India Equity Research Small & Mid Cap March 30, 2017 Initiating Coverage

Transcription

1 Radico Khaitan India Equity Research Small & Mid Cap March 30, 2017 Initiating Coverage Emkay Your success is our success Leading alcohol beverage stock at 13.3x PER CMP Target Price Rs135 Rs202 Rating Upside BUY 50.0 % We initiate coverage on India s fourth largest spirits company, RDCK with a BUY rating and TP of Rs202. RDCK has transformed itself from a bulk/country liquor manufacturer to a branded spirits manufacturer. We are positive on RDCK s long-term potential given 1) its brand equity which supports high margins, 2) moving up the value chain with premium branding of new product launches, 3) strong cash flow generation resulting in debt reduction, and 4) undemanding valuations at 13.3x PER FY19E (46% discount to comparable global peers, 12% discount to 5-yr historical average). Such valuation discount is unjustified given RDCK is embarking into an earnings upcycle with strong visibility on margins. We value RDCK at 20x FY19E PER which still cushions a 24% discount to peers. We forecast an earnings CAGR of 25% for RDCK over FY17-20E, backed by strong margin expansion with acceleration in sales volume in premium segment acting as the prime catalyst. Returns from premiumisation visible: RDCK launched Magic Moments premium Vodka in 2006 and since then the premium segment has remained a focus area for the company wherein it followed up with several other brand launches in the premium segment. The products in the premium segment have EBITDA margin of 20% vs 7% realized in the regular segment. We expect the premium segment to contribute 28%/46% to volumes/revenue by FY19 following new launches and consumer upgrading with improved brand perception. Earnings CAGR of 25% FY17-20E: We are positive on RDCK s long-term growth given the margin expansion prospects led by premiumisation. Also, the premium segment is growing at a faster pace, i.e. at 9% vs regular segment at 2%. We forecast YoY EPS growth of 28% for FY18E and 26% for FY19E. ROCE is expected to improve to 13.5% in FY19E from 11% in FY17. Debt on the decline trajectory: The alcoholic beverages business in India is working capital intensive. It increases disproportionately owing to excise duty hikes as the duty needs to be paid up front. However RDCK is benefiting from increased cash flows backed by high profitability from premium branded sales. We expect the company to repay Rs1-Rs1.2bn of debt every year leading to a reduction in net debt by 29% to Rs5.6bn in the next two years. Cheap valuations make it a compelling BUY: RDCK is trading at 46% discount to its global comparable peers and at a 12% discount to its 5-yr historic PER. We believe that with strong brands and a good distribution network, RDCK is poised for an upward rerating in its valuations multiple. We initiate coverage on the company with a BUY rating and a target price of Rs202 (potential upside of 50% from CMP). Our target PER of 20x is based on 24% discount to peer group. Change in Estimates EPS Chg FY17E/FY18E (%) NA Target Price change (%) NA Previous Reco NA Emkay vs Consensus EPS Estimates FY17E FY18E Emkay Consensus Mean Consensus TP Rs 154 Stock Details Bloomberg Code RDCK IN Face Value (Rs) 2 Shares outstanding (mn) Week H/L 151 / 84 M Cap (Rs bn/usd bn) 18 / 0.28 Daily Avg Volume (nos.) 8,16,255 Daily Avg Turnover (US$ mn) 1.6 Shareholding Pattern Dec '16 Promoters 40.5% FIIs 18.7% DIIs 14.8% Public and Others 26.0% Price Performance (%) 1M 3M 6M 12M Absolute Rel. to Nifty Relative price chart 150 Rs % Financial Snapshot (Standalone) (Rs mn) FY15 FY16 FY17E FY18E FY19E Net Sales 18,465 17,892 18,279 19,273 20,353 EBITDA 1,704 1,946 2,041 2,249 2,541 EBITDA Margin (%) APAT ,066 1,347 EPS (Rs) EPS (% chg) (5.1) ROE (%) P/E (x) EV/EBITDA (x) P/BV (x) Emkay Research is also available on Bloomberg EMKAY<GO>, Reuters and DOWJONES Apr-16 Jun-16 Aug-16 Sep-16 Nov-16 Jan-17 Mar-17 Radico Khaitan (LHS) Rel to (RHS) Nifty Source: Bloomberg Anubhav Gupta anubhav.gupta@emkayglobal.com Emkay Global Financial Services Ltd.

2 1. At an inflection point RDCK s stock price has suffered severely in the past 5 years with a 68% underperformance to the BSE Sensex. The reasons were flat earnings in FY11-16 and highly leveraged balance sheet. But we expect this to reverse with strong earnings upcycle starting FY17. The FY17 profit will rise 8% followed by an expected 28% rise in FY18 and 26% rise in FY19. Exhibit 1: Worst is behind What factors were holding the stock back? What has changed that will result in strong earnings performance? Flat earnings in FY11-16 RDCK s earnings have not increased in the past five years due to slowdown in the Indian alcohol beverage industry. Also the benefits of premiumisation strategy are yet to reflect in terms of significant improvement in EBITDA margins. The EBITDA margins in the business have remained stagnant at 11% in past 5 years due to rising RM costs and delay in pass through. The sales volume in the traditional segment also suffered due to ban of alcohol in a few states and lack of price hikes. Earnings growth to come back in FY17 RDCK s revenue is expected to rise 2% in FY17 backed by increased sales of premium brands. The revenue growth rate will accelerate to 5%/6%in FY18/19E. We expect the contribution from premium brands to rise to 28% in FY19 from 24% in FY16. The benefits of premiumisation is already visible in FY17 with EBITDA margin expansion of 30bps YoY to 11.2%. The premium segment has margins of 20% vs 7% for its regular segment. Margin expansion will accelerate further in FY18-19E. High leverage The alcoholic beverages business in India is working capital intensive. It increases disproportionately with excise duty hikes as the duty needs to be paid up-front. RDCK s net WC remained high at 90days. This prevented it from generating any free cash flows. Total FCF shortfall in past years was Rs2.7bn. This was funded by new debt. RDCK s D/E is 0.9x which is amongst highest in its peer group. In FY12-16, the interest cost increased 45% to Rs847m which impacted the net profit margin of RDCK. D/E to half in next 3 years Higher debtor days from government controlled markets drive high working capital intensity for the sector. Premiumisation helps RDCK generate free cash flow. We expect the company to repay debt of avg. Rs1.1bn every year. This will reduce the leverage substantially for RDCK. We expect D/E to reduce to 0.5x in FY19 from 0.8x in FY17. The interest cost reduction will lead to net margin expansion. Interest coverage will also improve to 4.7x in in next two years (from 2.6x in FY17). Exhibit 2: RDCK s stock performance vs BSE Sensex Nov/11 Feb/12 May/12 Aug/12 Nov/12 Mar/13 Jun/13 Sep/13 Dec/13 Apr/14 Jul/14 Oct/14 Jan/15 Apr/15 Aug/15 Nov/15 Feb/16 May/16 Aug/16 Dec/16 Mar/17 Radico Khaitan SENSEX Index Source: Bloomberg Emkay Research March 30,

3 Exhibit 3: RDCK on an earnings upcycle (Rsm) 1,347 1,066 Flat earnings FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Initiate BUY; 50% potential upside from CMP Focus on premiumisation to help expand EBITDA margins by 130bps over FY17-19E. Incrementally better pricing environment - has received price hikes in Karnataka Supportive valuations, 25% EPS CAGR to drive stock performance - expect 50% upside from CMP. Exhibit 4: RDCK s Portfolio Emkay Research March 30,

4 2. Investment Thesis 2.1 Investment positives Opportunity to re-rate Premium portfolio expanding Premium Vodka and Brandy brands already positioned strongly Market share gains going forward Premium market to outperform regular market growth Transformation into a premium liquor company from a bulk producer 25% EPS CAGR, Improvement in return ratios RDCK s current valuation does not truly reflect its premium positioning The Indian spirits market has slowed in recent years from double-digit growth to low single-digit volume growth. However, the slowdown has not been felt in the premium segment where volumes have continued to grow in mid-to-high teens. As such, the slowdown has been felt entirely in the traditional country liquor segment, where profitability is significantly lower. We believe RDCK s heritage and its unique product offering gives its premium Vodka and Brandy brands the strong position to dictate a similar EBITDA margin as global and local peers. In our view, the market has failed to adequately reward its earnings growth visibility as of yet. If we compare RDCK s PER and EBITDA margin with that of its global/local peers, then RDCK s multiple is under-rated (13.3x vs peer average of 25x) despite having a similar EBITDA margin. We get an identical conclusion if we run the quadrant as EV/EBITDA (about 40% discount to peer group).we therefore think RDCK's valuation is compelling. Premium branding aimed at offering a wider product portfolio and widen customer base India s liquor market tends to have a better consolidation in higher-end (value) space (top 10 players make up over 70% of market share in premium and super premium segments) while it s more fragmented at the lower-end (value) (top 10 players only make up 17-18% of economy and low mid-range segments). This, in our view, should help RDCK to further gain market share at the expense of smaller players. Indeed, RDCK s strong brand image and heritage has enabled market share gains in the premium/super premium space. The premium brands include Magic Moments Vodka, Morpheus Brandy, After Dark Whisky, Electra (ready to drink) etc. which make up 24% of its sales, and will rise to 29% by FY20. Their revenue contribution is much higher at 40%. The premium segment has delivered teens growth over the past 2-3 years as it benefitted from consumption shift led by rising per capita income in the country which has helped the consumption trend move up from the low-end to mid-end. We believe the upper mid-range will become RDCK s key growth leg in the mid-to-long term. Vertical integration transformed the company RDCK is one of the oldest and largest liquor manufacturers in India, with a pan-india presence. The company has transformed itself from a bulk and country liquor manufacturer to a branded IMFL manufacturer. RDCK has created brands and now houses four major brands which sell more than a million cases per year despite advertising and sales promotion in liquor not being permissible in the county. In addition to building up presence in the fastest growing segment of whisky, the company has also created a niche in the less competitive segment of brandy and vodka. Scope of re-rating on consistent market share gains in premium segment The sales volume growth in premium segment and margin expansion will drive RDCK s overall earnings. We forecast net profit to rise at a CAGR of 25% over FY17-20E. We forecast EBITDA margin to increase by 130bps to 12.5% in the next two years as premiumisation pays off. This will help earnings double to INR1.6bn in FY20 from INR769m in FY16. Emkay Research March 30,

5 2.2 Investment negatives Highly regulated industry Prohibition related uncertainties Volumes to be impacted in short term Price hike in the hands of government bodies Risk for margins post GST Higher taxes for liquor companies Stringent laws make life tough Unlike FMCG businesses where the premiumisation impact is clearly visible in the form of gross margin expansion, the impact is less clear in the liquor industry. RDCK s volume mix is shifting towards the premium category; however, no major impact is yet evident at the gross margin level. The main reasons for this are: a) regular duty increases; b) competitive pressure in the regular whisky segment, requiring price cuts; and c) controlled price increases by state governments, resulting in a delay in passing on the input cost increases. Prohibition has made a comeback in the political vocabulary Kerala and Bihar have announced phased prohibition After more than two decades, complete prohibition on alcohol has made its way back into the Indian political vocabulary. The state of Kerala announced last year that it will enforce prohibition gradually over 10 years, by shutting down 10% of the outlets every year over the period. The state of Bihar announced that it will begin a phased prohibition after the state elections as the winning political party had promised it as part of its electoral manifesto. Together, these states make for ~5% of total volumes, and there is increasing noise in support of prohibition in other states. In many Indian states such as Haryana and Andhra, prohibition was enforced in the 1990s as part of a political agenda. However these were subsequently lifted as alcohol is a major source of state revenues (~15-25% of total), and also illicit alcohol tends to see a sharp pickup post prohibition, posing an even bigger threat. Even now prohibition is not sustainable economically for most states, and hence we may see a reversal in a few years. However, in the interim, this could have some short-term impact. Almost no price hikes have come through in the past months from states with price controls Spirits pricing is effectively controlled by the government in 70% of the states in India, and government approval is needed to raise prices. In the past 18 months there have been almost no price hikes given to spirits companies by any state government (except Karnataka). Thus pricing as a tool to improve margins gradually has not played out. This also shows that price increases are tough in this industry irrespective of the nature of companies that operate in it. Note, input costs are relatively benign currently for the industry. GST impact could have a negative margin impact India is in the process of making its biggest indirect tax change under the proposed Goods and Services tax (GST). While GST is a major positive for the economy and most consumer products, alcoholic beverages are likely to be among the few sectors that could be adversely impacted by the GST. Alcoholic beverages are being kept out of the ambit of GST as state governments are unwilling to give up their control on taxation of this sector, as it is one of their largest revenue contributors. This will result in alcoholic beverages following a different taxation system while all the products including input raw material such as glass and ethanol would follow GST. Currently RDCK is able to offset the state value added tax on glass and ethanol against the end product taxes that it pays to the state government. Under GST this may not continue as the tax systems would become fundamentally different. Therefore, there would be an increase in input costs by the amount of the state value added tax, which was previously offset. This impact could be a ~150bps hit on RDCK's EBITDA margins. Emkay Research March 30,

6 3. RDCK s Premiumisation strategy has been successful Premiumisation is the key catalyst to margin improvement Transforming to premium from bulk RDCK is a leader in the domestic vodka market Strong success in Magic Moments, Positive early signs on Morpheus Brandy RDCK is strategically resorting to premiumisation to drive growth and margins and is making solid progress in the premium segment. Magic Moments has become one of the leading Vodka brands worldwide with volume of 3.5m cases while Morpheus Brandy s volume has increased 55% in the last 3 years. Favorable demographics, rising disposable incomes and changing social attitude towards alcohol consumption are the key factors driving demand for premium liquor. Until 2006, RDCK was a regular/economy segment player, participating in the sub-rs300/unit pyramid. In 2006, it launched Magic Moments, positioned in the premium segment. This was its first attempt at moving up the value chain. EBITDA margin in premium brands is 3x the regular brands. Magic Moments giving competition a tough time RDCK has captured 50% volume market share in the Vodka segment, from 5% in The nearest competitor is far second at 14% market share. The company has already launched an extension of Magic Moments brands with introduction of six flavors, which continue to do well. For RDCK to accelerate its prestige segment volume growth to 9-10%, it would require other premium brands to contribute as well; Morpheus could be the next Magic Moments for RDCK. Exhibit 5: RDCK continues to gain market share in Vodka (%) Source: Emkay Research Targeting brandy market as well Focusing on brandy segment to augment market share RDCK's recent thrust in the brandy segment is dictated by the need to improve its market positioning in South India, a key brandy market, in our view. Exhibit 6: Magic Moments Vodka Exhibit 7: Morpheus Brandy Emkay Research March 30,

7 Exhibit 8: RDCK s Magic Moments Vodka Volume (mcs) & Growth (%) FY15 FY16 FY17E FY18E FY19E LHS - Volume (mcs) RHS - Growth (%) Exhibit 9: RDCK s Morpheus Brandy Volume (mcs) & Growth (%) FY15 FY16 FY17E FY18E FY19E LHS - Volume (mcs) RHS - Growth (%) Nine brand launches since 2006 More brand launches After having posted 14% CAGR in volumes during FY12-16, and having availed the benefits of the premiumisation strategy, RDCK launched three more brands viz Rampur Indian Single Malt, Regal Talons Whisky and Pluton Bay Rum in the premium segment in Rampur is super premium Whisky which positions RDCK s Whisky portfolio in line with Pernod Ricard. Going forward, RDCK intends to keep up the momentum of new launches to drive revenue growth. Exhibit 10: High success rate of Brand Launches & Acquisitions PM Whisky Regular Range 2002 Old Admiral Regular Range 2006 Magic Moments Vodka Super Premium Range 2009 Morpheus Brandy Super Premium Range 2011 Verve Vodka Super Premium Range 2013 Verve Flavoured Vodka Super Premium Range 2014 Morpheus Blue Brandy Super Premium Range 2015 Electra Ready to Drink Super Premium Range 2016 Rampur Indian Single Malt Regal Talons Whisky Pluton Bay Rum Exhibit 11: Competitor s major portion of Premium Brands Volumes mcs) come from Whisky Segment Source: Euromonitor Pernod United Spirits ABD RDCK Emkay Research March 30,

8 Exhibit 12: Broad Consumer Choice with Focus on Premium Brands Whisky Rum Brandy Vodka Gin Ready to Drink Super Premium >Rs 600 Rampur Indian Single Malt Morpheus, Morpheus Blue Verve, Verve Flavored Semi-Premium / Premium Rs After Dark Regal Talons Pluton Bay Bonjour Magic Moments, Magic Moments Remix Deluxe Rs Whytehall Contessa White Excellence Regular Rs PM, Old Admiral Contessa, Bermuda, Lord Nelson Old Admiral, Brihans Grape, Whitefield Contessa, Goa Dry Gin Ready to drink Rs Electra Exhibit 13: RDCK s EBITDA (Rs/Case) in Prestige & Above IMFL Category FY15 FY16 FY17E FY18E FY19E Exhibit 14: Millionaire s Club 2016 ranked Magic Moments Vodka 12 th globally Emkay Research March 30,

9 4. Pricing outlook more positive Government controlled distribution Some price hikes in recent times Trend of lowering of taxes on liquor in some states Overall positive outlook 60% of alcohol sold in the country is subject to pricing regulations by state governments. Recently Karnataka announced a price hike while Uttar Pradesh dropped the tax rate, which are noteworthy positives for RDCK and the liquor industry in general; RDCK expects a few more states to give hikes. After two years of practically no price hikes across India, we see signs of an improving outlook. Karnataka announced a price hike for the spirits industry effective from 1st July The state contributes 17% to overall industry volumes and is a crucial market for RDCK. The price hike in our estimate is Rs35/case which is 5-7% on RDCK s net sales, which is very material. The state of Uttar Pradesh recently dropped taxes on alcohol by over 20% to combat decline in tax revenues from the industry, which is a first such instance in recent times. Industry players are hopeful of getting price hikes in the states of Telangana and Andhra Pradesh as well in the near future. Our discussions with industry players suggest improvement in the pricing environment for the IMFL industry. There has been modest increase in the quantum of price hikes received by the industry, especially from South Indian states. Secondly, the time lag between demand and approval of price hike has come down. Exhibit 15: RDCK s Realization (Rs/Case) in Prestige Segment Exhibit 16: RDCK s Realization (Rs/Case) in Regular Segment 1,254 1,249 1, ,219 1, FY15 FY16 FY17E FY18E FY19E Exhibit 17: State-wise Industry Volume (%) FY15 FY16 FY17E FY18E FY19E Exhibit 18: Region-wise Industry Volume (%) 39% 18% 11% 9% 17% 7% Andhra Pradesh Telangana Kerela Karnataka Tamil Nadu Others 8% 4% 9% 18% 62% North South East West CSD Exhibit 19: Top 6 revenue contributing states for RDCK (%) Exhibit 20: Region-wise RDCK s Revenue (%) 12.0% 9.0% 6.0% 6% 9% 8% 11% CSD East North 3.0% 0.0% Uttar Pradesh Andhra Pradesh Tamil Nadu Canteen Stores Dept Delhi Haryana 31% 35% South West Exports Emkay Research March 30,

10 5. Competitive dynamics Fourth largest player in volume terms RDCK s volumes stand at 18.2mcs, 6.4% market share In terms of volume, RDCK is the fourth largest player in the IMFL space with sales of 18.2mn cases (mcs) in FY16. Having entered the branded IMFL space in the late-90s, it has created four new millionaire brands (8PM, Magic Moments, Old Admiral and Contessa) across product segments like whisky, vodka, brandy and rum. RDCK was earlier focused on the value for money segment, with price points of less than INR300/750ml. It has four pillar brands and a host of midsized and regional brands. Exhibit 21: Market Share as of 2015 (%) 28% 11% 7% ABD Radico Pernod 2% 4% 4% 32% 12% United Spirits Jagatjit Industries John Distilleries Tilaknagar Industries Others Exhibit 22: Premiumisation of Peers Company Whisky Rum Brandy Vodka Ready to Drink ABD Officer's Choice Blue and Black Jolly Roger Kyron, Lord & Master Wodka Gorbatschow Pernod RDCK Blenders Pride, Imperial Blue, Royal Stag, Chivas Regal, Ballantine's, 100 Pipers Rampur Indian Single Malt, After Dark, Regal Talons, 8PM Whisky Havana Club, Malibu Macieira Absolut, FUEL Pluton Bay Morpheus Verve, Magic Moments Electra Signature, Whyte and Mackay, United Spirits McDowell N0.1, Bagpiper, Royal Challenge, Black Dog, Vat 69, Director's Special, Haywards Fine McDowell Celebrations, Old Cask McDowell No.1 Red Romanov, White Mischief Source: Emkay Research Exhibit 23: Company-wise IMFL details (mcs) FY12 FY13 FY14 FY15 FY16 Pernod Prestige & above Regular & others Total United Spirits Prestige & above Regular & others Total ABD Prestige & above Regular & others 2 2 Total RDCK Prestige & above Regular & others Total Emkay Research March 30,

11 6. Well positioned to capitalize on rising premium IMFL consumption Indian spirits market on growth trajectory The Indian spirits market has slowed in recent years from double-digit growth to low single-digit volume growth. However, the slowdown has not been felt in the premium segment (made up of mostly Indian made whiskies/ Scotch/Vodka) where volumes have continued to grow in the midto-high teens. As such, the slowdown has been felt entirely in the regular segment, where profitability is significantly lower. Exhibit 24: Brandy Sales in India (mcs) Exhibit 25: Rum Sales in India (mcs) E 2018E 2019E Source: Euromonitor Exhibit 26: Whisky Sales in India (mcs) E 2018E 2019E, Euromonitor Exhibit 27: White Spirits Sales in India (mcs) E 2018E 2019E Source: Euromonitor E 2018E 2019E Source: Euromonitor Exhibit 28: Total Spirits sold in India (Volume (mcs), growth (%)) E 2018E 2019E LHS - Total Spirits sold in India (mcs) RHS - Growth (%) Source: Euromonitor Indian preference - Higher alcohol content at a cheaper price Higher preference amongst Indian consumers for spirits and specifically IMFL arises from the preference for higher alcohol content at a lower price. This is in contrast to the global phenomenon where IMFL on the basis of alcohol content is priced higher than beer. The preference of Indians towards higher liquor content also arises from the fact that consumption of strong beer in India is comparatively more than that of lagar beer. Emkay Research March 30,

12 Market Sales Value growth 6.3% CAGR FY16-20E 6.1 Indian spirits market size and Growth opportunity The spirits market size in India was 285mcs in FY16 and is expected to reach 337mcs by FY20. During FY16-20E, IMFL sales value is expected to grow at a CAGR 6.3% and sales volume at 4%. In FY16, the industry volume declined by 1.7%; however, value growth was 0.7%. Key trends: Overall Whisky constituted the largest segment with 60% of volumes and 73% value Blended Scotch and Single Malt Scotch are expected to lead the growth with FY16-20 value CAGR of 14.7% and 11.6% respectively Premium & Super Premium Vodka remained one of the fastest growing segment with FY10-15 growth of 12.5% Of the total Vodka volumes in FY15, 52.7% was in the premium and super premium category (from 33.5% in FY2009) Exhibit 29: Sale of Spirits in India - Volume (%) Exhibit 30: Sale of Spirits in India - Value (%) Brandy 22% White Spirits 3% Rum 10% Brandy 12% White Spirits 5% Rum 15% Whisky 60% Whisky 73% Source: Euromonitor Source: Euromonitor 6.2 Structural Changes in the Industry Makes Indian Spirits Market More Attractive Entry of global majors With increasing participation of global players, the industry is expected to become more efficient, operationally disciplined, and transparent and aligned to best global practices. There is a clear shift towards creating and growing the overall market (including NPD and niche products). Exhibit 31: Indian & Global Alcobev Industry mix (%) Global 24 India Wines Beer Spirits Source: Emkay Research Shift from volume growth to value growth Corporates focusing on profitable growth as against volume growth. Expected price increases likely to result in increase in EBITDA margins, thereby aligning margin structures of domestic players with the global counterparts. Industry players negotiating price hikes with state governments. Emkay Research March 30,

13 Increasing premiumisation Improving product-mix Companies are increasing focus on premium products, thus driving the overall profitability. Encouraging macro factors such as rising disposable incomes and affluence, growth in middle class households and increasing brand awareness. Potential market growth for white spirits (vodka) an opportunity for RDCK White spirits is just 3.5% of alcohol volume in India (vs 47% globally) 6.3 Vodka to outperform overall IMFL growth in the coming years The white spirits segment - Vodka and Gin, primarily the former, holds a lot of promise in the Indian spirits industry. Rapid urbanisation, increased consumerism, and adoption of trendier lifestyles are driving vodka sales across smaller towns and cities (long considered a cosmopolitan drink in the Indian context, vodka is finding increasing acceptance among a large and growing number of youngsters and women in the Tier II cities and towns. Sale of clear drinks has soared, triggered by the adoption of big-city trends and habits. In cities, the perception that vodka has lower alcohol content compared to whisky and the colorless and odorless nature of the spirit has helped increase sales traction. The potential of Vodka also stems from the low contribution of white spirits to the total IMFL consumption basket as compared to the global spirits consumption where white spirits segment (primarily Vodka) forms a major portion. White spirits stand at 47% of the global spirits market in volume terms while in India, they form only 3.5%. Exhibit 32: Indian vs Global IMFL (Volume %) Global India White spirits Brandy Rum Whiskey Source: Emkay Research Exhibit 33: Indian IMFL Volume Trend LHS - Total Spirits sold in India (mcs) RHS - Growth (%) Source: Euromonitor 6.4 Key Drivers for Growth of Liquor Consumption in India Income Growth India GDP growth of 7.6% in FY2016 Growth in per capita income to drive discretionary income growth at much higher pace than the GDP growth, boosting demand for lifestyle products including alcoholic beverages Rural economy is likely to see a big upsurge in income levels due to various government initiatives in the mid to long term Emkay Research March 30,

14 Attractive Demographics Around 60% of India s population is in the age-group of Nearly 840m people in the drinking age in CY2015. Another 65m are likely to be added by CY2019 Following these favorable demographics, demand for alcoholic beverages is set to rise Underpenetrated Market India's per capita consumption (2.2 lpa) of alcoholic beverages is among the lowest in the world (over 7.5 lpa) A small increase in per capita consumption to significantly alter industry growth, given the large population base 6.5 Rural Consumption to Grow 3.8x and Tier 2 & Below Cities to Grow 4.4x by 2025 Cities which have a population below 1m would be the next drivers of growth; share of Tier 2 & below cities is expected to increase from 36% to 45% by 2025 These cities are expected to add 7m affluent/elite households resulting in increased demand for premium products Growing awareness, easier access and changing lifestyles have been the key growth drivers of the consumer market Companies will need to rethink their go-to-market, portfolio strategy and brand communication Exhibit 34: Rural alcohol consumption compared to urban region CAGR (%) Rural Urban Source: Emkay Research Emkay Research March 30,

15 7.0 Financial analysis 7.1 Revenue to rise 5% in FY18, 6% in FY19 Revenue CAGR of 6% FY17-20E Branded IMFL 73% of revenue; contribution of country liquor, bulk spirits on the decline Branded IMFL contributes 73% of RDCK's revenue, with country liquor (9%), bulk spirits (16%, molasses and grain based) and others (1%) accounting for the rest. The contribution of IMFL to overall revenue has increased significantly in the last 5 years. We expect it to surge further by 300bps over the next three years owing to lower growth in country liquor and bulk spirits. RDCK's strategy of driving premium IMFL brands should also augment overall sale of IMFL, in our view. The sale of country liquor is restricted to the state where the distillery is situated and as such this segment is growing at a CAGR of just 2%. Exhibit 35: Revenue Contribution (%) as of % 1%1% Exhibit 36: Revenue Contribution (%) as of % 1% 1% 14% 7% IMFL Alcohol Country Liquor 13% 9% IMFL Alcohol Country Liquor PET PET 73% Printed Bottles Others 73% Printed Bottles Others Premiumisation strategy paying off Exhibit 37: Net Revenue (Rsbn) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 38: IMFL Net Revenue (Rsbn) FY15 FY16 FY17E FY18E FY19E Regular & Others Prestige & Above Emkay Research March 30,

16 Exhibit 39: IMFL Volume Mix (%) Exhibit 40: IMFL Net Revenue Mix (%) FY15 FY16 FY17E FY18E FY19E FY15 FY16 FY17E FY18E FY19E Regular & Others Prestige & Above Regular & Others Prestige & Above Expect sales CAGR of 6% over FY17-19E We expect RDCK's sales to grow at a CAGR of 6% over FY17-19E driven by: Robust 9% volume CAGR in premium brands. We expect the premium segment to grow ahead of the market, as consumers trade up, driven by favorable macroeconomic factors. 1% sales CAGR in regular IMFL brands, 2% CAGR in country liquor and 2% CAGR in bulk spirits. Exhibit 41: Prestige Segment Volume (mcs) & Growth (%) Exhibit 42: Regular Segment Volume (mcs) & Growth (%) FY15 FY16 FY17E FY18E FY19E FY15 FY16 FY17E FY18E FY19E LHS - Prestige & Above (mcs) RHS - Growth (%) LHS - Regular & Others (mcs) RHS - Growth (%) Exhibit 43: Strong Distribution Footprint across India Pan India presence Radico has a strong sales and distribution network with a presence in retail and off-trade outlets in the relevant segments in different parts of India The Company has 33 bottling units spanning almost the entire country, of which 5 belong to the Company and 28 are contract bottling units Developed network of distribution Currently sells through over 55,000 retail outlets and over 5,000 on premise outlets Apart from wholesalers, a total of around 300 employees divided into four zones, each headed by regional profit centre head, ensure an adequate on-the-ground sales and distribution presence across the country Strategically located bottling units Radico sstrategic bottling units are spread across the country This is to avoid the high taxes levied on inter-state movement of finished and in-process liquor Collaboration with International players Ernest & Julio Gallo of California (one of the largest wineries in the world) for distribution of their wines Emkay Research March 30,

17 Exhibit 44: Rampur Single Malt Whisky Exhibit 45: Regal Talons Whisky Exhibit 46: Electra Ready to Drink Exhibit 47: Verve Flavored Vodka Emkay Research March 30,

18 Premiumisation led margin expansion 7.2 EBITDA margin to expand by 130bps over FY17-19E RDCK reported EBITDA margin of 10.9% for FY16, an increase of 165bps. We believe there is significant scope of margin expansion in the coming years, led by improving pricing environment in the IMFL industry, better product mix (led by 9% volume CAGR in premium brands) and benign input costs. We expect EBITDA margin to expand 130bps to 12.5% over FY17-19E. Exhibit 48: EBITDA (Rsbn) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 49: EBITDA Margin (%) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 50: Prestige Segment EBITDA (Rs/Case) Exhibit 51: Regular Segment EBITDA (Rs/Case) FY15 FY16 FY17E FY18E FY19E FY15 FY16 FY17E FY18E FY19E Emkay Research March 30,

19 Exhibit 52: Advertisement & Sales Promotion Costs (Rsm) 1,284 1,163 1,160 1,070 1,073 FY12 FY13 FY14 FY15 FY16 Exhibit 53: Magic Moments Vodka Adv Zing up Life with Hrithik Roshan (Actor) Exhibit 54: Morpheus Brandy - Marketing Campaign Emkay Research March 30,

20 Expect input costs to increase 5% Molasses: Molasses prices decreased 14% in FY16 after increasing 20% in FY15. Sugar production for 2017 is estimated at 28.8mtons (ISMA Report). The industry expects molasses prices to remain stable in FY18. Exhibit 55: Cost Break up as of 2015 (%) Exhibit 56: Cost Break up as of 2016 (%) SG&A 29% SG&A 31% Employee 7% Raw Material 64% Employee 8% Raw Material 61% Exhibit 57: Historical Molasses prices (Rs/Qtl) FY12 FY13 FY14 FY15 FY16 Grain/ENA: Grain prices should gradually increase in line with the increase in support prices by the government. ENA prices are currently ruling at Rs48-49/liter. Exhibit 58: Historical ENA prices (Rs/liter) FY13 FY14 FY15 FY16 FY17 Packaging/Glass: The cost of RDCK's packing material/case is directly correlated with glass prices, which are in turn directly correlated with crude prices. We are building in a modest 5% increase in packaging cost per case over FY17-19E. Emkay Research March 30,

21 Strong earnings growth backed by margin expansion and lower interest cost 7.3 PAT to grow at a CAGR of 25% over FY17-20E Over FY17-20E, we expect the company to post revenue CAGR of 6% and EBITDA CAGR of 11% (led by 190bps margin expansion). In FY19, we expect interest cost to decrease by 30% to Rs550mn owing to debt reduction. Assuming effective tax rate of 25% for the next three years, we estimate 25% CAGR in adjusted PAT over FY17-20E. Exhibit 59: Net Margin (%) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 60: Net profit (Rsm) 1,347 1, FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Emkay Research March 30,

22 Balance sheet de-leveraging is the key 7.4 Significant decline in leverage Higher debtor days from government controlled markets drive high working capital intensity for the sector. IMFL players are required to pay duties upfront at the time of sale while they receive payments after three-four months in government controlled states. Controlling debtors and advances is critical to long term cash flows and return ratios. Exhibit 61: Working Capital (Days) FY12 FY13 FY14 FY15 FY16 Inventory Debtor Loans & advances Other current assets Current liabilities Provision Total Working Capital (Days) However RDCK is benefiting from increased cash flows backed by high profitability from branded sales. We expect the company to pay Rs1bn - 1.2bn of debt every year. Net debt will reduce by 12% to Rs7bn by FY18. D/E will decline to 0.3x in FY20E from 0.8x in FY17. Emkay Research March 30,

23 Exhibit 62: Net Debt (Rsbn) Exhibit 63: Net Debt/Equity (x) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 64: Interest Coverage (x) Exhibit 65: Net Debt/EBITDA (x) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E 2.0 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 66: Operating Cash flow (Rsbn) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 67: Operating Cash flow (Rsbn) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Emkay Research March 30,

24 ROE/ROCE expansion here on 7.5 Capital return ratios to improve by 300bps over the next three years RDCK's RoCE is in low double digit and ROE in single digit. Increase in EBITDA margin in FY18 and lower interest burden post FY18 should help improve capital ratios by 300bps over the next three years. However, the controlled pricing and high proportion of sales to auction contractors and government-controlled wholesale agencies would act as restraining factors. Exhibit 68: ROE (%) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 69: ROCE (%) FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Emkay Research March 30,

25 8.0 Share price analysis 8.1 Valuation attractive given strong earnings growth ahead Attractive PER of 13.3x FY19E Unjustified discount of 46% to peer average Earnings recovery will bring about rerating RDCK is trading at PER of 13.3x FY19E. This is at a 46% discount to the peer average. We believe given RDCK s strong positioning in IMFL industry and solid visibility in earnings over the next 2 years, the valuation gap should get closed in. RDCK is trading at lowest valuation (PER of 13.3x FY19E) compared to its peers. As earnings improve and debt reduces, the valuation gap should narrow down. We forecast RDCK's overall earnings to double over FY16-20E. We expect revenues to rise at a 6% CAGR, with 130bps improvement in EBITDA margin to 12.5% in FY19E from 11.2% in FY17. This will also improve RDCK's return rations which were depressed in the past three years. We expect ROE to improve to 11.9% in FY19E from 8.9% in FY16 and ROCE to improve to 13.5% in FY19E from 10.7% in FY16. We believe this will lead to a re-rating in the stock. RDCK is also trading at 12% discount to its 5-yr historic average. Exhibit 70: Peer Valuation Companies MCap EPS Growth (%) PER (x) EV/EBITDA (x) P/BV (x) ROE (%) (USD m) FY17F FY18F FY19F FY17F FY18F FY19F FY17F FY18F FY19F FY17F FY18F FY19F FY17F FY18F FY19F United Spirits 4, United Breweries 3, Diageo PLC 72, Heineken NV 49, Carlsberg A/S 13, Anheuser-Busch 2,27, InBev NV Takara Holdings Inc 2, NA NA Thai Beverage PCL 16, LuzhouLaojiao Co Ltd 8, Pernod-Ricard SA 31, Average RadicoKhaitan Source: Bloomberg, Emkay Research 8.2 Valued at 20x PER FY19E 24% disc to peers PER methodology to value RDCK We use PER methodology to value RDCK as there is very strong earnings visibility. Moreover, it factors in the depreciation and interest costs as well. Our target PER of 20x FY19E is at 24% discount to the sector average. We expect the stock to re-rate as the company delivers strong earnings growth backed by increased sales in premium IMFL segment and margin expansion. Exhibit 71: Historical PER (x) Exhibit 72: Historical P/BV (x) FY8 FY9 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY8 FY9 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 PER 5 Year Average Price/Book 5 Year Average Source: Bloomberg Source: Bloomberg Emkay Research March 30,

26 9.0 Company & Management background 9.1 Company Background Started in 1943 as bulk spirits supplier Strong manufacturing infrastructure RDCK, earlier known as Rampur Distillery, commenced its operations in 1943 and over the years emerged as a major bulk spirits supplier and bottler to other spirit manufacturers. As a logical evolution, in 1998, it endeavored to launch and market its own brands and soon carved out a standing in manufacture and distribution of alcohol. Its product portfolio comprises IMFL, country liquor, bulk spirits and it has also tied up with bottling units in various parts of the country to boost its production capacity and also enhance its geographical reach. RDCK has three distilleries in Rampur, UP and holds 36% interest in a JV in Aurangabad, Maharashtra. It owns 5 bottling units and maintains 28 contract bottling units. It holds 6.4% market share in IMFL industry as at Exhibit 73: Company History : Spirit Company Started Distillery in 1943 A major spirits supplier Supplier of rum to armed forces Bottler for others 1998-Current: One of the Largest Indian IMFL Spirits Company Started branded division for production of IMFL and launced its first brand 8 PM Whisky in 1998 Created 4 Millionaire brands-8pm Whisky, Contessa Rum, Old Admiral Brandy and Magic Moments Vodka in last one decade in terms of cases sold Strong sales and distribution network, covering bars, clubs and other retail points in India 33 bottling units: 5 own bottling units and 28 contract bottling units in India In 2005, after creating brands in high volume regular categories, the Company ventured into the semi premium segment by launching Magic Moments Vodka, in the white spirits segment (and attained the sales of 1 million cases in FY 2009) In 2009, launched Morpheus Brandy, a super premium range brandy In 2011, launched After Dark, a premium whisky on a pan-india basis In May 2012, acquired Royal Lancer and Elkays whisky brands from Mysore based Yezdi Group In October 2012, launched Verve, super premium vodka and Verve flavoured vodka in March 2013 In Q3 FY2013, launched Morpheus Blue, a upgraded version of Morpheus super premium brandy In Jan 2014, launched two new flavours of Verve Magic Moments Vodka In June 2015, launched ELECTRA, a premium ready to drink product In April 2016, launched Pluton Bay Premium Rum In May 2016, launched Rampur Indian Single Malt and Regal Talons Semi Premium whisky Emkay Research March 30,

27 9.2 Senior Management Team Dr. LalitKhaitan - Chairman & Managing Director Dr. Khaitan studied at Mayo College, Ajmer and holds a Bachelor s degree in Commerce, and has participated in a management course from Harvard University. He is on the managing committee of a number of associations, including the PHD Chamber of Commerce and Industry, the Associated Chamber of Commerce and Industry of India, All India Distillers Association, Uttar Pradesh Distillers Association and Confederation of Indian Industry. Dr. Khaitan has 50 years of industry experience. He has been awarded the lifetime achievement award by the Confederation of Indian Alcoholic Beverage Companies in 2005 and by Alcobev in Mostly recently been awarded the Legend of the Industry at Spirits Abhishek Khaitan Managing Director Mr. Khaitan joined Radico in He holds a Bachelor s degree in Engineering in Industrial Production, as well as qualifications in managerial finance and managerial accounting from Harvard University. He has 19 years of industry experience and was named the Top Entrepreneur of the Year by Inspirit in He has also received the Inspirit 2014 Young Entrepreneur of the Year award. K.P. Singh Director, Production Mr. Singh is also the Occupier (as such term is defined under the Factories Act) of the company s factory in Rampur, Uttar Pradesh. He holds a Bachelor s degree in Science. Mr. Singh has over 45 years of experience in the liquor industry and has been associated with the company for over two decades. Dilip K Banthiya Chief Financial Officer Mr. Banthiya is a fellow member of the Institute of Chartered Accountants of India (ICAI). He has 31 years of experience in corporate finance, treasury, international finance and corporate mergers and acquisitions activity in India. He was invited to the CFO100 Roll of Honour 2012 in recognition of excellence. Mr. Banthiya has been associated with various professional bodies and committees. Emkay Research March 30,

28 Key Financials (Standalone) Income Statement Y/E Mar (Rs mn) FY15 FY16 FY17E FY18E FY19E Net Sales 18,465 17,892 18,279 19,273 20,353 Expenditure 16,761 15,946 16,238 17,024 17,812 EBITDA 1,704 1,946 2,041 2,249 2,541 Depreciation EBIT 1,321 1,543 1,633 1,836 2,124 Other Income Interest expenses PBT 871 1,077 1,248 1,600 2,020 Tax Extraordinary Items Minority Int./Income from Assoc Reported Net Income ,066 1,347 Adjusted PAT ,066 1,347 Balance Sheet Y/E Mar (Rs mn) FY15 FY16 FY17E FY18E FY19E Equity share capital Reserves & surplus 8,027 8,779 9,483 10,421 11,639 Net worth 8,293 9,045 9,749 10,687 11,906 Minority Interest Loan Funds 8,532 8,550 8,350 7,350 5,950 Net deferred tax liability ,149 Total Liabilities 17,540 18,339 18,946 19,018 19,005 Net block 5,728 5,771 5,463 5,151 4,834 Investment Current Assets 14,654 15,185 16,163 16,694 17,158 Cash & bank balance Other Current Assets Current liabilities & Provision 3,329 3,116 3,184 3,356 3,544 Net current assets 11,324 12,068 12,979 13,338 13,615 Misc. exp Total Assets 17,540 18,339 18,946 19,018 19,005 Cash Flow Y/E Mar (Rs mn) FY15 FY16 FY17E FY18E FY19E PBT (Ex-Other income) (NI+Dep) ,179 1,578 Other Non-Cash items Chg in working cap (163) (705) (1,090) (223) (131) Operating Cashflow 1, ,493 1,737 Capital expenditure (332) (458) (81) (100) (100) Free Cash Flow 1, ,393 1,637 Investments (24) (25) (26) Other Investing Cash Flow Investing Cashflow 220 (76) Equity Capital Raised Loans Taken / (Repaid) (543) 18 (200) (1,000) (1,400) Dividend paid (incl tax) (128) (128) (128) (128) (128) Other Financing Cash Flow (669) (503) (417) (206) (218) Financing Cashflow (2,240) (1,460) (1,531) (1,992) (2,292) Net chg in cash (673) (603) (700) (204) (241) Opening cash position Closing cash position Emkay Research March 30,

29 Key Ratios Profitability (%) FY15 FY16 FY17E FY18E FY19E EBITDA Margin EBIT Margin Effective Tax Rate Net Margin ROCE ROE RoIC Per Share Data (Rs) FY15 FY16 FY17E FY18E FY19E EPS CEPS BVPS DPS Valuations (x) FY15 FY16 FY17E FY18E FY19E PER P/CEPS P/BV EV / Sales EV / EBITDA Dividend Yield (%) Gearing Ratio (x) FY15 FY16 FY17E FY18E FY19E Net Debt/ Equity Net Debt/EBIDTA Working Cap Cycle (days) Growth (%) FY15 FY16 FY17E FY18E FY19E Revenue (0.6) (3.1) EBITDA (11.9) EBIT (14.6) PAT (5.1) Quarterly (Rs mn) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Revenue 4,009 3,776 4,304 4,473 4,152 EBITDA EBITDA Margin (%) PAT EPS (Rs) Shareholding Pattern (%) Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Promoters FIIs DIIs Public and Others Emkay Research March 30,