A strong player in the field of beverage industry - Varun Beverages Ltd

The improvement in return ratios over the past decade has settled the argument related to the nature of VBL’s business prevailing into pure manufacturing. EBITDA margins would remain stable (19-20%) but PAT margins have a huge scope to grow. Gains are expected on the back of rising out-of-home consumption after two years of sluggish performance. The stock has run up quite a lot, up 6 times since its IPO in December 2016. Over CY22- 24E, it is expected that the company will deliver Volume/Revenue/EBITDA/PAT CAGR of 19%/19%/18%/29%. We value the stock at P/E of 45x CY23E.

Varun Beverages Limited (VBL or Company) is a key player in beverage industry and one of the largest franchisee of PepsiCo in the world (outside USA). The Company produces and distributes a wide range of carbonated soft drinks (CSDs), as well as a large selection of non-carbonated beverages (NCBs), including packaged drinking water sold under trademarks owned by PepsiCo. PepsiCo CSD brands produced and sold by VBL include Pepsi, Diet Pepsi, Seven-Up, Mirinda Orange, Mirinda Lemon, Mountain Dew, Mountain Dew Ice, Seven-Up Nimbooz Masala Soda, Evervess, Sting, Gatorade and Slice Fizzy Drinks. PepsiCo NCB brands produced and sold by the Company include Tropicana Slice, Tropicana Juices (100%, Delight, Essentials), Nimbooz, as well as packaged drinking water under the brand Aquafina.
VBL has been associated with PepsiCo since the 1990s and have over two and half decades consolidated its business association with PepsiCo, increasing the number of licensed territories and sub-territories covered by the Company, producing and distributing a wider range of PepsiCo beverages, introducing various SKUs in the portfolio, and expanding the distribution network. As on date, VBL has been granted franchises for various PepsiCo products across 27 States and 7 Union Territories in India. VBL has 31 manufacturing plants in India and 6 manufacturing plants in international geographies (two in Nepal and one each in Sri Lanka, Morocco, Zambia and Zimbabwe).

Appeasing seasonality by focusing on International territories/acquiring South & West region/entry into food products – VBL recently acquired South and West regions in CY19 (volume growth of 45%) where it has lower than avg. market share, thus huge scope of growth. Moreover, VBL’s International market (19% of total volume) with higher realization than India, having clocked lofty CAGR volumes of 24% compared to 14% growth in India over CY15-21. Production of “Kurkure Puffcorn” (started in Q3CY22) will reduce seasonality in the business.

Improving Product mix to attract diverse market – Aggressive expansion into higher realization SKUs like Juices (Tropicana), energy drink (Sting, which posted massive 400% growth in CY21) and dairy products (Cream bell) to capture diverse market.

Building backward integrated facilities & in-house production of “Tropicana” will boost production – In-house plant of “Tropicana” with backward integration at “Pathankot” (2019) and 2 new plants in J&K and Bihar will be the key growth drivers.

Cost cutting initiatives & debt reduction to boost margins by 240 bps – Improving EBITDA margins (13% in CY12 to 19% in CY21, which peaked at 21% in CY19) on the back of reduced weight of preforms (bottles) & closures (caps) by 10 to 20%, and adding visi-coolers and outlets. Also, we expect a sharp debt reduction in the next 2-3 years (₹ 24,418 to ₹ 15,376 Mn by CY24E) due to less CAPEX requirement leading to fall in interest cost (₹ 1847 in CY21 to ₹ 923 in CY24E). 

Extension of franchise agreement for another 20 years exhibits strong relationship of VBL with PepsiCo – VBL’s franchise agreement with PepsiCo extended till April 2039, the first time ever for 20 years. Earlier, it used to have contract only for a 10 year period, this makes VBL the only franchisee to have such long term contract. 

• VBL has been associated with PepsiCo since 1991 and single-handedly accounted for more than 85% of PepsiCo India’s business.
•  Now, it has a presence across India through its 37 state-of-the-art production facilities, along with over 100 depots, 2,500 owned vehicles more than 2,000+ primary distributors, 2 mn+ outlets and 8,40,000 visi-coolers installed. It’s product portfolio includes carbonated soft drinks (CSD), non-carbonated juice-based drinks, energy drinks and packaged bottled water (PDW).
•  Brands - PepsiCo CSD brands produced and sold by VBL includes Pepsi, Diet Pepsi, Seven-Up, Mirinda Orange, Mountain Dew, Mountain Dew Ice, Seven-Up, Nimbooz Masala Soda, Evervess, Sting, Gatorade and Slice Fizzy Drinks. PepsiCo NCB brands includes Tropicana Slice, Tropicana Juices (100%, Delight, Essentials), Nimbooz, as well as packaged drinking water under the brand Aquafina. 
• Apart from India, it has a strong presence in Nepal, Sri Lanka, Morocco, Zambia, and Zimbabwe through its extensive manufacturing facilities and deep-rooted distribution network. 
• As per the annual reports of the company and various management meets following data can be observed:

Business Model Of Varun Beverages:

•  The production process of CSDs involves mixing concentrate (formula), sugar and treated water. The mixture is carbonated and filled in containers such as bottles (PET and glass) or cans on automated filling lines. The production process for NCB products involves a similar process, except that the beverage is pasteurised. Packaged drinking water (PDW) is processed using the water filtration process specified by PepsiCo.
• The concentrate is supplied by PepsiCo and its price is decided after considering the selling price, taxation, input cost, market, and other conditions.
• VBL is engaged in local marketing and promotional activities; e.g. through investment in chilling equipment such as visi-coolers, ice chests, bottle coolers, delivery vehicles, etc.; and distributes PepsiCo products to retailers, which include traditional and modern retail outlets, either directly or indirectly, through distributors and wholesalers.

Terms of VBL’s agreement with PepsiCo:

• As per the arrangement with PepsiCo, VBL has to set aside 20% of net revenues, out of which, 14% is paid to PepsiCo (8% as concentrate cost that VBL purchases from Pepsi and 6% for the payment towards ‘above the line’ (ATL) advertising spends).
• The remaining 6% is spent by VBL on below-the-line (BTL) marketing. For products, which do not involve any concentrates, VBL pays royalty of 1.3% for “Aquafina” and 1% for “Evervess Soda”.

Aquiring International Markets:

• Geographically, the international market (19% of total volumes) has clocked an amazing 24% CAGR volume growth, while the Indian business saw a 14% growth over CY15-21 and has doubled its market share in most of the international market in the past five years, due to higher realization and expansion into newer geographies. 
• It has expanded into a new international region (Democratic Republic by incorporating a new entity ‘Varun Beverages RDC SAS’ in the Democratic Republic of Congo. 
• Varun Beverages is also looking to expand its operations by setting up outlets in rural Zimbabwe powered by solar energy. It has already invested some over US$ 85 million so far. 

VBL now controls more than 85% of PepsiCo India’s beverage business 

• VBL has achieved a monopoly in India, in terms of selling PepsiCo’s products, by expanding its operations and relentless acquisition of new territories in the past few years. These were either franchised to other bottlers of PepsiCo or operated by PepsiCo directly. VBL's contribution to PepsiCo India’s volume increased from 27% in CY11 to 45% in CY16 and gradually to 85% in CY21. 
• The very recent acquisitions of West and South regions have been completed in H1CY19, resulting in 47% increase in the domestic volumes. While VBL is expected to benefit from the economies of scale in these adjacent territories, the ability to successfully integrate and increase profitability will be a key factor. We expect a strong execution in these under-serviced territories. 
• Also, given the climatic difference between the North & East and South & West regions The increase in operations is expected to kick in the economies of scale, thus, providing VBL with better negotiating power with its suppliers. 
• It is believed that increasing the distribution network along with newly acquired territories should drive volume growth for VBL in the long run. The full benefit was expected to flow in 2020. However, the pandemic hampered the growth in volume and market penetration in 2020 and 2021. As things have started to normalise in 2022, VBL will benefit from the economies of scale in these neighbouring territories. 

Growth in demand of NCB – Non Carbonated Beverages:

• NCBs segment has recorded a robust volume CAGR of 16% over CY18-21, although the average volume share stood at a decent ~6-7% for the same period. The margins in the NCB business are expected to improve, as juices (which were previously outsourced) are now manufactured in-house at VBL’s new Pathankot plant. 
• Further, increased awareness of the health benefits of juices and other NCBs in Metros and Tier-1 cities is a good indicator of their growth potential going forward. 
• Realization and margins are also highest in the juices segment compared to blended realizations for VBL. 
• Portfolio expansion into lemon-based drinks (40% of industry) and continued traction in 'Sting' should boost growth. 

VBL’s Cost Cutting Initiatives:

• The concentrate and sugar constitute a significant chunk of VBL’s raw material (in the range of 57-60%). VBL has lower susceptibility to changes in concentrate prices as the company is easily able to pass on the price increase to distributors.
• PET is a dominant packaging material in the soft drinks space, with ~85% of products sold in PET bottles, ~12% in glass and aluminium cans and tetra packs making up ~2-3%.
• VBL is undertaking measures to make light weight PET preforms (bottles) and closures (caps) which will help further to reduce the cost.
• Through light weighting, the Company intends to reduce the usage of plastic. During the last 10 years, the Company has reduced the weights of preforms and plastic closures by 10% to 20% in different SKUs.
• During CY21, 70% of plastic waste was recycled, which was sold in the form of finished products, as compared 66% during CY20. Plastic waste includes PET, shrink film, plastic closures and labels & laminates post consumption.
• Due to these initiatives, the EBITDA margins have improved from 13% in CY12 to 19% in CY21, which peaked at 21% in CY19. 

Strong financial Growth can be seen:

• VBL has delivered a healthy Volume/Revenue/EBITDA/PAT growth of 20%/22%/19%/37% CAGR respectively during CY17-21.
• Sharp rise in its return ratios (ROCE of 18% in C21 vs. 13% in CY17) is due to strong volume growth and measures taken to increase the cost-efficiency. We expect further improvement in the return ratios (24% ROCE by CY24E). 

Increase in Sales Volume:

Increase in Net Revenue:

Financials:

Conclusion:

• The improvement in return ratios over the past decade has settled the argument related to the nature of VBL’s business prevailing into pure manufacturing. EBITDA margins would remain stable (19-20%) but PAT margins have a huge scope to grow. Gains are expected on the back of rising out-of-home consumption after two years of sluggish performance. 
• The stock has run up quite a lot, up 6 times since its IPO in December 2016. Over CY22- 24E, it is expected that the company will deliver Volume/Revenue/EBITDA/PAT CAGR of 19%/19%/18%/29%. We value the stock at P/E of 45x CY23E.

Articles

Comments

• 

  Vaibhav

  22 July, 2022, 5:23 pm
  Good analysis
  Reply

  POST Cancel Reply

• 

  Shreyansh

  22 July, 2022, 6:24 pm
  Detailed analysis👍
  Reply

  POST Cancel Reply