United Spirits Limited (UNITDSPR) Earnings Call Transcript & Summary

Welcome to United Spirits Limited Diageo India's Second Quarter Earnings Conference Call. Hosting the call today from USL Limited are Ms. Hina Nagarajan, Managing Director and Chief Executive Officer; and Pradeep Jain, Chief Financial Officer. [Operator Instructions] I now hand the conference over to Ms. Hina Nagarajan. Thank you, and over to you, ma'am.

Thanks so much. Good evening, ladies and gentlemen. Thank you for joining us on the second quarter earnings call of United Spirits Limited. At the outset, I would like to take the opportunity of wishing all of you and your families a very joyous and safe Diwali. I hope you had a lovely unconstrained celebration this year after a couple of years of very quiet Diwali during COVID. As always, it's a delight to interact with all of you. And I'm joined today by Richa, our Investor Relations Head and Pradeep, our CFO. I intend covering the following today in the opening comments. A little bit on the consumer context in the current environment as we are seeing it, a short update on the key pillars of our strategy communicated last year, especially the portfolio reshape and the Society 2030 goals, some context on the results that we announced last Friday and then we can open it up for Q&A. On the consumer context, while inflation has been a bumper in the recent past, the latter consumption story anchored in premiumization continues strongly for our consumers. Premium and luxury consumers are driving growth ahead of middle India Prestige consumer and the latter are also coming back to pre-COVID growth trajectory. Affluent consumers continue repertoire drinking with non-risky categories like gin and other white spirits gaining further traction. This is also indicative of consumers increasingly wanting to drink better, not more. Among the middle India consumer, while we are witnessing downgrading in the larger FMCG space, I would say the Prestige consumers in our category are managing their wallet share by moving to smaller-sized SKUs, but not downgrading to lower-priced brands. This is reflective of the brand facility in our categories. On the strategic side, on our strategy pillar, our portfolio reshape strategy is accelerating. We have covered a lot of ground, and we are relentlessly at it. We had announced earlier in the quarter that an investment of INR 45 crores was made by the company for its state-of-the-art craft and innovation hub in Ponda, Goa. This investment is in line with the company's strategy to accelerate transformational innovation and strengthen our craft and premium portfolio. Our recent innovations renovations position us better to meet changing consumer tastes and preferences and will propel growth. Godawan, our Indian Single North is now available in 5 states, Rajasthan, Delhi, Nagaland, Haryana and launched in the international market of UAE. It will soon be available in the U.K. and in the United States later. Black Dog renovation that was rolled out last year continues to be well accepted by consumers, leading to continued momentum on the brand. We continue to scale the campaign with global icons Keira Knightley across digital platforms as well as Autozone. Royal Challenge American Pride has now become available in 8 states. During the quarter, we are launching the brand in October in 3 more states, Maharashtra, Amritsar, Punjab. On Signature, the momentum from the renovation last year continued on the back of significant improvement in consumer equity with consumers really appreciating the 3M blend and differentiated packaging and crafted from nature propositions. With focused energies on Royal Challenge, we have been able to lead the growth in that segment in this quarter. It grew on the back of both competitive pricing as well as renovation, especially in the state of Maharashtra, Telangana, and Delhi and we are now in the process of extending the renovated Royal Challenge to other states in the country. On the #1, our intellectual property of Yaari Jam with a tribute to the singer KK has driven huge engagement with over 2 billion views and the first of which kind consumer engagement in the relevant states. Despite segment headwinds, this is one segment where we do see some impact of the inflation. But despite those headwinds, McDowell No. 1 has delivered really good performance. Last but not the least, a critical component of our portfolio reshape strategy. We have successfully completed the sale of the entire business undertaking associated with 32 brands in the popular segment to Diageo Beverages Private Limited and have given effect to the franchise of 11 other brands in that segment for a period of 5 years. The completion of this transaction enables us to unequivocally focused on Prestige and above and capitalize on the rapidly changing consumer and category trends. 5 manufacturing facilities have been transferred 4 of the third party and one of our own manufacturing to Diageo. We have also provided continuity of jobs and benefits to employees working on this portfolio who have now moved from the Diageo USL to be part of this input. On the digital side, in.thebar.com is the half for our brands to enable hosting landing pages of different brand campaigns. The biggest initiative has been linked to e-commerce in West Bengal, building the direct-to-consumer linkage of the bar with third-party aggregators like [ USL ], Buzzi, Big Basket, for consumers visiting the bar from that market. The social content calendar, which comprises of cocktails, knowledge, drinks, bar, bartender, fix brands and celebrations also went live with now regular content available to consumers. We will continue to scale this up with more content, better user experience, and engagement for the community. On our Society 2030 goal, we continue to progress towards our Society 2030 goals. Aligning proactively with the steady disclosure requirements on business responsibility and sustainability report for next year. We have published on our website an independent, environmental, social and governance report for the fiscal 2021 '22. It has been prepared in accordance with global reporting initiative standards. The disclosures are also mapped with United Nations Global Compact principles and Sustainability Accounting Standards Board sector-specific standards. This is further aligned with the Go PLC's ESG reporting Index 2022. We request you to go through the above ESG disclosures, both quantitative, qualitative for a comprehensive understanding of our objectives and progress in this space. Now a little bit on our financial performance. We have delivered strong top-line growth and resilient EBITDA performance. Like-for-like, our business is bigger and stronger versus pre-pandemic levels of 2019. We have delivered a growth of almost 18% in the second quarter. P&A growth stands at 23%, growing on a strong base and the highest underlying growth in the last 24 quarters. The price mix during the quarter was at 9.4%, reflecting the higher growth in more premium segments as we move out the consumer price later. More importantly, we have seen sequential gains driven by the recent innovation and brand renovations in both mid-Prestige and upper Prestige. Double-digit inflation and ongoing scotch pricing discussions led supply constraints adversely impacted our gross margin. Our marketing reinvestment rate during the quarter was 5.5% of net sales. We continue to drive customer-centric activation, strengthen our brand equity and premiumize the portfolio. We have also leveraged media opportunities on the back of marquee cricket associations like that on Asia Cup and the Indian series. And of course, you must be delighted when Vera performance in the match that happened just a couple of days ago - yesterday. EBITDA was INR 446 crores and EBITDA margin was 15.5%. Underlying EBITDA, excluding one-off in previous year was up 1%. Exceptional items primarily include a net one-time profit arising from the slump sale of the business undertaking associated with 32 brands in the popular segment. Profit after tax after incorporating the tax-adjusted exceptional gain was at INR 563 crores in the quarter, up 105.9%. Our outlook on inflation and pricing, we do expect double-digit inflationary pressure to continue to impact in the near term, driven by the sequential serving prices of input going into glass manufacturer and ENA. We are cautiously awaiting the ethanol blending policy that we will stand announced in this coming quarter. On the flip side, we are also seeing some green shoots in paper price and crude-linked commodities. Pricing realized in some of the states will now start ramping up in the quarters to follow. Revenue growth management and delivering on our productivity initiatives across the value chain will also help us to partially combat the inflationary headwinds. In conclusion, all I want to say is that we are confident in the resilience of our business, our strategy and our ability to navigate headwinds as our team has demonstrated over the last couple of years. We remain focused on our strategy of reshaping the portfolio, driving commercial excellence, in-store and on-premise, revenue growth management and everyday efficiency and productivity extraction. This gives us the confidence to deliver sustainable growth and create long-term value for all our stakeholders. With this, we can now open the line for Q&A.

[Operator Instructions] The first question is from the line of Abneesh Roy from Nuvama Institutional Equities.

My first question is on demand side. So you made 2 remarks. One was premium and luxury growing faster than the overall P&A. And second is the customer is not down trading these continuing smaller SKUs, just like in FMCG. So is it possible to give some insight, some numbers on both of these? And the related question on overall P&A was when I compare to pre-COVID in terms of the specific channels of take-up bars, larger event consumption, for example, say, large weddings or stay in hotels, is it now back to the pre-COVID whatever data you have, if you can share on that?

Abneesh, your question on -- I'll answer the second question first, which is that our emanates back to pre-COVID level. Actually, yes, there are. And manages are back and how. I mean, we are seeing larger and larger manages. So that's pretty good for our demand product. Luxury premium, I mean, we continue to see the double-digit growth that we have been seeing for a while. That has not changed really over the last few years. So the premiumization trend is continuing there. I would say the -- even on the Prestige side, we have seen pretty healthy growth. I would only caution that, look, it's just a few quarters after the opening up of the market. So I don't feel that the demand in this segment has fully settled. I would say, basically mid and upper-Prestige. But there is some level of premiumization that's continuing in these segments. We've seen a little bit of slowdown on lower Prestige which is primarily attributed to, I would say, upgrade from the popular and the country liquor. This is a bit slower than what we've seen over the last few years. But having said that, I think our brands are performing very competitively in each of these segments. And overall, we feel very confident about the demand scenario in the industry.

Sure. My second question is on the specific statements you made on 2 of your brands. So on Royal Challenge, you mentioned competitive pricing and in McDowell, you mentioned some inflation impact. Now inflation is across the board as a portfolio itself. So what do you mean when you said that McDowell is facing the inflationary impact?

So no, my comment on McDowell was largely to explain that we see some slowdown in the lower Prestige category on account of inflation hitting that category of consumer, and therefore, some slowdown in upgrade from, say, popular or complete to this segment. So that's the clarification on inflationary impact on the category rather than McDowell. So on Royal Challenge, we were not fully competitively priced in a couple of states, and we have corrected that pricing, to be competitive in those states. And the brand is actually showing very good growth momentum, not only in those states, but across the market.

Yes. And maybe an additional build Abneesh from my side is that, look, if [ Anella ] has consistently maintained over the last 2, 3 quarters that when we renovated McDowell's and RC, we were not really delighted with how RC had performed. And therefore, over the last 3, 4 quarters, we were working on reengineering the blend to make it grow further. And now what we have done with the Delhi RTM change and this competitive pricing reaction in Maharashtra and Telangana, we are pretty happy with the way they've responded.

Sure. One follow-up on that, your corrective action in Royal Challenges, has it led to any retaliation by the other players? And on Delhi market, if you could elaborate what is the current situation?

So like we said, we were overpriced in a few of the critical markets. We've just become competitive on pricing. So that addresses your first question, Abneesh. And on Delhi market, maybe I'll hand over to Hina to talk about the renovation that we did.

Look, so I can't put an retaliation. I think all competitions are following their strategy and continue to follow their strategy. And for that, clearly, we had said that we will reshape the value proposition in mid-Prestige through the renovation of Royal Challenge. And I think we are feeling very confident that we have managed to now reshape the value proposition, and we are seeing good results for Royal Challenge whiskey. And therefore, we are rolling out this renovation to many more states sequentially. So I think our strategy is now falling in place as we had expected it to. And competitors continue to follow their own strategy.

The next question is from the line of Harit from Investec.

So just my 2 questions. Firstly, on the quarter. So you mentioned that in your release that you've successfully concluded discussions in a few states for scotch prices. So would that -- would we assume now that some of these -- most of this is now done with and the supplies are normally resumed? Or should you give us an update on that - on those discussions as well as what's been the impact of that in quarter 2 to you?

So in some of the space, we have concluded discussions and supplies will be normalized in this quarter. Even in the couple that are pending, we expect closure on that during the current quarter. So you can assume supplies will get -- start getting normalized during the quarter.

And are you calling out what is the impact on quality on account of this and any basis point impact that you would have had a net supply in the state?

In quarter 2, the quarter that has just passed?

Yes.

Okay. and maybe I'll just start and then Hina can build. Look, it's not just one isolated factor of the BI of supplies. There are a couple of balancing factors, I would say. In terms of the benefits that we have got, I think it's 2 things. One is improving our investing all was a little ahead compared to last year. So therefore, the loading that happened into the trade happened a month earlier. Last year, it was October, this year, large part of it of September. And it's so large that it does impact national numbers. And also, we were lapping a soft base of last year in 2 states, which is again Delhi and Bengal because both were gearing for an RTM change last year in October, November. So therefore, the July August, September numbers were a bit soft. And conversely, these 2 benefits that we had in July, August, September this year are alanced by the BI of supplies due to the pricing deflation. Now net-net, yes, the 2 are squaring off this year. Maybe some amount of moderation will happen to the 23% P&A growth that we have said. But we'll have to wait and watch over the next 2, 3 months, how much is that. Does that answer it?

Yes. Got it. The second question is on -- if you look at the first half, you've done about close to 14.5% margin 13.8% if you just for the one-off in quarter 1 and 15.5% in this quarter. This is in spite of your gross margin being close to 500 bps plus down versus normalized levels if I recall them. Does that give you more confidence on the medium-term guidance of mid- to high teens? Or rather, is there a possibility that given your cost structure currently, you would look at maybe a revised guidance, given the fact that you're already almost hitting a mid-teen number with such high inflationary pressures?

So look, Harit again, let me start and Hina will build on that. So first of all, yes, absolutely, we are committed to our mid-to-hiking guidance. And obviously, it's a desire to try and stay true to that. Now having said that, let me start with what we are happy about. We are happy with the growth momentum which continues to give us an operating leverage on our fixed costs. So that is something that we are happy about. We are also happy about the fact to exactly what you mentioned that if you take the inflation impact, our gross margin is probably up by about 720 bps to 730 bps. But we are offsetting a good 1/3 of that team through a combination of headline pricing, mix management, and management productivity. So that again reassures us. Now having said that, if you also then -- we are also maintaining a good cost discipline on our overall fixed overheads. So that allows us to get a further operating leverage on our P&L. Now what -- and I would ideally want to do a little more is the 5.5% on A&P, we would want to ideally inch that back to about 8% to 9% A&P level. And in this environment, when the inflation is so steep, et cetera, you end up making some tough choices and calibrating that a little bit. So that's the way I'll pass it to Hina if she has any additional build on that.

Yes, I would say the year will continue to be challenging. Look, Harit, our inflationary pressures, we are not seeing them come down like other FMCG companies primarily because of the raw materials we use, which are glass and [ in ]. So I would say there will be pluses and minuses. Some pricing will flow through better in the coming quarters, a little bit of mixed advantage we will have. On the other side, we do want to go up on A&P as Pradeep said. So I would say that, we will try and, of course, pay through to our mid-to high teens, but I see our margins pretty much in this range for the next few quarters.

Yes. In the lower end of the mid- to high teens.

The next question is from the line of Pranav Bhavsar from ASA Finance.

First question was I want to check with you after the legal conclusion, what quantifiable working capital release that they've seen?

Working capital.

Okay. Yes. Did I get the question right? You're saying that post the deal closure, how much of working capital has got released?

Yes.

Okay. So the number is roughly about -- it will come in 2 cases. The number is roughly about INR 420 crores, INR 280 crores to INR 250 crores is part of the slump sale. And then the balance 11 brands that we franchise, that leads to a further relief of about INR 140 crores. So those are the broad ballpark numbers.

Got it. Secondly, just on the gross margin front. So as Hina mentioned that there has been a lot of optimization that has happened this quarter, plus just a little bit like size, but it's effective in the big size component coming down instead of a 60% to 65% this quarter on one on a Y-o-Y basis, despite a better gross margin actually contracted to 39%. Is that indicative of a high inflation and unless you get a price hike from the larger states like Maharashtra and Karnataka, you would actually be able to go back to that 44%, 45% gross margin?

Yes. So Pranav, like I said, we've always maintained that the inflation that is impacting us is roughly in the double-digit range, double-digit to low teens. And then it's pure math. On a 40% gross margin, roughly that whatever low double-digit inflation will knock off roughly about 750 bps of a gross margin. Simple math. And then what it has actually diluted by is roughly about 480 bps. So therefore, the way you will have to see it is that what we are being able to recoup despite the commodity inflation. What I do acknowledge is there is still not too much of pricing flowing through in our P&L. To the point that last year, some of the BIO reversals happen, we had to participate as forcing by the government. And then a couple of competitive pricing actions that we had to get back to parity, et cetera. So therefore, there's not too much of pricing going through. Having said that, the inflation is also likely to continue. For example, you've seen the natural gas pricing announced by the government. That's a 40% increase already on top of an 80% to 90% increase that was made in April. So that sequential inflation will continue. But we are confident, having seen the approvals come through, et cetera, pricing will also ramp up in the coming quarters. So that's broadly what it is. Our gross margin will remain under pressure for right now. And we will have to just play with the other lines of the P&L and the other value drivers to maintain our EBITDA margins.

Got it. Just a follow-up on this, which states have actually got price lag during Q2?

So we have got in the last 3 to 6 months over 6 states. I'm just looking at -- so you've got pricing in Haryana, Punjab, UP, West Bengal, some pricing in Maharashtra and some pricing in Kerala. So we have that pricing in all these takes. By this time, we had got pricing in the April-June quarter. Assam had got pre-pricing in the Jan-March quarter.

The next question is from the line of Latika Chopra from JPMorgan.

I just further just digging a little bit more into the pricing part. Would it is possible to tell us with 8% price mix growth for P&A portfolio? How much of this could be pure pricing because you did take some competitive pricing action and you did get incremental price hikes from 3 states as well? So just wanted to understand where the zero net price effect settles down and what is the mix effect of the [indiscernible].

Yes, it's largely mix, Latika. It's largely mix. 90% of this is largely mix in this quarter. Like I said, net pricing flow-through is minimal because of the negatives and the positives, but we expect that to ramp up as the negative fallout. And we've got fresh pricing from the state that, in fact, will ramp up significantly in the coming quarters.

Pradeep, is it fair to assume that gross margins bottomed out because of scotch pricing discussions, which were concluded and some more might come in will flow through fully in Q3? And that also happens to be seasonally a strong quarter for you.

Latika, I would -- one would. I would want to believe, yes. Now unfortunately, the commodity environment remains a little volatile. I would have been in a far more confident position to agree with you but come 1st October, natural gas pricing has happened, 40%. As a result of which, we are having to give the price increase to our glass suppliers. And then the big impact of the Delhi RTM. That's a reversal. That's a big blow all in and done. Delhi was adding about in the last 4 quarters, then Delhi was adding about almost 4 to 5 points of national growth. And as the Delhi team has reverted back to its original pre-RTM change contract, we will have to figure out a way to recoup that loss through the rest of the country. How much of that we will be able to recoup that is yet to be established.

So as it stand, Pradeep, does it imply that they is a no go? What's really happening there? Are you -- the sell-through the lesser significantly lower?

Sorry, the -- okay. sell-to. No, so we are waiting for things to stabilize Latika. The new RT has come into effect. The [ RT ] has come into effect towards September and first week of October. Our sense is that things will stabilize over the next 60 to 90 days. And then we will be in a better position to call out what's the longer-term impact of the Delhi. It's too volatile right now to talk what the long-term implication of Delhi.

All right. And then the last bit that I wanted to check was on your efforts towards [ non-res ] portfolio. I think I mentioned that in our opening comments as well. What growth are you seeing in this portfolio? What are the brands that excite you? Is that something which could pick up a meaningful part of our growth contribution over the next couple of years?

Sure. I would say that both gin and vodka, are the categories that are really growing well. Largely because I think other highly mixable drinks, and they make fantastic cocktails. Cocktails really taken off, especially for the pandemic. So during the pandemic and post and in the cocktail culture, especially driven by millennials. So I'm very excited by both the category. We have really activated Smirnoff and Godawan gin brand. And in the canary in the branch occasion gotten in the Sundown location. And both brands are seeing very strong double-digit growth, I would say. [ Earn off ], we introduced the profit format of a quarter ago, quarter or 2 ago, and it rolled out given the thing. And we've done activation on-premise with Smirnoff, when our range of -- our work are going along with a range of other drinks. And Smirnoff is also growing at a very healthy double-digit growth rate. So I'm quite excited by the white category per se. I think this category will continue to grow with millennials and the whole refer to our drinking that I was talking about in my opening analysis, which especially at the premium and luxury end seems to be a phenomenon to state. So we are continuing to invest behind these brands and grow them.

The next question is from the line of Prakash Kapadia from Anived Portfolio Managers.

2 questions from my end. How large is Delhi contribution to our annual sales, if you could give some percentage?

Delhi will be broadly, and we have some broad ballpark numbers. It will be about 6% to 7% of our national P&A business. This was on the revised ramp-up volumes, Prakash. Now as I said to Latika earlier, we'll have to wait for what the volumes settle down to.

Understood. And in the first half, we've seen broadly a 50% impact on sales due to volume and 50% impact due to price and mix as we progress more towards P&L that contribution increases post the divestment, that should be 2/3, 1/3 going forward? Is that the right understanding?

You mean volume to mix...

Yes.

I would say -- well, yes, probably, like we have said earlier, when we are selling the full portfolio or our price mix should stabilize around the 7% to 8% range. Once we have the full scotch availability and we are supplying across the country, right, in the full portfolio, our price/mix should be about 78%. And then yes, our aspiration would be that volume can also so probably it will remain in this -- in the 50-50 range.

Yes, I expect this to remain in the same way of volume growth in the Prestige categories and things. So I wouldn't expect that to…

It should be in the 50s.

And lastly, as this, again, contribution of the premium segment increases, there have been carton cost reductions, there have been declines due to some of the mix changes. Could you call out a number or an annual impact, which could happen once on a full-year basis or next year once this entire sale has gone through?

Sorry, Prakash. So I missed the question. Can you repeat that? So I know it's to do with the divestiture. So once the divesture...