely affect profitability of the company Inability to integrate newly acquired operations: VBL has constantly grown its revenues by acquiring new territories and excelling in integrating the businesses. Any inability to do so in future with new acquisitions would be a deterrent to the company s revenue Price of concentrate: Concentrate, the key raw material, forms ~24% of total raw material requirement of the company. As per the agreement, PepsiCo has the right to unilaterally determine the price. However, so far, it is being mutually decided at the beginning of each year. If PepsiCo decides to exercise the right in an adverse manner, it could affect the future financial performance of the company Change in consumer s preferences: In CY16, the carbonate category contributed ~86% to VBL s revenue. However, a shift was visible in the consumer s preference towards healthy drinks. Any failure to adapt to changing consumer s preferences may impact the financials. PepsiCo is continuously doing R&D to come up with new launches, especially in the NCD segment Seasonality of business: April-June is the most important quarter for VBL s businesses as ~47% of sales come in that quarter, followed by July-September contributing ~23% of the business. Any unfavourable weather change i.e. short summer season or heavy rainy season, would impact the company s performance Exhibit 49: Seasonality plays important role quarterly contribution (%) Q1 Q2 Q3 Q4 3 Volume EBITDA ; Inability to come up with new launches to keep up with competition, especially in NCD segment: In the carbonate segment, PepsiCo s major competitor is Coca Cola. However, in the NCD, VBL competes with regional players as well as big FMCG companies dealing in juices. To keep up with the competition, PepsiCo needs to come up with new launches at regular intervals to keep consumers interested Increase in royalty: At present, VBL only pays royalty for usage of the Lehar brand while PepsiCo is entitled to revise it from time to time. Currently, it is 0.6% of total sales. In case PepsiCo revises it significantly or amends the clauses and puts royalty charges on other brands as well, then it would be negative for VBL Page 21

22 Valuation We believe that with consolidation of acquired territories, both in India as well as globally, VBL would be able to increase its footprint. Hence, the company would be able to improve the penetration. Supported by a) consolidation of newly acquired territories, b) growth opportunity in the international market, c) new product launches from PepsiCo, mainly in the non-carbonated segment, we expect revenues to grow at 12.3% CAGR in CY16-19E with an operating margin of 21.6% in CY19E. Exhibit 50: One year forward Price to Earnings band Exhibit 51: One year forward EV / EBITDA band Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Share Price ( ) 25x 30x 35x 40x Source: Company, ICICIdirect.com, Research Source: Company, ICICIdirect.com, Research 8x 10x 11x 13x EV Though there is no direct competitor to Varun Beverage in the Indian listed space, globally, there are some listed bottling plants exclusively manufacturing for Coca Cola or Pepsi. These bottling companies with return ratios between 5% and 12% are trading at 8-10x CY19E EV/EBITDA. We believe VBL with improving operating margins, limited capex requirement and robust free cash flow would witness an improvement in RoCE & RoNW to 18.9% & 16.9%, respectively, in CY19. Considering the higher return ratios compared to its peers, we believe VBL should command a premium to its global competitors. With the comfort of earnings visibility and expected improvement in return ratios, we value the stock at 10x CY19 enterprise value to EBITDA to arrive at a target price of 590 per share. We initiate coverage on VBL with a BUY recommendation. Exhibit 52: Global Peer Comparison Market Cap Operating margins (%) PE (x) EV / EBITDA (x) RoNW(%) RoCE (%) (US $ m) CY17 CY18 CY19 CY17 CY18 CY19 CY17 CY18 CY19 CY17 CY18 CY19 CY17 CY18 CY19 Coca-Cola Femsa Arca Continetal Coca-Cola Embonor Coca-Cola Icecek Varun Beverage Page 22

23 Financial Summary Exhibit 53: Income statement (Consolidated) ( crore) CY16 CY17E CY18E CY19E Total operating Income Growth (%) Raw Material Expenses Employee Expenses Marketing Expenses Other expenses Total Operating Expenditure EBITDA , ,180.7 Growth (%) Depreciation Interest Other Income PBT Exceptional item Total Tax Minority interest 11.1 Profit from Associates PAT Growth (%) EPS ( ) Exhibit 54: Balance sheet (Consolidated) ( crore) (Year-end March) CY16 CY17E CY18E CY19E Liabilities Equity Capital Reserve and Surplus Total Shareholders funds LT Borrowings & Provisions Deferred Tax Liability Others Non-current Liabilities Total Liabilities Assets Gross Block 4, , , ,797.7 Less: Acc Depreciation 1, , , ,576.3 Net Block 3, , , ,221.4 Capital WIP Net Intangible Assets Non-current Investments Goodwill Current Assets Inventory Debtors Loans and Advances Other Current Assets Cash Deferred Tax Assests Current Liabilities Creditors Provisions Short term debt & other CL 1, , , ,303.9 Application of Funds 3, , , ,913.1 Page 23

24 Exhibit 55: Cash flow statement (Consolidated) ( crore) (Year-end March) CY16 CY17E CY18E CY19E Profit After Tax Add: Depreciation (Inc)/dec in Current Assets Inc/(dec) in CL and Provisions CF from operating activities (Inc)/dec in Investments 35.0 (Inc)/dec in LT loans & advances (Inc)/dec in Fixed Assets Others CF from investing activities -1, Issue/(Buy back) of Equity Inc/(dec) in loan funds Dividend paid & dividend tax Others CF from financing activities Net Cash flow Opening Cash Other Bank balance Closing Cash Source: ICICIdirect.com Research Exhibit 56: Ratio analysis (Year-end March) CY16 CY17E CY18E CY19E Per share data ( ) EPS Cash EPS BV DPS Cash Per Share Operating Ratios (%) EBITDA Margin PBT / Total Operating income PAT Margin Inventory days Debtor days Creditor days Return Ratios (%) RoE RoCE Valuation Ratios (x) P/E EV / EBITDA EV / Net Sales Market Cap / Sales Price to Book Value Solvency Ratios Debt/EBITDA Debt / Equity Current Ratio Quick Ratio Page 24

25 Exhibit 57: VBL s business model end-to-end execution capabilities Annexure I Business Model Exhibit 58: Manufacturing process Page 25

26 Exhibit 59: VBL s key milestones Annexure II Company s milestones Bottling & Trademark License Agreement with PepsiCo through a group Company in Varun Beverages Ltd (VBL) incorporated as Public Ltd company in Commenced operations in Noida in 1995 & Jaipur in Acquired existing operations at Nepal in Commenced operations in Alwar, Jodhpur and Kosi in Expanded into international territories Sri Lanka and Morocco - Investment by Standard Chartered PE (2011 & 2012) - Consolidated territories held by various companies into VBL (Goa, North East, Sri Lanka, Nepal & Morocco) - Acquired the business of manufacturing and marketing of soft drink beverages in Delhi, India in Presence in 15 states and a union territory sales volume increased to million cases - Investment of 4,500 mn by promoter group in Acquired PepsiCo s India sub-territories in Uttar Pradesh, Uttarakhand, Himachal Pradesh, Haryana, Punjab and Chandigarh in Investment by AION Capital in Incorporated Varun Beverages (Zimbabwe) Pvt. Ltd - Sales volume increased to million cases - Acquired shareholding from Arctic International Pvt Ltd. in Varun Beverages (Zambia) (60%) & Varun Beverages Mozambique (51%) - VBL's shares got listed in NSE and BSE - Acquired two co-packing facilities located at Phillaur (Punjab) and Satharia (Uttar Pradesh) for operational efficiencies - Established new production facility in Goa - Acquired franchisee rights in the state of Madhya Pradesh and Odhisa (Sep 2017) Page 26

27 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more; Pankaj Pandey Head Research ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai Page 27

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