United Spirits Limited (UNITDSPR) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to United Spirits Limited Q2 FY '21 Results Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Anand Kripalu, Chief Executive Officer; and Mr. Pradeep Jain, Chief Financial Officer from United Spirits Limited. Thank you, and over to you, sir.

Thank you very much, and hello, everyone, and a warm welcome to the F '21 Second Quarter and Half Year Results Call. As we normally do, before we open the lines to Q&A, I just wanted to share a perspective of the results that we announced last evening. As everyone is well aware, we entered this fiscal in an unprecedented and challenging external environment, driven because of the pandemic. It's reassuring to see progressive improvement in the environment as the economy progressively opens. While the on-trade continued to remain closed for a good part of Q2, the off-trade channel is pretty much back to pre-COVID level. I'm particularly pleased that the agility demonstrated by our supply team to provide a fast start post the lockdown, which is completely new kind of protocols for the new normal, where we were able to ensure the safety of our employees while keeping the factories running. This enabled us to continue the rollout of our renovated brands, McDowell’s No.1 Whisky and Royal Challenge Whisky. Our commercial teams too went the extra mile and ensured that these were executed on the ground, in the market, in a manner similar to what we do during normal time. As you may have seen in the published results, our reported revenue declined 6.6%. The underlying revenue, however, declined 3.4%. The route-to-market change in Andhra Pradesh completely contracted our owned and franchised business in that state. Excluding the impact of bulk Scotch inventory, which we saw last year during this quarter and adjusted for the Andhra Pradesh business base effect, our net sales grew 1%. Prestige & Above segment grew 1%, driven by our renovated bundles and somewhat softer comparatives of the previous year. Price/mix was positive due to the improved relative price positioning of the BIO portfolio in key markets, particularly in North India. Excluding Andhra Pradesh from the base, our Prestige & Above segment grew 7.6%. The Popular segment declined 12.5% in the second quarter, increased consumer prices impacted demand in this particularly price conscious segment of this category. Further, the contraction of the Andhra Pradesh business driven by the route-to-market change, impacted the overall franchise business in Andhra Pradesh and more broadly in South. Commodities have been relatively benign in the second quarter. However, as mentioned earlier, contraction of our own and franchise business in AP and some related one-off inventory provisions compressed our gross margins to 42.1% for the quarter. Our A&P expense was down in quarter 1. In fact, we tried to cut as much as we could in quarter 1 because things were pretty much under lockdown. However, starting in Q2, we have reverted to our normative spend level. Quarter 2 spending was also to support the national rollout of the renovated McDowell's No.1 Whiskey and Royal Challenge Whiskey and also to leverage IPL. Reported EBITDA margin was 12.6%. However, eliminating the impact of one-off inventory provisions, the underlying EBITDA margin for the quarter was 14.5%. The PAT margin for the quarter stood at 6%. Apart from the P&L, I am particularly pleased with our working capital and cash performance, which has really been the best in the recent past. There has been improvement across lines of working capital as well as the quality of our accounts receivables. And I feel particularly pleased that we've been able to do this at a time when the marketplace has been heavily constrained. In the first half of the year, we repaid INR 780 crores of debt. We aim to continue our journey of monetizing noncore assets, so that we can further deleverage our business and lower our interest costs. A positive monsoon and Kharif outlook should limit commodities volatility in the larger part of this current quarter, which is Q3. However, we do see some possibility of mild inflation in the second half based on the just announced ethanol blending policy, and we need to see how that plays out. We look forward to welcoming our consumers to the on-premise channel as restrictions gradually ease out and we will leverage our Raise the Bar program to ensure that, that happens as best as possible. We, of course, will remain diligent and disciplined on our investments, as the environment continues to evolve. Our balance sheet remains strong, and our capacity to generate free operating cash flow is also sound, that positions us well to stay competitive in this marketplace. So with that, I'm going to open it up for questions.

[Operator Instructions] The first question is from the line of Abneesh Roy from Edelweiss.

Yes, sir, congrats on debt reduction and good recovery in the P&A. My first question is on the gross margins. Even if I remove the one-off, there is a pressure. So I wanted to understand in spite of the comment which you made that raw materials may firm up a bit because of the new policy, and the fact that now the airport footfall is also reviving, which means the duty-free sales will also pick up. Putting all this together, where do you see gross margins? And how was the mix in P&A this quarter? So your P&A saw good recovery, but within P&A, how has been the mix?

Okay. Thanks, Abneesh. I'll answer it, and then Pradeep will supplement my answer. I mean we have never given an outlook for gross margin, Abneesh, you know that. We have given an outlook in the past for EBITDA margin, and we have said that we will play the lines of the P&L as appropriate, and I'm sure you'll appreciate that, that is what we have been doing. Within P&A, it's a mixed bag. Now overall price/mix is positive, right, which means that generally, the right things are happening in the right thing. And some pricing is also there in terms of headline pricing. But I still say that it is very hard to read any trend right now in terms of, is there a complete premiumization trend? Now our BIO portfolio has done particularly well. It's possible that there will be some tempering of those explosive volume if duty-free travel -- duty-free sales significantly comes back. But our understanding is that right now, duty-free is at best 10% or 15% of what it used to be. So I don't think it's coming back overnight, right? There could be some gradual comeback. And obviously, we have got some benefit of that happening. But part of the benefit of our BIO performance is also because the relative price positioning of BIO versus BII and upper prestige has become a bit more favorable, particularly in some states of North India. And we are seeing that momentum each month and it's continuing on BIO. So I think it is some time before it tempers fully. And whether it'll temper fully or still stay fairly strong is to be seen. Our belief is that the intrinsic relative price positioning will stay as a benefit to this business. Some shift of duty-pay to duty-free could happen, right, as flights become normal, though I think it is some distance away. So that's the answer that I want to have. Is there anything to add, Pradeep, on gross margin, specifically?

Yes, Anand, thanks. Maybe just 2 points I want to add on gross margin. The first is driven by the Andhra Pradesh RTM change. And obviously, that has impacted our franchise business as well, right? So that is one. And the second thing is that our volumes, if you see in the current quarter, are still shrinking by about 3% to 4%, right? Whereas typically, if you -- we would want to grow our volumes at whatever -- the usual 4%, 5%, which provides a bit of an operating leverage. So we are still not getting that, right? So those 2 reasons are the add-on things that have impacted our gross margin. That's all, Anand.

That's very useful. My second question is on very good recovery in the P&A quarter-on-quarter. So what's driven this? Is this market share gain? Or is it that on-premise consumption is shifting to home consumption? Or is it the beer consumption shifting towards liquor? And finally, any update on your Support the Bar program, which you're running, how much has been rolled out, how much has been already consumed versus the budget?

So I'm not sure I have hard answers. So I think you're asking, Abneesh, but I'll tell you what our best understanding is right now. So first of all, I'm very pleased with our P&A recovery, okay? No question about that. It has been significantly enabled by our renovation, which I'm pleased about as well as our BIO performance, which we spoke about. You can decide what our competitive performance is, you have all the numbers and the data and you can decide, right? But I'm pleased about how the whole thing has happened. As far as on-trade is concerned, see on-trade, which includes weddings, banquets and so on is, let's say, about 1/4 of our business, give or take a bit. It is beginning to open, but footfalls are still low. I would say at best falls, if you walk into a restaurant, at best, it will be maybe 50-odd percent of what it used to be, right? So it is still some time to go for it to recover fully. Now our Raise the Bar program, I think we had 900 registrations in our first week itself. We've handed over starter kits. We've started training programs for many people already. So it is getting now very, very good response, and the response will only increase, as people are opening because they want to also demonstrate that they are safe for people. So I think it's coming in very handy to support our customers. And our customers, I must say, have been very, very pleased with the initiatives that we have taken. Finally, is there an increase in in-home consumption? Absolutely, yes. I don't want to answer a guess on what percentage that shift is. But I can tell you that we have been running so many virtual programs on DIY, right, which is do-it-yourself cocktails, right, and stuff like that. So our brand ambassadors and bartenders have been running online program. There has been a lot of interest. And in-home penetration absolutely has gone up. I think what people have also realized is, so drinking at home, you can afford to drink even better stuff because it's much cheaper to buy the bottle and take it home versus drinking at a bar. And I think it's also that bit of price discovery that's happening. And then if you buy the right ingredients and make your own cocktail, you can create a bit of magic in your home. So maybe some of these will stay, including, I believe, the breakdown of traditional barriers of drinking at home amongst many conservative Indian family. I think that barrier has also come down, where people are saying, rather than drink on the street or drink in a place that's not safe, you may as well drink at home, all right? So I think there are some collateral benefits that we could stay on, right, and benefit our industry over the medium term.

Sir, that's quite useful. Just 1 last follow-up. So in terms of consumer behavior, because you said in-home consumption has picked up, so is he buying much higher ticket price versus earlier, anything you're picking up from the stores? So that's something which will ease off because now people are definitely going out.

So if you look at our numbers, right, clearly, the off-trade is delivering almost and above-par performance because the on-trade contribution is small. And if on-trade was a 1/4 of our business, and we delivered more than 7% P&A growth without AP, right, it tells you that the off-trade has delivered an above-par performance. The mathematics of it tells you that, right? Now that means there must be more ticket size, right? That's the only way it really happens, unless we have a whole generation of new consumers, who have come in post the pandemic, which I think is less likely. So yes, I think there is definitely an enhancement of ticket price by deduction. I've not looked at the data closely enough at a store level by deduction, yes?

The next question is from the line of Arnab Mitra from Crédit Suisse.

So Anand, the P&A growth is quite remarkable...

Apologies, Mr. Mitra, your voice is breaking up.

Yes. Is it audible, my voice?

Sir, can you use the handset mode while speaking because there's a lot of static from your line.

Okay. I'm actually on the handset, maybe I'll come back in the queue then after logging on from another device.

No, why didn't you -- I think I can make out, Arnab, so why don't you just tell, I'll try and capture it and answer it.

Sure, Anand. So the P&A growth of 7% is quite remarkable given the headwinds, and there would have been progressive improvement through the quarter. So would you have exited the quarter at a double-digit kind of growth in P&A, excluding AP? And your commentary in the note seems still a little cautious, in the press note that you put out. Any reason for that caution given the kind of growth that you have seen in this quarter?

Sure. So first of all, I'm not going to hazard a response to whether we are in the double digits and whether there's successive improvement, right? Because I think it would be unwise of me to share that level of granularity. I think what you have to just see is that, listen, this, itself, is a strong performance we have seen. I think our renovation impact is not fully there across India because there's been successive rollout post the opening up. And in some states, like, big states, like Maharashtra, has only gone in, in the last 4 weeks. So the impact of our renovations have not yet been fully felt. And I see that, that is going to -- the impact is going to continue and extend right across the nation. So I feel good about that. I feel good about the fact that on-trade has started opening. I'm still uncertain and hence, the cautious optimism. I'm still uncertain, by the way, of how the festive season will pan out. Will people start hounding the bars again? Or people are going to be cautious? Because yesterday again, and this is a big problem right now, it's 2 steps forward, 1 step back. After going down to 30,000 cases a day, we are again above 50,000 cases a day. What will the government do? Will -- what will people do? Are people still going to exercise more caution and say, "[Foreign Language], I'm not going to step out of my home now again in some time, and certainly not going to go to bar." So I think you see this October-December season is a significant step-up normally on July-September. And that's basically winter and festive, okay? Now I do not know if that kind of step-up is going to happen because of the environment we're in. And I think in this situation -- we are not a home hygiene product, right? Our product is consumed at the center of socializing. And I just do not know if socializing is going to come back the way it was last year in Q3. So I think that's where it is. So I would say I feel good. I feel good about our renovation. I feel good about the continued rollout of our renovations, the impact they'll have, the environment remains uncertain. Okay? And it would be unwise for me to try and predict what that environment is going to be like over the next 3 months, Arnab, and that's the reason for this.

Okay. And my last question was on the balance sheet improvement. So this very high cash flow generation seems to have come from an increase in other liabilities, current liabilities. If you could just explain what has driven this? Is this sustainable? Because normally, this is excise duties to be paid is my sense. So any color on that, please?

Maybe I hand that over to Pradeep.

Yes. Anand, let me take that. Yes, let me take that. So my guidance will be, let's not look at current liabilities in isolation. I think the point that Anand made in his opening part is that overall of net working capital, we have done well, which has enabled us to release debt to the extent of INR 780 crores, starting 1st April to 30th September. However, I do want to say that roughly about 1/3 of this was on account of the inflated position that we were sitting as on March 31 because of the sudden lockdown that got announced, right? And the balance 2/3 is on account of hard core operating cash flow that we've generated during the 6 months.

The next question is from the line of Aditya Soman from Goldman Sachs.

My first question is on BIO. So we've seen, obviously, you indicated there has been a significant activation in BIO sales. Now on the other hand, if you look at gross margins that those haven't expanded as one would expect with the acceleration in the BIO. Is this because there is -- I mean, the gross margins or the margins for you for BIO would be similar to that of the other Prestige brands, particularly because of maybe there's -- the margins are balanced out with -- depending on your agreement with Diageo.

So Pradeep, do you want to take that? On -- you think the -- it's basically to do with gross margins despite the performance, right? Why we're not seeing the improvement? And is it because we don't get accretive gross margin from BIO?

Absolutely. So let me take that Aditya. So like I responded to Abneesh, right, the gross margin impact is largely driven by the Andhra Pradesh RTM change impact, and its impact on our owned, owned, if we lose the revenue also, it doesn't impact margins, but the franchise business. right? So that's a large franchise business that our franchisee were running. And obviously, our South franchise is a portfolio franchisee. So that has its own associated impact on its overall portfolio. So that's the reason that we are not seeing. And the other reason which I mentioned was on account of our volumes are still kind of shrinking versus prior year. So therefore, there is some element of fixed cost deleverage that we are seeing. On your larger point of the mix impact on gross margins, this is -- the way I'll say is that there is a top end, right, which is not hugely accretive in terms of percentage margin, but it is highly accretive on rupees per case. So that is one. And yes, our performance in this quarter has also been driven by a huge growth in the lower Prestige segment, which is our anchor trademark of McDonald's No.1, right? So the 2 of them are, by and large, squaring each other, I would say. Hope that kind of provides some commentary, some color to the gross margin performance?

Yes. I mean that was very clear. So it's basically the point being that the lower prestige has grown faster and then BIO, you're saying the gross margins aren't necessarily hugely accretive. And the second question that I had was on the new launches, McDowell's No.1, RC. Have we seen any pricing changes due to the launches?

Have we seen any pricing changes? See, we -- I mean you know how pricing is done in this industry, right? So there has been really no pricing changes as a result of this. There has been price increases in terms of headline prices that we have received from states, which have happened, and that is not related to the renovation directly. Now let me say this, our strategic intent with these improved mixes is to charge a premium to competitive brands in that segment, okay? Now in some states, we have that premium already. In some states, we don't have the premium already, right? And our intent with both McDowell's and Royal Challenge is to take a premium to other brands in that segment. And we will keep moving towards trying to do that, dependent on regulatory approval, right? Because we believe that these mixes have the potential to take that premium. So just to look in Maharashtra, No.1 is at a premium to other brand in the segment, right, and it is growing faster than other brands in that segment, right? It can take [Audio Gap] because even before the renovation happens. So post renovation, I think there is higher propensity to do this across states. And we will do everything we can to get to our strategic price positioning for these brands.

No, that's very clear. So could you share any number on how many states you would be -- or what proportion of your sales you would be at a -- already at a premium to your competitive brands?

No, I don't have that data handy, what percentage of our business is at a premium. But let me put it this way, it is not a -- it is some part of our business, I would say, not a dominant part of our business for sure, right? We are going to move in that direction. And you will see this playing up, right? Based on regulatory constraints, like I said, which is always a caveat as such.

The next question is from the line of Mayur Gathani from Ohm Portfolio Equi Research Private Limited.

A great set of numbers, sir. Sir, I would like just hopping a little bit more on the working capital. Can you throw some more light on that? I mean, is it sustainable? How did we manage this?

Sure. I'm going to request Pradeep to answer that question, but I just want to say this that working capital has been a key management performance metric for several years now. And therefore, there has been huge focus on working capital as a management team, to the extent that I share a monthly cash committee meeting, where every month, we look at every constituent of cash and try and tease out efficiencies. And what you're seeing now is a culmination, I would say, of years of focus, right? At least here, we have improved working capital by the way consistently and very significantly, we improved working capital. But I've always said this that there is further opportunity to squeeze the level, right? What I felt good about this time is not just that the improvement was just a continuation in the past, that it was better than the past. And it was done in a significantly more challenging environment as you would imagine, where cash flows were not that easy for many of our customers and vendors, right? And that's what I feel pleased about. But to add more light, I'm going to hand it over to Pradeep.

Yes. So Mayur, again, I've responded to that earlier. So roughly about 1/3 of the improvement is simply driven by the fact that we were sitting on a higher days in March 31 because of the sudden lockdown announcement. And the balance 2/3, we believe, is purely on account of the working capital efficiencies that we have generated. We are particularly pleased with our accounts receivable performance driven by the momentum that we are beginning to generate on our P&A side, right, and especially the scotch side, et cetera, which is a lot more prevalent and not. We are doing well there and North obviously, is very, very credit intensive, right? So the cash rotation is happening at a faster pitch in that part of the country, which is providing us a flip, right? And also, I may want to add that by and large, in this year, the corporations have been behaving, right, and they have been paying us on time. So that also adds to it. Whether it will sustain or not, as Anand mentioned, this category has its own set of volatilities associated with it, so we will take that as it comes.

Okay. But sir, if you -- when you talk about 1/3 being the -- is the inventory that you're talking about was high in the month of March? Because I don't see much change. In fact, inventories increased, if you look at March to September, receivables are more or less similar to March to September comparison. So what you're saying, I completely take that, but in the numbers I'm unable to figure that out.

So Mayur, maybe -- I'm talking about net working capital, right? That's the provision that we run with in our minds. But you could always reach out to Richa subsequently after the call, and she'll be able to provide some commentary on that.

Okay. Great, sir. And one more question from my end. What is your outlook on the AP issue because it's impacting our gross margins and the franchisee income?

So listen, AP is a route to market or a regulatory deadlock, right, as far as our business is concerned at this point in time. I want to say this though, right, when it will unlock, I think your guess is as good as mine right now because there's no input-output in terms of effort and outcome that's going to happen. Our effort remains continuous and our advocacy program, right, is comprehensive. But I want to say this, in this industry, and this is something that I want to share the larger group, based on my 7 years of experience in the industry is, every couple of years, some door will shut, but some other door will open, okay? That's how this industry plays out. 3, 4 years ago, for those of you who have been on our call since then, we had a situation in Uttarakhand about 4 years ago, where our business went to 0, from having leading market shares went to 0. 9 months, it was almost 0. Today, we're growing market share and the business is booming. Chhattisgarh, we were doing well. Our business went close to -- I mean, not 0, but I can say almost, right, a fraction of what it used to be. Today, Chhattisgarh is back. And our business is doing really well there. And we are growing market share there. Bihar, from whatever I'm hearing, right, and you read the same papers that I do, prohibition doesn't seem to be essential to this current election manifesto as it's been in the past, right? Now I'm not saying that it's going to get listed or something, so don't quote me because I am nobody to say that. But whatever I'm reading, makes it clear that it's not as central to the manifesto and to the election as it has been in the past, right? Now who wins, I do not know, but what's going to happen post that on our categories in Bihar, right, I just remain, but use the same word, cautiously optimistic, that something could happen, a door may open. This is be nature of the beast we are dealing with, right? We've been through the Supreme Court Highway band when we could, had to shut down a lot of store, everything found its way back and it reopened. So this is what I call funnies in our industry. These funnies happen. right? I think we have to remain optimistic. And yes, none of these decisions are permanent, by the way. But what I cannot predict is the timing. So I'm just saying just step back and look at it from a broader point of view, because it is the nature of the environment we're in.

The next question is from the line of Percy Panthaki from IIFL.

My first question is on your margins going ahead. You mentioned that there could be some pressure on ENA prices going ahead, which can affect margins. Already, our gross margins are under pressure. And if ENA prices go up, that could put even more pressure on the margin. So just wanted to understand what tools do you have in your arsenal to offset this margin pressure? And as a sub-question to that, in terms of price increases in any of the states, are you hopeful in the next three quarter, are any of the states sort of due because there have been several years in terms of price increases? And are you optimistic that any of these will actually go through?

So first of all, yes, you could say margins are under pressure. What we have always said is and I'd like to believe that we have broadly delivered, apart from this pandemic period, is consistent improvement in EBITDA margin year-on-year towards what was that time our guidance on our medium-term grower. And we have played different lines with the P&L, not only gross margin, but different lines of the P&L to deliver that margin guidance, right? Whether it was A&P, increasing it or tempering it; whether there is overhead, controlling it, right, apart from everything else. So first, I think when we think margin, please recognize that our management focus is to make sure that we deliver continuous improvement in operating margin, which is the EBITDA margin for this business, notwithstanding this interim period of a pandemic or our prices, right? But once we come out of this, we'll get that. Now on your point of what levers do we have? Apart from levers of the P&L, we have received about 0.5% of realized headline pricing, right. Realized means, net of trades spend, et cetera, et cetera, in our P&L in this quarter, right, give or take a bit. And that's the result of pricing across 6, 7 states. Now our efforts on price increases will continue. And I'm hoping that as we get to the next excise cycle, the broader economy and industry seems to be reviving, GST collections seem to be reviving, and I'm hoping that the acute pressure that states has faced on GST collections from the center, right, that will waive a bit, and states will get a bit more control of the finance, right? Because we still have a few months before the actual decisions are going to be taken for the next excise cycle. So I just want to say that pricing remains an important lever, and we're going to put a lot of effort behind trying to get more realized headline pricing. As far as commodities are concerned, right, we delivered P&L when our commodity prices were even higher than what they are today, particularly on ENA, okay? So I just want to say this, we have flagged the caution because the government announced an ethanol vending program and a procurement price, okay? currently, the rates of ENA are well below that, okay? That's how it's currently playing out. So -- and I think, like I have said in the opening statement, this quarter, which is October to December, right, barring some funny, I think it will be okay and under control commodity pricing, right? Because it's -- already they are in early November, right? And we've obviously covered enough for most of this quarter, so it's not going to be a huge negative. So we have the wait and see what happens with commodities. I mean we've seen what's happened with global oil prices gone down again to $39 a barrel, right? So I'm saying this is just a cyclical and unpredictable environment we're in. I think what you should take out from what I'm saying is that the management team is absolutely committed to delivering the right level of operating margin, right? And in peace times -- this is war time, but in peace time, to deliver continuous improvement operating margin and despite high commodities, despite poor pricing, despite everything, if you look at our last few years, we have delivered that every year. And I think you need to get confidence from that rather than hold us to account for every line of the P&L.