Varun Beverages

Pepsi bottler at P/E of 93

The company's fortunes are tied to growth of Pepsi branded carbonated and not carbonated beverages

CM RATING

38/100

Promoted by Ravi Kant Jaipuria, Varun Beverages (VBL) is one of the largest franchisee in the world (outside USA) of carbonated soft drinks (CSD) and non–carbonated beverages (NCB) sold under trademarks owned by PepsiCo. It produces and distributes a wide range of CSD as well as a large selection of NCB including packaged drinking water.

PepsiCo CSD brands produced and sold by the company include Pepsi, Diet Pepsi, Seven -Up, Mirinda Orange, Mirinda Lemon, Mountain Dew, Mountain Dew Game Fuel, Seven-Up NiMbooz Masala Soda, Seven -Up Revive and Evervess. PepsiCo NCB brands produced and sold include Tropicana Slice, Tropicana Frutz (Lychee, Apple and Mango), Nimbooz as well as packaged drinking water under the brand Aquafina. In addition, it has also been granted the franchise for Ole brand of PepsiCo products in Sri Lanka.

VBL has been associated with PepsiCo since the 1990s and has over two-and-half decades consolidated its business association with PepsiCo, increasing the number of licensed territories and sub-territories covered by them, producing and distributing a wider range of PepsiCo beverages. The total sales volumes grew at a CAGR of 32.78% from 437.9 mn litres (equivalent to 77.1 mn unit cases) in CY 2011 to 1,361.1 mn litres (equivalent to 239.7 mn unit cases) in CY 2015.

The company has 21 plants across Indian and outside India. Out of 21 plats, 16 plants are present in India. The company is largely present in North and East India.

As of June 30, 2016, VBL had an estimated aggregate annual production capacity of 3,438.4 mn litres (equivalent to 605.6 mn unit cases) in India and an estimated aggregate annual production capacity of 991.57 mn litres (equivalent to 174.6 mn unit cases) in its international production facilities. The company has two facilities dedicated to backward integration located at Jaipur and Alwar which manufacture crowns, plastic shells, corrugated boxes and pads and shrink wrap film.

The company has 10 years agreement with PepsiCo, with auto renewal. This agreement defines the territory as well. As of June 30, 2016, VBL has been granted franchises for various PepsiCo products across 17 States and two Union Territories in India. The licensed sub-territories in India includes Delhi, Rajasthan, West Bengal Goa, Arunachal Pradesh, Assam, Meghalaya, Manipur, Mizoram, Nagaland, Tripura, Punjab, Himachal Pradesh, Chandigarh and certain designated parts of Madhya Pradesh, Uttar Pradesh, Uttarkhand, Haryana and Maharashtra. The company has also been granted the franchise for various PepsiCo products for the territories of Nepal, Sri Lanka, Morocco, Mozambique and Zambia.

The company is present in three segments namely 1) carbonated soft drinks (82% revenue contribution); 2) non-carbonated drink (6% contribution); and 3) packaged drinking water (Aquafina 12% contribution). The company accounts for 44.1% of PepsiCo's sales in India. The balance is controlled by Pepsi (~30%) and other 2-3 bottlers (24%).

The Offer and the Objects

The issue comprises fresh offer of 1.5 crore shares, which at lower price band of Rs 440 per share works out to issue size of Rs 660 crore and, at the higher price band of Rs 445 per share, works out to an issue size of Rs 667.50 crore. The issue also comprises of offer for sale of 1 crore shares by promoters, which at lower price band of Rs 440 per share works out to issue size of Rs 440 crore and, at the higher price band of Rs 445 per share, works out to an issue size of Rs 445 crore.

The minimum bid lot is 33 equity shares and in multiples of 33 equity shares. The issue is made through a book building process and will open on 26^th October and will close on 28^th October, with anchor Investor bidding date of 25^th October 2016.

The issue proceeds accruing to the company will be used for prepayment or scheduled repayment of a portion of outstanding indebtedness availed by the company and rest for general corporate purposes.

The soft drinks market in India is underdeveloped in terms of per capita consumption of 9.4 litres in 2015, especially when compared with the world average of 91.9 litres and the more mature U.S. market, with a per capita consumption of 347.3 litres in such period.

During the period of 2015-20, the per capita consumption in litres of the beverage markets in India, Nepal, Sri Lanka, Morocco, Zambia, Mozambique and Zimbabwe are expected to grow at a rate much higher than the world average of 2.3%. This is expected to result in increased consumption of PepsiCo's beverages and will enable VBL to capitalize on such market growth.

Wide spread and integrated sales and distribution network that ensures effective market penetration. As of June 30, 2016, VBL's distribution network in India included 60 depots and 1,438 delivery vehicles. The company has 562 primary distributors in India and 415 distributors in international operations.

By expanding its product portfolio and distribution reach, particularly in markets and demographic segments with relatively low per capita consumption like semi-urban and rural markets, the company can leverage its brand strength and can grow more organically.

The company continues to focus on acquiring additional franchisee rights of Pepsico within India as well as worldwide. VBL will also continue to focus on the integration of operations in the recently acquired territories and any licensed territories or sub-territories it acquires in the future with its existing production and distribution operations to benefit from operational efficiencies and derive business synergies.

Weaknesses

The carbonated and non-carbonated beverage markets are highly competitive in India and the international markets.

The company's growth prospects are directly linked to the growth of PepsiCo Inc. Its growth plans and expansion strategies are also subject to prior approval of PepsiCo.

Demand for products may be adversely affected by changes in consumer preferences. In recent years, VBL has experienced slower growth rates for cola based drinks such as Pepsi compared to Non-cola based CSDs such as Mountain Dew and fruit juiced based CSDs such as Seven-Up Nimbooz Masala Soda. Changes in consumer preferences may reduce consumers' willingness to purchase certain of its products and adversely affect its business prospects.

Obesity or nutritional concerns may reduce demand for some of its products

PepsiCo India / PepsiCo Inc. and the PepsiCo International Entities are entitled to various rights under the PepsiCo India Agreements and the PepsiCo International Agreements, including the right to unilaterally determine the price of the PepsiCo beverage concentrates VBL purchases. In the event any such right is exercised by PepsiCo India, PepsiCo Inc. and / or the PepsiCo International Entities in a manner adverse to VBL's business interest, the business prospects and future financial performance of VBL can be materially and adversely affected.

Termination or non-renewal of the PepsiCo India Agreements or the PepsiCo International Agreements by PepsiCo India or PepsiCo Inc. or PepsiCo International Entities or any material modification to the existing terms under such agreements adverse to VBL's interest can materially and adversely affect VBL's ability to continue its business and operations and its future financial performance.

The company generates a significant proportion of its total sales volume from their operations in Uttar Pradesh. Any adverse developments affecting their operations in this state can adversely affect its business operations and financial performance. Its operations in Uttar Pradesh contributed 29.56% and 32.19% of its total Sales Volume in India in Fiscal 2015 and in the six months ended June 30, 2016, respectively.

Bad weather conditions, including disturbed summers or untimely rains during the peak sales season of summer, may adversely affect its sales volumes and results of operations in the relevant year.

Any contamination or deterioration of beverages could result in legal liability, damage reputation and adversely affect the business prospects and financial performance. As on 30 June 2016, there were 142 criminal cases pending against the company and related parties.

A majority of group entities are loss making and have negative net worth. Certain other concerns on corporate governance are change in auditor just prior to the Initial public offer, high rate of receivables is written off, advances to loss making group companies, sharp decline in concentrate price by Pepsi in the year leading up to the IPO.

Pepsi remains #2 player in the CSD market in India, with 33% market share by value and 31% by volume. However, the gap between Coca Cola and Pepsi is reasonably large, with Coca Cola enjoying a 60% market share by value and 57% share by volume. The gap between Coca Cola and Pepsi has been gradually but steadily widening. Over the last 6 years, Coca Cola has gained 100-150-bp share in value/volume terms as compared to 310-bp volume or value share loss for Pepsi, widening the market share gap by 400 bps.

Valuation

For the six6 months ended June 2016, consolidated net sales stood at Rs 2529.70 crore up by 13% YoY. The OPM stood at 23.9% and OP at Rs 604.20 crore up by 24%. Interest cost was higher by 25% to Rs 111.20 crore and depreciation was higher by 30% to Rs 189.50 crore on YoY basis. After providing total tax of Rs 99.70 crore, consolidated PAT for half year ended June'16 stood at Rs 209.80 crore up by 19% on YoY basis. Sales of the PepsiCo beverages are generally significantly higher in the summer months of April through June and considerably lower during the winter months of December through February. Hence, the first half is the peak season and the first half financials cannot be annualised.

The company's financial track record before CY 2015 is not encouraging. For CY 2015, consolidated net sales were up by 36% to Rs 3394.10 crore. The OPM was up by 330 bps to 18.7%, leading to a 65% increase in OP to Rs 634.10 crore. Interest costs stood at Rs 168.80 crore down by 9% and depreciation was up by 51% to Rs 317.40 crore. After providing total tax of Rs 76.60 crore and minority interest of Rs 1.50 crore, consolidated PAT for the 12 months ended December 2015 stood at Rs 87.10 crore. On a fully diluted equity share capital of Rs 18.20 crore of face value of Rs 10 each, EPS for CY 2015 works out to Rs 4.8. At higher price band of Rs 445 per equity share, the scrip is offered at P/E multiple of 92.9.

Varun Beverages: Issue highlights

 Varun Beverages: Consolidated Financials