Diageo rejigs United Spirits portfolio

Last Updated: Sat, Nov 23, 2013 06:20 hrs

As Diageo intensifies its focus on premiumisation as the long-term bet in India, it has confirmed United Spirits Ltd (USL) has begun exiting its unprofitable low-end brands in India. Diageo says it believes consumers in India would up-trade through the long term. Notwithstanding the slowdown seen in the September quarter, the company plans to capitalise on the trend.

At a time when many states resisted price rises to incorporate rising input costs, USL had begun considering assigning its premium brands greater priority, even before Diageo acquired 25.02 per cent controlling stake in the company. However, a close look at USL's performance during the quarter ended September shows the company's strategy took a toll on its total volumes, as low-end brands account for about 70 per cent of its volumes.

Diageo, the maker of Johnnie Walker and Smirnoff, acknowledged the slowdown in India, but said it had already factored this in during the stake purchase. Emerging markets were facing a slowdown in growth and India was not immune to this, Diageo said. "In the short term, the market is experiencing some slowness...and cost pressures have increased. However, we have factored this into our acquisition model. So, we expect to remain on track against our original investment case," Diageo chief executive Ivan Menezes said at the company's investor conference in London.

The company confirmed United Spirits had begun exiting some "unprofitable price points" to raise the margins it had once sacrificed to boost volumes. "We believe over time, we can deliver cost efficiencies. We may have to make some capital investments to improve productivity, but we remain confident operating cost savings can be made," Menezes said.

After Diageo acquired stake in United Spirits and increased the company's focus on premiumisation, the market had expected the company's margins to surge about 20 per cent. However, analysts who attended the conference in London said the Diageo management had dismissed the estimates, terming these "unrealistic".

The September quarter has been challenging for the spirits sector. USL's margin growth dropped to 10.9 per cent from 12 per cent in the corresponding period last year. The company was banking on the sale of high-value products to help offset the increasing costs of molasses and extra-neutral alcohol, crucial in making spirits, but margins began to fall when consumers cut discretionary spending.

"Our strategy for long-term value creation remains unchanged from the future we outlined in November last year. The consumer in India is trading up, and United Spirits has the brand portfolio to capitalise on this trend," Menezes said. "In the medium term, we may have to increase marketing for the premium brands, but I am confident we can deliver the right return from any upgrading."

Diageo said India remained crucial to its growth in emerging markets. It added it sought to boost its overall revenue, adding the company had factored in the cost pressures and slowdown in the market. "This transaction (the deal with USL) has not only transformed Diageo's position in India; it will also transform Diageo. India is one of the biggest growth opportunities in our industry. United Spirits' distribution reach is an enviable strength, as the number of middle-class consumers looking for premium and prestige local spirits brands increases as income levels rise," he added.

Debt rating improves
The deal with Diageo and infusion of funds into USL's books in the second quarter led Icra, an associate of Moody's Investor Service, to upgrade its rating on USL's term loans, fund-based facilities and non-fund-based facilities. The Rs 320.65-crore term loans of the company were upgraded to a long-term rating of BBB-' from D', while the short-term rating on the Rs 2,100-crore fund-based facility was upgraded from D' to A3'.

Icra also upgraded the Rs 400-crore non-fund based facility from D' to A3', while the Rs 400-crore fixed deposit programme of the company was upgraded to from MB' to MA-'.

The debt rating upgrade helped the USL stock close at Rs 2525.55 on BSE on Friday, up four per cent. Icra had downgraded its rating on the company's debt in September, 2012, two months before the stock-sale deal with London-based Diageo was sealed.

The infusion of Rs 1,453 crore during the quarter helped USL repay some of its borrowings to reduce its own debt. However, analysts said despite the infusion from Diageo, USL's long-term debt of Rs 998 crore had fallen only to Rs 454 crore, a possible indication of increasing working capital requirements that do not bode well for the company.

USL volumes slip in Q2
On a year-on-year basis, overall volumes fell one per cent to 28.1 million cases in the second quarter, despite a lower base in the corresponding quarter last year (one per cent fall). Sequentially, the fall in overall volumes was 10 per cent.

While USL stated its volumes in the prestige-and-above segment rose 21 per cent during the September quarter, the reported volume of 7.7 million cases during the quarter showed a modest five per cent rise, against 7.4 million cases in the corresponding quarter last year, as USL dropped a few of its brands from prestige to the lower segments. The company is said to have reclassified its portfolio, shifting a couple of brands - Bagpiper Gold and Director's Special Black - from the prestige-and-above segment to its regular/economy segment.

On a sequential basis, the company has seen a five per cent fall in volumes in the premium segment. It had sold 8.21 million cases in this segment in the quarter ended June.

According to the company's balance sheet, net sales fell eight per cent to Rs 2,057 crore, with the premium segment now accounting for 28 per cent of sales. Analysts said the company's consolidated net profit stood at about Rs 33 crore, a year-on-year fall of 72 per cent.

Excluding foreign exchange gains, the company's adjusted earning per share is, in fact, a loss of Rs 1.3 on a consolidated level, says analyst Vivek Veda of Espirito Santo Securities.

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