Ambit Capital - Alcoholic Beverages (Consumer)

CONSUMER
April 2017
USL
UBL
PR
PR
PR
IC
OM
PL
OD
AC
OT
UC
E
IO
T
Sin hard if you must

Research Analysts:
Anuj Bansal Dhiraj Mistry, CFA

anuj.bansal@ambit.co dhiraj.mistry@ambit.co
Tel: +91 22 3043 3122 Tel: +91 22 3043 3264
Ritesh Vaidya, CFA

ritesh.vaidya@ambit.co
Tel: +91 22 3034 3246
Consumer
CONTENTS
Sin hard if you must ………………………………………………………………….3
Alcoholic beverages industry in India ……………………………………………..4
Missing 4Ps override macro tailwinds ……………………………………………..5
Regulatory/taxation environment is tough and unpredictable ……………….12
USL vs UB: Is one better than the other? ………………………………………..16
Valuation not justified in case of business as usual ……………………………22
COMPANIES
United Spirits (BUY): Drink it up for a strong kick ………………………………29
United Breweries (SELL): It is a flat brew …………………………………………55
April 07, 2017 Ambit Capital Pvt. Ltd. Page 2

Consumer
NEGATIVE
THEMATIC April 07, 2017
Sin hard if you must Key Recommendations

United Spirits BUY
Tailwinds of low penetration, rising income, young population and
changing lifestyle support alcohol consumption. But tough/complex Target Price: 2,575 Upside 27%
regulatory and taxation environment that varies across states outweigh
United Breweries SELL
benefits. This reduces affordability, curtails pricing power, restricts
distribution and creates manufacturing inefficiencies. We prefer United Target Price: 625 Downside: 18%
Spirits (USL) over United Breweries (UB) given: 1) affordability,
competition and profitability headwinds hurt beer more than spirits; 2)
USL’s internal drivers of premiumisation, improving profitability and
deleveraging; and 3) Diageo controls USL while Heineken shares
control of UB with UB Group. Valuations for both seem high (41x FY19E
P/E for USL and 55x FY19E P/E for UB) but justified for USL given 45%
EPS CAGR over FY17-20E led by business transformation vs a staid 17%
for UB. Key risk for the sector is toughening of regulations.
Alcoholic beverages at best a quasi-consumer sector in India

Indian alcobev industry lacks four key marketing tools defining a consumer
company. Low affordability for quality product and weak innovation reduce
product differentiation, pricing power rests with Government via taxation and
actual price control (Government-driven consumer price CAGR is 11% vs brand
owner’s at 3% since FY07), promotions are restricted to PoS or surrogate
advertising, and place is restricted qualitatively and quantitatively (liquor vends
at 86,000; 2% CAGR in last 10 year vs 9.5mn for FMCG growing at 7% p.a.).
Regulatory environment is going from bad to worse

Tough and complex regulatory environment (controlled distribution, ban on
direct ads, taxes on inter-state movement) for alcobevs is worsening given: 1)
rising taxation (11% CAGR since 2007 in Maharashtra) that is out of purview of
GST, 2) rising instances of prohibition across states (Bihar and Kerala in addition
to Gujarat), and 3) rising vigilantism by courts (8 unfavorable rulings in last 3
years) including removal of vends along highways. With not much
differentiation in regulations based on alcohol content of a drink, case for
favouring beer over spirits as a category remains weak.
But USL has internal drivers that are missing in UB
We prefer USL to UB on both external and internal factors. Industry construct is
weaker for beer given: 1) low affordability and premiumisation due to high
taxation when indexed for alcohol content, 2) sub-optimal profitability due to
fragmented manufacturing, 3) rising competition from brewpubs limiting upside
from urbanisation and younger population, 4) constraints to geographical
penetration due to lack of refrigeration. Internally, USL is 1) driving
premiumisation by franchising out entry-level brands, 2) cleaning up balance Research Analysts
sheet and deleveraging, 3) revamping products, systems and processes to Anuj Bansal
improve customer connect and drive profitability, and 4) wresting complete
+91 22 3043 3122
control from erstwhile management unlike UB where control is still shared by
Heineken with erstwhile management. anuj.bansal@ambit.co
Dhiraj Mistry, CFA

‘Business as usual’ is not enough to justify high valuations
+91 22 3043 3264
USL is trading at 41xFY19E P/E and UB is at 55x FY19E with 24/65% premium
to our FMCG coverage and 73%/158% premium to global peers. USL’s dhiraj.mistry@ambit.co
turnaround leading to 45% EPS CAGR over FY17-20E justifies this premium Ritesh Vaidya, CFA
whereas UB’s business as usual EPS CAGR of 17% over FY17-20E is not enough +91 22 3043 3246
to warrant such premium.
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Consumer
Alcoholic beverages industry in India

Exhibit 1: Alcobev placed low in our pecking order in FMCG space
6 Tobacco Tobacco Fut

High
5 HPC Fut HPC
4 Paints F&B Fut

Medium
ROCE
3 AlcoBev Fut Paints Fut F&B
1 AlcoBev
Low
-
-Low 1 2 Medium
3 4 5 High 6
Growth
Source: Ambit Capital research, Size of the bubble denotes valuations
Exhibit 2: USL set to outgrow UB in the near and long term

USL UBL Comments
FY16-21
USL has lower volume growth compared to UBL due to
Volume growth 3% 3%
franchising of Popular brands in more regulated states
With lower volume growth USL sales growth will be higher than
Sales growth 12% 7%
UBL due to premiumisation driving value growth
Operating margin expansion for USL will be 420bps compared to
Operating margin 8.1-13% 9.5-10% 150bps expansion to UBL led by higher premiumisation and cost
saving programs
Higher sales growth and margin expansion combined with strong
EPS 49% 13%
deleveraging leads to superior EPS growth for USL vs UBL
FY21-30
Expect higher growth of USL vs UBL as affordability and
premiumisation will be in favour of USL. Also we do not expect
Sales growth 12% 9%
lenient Government policy on Beer vs Spirits which may have
helped Beer outgrow Spirits
Given the cap on profitability of beer due to fragmented
Operating margin 13-17% 10-14% manufacturing and weaker premiumisation we expect USL to
have higher margins vs UB over the long term period
Higher margin expansion and better sales growth leads to higher
FCF 14% 11%
FCF growth for USL
Source: Ambit Capital research
Exhibit 3: Qualitatively USL is better placed vs UB

Parameter USL UBL Comments
Affordability Affordability (price/alcohol content) is higher for spirits than beer in India
Premiumisation USL has better forecast for premium product as Popular brands are franchised out
Pricing Power There is limited pricing power for both USL and UBL given the high Government regulation
Taxation Taxation is in favour of USL as spirits are taxation/ alcohol content is less vs UBL
Distribution Even though more vendors are allowed for Beer but rural reach is limited compared to spirits
Leadership UBL has strong leadership with 52% market share in beer vs USL 38% market share in spirits
Carlsberg and SABMiller are in direct competition with UBL due to much less product
Competitive Intensity
differentiation while impact of ABD’s share gains is limited on USL as it is at the Popular end
Innovation USL has better innovation capability in terms taste, blends and product positioning
Now Diageo being in complete control of USL gives better control on management whereas
Management Control
Heineken has to share control with UB Group due to shareholder agreement
USL is better compared to UBL given high capex is required for set up of breweries compared
Capital Intensity
to distillers
Fragmented manufacturing that prevent scale efficiencies and limited scope of
Profitability
premiumisation hurt profitability for UB
Source: Ambit Capital research, Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Consumer
Missing 4Ps override macro tailwinds

We acknowledge that India provides the perfect platform in terms of a young
and growing population, rising affluence and changing lifestyles for a strong
and long growth ramp for alcoholic beverages (alcobev). However, the
opportunity is likely to remain unrealised till the time the restrictive
environment in terms of regulation and taxation prevails. We believe most
levers (branding, pricing power, channel management, new product
innovation) that make a company an FMCG business are missing for alcobev
companies in India. Hence, we have a negative stance on the Sector.
Socio-economic demographic tailwinds overplayed

The alcohol market in India is ~850mn cases per annum and has grown at ~5%
CAGR since 2010-11. The split between spirits, beer and country liquor is 37%, 37%
and 26%. Growth has been the highest for beer at 5% CAGR followed by spirits at 4%
and for country liquor at ~0%. Some of the key drivers of this growth are: 1) low
penetration rate as only ~25% of Indians consume alcohol, 2) rising income level,
which is expected to improve affordability, and 3) changing lifestyles leading to rising
consumption levels among youth and women. However, we believe this growth rate
is not exciting enough, especially compared with other F&B categories like snacks,
biscuits, carbonated soft drinks and fruit juices.
Exhibit 4: Consumption of beer and spirits has been Exhibit 5: Alcobev growth lags growth of other F&B
plateauing categories in India 2011-16
4.0 Alcohol, recorded per capita (age 15+) 0.3 Five-year growth CAGR
consumption (in litres of pure alcohol)
3.0 30%
0.2
20%
2.0
0.1 10%
1.0
0%
Coffee
Snacks
Alcohol
Tea
Carbonated
Mineral water
Fruit Juices
Biscuits
0.0 0.0
drinks
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Spirits Beer
Source: WHO, Ambit Capital research Source: Ambit Capital research
Per capita consumption of alcohol remains low

India’s per capita consumption of alcohol and percentage of people consuming
remain low. Key reasons for this are: 1) religious inclination where Muslims (15% of
Indian population in 2016) are prohibited from drinking and Hindus are in general
are also discouraged, 2) low affordability levels, and 3) difficulty in accessing alcohol
with distribution being limited and tightly controlled by the Government.

Consumer
Exhibit 6: Low per capita consumption in India provides Exhibit 7: Rate of abstinence also remains fairly high in
long-term growth opportunity India
Alcohol per capita (age 15+) consumption (in Lifetime abstainers (%)
litres of pure alcohol)
100
16
12 75
8 50
4 25
0 0
Japan
Russia
China
India
US
UK
Brazil
Germany
Japan
Russia
China
India
US
UK
Brazil
Germany
Source: WHO, Ambit Capital research Source: WHO, Ambit Capital research; Lifetime abstinence means person
who has never consumed alcohol in its lifetime
This should provide long-term volume growth potential as there is a case for more
consumers consuming alcohol. However, alcohol/consumer in India is already higher
vs several other countries. This implies that the bulk of volume growth for alcohol in
India has to come from new consumers and not from increasing consumption per
alcohol drinker. This shows a weaker case for volume growth than for most other
FMCG categories which enjoy both drivers - addition of new consumers and
increasing consumption per existing user.
Exhibit 8: Per capita consumption of alcohol in India has Exhibit 9: Alcohol consumers in India consume higher
grown by 6% CAGR over FY05-10 levels than peers globally
Alcohol per capita (15+) consumption Alcohol, average daily intake in grams
4.4 (in litres of pure alcohol) among drinkers
4.2 75
60
4.0
45
3.8
30
3.6 15
3.4 0
India
Germany
UK
Japan
Russia
China
USA
Brazil
3.2
2003-05 2008-10
Source: WHO, Ambit Capital research Source: WHO, Ambit Capital research
Affordability remains an issue; price hikes running ahead of CPI and other
consumer products
We believe one of the key reasons for high volume growth potential not playing out
as per expectations is the low affordability levels of alcohol in India. This has kept
country liquor as a sizable proportion of the overall market and has prevented a large
proportion of consumers from moving towards IMFL and beer.

Consumer
Exhibit 10: Cost per unit of alcohol is highest for beer Exhibit 11: Alcohol in India is expensive vs peers when
followed by IMFL and IMIL* adjusted for GDP per capita (PPP)
6
` per ml of alcohol content 6 4%
5
3%
4
4
2%
3 2
1%
2 0 0%
Japan
Russia
China
India
US
UK
Brazil
Germany
1
0
Spirits Beer IMIL US$/Pint Cost of 100 Beer /GDP PPP (RHS)
Source: Ambit Capital research , * for Maharashtra Source: Ambit Capital research
One of the key reasons for alcohol being expensive in India is the high level of
taxation and the fact that the tax structure is similar for all kinds of alcoholic drinks
and does not adjust enough for the level of alcohol content in a particular drink.
Exhibit 12: Taxes on beer in India are higher than that of peers and largely in line in
the case of spirits
Tax as % of MRP - Spirits Tax as % of MRP - Beer
100%
80%
60%
40%
20%
0%
Japan
China
Russia
India
UK
US
South Africa
Germany
Brazil
Source: OECD, Ambit Capital research
Not only is affordability low in India, we believe it is not improving as fast as it could
have due to the fast pace of price hikes. For example, the prices of spirits, beer and
country liquor have gone up by 12% CAGR in Maharashtra since 2009. This rate of
inflation is higher than Consumer Price Inflation (CPI) and is contrary to price hike
trends for most other consumer categories that tend to be lower than CPI.
Exhibit 13: End-consumer price inflation has been higher in alcohol
Price CAGR over 2009-16

13%
11.5%
10%
7.5% 7.2%
6.8% 7.1%
7%
4%
Alcohol Toothpaste Soaps Noodles CPI

Consumer
Changing lifestyles and rise in alcohol consumption by women not supported

by pace of urbanisation
Some of the key socio demographic trends that are driving consumption of alcohol in
India are not as strong as made out to be.
 Changing lifestyle/attitudes bringing in younger consumers: There is
anecdotal evidence of changing attitudes towards alcohol consumption, leading
to more youth getting into the alcohol consumption fold. However, only if one
looks at rate of abstinence (% of people never ever consumed in their lifetime),
has fallen by only 10% from 2001-10.
 Rising consumption by women: As per WHO data, the percentage of women
consuming alcohol in India has actually gone down marginally by 0.5% from
10.5% to 10% over 2001 to 2010.
Exhibit 14: Percentage of lifetime abstinence women has Exhibit 15: India’s abstinence rate is lowering but not fast
increased marginally over 2001-10 enough
India Women Lifetime Abstainers (%) India Lifetime Abstainers (%)
92 80
78
89
76
86
74
83
72
80 70
2001 2010 2001 2010
Source: WHO, Ambit Capital research Source: WHO, Ambit Capital research
We believe the key reason for this lower-than-expected support from socio-
demographic factors is the slow pace of urbanisation in India. Rising consumption of
alcohol in India among youth and women is largely an urban phenomenon. Hence,
with urbanisation not moving up rapidly, the impact of these trends gets limited.
Exhibit 16: Urbanisation has been picking up in the country Exhibit 17: …it will reach 50% urbanisation only by 2050;
but… peers have already hit this level
60 2.7 3.0 100

2.6 2.7 2.7
2.5 48 50 2.5
50 45
2.3 42
1.8 2.0 39 80
40 1.8 37 2.0
1.6 1.7 35
30 24 26 27 28 31 33 1.5
23 60
29
20 1.3 1.2 1.0
1.11.1
40
10 0.5
0 0
20
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
Japan
China
Russia
World
India
UK
EU
Brazil
USA
Australia
Urbanization Rate
Source: Ambit Capital research Source: Ambit Capital research

Consumer
The missing 4Ps – Product, Price, Promotion and Place

Not only are socio-economic and demographic tailwinds overplayed, the weak
industry construct that alcobev companies suffer from in India is also not recognised.
For a true consumer goods company, the four Ps (Product, Price, Promotion and
Place) as advocated by Philip Kotler are key to its business model. We believe alcobev
companies in India are constrained on each and every of these factors, which make
them less than ideal consumer goods companies and prevent them from realising
their growth and profitability potential.
Product: Innovation and new launches fairly limited
Product is defined as the bundle of benefits that are sold to a consumer for a price. A
good consumer goods company therefore looks to provide products that provide
consumers benefits for which they are willing to pay the price the company is asking
for. To drive growth based on differentiated products, companies look to constantly
innovate and improve or close gaps in their existing offerings. If we look at the track
record of new launches in the alcobev space in India we will realise that 1) the pace
and extent of launches are lower vs FMCG categories and 2) contribution to sales
from successful new launches is also lower.
Price: Governments exert pricing power on behalf of companies
Price is defined as the amount charged for a product. Factors determining price are
demand, cost of production, competitive intensity, customers’ ability and willingness
to pay and Government regulations. When it comes to pricing, problems faced by
alcobev companies in India are two-fold:
 Cost of production is made high by taxes: Given the multi-layer taxation
structure with high level of tax rates, the final price that a customer pays is 3-5x
that of End Distillery Price (EDP). This makes alcobevs expensive in India and
reduces affordability, which in turn limits pricing power of alcobev companies and
impacts potential volume growth.
 Government regulates/decides prices in several states: In states which
account for almost 2/3rd of alcobev consumption in India, the Government is also
the distributor and sets the prices at which it will buy from alcobev companies and
at which it will sell to consumer. Thus, alcobev companies lose their pricing power
and their ability to drive profitability or volume growth.
The impact of this pricing environment is that the inflation in end-consumer price has
been far higher than the pricing-led growth hat alcobev companies have enjoyed in
India. This leads to a double whammy where volume growth is impacted by high
consumer price inflation led by rising taxation without any commensurate benefit to
alcobev companies on the topline from price hikes.
Exhibit 18: Consumer price inflation trend in beer is higher Exhibit 19: Consumer price inflation trend in spirits is also
vs price/mix benefit for UB high vs price/mix benefit for United Spirits
Price CAGR over 2008-15 Price CAGR over 2008-15

18% 16% 12%
10%
15% 10%
12% 8%
9%
9% 6%
6% 4% 3%
3% 2%
0% 0%
United Breweries Overall Beer price United Spirits price/mix Overall Spirits price
price/mix change change change change

Consumer
Promotion: Point of sale is the only avenue for brand building; surrogacy can
help only to an extent
Promotion is defined as a process of informing, persuading and influencing a
consumer to make choice of the product to be bought. Given that advertising and
promotional activities for alcohol are banned in India, a company’s ability to do
promotion is severely curtailed. This limits the ability for alcobev companies in India
to build brands or market newly launched products. While this acts as an entry barrier
that supports incumbent players, it restricts the ability of existing players to support
their current brand portfolio. Only two forms of advertising are possible for alcobev
companies in India:
 Point of sale advertising: Companies are allowed to put up posters and other
promotional signage and materials at point of sale. This gives advantage to
companies with larger scale as they are able to invest behind a sales team that
helps manage the shelf space and promotional campaigns at point of sale.
 Surrogate advertising: Brands for various alcobevs are used to promote other
products like drinking water, club soda, music labels etc. for which advertising is
allowed. While this helps build brand recognition, given the products are
surrogate, the exact messaging and positioning of a brand that is relevant for
alcobev consumers at times gets diluted.
As a result, alcobev companies end up investing lower than their FMCG peers on A&P
spends and, therefore, have weaker brand connect with the consumers. Potential
impact of branding can be gauged from growth of United Spirit’s brand Royal
Challenge, which has been growing at 25% CAGR over FY11-15 benefiting from the
brand name being associated with a highly successful cricketing franchise as part of
Indian Premier League (IPL) T20 tournament.
Exhibit 20: Lower A&P spend as a percentage of sales for Exhibit 21: Surrogate A&P spends propped RC volume
USL compared to other FMCG companies growth higher than overall growth for USL
18% 17%
17% 17% Volume growth over 2011-15
30% 28%
16%
15%
14% 25%
14%
20%
12% 15%
10%
10% 10%
5% 1%
8%
0%
Colgate
USL
HUL
UBL
Dabur
GSK
USL Total Volume Royal Challenge Volume

Growth growth
Place: Both quantity and quality are issues

Place is defined as providing convenient access to consumers to buy the product. We
believe the issue with place for alcobev companies is two-fold in India. Given that the
number of outlets is controlled through a licensing mechanism by State Governments,
the ability of companies to drive this component of marketing mix is restricted.
 Growth in number of alcohol vends has been abysmal in India: With a
total reach of just 86,000 outlets, India has one of the worst shop per 1000
people ratio in the world. Despite the low base, growth has been weak with only
12,000 outlets getting added in the last 10 years. This looks especially weak
compared to healthy growth in retail outlets for other FMCG products (7% CAGR
with outlets doubling from 4.5mn to 9mn in the last 10 years).

Consumer
Exhibit 22: India lags global peers in terms of alcohol store Exhibit 23: Growth in retail outlets for alcobev has been
density weaker vs consumer staples in last 10 years
Population per alcohol store Liquor stores (LHS) General stores (in mn, RHS)
18,000
14,535 90,000 12
15,000
85,000 10
12,000
8
9,000 80,000
6
6,000 75,000
4
3,000 966
252 279 260 271 70,000 2
-
India UK US South China World 65,000 0
Africa 2005 2016 2005 2016
 Buying experience is a deterrent: Bulk of liquor vends in India tend to be

small, unattractive and crowded shops with customers not having any access to
the products. This makes buying experience unpleasant and restricts consumer’s
ability to touch and feel a product before purchasing it. This limits the ability of
alcobev companies to 1) launch new products and 2) drive premiumisation. This
is in stark contrast to other Food & Beverage categories where companies are
able to provide consumers access to products (especially through Modern Trade)
and experience them through touch, feel and sampling.
Exhibit 24: A typical grocery store in India Exhibit 25: A typical alcohol retail shop in India

Consumer
Regulatory/taxation environment is tough

and unpredictable
The potential of India’s alcobev industry is limited by the high level of
regulations, which in turn vary across states. Some key regulatory
bottlenecks are: 1) prohibition in some states, 2) entry/exit taxes on cross-
border sale of alcohol from one state to another, 3) control of distribution by
State Governments, and 4) high taxes applied through complex structures.
Alcohol abuse remains a key problem in India, especially in economically
weak households. This makes curbing consumption a popular political move
for politicians looking to gain favour with women voters. Alcohol also
remains a key revenue driver for states and is treated as the proverbial
goose that lays golden eggs with State Governments looking to gain as much
economic mileage as possible through high taxation.
Exhibit 26: Alcohol in India is a highly regulated industry, more than most peers globally
India China Germany Japan UK US Russia Brazil South Africa
Place
Consumption Y N N N N Y Y N Y
Distribution Y N N N Y Y N N N
Promotion
Advertising ban Y Y Y N Y N Y Y N
Point of Sale Y/N N N N Y N N Y N
Sponsorship Y N N N N N N N N
Price Y N N N Y Y Y N N
Source: OECD, Ambit Capital research; Y denotes regulated and N denotes Not regulated
Tax structure is complex for alcohol in India

The issue with tax on alcohol is not just the high level but also complexity, which
makes managing a truly national business difficult. The table below highlights how
taxes are multi-layered in a state. This is unique to alcohol as most other products
and services have just two levels – excise duty and VAT or service tax. Flow of taxation
in Maharashtra (one of the most liberal states for alcohol) highlights the complexity.
Exhibit 27: Multi layered tax structure for alcohol in Maharashtra
Popular Prestige Strong Mild Country
Spirits 750ml Spirits 750ml Beer 650ml Beer 650ml Liquor 750ml This table also helps to bring out
Manufacturing cost 50 100 30 30 50 potential margin ramp from
EDP 66 179 51 46 96 premiumisation. GM for Prestige
Spirits works out to 44% vs only
Gross margin 24% 44% 41% 35% 48%
24% for the popular segment.
Taxes
Excise 169 300 60 45 100
VAT 81 165 38 32 68
Total taxes 249 465 98 77 168
Total taxes as % of EDP 380% 261% 193% 165% 175%
Trade margin @10% 35 72 17 14 29
MRP 350 715 166 137 293
Taxes as % of MRP 71% 65% 59% 56% 57%
EDP as % of MRP 19% 25% 31% 34% 33%
Alcohol % 42% 42% 6% 4% 36%
Alcohol ml 315 315 39 26 270
MRP/ unit alcohol 1.1 2.3 4.3 5.3 1.1
Total Tax/ unit alcohol 0.8 1.5 2.5 2.9 0.6

Consumer
Key issues with taxation on alcohol in India:

We believe the problem with taxation on alcohol in India is three-pronged:
 Taxation is not based on alcohol content: In most countries tax levels are
based on alcohol content in a drink, which allows for beer to be taxed at a lower
rate and makes it affordable. However, in India most of the states’ taxes on
alcohol are based on price slabs, which make taxes on beer comparable to that
of spirits and lower its value for money on a per unit alcohol basis.
 Tax structures and rates differ significantly across states: Taxes as a
percentage of consumer price vary significantly from one state to the other with
states like Goa being cheaper and states like Maharashtra being at the higher
end at ~65%. This makes it difficult for companies to have a national pricing and
marketing strategy. Also, this leads to significant cross-border sales, especially if
two states with widely varying tax structured are neighbours (e.g. Haryana, Uttar
Pradesh and Delhi have a price differential of ~3x with Haryana being cheapest
flowed by Delhi and U.P).
 Entry/exit taxes make India a fragmented market and make supply chain
costly and inefficient: All states in India have a high level of entry/exit taxes for
cross-border manufacturing and sale of alcohol. The level of taxation is so high
that it makes it economically unviable to have centralised pan-India
manufacturing and forces companies to have a fragmented manufacturing
footprint either through a series of own manufacturing units or by relying on
third-party contract manufacturers. This adds to the cost and complexity of
operations.
Taxation structure in India is more damaging to beer than spirits

We believe the high level of taxation and fragmentation caused in manufacturing
footprint due to interstate taxes hurt beer more than spirits. This is because:
 It takes away scale advantage that is crucial for beer’s profitability: For
beer, large breweries are crucial as capital intensity for manufacturing beer is
higher and scale efficiency is significantly higher than that of spirits. Hence, the
entry/exit taxes that states apply on alcohol in India force breweries to be spread
across states, which makes them sub-optimal in scale and reduces profitability.
 It makes beer significantly more expensive than spirits: Beer has a much
higher minimum economy of scale level than spirits. Hence, having a
consolidated manufacturing footprint of a few large breweries is key to
profitability. However, given the compulsion to have fragmented operations
across states, brewers in India end up having several sub-scale breweries, which
hurts profitability.
Regulatory environment is getting tougher

While India is already a tough market in terms of restrictions on sale and
consumption of alcohol, we believe the environment is worsening. Some of the key
developments that make us believe so are: 1) rising number of states that are
implementing prohibition and 2) rising number of court rulings against the alcohol
industry.
Prohibition is increasingly becoming a political tool
In the last three years, we have seen Kerala and Bihar implementing partial or
complete ban on production, sale and consumption of alcohol. Currently 6 states in
India have prohibition. There have been several historical instances of prohibition
being implemented by various states but invariably repealed given massive revenue
loss to State Governments. However, we have not seen any reversal in recent times.

Consumer
Exhibit 28: Prohibition related actions by various states in India show a reversal of
prohibition in many states
Alcohol’s contribution to the state exchequer in India is quite high compared to most
other countries globally. This makes it even more difficult to implement prohibition in
India, especially given the high level of revenue and fiscal deficit that is run by State
Governments in India. This gives us hope that prohibition will not be extended in
several other states.

Consumer
Exhibit 29: Alcohol’s contribution to the exchequer is high Exhibit 30: State Governments in India with fiscal deficit
in India vs global peers of 2-3% can ill-afford prohibition
Alcohol excise tax revenue as a % of 4 State fiscal deficit (in %)

government revenue
12 3
9
6 2
3
1
0
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
India
UK
Germany
Mexico
South Korea
France
South Africa
State fiscal deficit (in %)
Source: WHO, Ambit Capital research Source: RBI, Ambit Capital research
Courts are adding to the misery

To add to the regulatory issues being faced by alcohol industry in India, court rulings
have also tended to curb alcohol consumption in India. The number of rulings is
increasing by the year and the language is also getting stricter; the latest instance is
the Madras High Court taking up the issue suo moto, i.e. on its own without anyone
filing a case. This is an even more worrying sign because Government decisions on
prohibition have a history of being repealed, with a change in Government often
bringing with it changes in regulatory restrictions. However, in the case of a court
ruling, especially at the level of the Supreme Court, the imposed restriction is unlikely
to reverse and becomes a permanently damaging issue for the industry.
Exhibit 31: List of legal strictures by the judiciary on the alcohol industry in India
Year Court Related To Key points of judgment
2014 Punjab & Haryana HC Vends along highways  Ordered closure of liquor vends along National highways and abutting service roads
 SC did not over turn the judgment on appeal
2015 Rajasthan High Court Vends along highways  Ordered removal of all liquor vends within 150m of National and State highways
 Earlier exemption granted to Municipalities also removed
 Ordered all hoardings and billboards related to alcohol to also be removed from highways
2015 Supreme Court Kerala liquor policy  State Government is Constitutionally bound to curtail alcohol consumption
 Upheld phase wise restriction on sale of alcohol
 Advised Government to extend same norms to beer and wine as well
2016 Supreme Court Bihar prohibition  Patna High Court set aside the Bihar prohibition
 Supreme Court has stayed the HC verdict continuing the prohibition
2016 Uttarakhand HC Vends near shrines  Court has banned all liquor vends in districts with Chardham shrines
 The order states this ban is just to 'begin with'
 Ordered removal of liquor vends within 1km radius of educational institutes
2016 Supreme Court Vends along highways  Banned liquor shops within 500 meters of National and State highways
 40%+ of stores would get impacted by this order
2017 Madras HC Prohibition in Tamil Nadu  Madurai bench of Madras HC has suo moto raised queries to Government
 Terming alcohol as 'mother of many evils' the Court said it wants to deal with the issue in
detail

Consumer
USL vs UB: Is one better than the other?

We believe while both USL and UB share the weak industry construct and are
market leaders within their own segments, there is a clear case to prefer USL
over UB. This preference is driven by: 1) industry construct being less poor for
spirits than for beer which is affected by premium pricing and fragmented
manufacturing footprint, 2) internal drivers for profitability are more visible
for USL than UB, and 3) USL has better control over its strategy and execution
vs UB which still has to share the Board with Vijay Mallya.
Exhibit 32: USL scores better than UB in most of our parameters
Parameter USL UBL Comments
Affordability Affordability (price/alcohol content) is higher for spirits than beer in India
Premiumisation USL has better forecast for premium product as Popular brands are franchised out
Pricing Power There is limited pricing power for both USL and UBL given the high Government regulation
Taxation Taxation is in favour of USL as spirits are taxation/ alcohol content is less vs UBL
Distribution Even though more vendors are allowed for Beer but rural reach is limited compared to spirits
Leadership UBL has strong leadership with 52% market share in beer vs USL 38% market share in spirits
Carlsberg and SABMiller are in direct competition with UBL due to much less product
Competitive Intensity
differentiation while impact of ABD’s share gains is limited on USL as it is at the Popular end
Innovation USL has better innovation capability in terms taste, blends and product positioning
Now Diageo being in complete control of USL gives better control on management whereas
Management Control
Heineken has to share control with UB Group due to shareholder agreement
USL is better compared to UBL given high capex is required for set up of breweries compared
Capital Intensity
to distillers
Fragmented manufacturing that prevent scale efficiencies and limited scope of
Profitability
premiumisation hurt profitability for UB
Source: Ambit Capital, Note: - Strong; - Relatively Strong; - Average; - Relatively weak.
UB’s dominance in beer is higher than USL’s position

in spirits, but…
UB clearly has a better positioning vs peers within the Indian beer industry as
evidenced by: 1) 50%+ market share, 2) dominant brand portfolio led by Kingfisher,
3) widest distribution network supported by scale, 4) well spread manufacturing
footprint across all key states, giving it taxation and pricing advantage vs peers, and
5) healthy track record of innovative new launches like Kingfisher Ultra and Ultra
Maxx; ability to tap into Heineken’s portfolio allows for premiumisation.
SAB Miller is the number two player with 20% market share with Carlsberg following
close at 15%. SAB has been losing share consistently to Carlsberg, which has
followed an aggressive off trade strategy by focusing on on-premise in larger cities
through price promotions and branding exercises. ABInBev has failed to take off in
India with its limited manufacturing footprint and a single brand portfolio.
Exhibit 33: UB dominates the beer industry
UB SAB Miller ABInBev Carlsberg Remarks
UB dominates with 52% share but Carlsberg has gained the most with
Market Share
15% share in 5 years
UB has the largest brewery footprint with 30 breweries ABInBev being
Manufacturing footprint
the smallest with just two
UB covers all 86,000 outlets in India followed by SAB which benefits
Reach
from legacy network. Carlsberg has limited its reach to larger cities
UB has 100%+ of profit share of the industry while SAB is close to
Profitability
break even. ABInBev and Carlsberg are in investment mode
UB has done well with Heineken and Ultra launches while Carlsberg
Innovation
has innovated with On Premise brand push for Tuborg and Carlsberg
Though no one has been able to do well here, UB with Heineken and
Premiumisation
Ultra launch has done better

Consumer
USL, while being the largest spirits company in India with 40% market share, does
not dominate the category as much as UB. It does have the key advantages of: 1)
scale, 2) diverse product/brand portfolio straddling all segments and price points, and
3) a wide distribution network. However, it has been weak in terms of: 1) maintaining
market share where ABD’s Officer’s Choice has done a great job (15% CAGR over
the last five years) with a 5% market share gain, 2) profitability where Pernod Ricard
is the leader despite selling 1/3rd the USL’s volumes, or 3) innovation, where Pernod’s
marketing and Radico’s new launch pipeline have been more impressive.
Exhibit 34: USL is the largest spirits player in India but lags peers on several parameters
Pernod Radico
USL ABD Remarks
Ricard Khaitan
USL is the market leader with 38% share but has been losing share (-4%) to
Market Share
Pernod (+4%) and ABD (+7%) since 2011
USL covers all 86,000 outlets given its scale with Pernod and ABD following
Reach
closely. Radico with its limited scale covers only 64,000
USL has the widest distillery network (74) followed by Pernod (32) and ABD (40)
and Radico (34) is weaker in West
USL is gradually moving up the margin curve with Pernod already earning
Profitability margins (20%+) close to global levels. ABD and Radico due to mass end
portfolio are weak on margins (10-12%)
USL has mainly focused on re-launches while Pernod has been innovative in its
Innovation On Premise focused brand building. ABD remains one trick pony while Radico’s
launch of 8PM and Magic Moments is worth noting
USL is catching up on premiumisation (40%) while Pernod already runs a
Premiumisation premium portfolio (100%). ABD is unlikely to move up (20%) rapidly while
Magic Moments Vodka should aid Radico to improve (24%)
…we prefer industry construct of spirits

Despite UB dominating the beer segment more than USL’s domination in spirits, we
prefer USL over UB. This is because the industry construct of spirits is much better
than that of beer. Being a market leader (albeit weaker) in spirits is better than being
a dominant player in Beer.
Exhibit 35: Spirits does better as an industry on key parameters for alcohol industry in India
Spirit Beer FMCG Remarks
Spirits is INR400bn category while Beer is INR100bn category. FMCG is much larger at INR2.5tn but
Scale
is split into several smaller categories each with its own dynamics
We expect Spirits to grow faster than Beer but in line with overall FMCG space. There are parts of
Growth
FMCG that will grow slower (Soaps, detergents) and some will grow faster (F&B, Personal care)
Spirits are expensive but have a price ladder suiting wide array of customers while Beer is largely
Affordability
premium. FMCG has the best affordability given rational taxation regime
Spirits have limited availability (86000 outlets) vs FMCG (9.5mn outlets) but Beer lags a bit behind
Penetration
due to lower penetration in rural India
Both Spirits and Beer have higher entry barriers vs FMCG and only select players are gaining shares.
Competition
Competition in FMCG remains intense across most categories.
While both Spirits and Beer suffer from strict regulation, Beer is hurt more as its affordability is
Regulation
reduced and fragmented manufacturing hurts profitability.
Spirits due to premiumisation trends can and are more profitable than beer. FMCG will however
Profitability
remain more profitable due to higher pricing power.
Spirits have a price/brand/product ladder to premiumise consumers while Beer is largely constrained
Premiumisation
by preference for Strong beer which tends to be Mass.
 Size of the industry: India is unique in terms of having a spirits industry larger
than beer in terms of volumes. The key reason for this, we believe, is affordability
as beer on a per unit of alcohol basis is 4x costlier than spirits in India. This
difference in size makes spirits the preferred segment.

Consumer
Exhibit 36: Spirits dominates in India unlike in other key countries
Spirits Beer Wine Others
100% 3% 7% 4%
7% 11%
17%
28% 25%
28%
75% 34%
38%
60%
50% 19%
50% 93% 54%
37%
69%
25% 52% 51%
33% 36%
22% 18%
0%
India China US UK Germany Japan Brazil Russia
Source: WHO, Ambit Capital research
 Penetration: Beer is a largely urban phenomenon in India given constraints

around 1) affordability 2) shortage of cold storage in rural locations and 3)
shorter shelf life due to fear of loss of fizz. These restrict penetration potential.
 Growth: Being a youth-oriented beverage, beer does have a strong demographic
tailwind for growth. However, low affordability and constraints to deeper
penetration into smaller towns/rural India offsets its higher growth potential.
 Competitive intensity: It is similarly high for both Beer and Spirits with ABD in
spirits and Carlsberg in beer growing aggressively and taking away share from
incumbents. However, beer requires has higher operating scale efficiency
threshold and therefore tends to be a monopoly or a duopoly globally. India is a
four player market, making it relatively unattractive market for beer. Also, the
advent of brew pubs and microbreweries is taking away share from branded
beer, especially at the premium end in high-growth T1 cities.
Exhibit 37: USL has been losing market share in spirits to Exhibit 38: UBL dominates market share in beer;
Pernod Ricard and ABD Carlsberg gained significantly over 2011-16
50% 60% 56% 57%

42% 52% 51% 52% 52% UBL
41% 40% 39% USL
38% 50%
40%
Pernod 40% SAB
30% Ricard 28%
26% 25% 26% 26% 26% Miller
30%
ABD
20%
11% 13% 20% Calsberg
9% 9% 10%
10% Radico 17% 17%
10%
10% 11% Khaitan
8% 8% Others
0% 6% 6% Others 0% 6% 7% 7%
2011
2012
2013
2014
2015
2011
2012
2013
2014
2015
2016
 Profitability: Spirits remains a more profitable segment than beer in India as

fragmented manufacturing prevents the latter from achieving the optimal scale
required for higher profitability.

Consumer
Exhibit 39: OPM and return ratios have been better for spirits than beer
Sales growth over 3 year 3 Year 3 year
last 2 years avg GM avg OPM avg ROCE
Spirits
USL -6% 45% 3% 0%
Pernod Ricard 16% 57% 23% 108%
Radico Khaitan 3% 53% 12% 10%
ABD 33% 60% 10% 22%
Beer
UBL 10% 60% 14% 11%
SABMiller India 4% 52% 6% 1%
Carlsberg India 42% 43% -27% -23%
Source: Company, Ambit Capital research
 Premiumisation: Beer due to its expensive pricing is already a premium product

in India and, hence, further premiumisation within the segment is proving
difficult. Preference for strong beer (alcohol of content of >5%) also constrains
entry of premium international brands, most of which tend to be light beer. An
additional issue is the rise of microbreweries and brewpubs in larger cities at the
premium end which are preventing large branded beer brands from driving
premiumisation. In case of spirits, a complete price ladder from entry level to
imported luxury segment implies strong potential to premiumise consumers as
their spending power improves.
 Regulatory environment: This is marginally in favour of Beer with states like
Karnataka allowing a more liberal distribution of Beer or prohibition in Kerala
being stricter for spirits than for beer. However, the difference in regulations is
not large enough to make beer a preferred segment over spirits.
Internal drivers are more supportive for USL vs UB

Besides the external industry construct being favorable for USL, we believe there are
also internal factors that support USL. These are: 1) strong premiumisation trend led
by franchising of lower end brands and higher growth of Prestige and Above brands;
2) stronger profitability ramp due to premiumisation, cost efficiency programmes and
exertion of pricing power; and 3) complete control by Diageo over USL vs Heineken’s
partial control over UB, providing higher corporate governance comfort.
Premiumisation as a trend is playing out much better for USL
While the contribution of Prestige and Above brands has gone up to ~57% for USL, it
remains stuck at 4-6% for UB. We believe there is a strong case for USL to continue
this trend of premiumisation while UB will struggle to cross 10%.
 Beer is already a premium product: Given the lower affordability of beer, it is
already a premium product in India. Driving further premiumisation within this
segment is constrained by income levels.
 Competition from microbreweries at the high end: Consumers at the
premium end tend to be more aware, aspirational, brand conscious and
discerning. This has led to a rapidly rising trend of premium customers preferring
craft beer at microbreweries or brew pubs. This is limiting the premiumisation
potential for mass produced bottled beer sold by UB.
 USL is providing renewed support to Prestige & Above brands: USL has
witnessed a significantly higher growth for its Prestige & Above brands (at 2x the
overall company growth rate) led by its renewed marketing support, limiting price
hikes and revamping product by shifting from molasses-based alcohol to grain-
based alcohol.
 USL is franchising out lower-end Popular brands: This is also increasing the
contribution of Prestige & Above brands for USL and driving premiumisation. As
of now ~20% of USL volume (accounting for 1/3rd of USL’s volume from Popular
segment) has been franchised out with potentially another 20% volumes likely to
be franchised out over the next few quarters.

Consumer
Exhibit 40: Contribution of premium has grown faster for USL than for UB
40% 7%
35% 6%
30% 5%
25% 4%
20% 3%
FY11 FY12 FY13 FY14 FY15 FY16
UBL (% of sales, RHS) USL (% of sales)

Drivers of improvement in profitability are in place

UB has witnessed a gradual and consistent margin improvement trajectory led by its
1) cost savings from using proprietary bottles, 2) favorable input cost inflation, and 3)
scale efficiencies. We, however, believe that while the bulk of margin improvement
from these trends is largely done for UB, for USL, the margin improvement ramp will
begin now. This will be driven by:
 Premiumisation: While contribution from premium brands has gone up from
38% to 57% for USL, the impact on GM has been marginal (120bps). The key
reason for subdued margin gain was: 1) investment in improving product quality,
2) high cost inflation in alcohol prices (200bps GM hit), 3) lack of price hikes for
last two years, and 4) retrospective tax hikes in Maharashtra. With price hikes
resuming and input cost inflation running lower than expected, we expect further
premiumisation to lead to a healthy GM gain.
 Cost efficiency programmes: USL has also undertaken cost saving programmes
by cutting inefficiencies and leakages from the system that had come up under
the previous management. We expect these programmes to add 30-50bps to
OPM for USL each year.
 Deleveraging: USL currently has a net debt/equity ratio of 2x. It plans to sell
`20bn worth of non-core assets which are mainly treasury shares and real estate
used by the previous management but owned by USL. This should help to
deleverage the balance sheet and drive profit growth through lower interest cost.
Exhibit 41: GM trends for USL vs UB over FY14-19 show Exhibit 42: EBITDA margin trends for USL vs UB over
similar gains FY14-19 show USL’s faster improvement
47% 63% 16% 16%
46% 12%
14%
45% 8%
60%
44% 4%
12%
43% 0%
42% 57% -4% 10%

FY14
FY15
FY16
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY17E
FY18E
FY19E
USL UBL (RHS) USL UBL (RHS)

Consumer
Complete breakaway from previous management is a positive

Diageo, through a series of transactions and open offers, has now managed to own
55% of stake in USL. Also, through a one-time settlement of US$75mn paid by
Diageo (and not USL as is believed by some), Diageo has ensured that there is no
Board or Management representation by the erstwhile promoter. This has allowed
Diageo to formulate future strategy and clean up the system without any interference
from the erstwhile promoters. In the case of UB, however, though Heineken has now
managed to get a higher stake in the company than the erstwhile promoter, it is
bound by a shareholder agreement. This agreement makes Vijay Malaya the lifetime
chairman and gives him power to appoint CEO. Heineken only gets 3 board seats
and power to appoint CFO. While we believe Heineken maintains a tight control over
UB’s finances, presence of the erstwhile promoter with a questionable track record
remains an overhang.
Exhibit 43: Shareholding pattern for USL Exhibit 44: Shareholding pattern for UB
Vijay Mutual Others,

Others, Mallya, Funds, 4% 6% Vijay
14% 4%
Mallya,
Mutual 30%
Funds, 5% FII, 16%
FII, 22% Diageo,

55%
Heineken,
44%
Source: BSE India, Ambit Capital research Source: BSE India, Ambit Capital research
Exhibit 45: Board and management representation for UB is a mix of UB Group and
Heineken while USL is completely represented by Diageo
USL UBL
Position
Name Appointed by Name Appointed by
Chairman Mahendra Sharma Diageo Vijay Mallya UB Group
CEO/MD Anand Kripalu Diageo Shekhar Ramamurthy UB Group
CFO Sanjeev Churiwala Diageo Steven Bosch Heineken
Director V.K. Viswanathan Diageo Ravi Nedungadi UB Group
Director Vinod Rao Diageo Chugh Pal UB Group
Director D Sivanandhan Diageo Sunil Alagh UB Group
Director Rajeev Gupta Diageo Chhagan Jain UB Group
Director Indu Shahani Diageo Frans Eusman Heineken
Director John Thomas Kennedy Diageo Kiran Mazumdar
Director Madhav Bhatkuly
Director Sijbe Hiemstra Heineken
Director Stephan Gerlich Heineken

Consumer
Valuation not justified in case of business

as usual
We initiate USL with a BUY (TP `2,575, 27% upside) and UB with a SELL (TP
`625, 18% downside). Our target price is based on DCF with an explicit
forecast period of 5 years followed by a 20-year fade period and then a
terminal growth rate of 5% for both the names. WACC has been calculated at
13% for both USL and UB. USL is currently trading at 41xFY19E P/E and UB is
at 55xFY19E P/E. We believe UB deserves a discount to USL as both internal
as well as external factors support USL and we estimate FY17-20E EPS CAGR
of 45% for USL vs 17% for UB.
Exhibit 46: DCF-based valuation ascribes 52x FY19E P/E for US and 40x for UB
Target Up/ CMP P/E TP P/E 5Yr EPS Fade EPS
Stock CMP
Price Down (FY19) (FY19) CAGR CAGR
USL 2031 2,575 27% 41.4 52.5 49% 15%
UBL 762 625 -18% 54.8 45.0 13% 11%
Exhibit 47: Thesis for our assumptions for USL and UB

USL UBL Comments
FY16-21
USL has lower volume growth compared to UBL due to
Volume growth 3% 3%
franchising of Popular brands in more regulated states
With lower volume growth USL sales growth will be higher than
Sales growth 12% 7%
UBL due to premiumisation driving value growth
Operating margin expansion for USL will be 420bps compared to
Operating margin 8.1-13% 9.5-10% 150bps expansion to UBL led by higher premiumisation and cost
saving programs
Higher sales growth and margin expansion combined with strong
EPS 49% 13%
deleveraging leads to superior EPS growth for USL vs UBL
FY21-30
Expect higher growth of USL vs UBL as affordability and
premiumisation will be in favour of USL. Also we do not expect
Sales growth 12% 9%
lenient Government policy on Beer vs Spirits which may have
helped Beer outgrow Spirits
Given the cap on profitability of beer due to fragmented
Operating margin 13-17% 10-14% manufacturing and weaker premiumisation we expect USL to
have higher margins vs UB over the long term period
Higher margin expansion and better sales growth leads to higher
FCF 14% 11%
FCF growth for USL
 United Spirits (BUY, TP `2,575, upside 27%): USL is currently better placed to
navigate the business (low affordability, restricted distribution, limited pricing
power) and regulatory (high taxation, fragmented manufacturing, restricted
promotions) issues faced by alcobev companies in India. Key drivers for this
strength are: 1) strong premiumisation trend, 2) expected ramp-up in profitability
as investments in business revamp are largely behind, and 3) potential
deleveraging as working capital stabilizes and non-core assets are sold. USL is
trading at 41x FY19E P/E, which is at a 24% premium to our FMCG coverage and
a 73% premium to global peers. However, a strong EPS CAGR of 45% over FY17-
20E justifies the valuation premium.
 United Breweries (SELL, TP `625, downside 18%): We believe the industry
construct is worse for beer due to lower affordability led by higher taxation, hit to
profitability from fragmented manufacturing and rising competition from
microbreweries limiting premiumisation potential. Internal factors for UB are also
unlikely to see a meaningful uptick as: 1) premiumisation remains weak with only
5-7% of sales coming from premium brands, 2) profitability gains are tapering as
benefits of benign raw material prices and proprietary bottling programme wane,
and 3) Heineken maintains only partial control over UB. With EPS CAGR of 17%
over FY17-20E, a valuation of 55x FY19E P/E (65% premium to our FMCG
coverage and 158% premium to global peers) appears unjustified.

Consumer
Valuation premium justified for USL but not for UB

Both USL (41x FY19E) and UB (55x FY19E) are trading at rich multiples at a significant
premium of 73% and 158% premium to their respective global peers. The premium to
other FMCG names under our coverage is 24% and 65% for USL and UB respectively.
We believe the premium is justified for USL as it is in the process of turning around its
business fundamentals as well as earnings trajectory with an estimated EPS CAGR of
45% over FY17-20E. However, in the case of UB, given the earnings trajectory is
likely to follow a ‘business as usual’ path, delivering 17% EPS CAGR over FY17-20E,
the premium is unjustified.
Comparison with historical trend is futile given unfounded hope in the past
In case of USL, historical trends for P/E and EV/EBITDA are not available given losses
it incurred in the past. Comparing on P/sale basis, USL is trading at a slight discount
to last 5-year average, which provides a case for re-rating given the earnings
turnaround that is expected. UB is also trading at a ~25% discount to its last 5-year
trading average.
Exhibit 48: USL – one-year forward P/sales Exhibit 49: UB – one-year forward P/sales
7.0 7
6.0 6
5.0 6
4.0 5
3.0 5
2.0 4
1.0 4
- 3
Jan-14
Jan-15
Jan-16
Jan-17
Jan-12
Jan-13
Sep-14
Sep-15
Sep-16
Sep-12
Sep-13
May-12
May-13
May-14
May-15
May-16
Jan-14
Jan-15
Jan-16
Jan-17
Jan-12
Jan-13
Sep-12
Sep-13
Sep-14
Sep-15
Sep-16
May-14
May-15
May-16
May-12
May-13
1 year fwd P/Sales 5 yrs average P/Sales

1 year fwd P/Sales 5 yrs average P/Sales
+1 s.d. -1 s.d. +1 s.d. -1 s.d.
Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research
We believe the key reason for the discount to historical valuations is unrealistic
expectation in the past. Key evidence that market exuberance was unfounded is the
fact that earnings expectations for UB and USL have been cut by about 20 times in
both the names with an overall miss/cut of 45% for UB and 75% for USL. We believe
market expectations are now largely rational for UB with street at 13% EPS CAGR vs
our estimate of 14% over FY17-19E.
What is important is the delivery of EPS expectations for USL, which are at 45% CAGR
over FY17-20E. In the past, markets were right in assuming that Diageo will deliver
margin gains and deleverage the balance sheet by cleaning it up. However, the street
had underestimated the time and investments it would take to achieve these results.
We believe Diageo has taken longer than expected but has put the fundamentals in
place to achieve this margin ramp-up and deleveraging. The inflection point where
the efforts and investments of last three years will start reflecting in the earnings is
now approaching.

Consumer
Exhibit 50: USL’s EPS estimates have been cut by ~75% by Exhibit 51: UB’s EPS estimates have been cut by ~45% by
consensus consensus
Historical Mean FY16 Historical Mean FY16

120 Historical Mean FY17 25 Historical Mean FY17
100
20
80
60
15
40
20 10
Aug-13
Aug-14
Aug-15
Aug-16
Aug-13
Aug-14
Aug-15
Aug-16
Nov-13
Feb-14
May-14
Nov-14
Feb-15
May-15
Nov-15
Feb-16
May-16
Nov-16
Feb-17
Nov-13
Feb-14
May-14
Nov-14
Feb-15
May-15
Nov-15
Feb-16
May-16
Nov-16
Feb-17
Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research
Premium valuation vs global peers is justified, but only to an extent

USL is trading at a 73% premium to its global spirits peers. UB is trading at a
significantly higher premium of 158% vs its global brewery peers. While we believe
some premium is justified for both USL and UB given higher growth potential at
similar return ratios, we believe the premium for UB is too high to sustain. Also,
globally brewers are trading at a 15% discount to spirits companies despite improving
industry construct due to consolidation. We believe there might be a case for
valuation gap between spirits and brewers to narrow but that should not support
valuations for UB in India as global consolidation is actually negative for UB as a
stronger competitor has emerged in the form of combined ABInBev and SABMiller
entity. Similarly, any potential de-rating of spirits companies should not impact USL
as its valuations should be supported by its internal earnings trajectory ramp-up
delivering 45% EPS CAGR over FY17-20E.
Exhibit 52: Relative valuations – a global comparison
Div Yld Sales EPS
CMP Mkt cap P/E EV/EBITDA P/Sales ROE (%)
Company Currency (%) CAGR CAGR
LC (US$)
FY18 FY19 FY18 FY19 FY16 FY17 FY16 FY17-19 FY17-19
Spirits
United Spirits Ltd INR 2,032 4,571 60.2 41.4 27.7 21.9 3.0 16.0 - 11% 49%
Diageo Plc GBp 2,287 71,611 21.7 20.0 16.6 15.4 5.3 26.1 3.1 9% 14%
Brown-Forman Corp-Class B USD 46 17,815 26.3 24.6 18.3 17.3 5.7 41.9 1.3 1% 5%
Pernod Ricard Sa EUR 112 31,641 19.8 18.3 14.3 13.4 3.5 10.1 1.7 3% 9%
Suntory Beverage & Food Ltd JPY 4,795 13,380 30.4 25.2 9.1 8.5 1.1 7.3 1.3 1% 18%
Remy Cointreau EUR 91 4,854 35.7 30.6 21.5 19.3 4.7 9.9 1.9 6% 16%
Beer
United Breweries Ltd INR 762 3,107 76.8 54.9 29.3 23.4 4.0 13.0 0.1 7% 14%
Heineken Nv EUR 80 49,200 20.3 18.6 11.0 10.1 2.2 14.1 1.7 5% 8%
Anheuser-Busch Inbev Sa/Nv EUR 104 223,787 22.9 20.3 15.1 13.9 4.8 11.5 3.1 15% 22%
Asahi Group Holdings Ltd JPY 4,273 18,660 18.8 16.3 14.1 12.3 1.1 10.1 1.3 4% 19%
Carlsberg As-B DKK 647 14,088 19.5 17.7 9.2 8.6 1.5 9.8 1.5 3% 14%
Tsingtao Brewery Co Ltd-H HKD 35 6,285 32.3 30.2 14.1 12.7 1.9 8.9 1.2 2% 1%
China Resources Beer Holdin HKD 18 7,592 28.8 24.8 13.1 11.4 1.7 6.3 - 4% 41%
Source: Bloomberg, Ambit Capital research

Consumer
Premium valuation vs FMCG peers is unjustified

In the five key segments of our FMCG space, we believe alcobev stacks unfavorably
to most others in terms of growth and returns. However, its future trajectory is
positive as we expect it to maintain growth while improving return ratios; this should
lead to an only marginal de-rating from current lofty valuations.
 Home and Personal Care: While HPC is currently growing in line with the
sector, with rising penetration we expect growth to slow to below sector average.
However, return ratios should remain high and hence de-rating hereon should be
marginal.
 Food and Beverages: We believe F&B is the best-placed segment in FMCG. Low
penetration, rising affordability, strong innovation and changing lifestyles support
growth acceleration. Investments to drive growth have already been done to a
large extent and, hence, return ratios should also improve. We expect valuations
to expand from above sector average to even higher levels.
 Paints: Paints have historically grown ahead of FMCG sector average. But we
believe that as re-painting cycles stabilise and housing addition slows, growth
rate should moderate and get in-line with the sector. Rising investments by key
players combined with this slowdown should bring down return ratios from above
average to average levels. This should lead to a significant de-rating.
 Tobacco: We believe tobacco’s below-average growth should move up to in-line
growth as taxation regime post GST turns favourable. Return ratios remain high
and with higher earnings visibility, multiples should re-rate from below average
currently to in-line levels.
Exhibit 53: Alcobev placed low in our pecking order in FMCG space
6 Tobacco Tobacco Fut

High
5 HPC Fut HPC
4 Paints F&B Fut

Medium
ROCE
3 AlcoBev Fut F&B
2 Paints Fut
1 AlcoBev
Low
-
-Low 1 2 Medium
3 4 5 High 6
Growth
Source: Ambit Capital research, Size of the bubble denotes valuations
USL is trading at a 24% premium to other FMCG names in our coverage and UB is
trading at a 65% premium. Ideally, we believe both the names should not be trading
at a premium to the FMCG sector given significantly weaker industry construct and
regulatory issues. Also, there is no case for a significantly higher growth trajectory for
alcobev companies in India as compared to other FMCG categories and companies.
This combined with weaker return ratios make a case for a valuation discount to the
sector. However, in case of USL, given its earnings turnaround would lead to a sharp
45% EPS CAGR over FY17-20E, a premium to the sector can be justified. In case of
UB, in the absence of any significant earnings growth ramp, such a premium to the
sector is unjustified and we expect de-rating hereon.

Consumer
Exhibit 54: Relative valuation with Indian FMCG companies

P/E based on Implied P/E Div. Rev EPS
CMP Mcap Up / EV/EBITDA ROCE (%)
Relative valuations Stance TP CMP based on TP Yield (%) growth Growth
Down
(`) (LC bn) FY18E FY19E FY18E FY19E FY18E FY19E FY18E FY19E FY16 FY17-20 FY17-20
Alco-Bev
United Spirits 2,031 295 BUY 2,575 27% 60.2 41.4 27.7 21.9 13.1 16.7 76.4 52.5 0.0% 12.7% 44.6%
United Breweries 762 202 SELL 625 -18% 76.8 54.9 29.3 23.4 10.6 13.9 62.9 45.0 0.2% 8.7% 16.6%
Average 4% 68.5 48.2 28.5 22.7 11.8 15.3 69.7 48.8 0.1% 10.7% 30.6%
Staples
HUL 935 2,024 BUY 950 2% 44.0 34.7 31.7 25.7 153.3 258.7 44.7 35.2 1.7% 15.9% 21.4%
Nestle 6,628 639 SELL 5,800 -12% 55.2 46.1 30.6 25.5 35.9 41.7 48.3 40.3 0.6% 16.2% 17.4%
GSK Consumer 5,193 218 SELL 4,800 -8% 29.7 26.1 26.0 22.5 25.8 25.8 27.5 24.1 1.3% 11.4% 12.4%
Colgate 1,003 273 SELL 825 -18% 38.9 32.5 23.8 20.4 54.9 57.0 32.0 26.8 1.0% 16.8% 18.2%
Godrej Consumer 1,698 578 SELL 1,060 -38% 43.7 38.2 29.7 25.8 15.0 15.7 27.3 23.9 0.3% 12.1% 10.6%
Dabur 284 500 SELL 240 -15% 36.0 30.3 28.3 23.5 24.1 25.6 30.5 25.6 0.8% 15.5% 17.2%
Marico 299 386 SELL 245 -18% 41.8 36.1 29.3 25.0 33.0 33.6 34.3 29.6 0.8% 15.3% 16.5%
Britannia 3,376 405 SELL 2,720 -19% 44.0 35.9 27.5 22.7 38.4 38.8 35.4 28.9 0.6% 16.4% 19.3%
Hatsun Agro 519 79 BUY 505 -3% 38.2 29.9 17.7 14.4 20.7 21.4 37.2 29.1 0.8% 19.5% 38.1%
ITC 279 3,389 BUY 297 7% 27.1 23.7 17.6 15.1 31.2 32.7 28.9 25.2 2.0% 16.2% 15.5%
Average -12% 39.9 33.4 26.2 22.1 43.2 55.1 34.6 28.9 1.0% 15.5% 18.7%
Paints
Asian Paints 1,083 1,038 SELL 800 -26% 54.6 45.5 34.2 29.0 44.7 54.8 40.4 33.6 0.7% 14.2% 15.7%
Berger Paints 247 240 SELL 180 -27% 53.7 42.8 31.8 25.9 29.8 35.5 39.0 31.0 0.5% 15.1% 19.2%
Average -27% 54.2 44.1 33.0 27.4 37.2 45.1 39.7 32.3 0.6% 14.7% 17.5%

Consumer
Key risks
 Worsening regulatory environment: We believe rising instance of prohibition
by States and adverse court rulings is making the regulatory environment tougher
for the sector. The impact of ban of liquor vends within 500m of Highways still
remains un-quantified and can be significant in the near term till vends shift to
inside locations as almost 40% of sales is estimated to be generated from
impacted outlets.
 Continued market share declines: Both USL and UB have been losing market
share to smaller players like ABD and Carlsberg. Both ABD and Carlsberg are still
expanding their distribution reach and manufacturing footprint. Hence, their
above industry level growth is likely to continue. In case of Beer, combination of
SABMiller and ABInBev is also likely to create more credible competitor.
 Raw material price inflation could hurt margins: Both USL and UB have
benefited from a benign input cost scenario over last 3 years. However, with price
of grains, molasses and glass starting to move up, there is a possibility of higher
than expected input cost inflation. Given limited pricing power that these
companies enjoy, their ability to pass on this inflation will be low and hence hit to
margins can be high.
Key catalysts
 Premiumisation and profitability gains: We expect strong premiumisation
trend to continue for USL and with investments behind revamping of products,
brands and channel now largely behind us, we expect profit margins to move up
sharply for USL. Also, in case of UB as scale efficiencies keep improving, we
expect a steady margin gain ramp to continue. We are building in EBIT margin
gains of 210bps for USL and 40bps for UB over FY16-19E.
 Rising cash pile to add to EPS growth: We expect positive cash generation and
sale of non-core assets to drive deleveraging for USL which will further support
higher EPS growth as finance cost comes down from `4.6bn in FY16 to `3bn by
FY19E. Similarly, we expect UB’s cash pile to grow to `7.4bn by FY19E vs `139mn
in FY16. This should help Other Income from investments to move up from
`220mn in FY16 to `514mn (9% of PBT) by FY19E.
 Weak volume growth: We expect volume growth to be weak for both USL (-1%
CAGR over FY16-19E) and UB (2% CAGR over FY16-19E). USL continues to
franchise out Popular brands and Beers should follow its past 5 year growth
trajectory with no visible reason for it to accelerate. In case of USL this volume
decline is expected and healthy for overall profitability of the company and hence
not an issue. But for UB this decline might be truly disappointing.

Consumer
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United Spirits
BUY
INITIATING COVERAGE UNSP IN EQUITY April 07, 2017
Drink it up for a strong kick Consumer
Diageo transformed USL by improving product quality, channel Recommendation

management and working capital efficiency as also driving Mcap (bn): `295/US$4.5
premiumisation. During this transformation, topline growth suffered 6M ADV (mn): `848/US$13.0
and gains were reinvested (sales/OPM down 4%/20bps, FY14-16). The CMP: `2,031
inflection point for the benefits of price hikes, premiumisation and TP (12 mths): `2,575
franchising to kick-in is near. We estimate 45% EPS CAGR over FY17- Upside (%): 27
20E driven by 13% sales CAGR, 350bps OPM gain and deleveraging.
Current P/E of 41x FY19E at a 24% premium to the FMCG sector is Flags
justified by stronger earnings growth. Key risks: Stricter regulations
Accounting: AMBER
and continued investments that can hurt earnings growth.
Predictability: AMBER
Earnings Momentum: RED
Competitive position: STRONG Changes to this position: NO CHANGE
USL revamping business on multiple fronts to beat industry handicaps Catalysts
Diageo revamped all four Ps (Product, Price, Promotion and Place) crucial for a
 Expected improvement in OPM by
consumer firm. To revamp product, 20-30% volumes were moved to grain-
350bps over FY17-20E due to
based ENA. To drive pricing power, it is focusing on free pricing states and premiumization
franchising in low-profit, low-growth markets. On promotions, A&P spend
(60bps in FY17) increased with focus on 14 Power Brands. Place improved by  28% fall in finance cost over FY17-20E
adopting technology for better store servicing, accurate demand forecasting due to deleveraging as cash flow
generation improves
and revamping 25% stores under ‘Perfect Store’ plan for higher PoS impact.
Profitability should improve with investments largely over Performance (%)

USL’s GM/OPM declined by 100bps/200bps since FY12 as margin gains from 130
premiumisation (200-300bps) were invested. USL is now entering a phase of
monetisation of these investments; GM/OPM should improve by 110
130bps/350bps over FY17-20E led by price hikes, franchising, premiumisation, 90
workforce reduction and cost efficiency programmes.
70
Improved balance sheet health and cash flows to drive deleveraging
Aug 16
Oct 16
Apr 16
Apr 17
Jun 16
Dec 16
Feb 17
Diageo has brought down USL’s net-working-capital/sales to 35% vs 30% over
FY14-16 as related parties loans were curtailed and inventory levels optimized.
We expect this to reach 23% by FY19. Cumulative FCF over FY17-19E is USL Sensex
estimated at ~`23bn with no major capex plans. These should help pare debt
from `37bn in FY16 to `30bn by FY19E, with further reduction potential on Source: Bloomberg, Ambit Capital Research
sale of non-core assets (real estate and treasury shares) worth `20bn.
Value on DCF and not multiples as current earnings level is suboptimal
Given USL’s transformation, its current profitability (8.5% OPM in FY16) is sub-
optimal and does not capture its inherent earnings potential (we expect 17%
OPM by FY29). Hence, a 53x FY19E P/E at our TP looks high but is based on
DCF which captures the true long-term earnings potential of USL.
Research Analysts
Key financials Anuj Bansal
Year to March FY15 FY16 FY17E FY18E FY19E +91 22 3043 3122
Operating income (` mn) 93,350 93,793 98,803 107,598 122,545 anuj.bansal@ambit.co
EBITDA (` mn) 330 9,569 9,583 11,835 14,851
Dhiraj Mistry, CFA
EBITDA margin (%) 0.4% 10.2% 9.7% 11.0% 12.1%
+91 22 3043 3264
EPS (`) -58.4 12.3 22.0 33.7 49.0 dhiraj.mistry@ambit.co
RoE (%) -45.9% 14.5% 16.4% 20.8% 24.1%
Ritesh Vaidya, CFA
RoCE (%) -2.7% 7.3% 10.3% 13.1% 16.7%
+91 22 3043 3246
P/E (x) -.4.8 165.8 92.4 60.2 41.4
United Spirits
Snapshot of Company Financials

Profit and Loss Company Background
Year to Mar (` mn) FY17E FY18E FY19E
United Spirits Limited is a subsidiary of Diageo PLC after
Net revenues 98,803 107,598 122,545 acquiring 54.8% in FY14 from Vijay Mallya. Founded in
EBITDA 9,583 11,835 14,851 1826, USL is the largest spirits company in India engaged in
Depreciation 1,607 1,727 1,859 the business of manufacturing, purchasing and selling
Interest expense 3,760 3,331 2,975
alcoholic beverages.
Adjusted PBT 4,766 7,315 10,630 Its product segments include whiskey, vodka and rum. The
Tax 1,573 2,414 3,508 company caters to various consumers through luxury,
premium, prestige and popular spirits categories. Its brand
Adjusted net profit 3,193 4,901 7,122
portfolio includes McDowell's No.1, Royal Challenge,
Reported net profit 3,193 4,901 7,122 Signature and Antiquity. It has 15 millionaire brands
Profit and Loss Ratios including 3 brands with over 10mn cases per annum in
EBITDA Margin (%) 9.7% 11.0% 12.1% sales. USL has over 74 manufacturing facilities spread
Net profit margin (%) 3.2% 4.6% 5.8% across approximately 23 states and over three union
territories in India.
EV/ EBITDA (x) 34.2 27.3 21.3
P/E on adjusted basis (x) 92.4 60.2 41.4
Price/Sales (x) 3.0 2.7 2.4
Balance Sheet Cash flow

Year to Mar (` mn) FY17E FY18E FY19E Year to March (` mn) FY17E FY18E FY19E
Total Assets 83,643 89,759 100,096 PBT 4,766 7,315 10,630
Fixed Assets 22,112 22,885 23,526 Depreciation 1,607 1,727 1,859
Current Assets 59,542 64,885 74,581 Tax (1,573) (2,414) (3,508)
Investments 1,989 1,989 1,989 Net Working Capital 265 716 (149)
Total Liabilities 83,643 89,759 100,096 CFO 8,275 10,138 11,194
Total networth 21,072 25,973 33,096 Capital Expenditure (2,000) (2,500) (2,500)
Total debt 34,313 32,313 30,313 Investment - - -
Others (1,235) (1,235) (1,235) CFI (1,450) (1,962) (1,887)
Current Liabilities 29,493 32,708 37,923 Issuance of Equity - - -
Balance Sheet ratios Inc/Dec in Borrowings (3,000) (2,000) (2,000)
RoCE 10.3% 13.1% 16.7% Net Dividends - - -
RoE 16% 21% 24% Interest paid (3,760) (3,331) (2,975)
Gross Debt/Equity (x) 1.6 1.2 0.9 CFF (6,445) (5,331) (4,975)
Net debt (cash)/ Eq (x) 1.5 1.0 0.6 Net change in cash 381 2,844 4,332
P/B (x) 14.0 11.4 8.9 Closing cash balance 1,671 4,516 8,848
USL dominates spirits in India with 38% market share Whiskey/rum/brandy form 65%/17%/16% of USL’s portfolio
Market share Product mix
Vodka, 1%
Rum, 17%
Others,
34%
USL, 38%
Brandy,
16%
Radico Whiskey,
Khaitan, 65%
5% Pernod
Ricard,
ABD, 11% 13%

United Spirits
Story in charts
Exhibit 1: Parameters on which Diageo has transformed USL business
Parameter Action Before Now After Comments
Product quality has improved with ~40% of its portfolio moved to grain-
Increased grain-based
based alcohol versus 10-15% earlier. Going forward, we expect more
products
brands to be moved to grain-based alcohol.
Product
Portfolio mix has improved with franchising of low-growth, low-margin
Franchised popular
popular brands in 4 states and 2 UT; Management further plans to
brands
franchise popular brands in more states.
USL has revamped 20,000 stores in new ‘Perfect Store’ format and wants
Improve channel
to add more stores in new format. Frequency of channel servicing and
management
inventory forecasting has also improved.
Place
By exiting more regulated states like Kerala and Tamil Nadu by
Sharper geographic focus franchising of popular brands, USL can focus on key states like
Maharashtra, Karnataka and West Bengal.
USL continues to do branding exercise through various music and sports
Increasing branding
Promotion events. USL has also started bar academy to train bartenders. A portfolio
activity
of 14 brands has been created for focused marketing effort.
Premiumisation Premiumisation of portfolio is helping USL to increase its price/mix.
Price
Price hikes have resumed after two years. We expect stronger hikes in
Increasing pricing power
future.
Employee and system Rationalisation of employee count and adoption of system and processes
management of Diageo have improved USL’s efficiency.
Resource
Working capital as a percentage of sales has reduced by 500bps in the
management
Working capital efficiency last 2 years and we expect that to further reduce by 700bps in the next 3
years.
Exhibit 2: Turnaround in profitability is round the corner Exhibit 3: Cash flow has improved profitability and capital
due to premiumisation efficiencies
Revenue growth Gross margin (RHS) CFO (Rs mn) FCF (Rs mn)
20% 48% 20,000

15,000
10%
46% 10,000
0% 5,000
44% -
-10%
(5,000)
-20% 42% (10,000)
FY15
FY16
FY11
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY21E
FY17E
FY18E
FY19E
FY20E
FY21E
Exhibit 4: Deleveraging to further aid EPS growth Exhibit 5: As working capital reduces RoCE will improve
EPS growth Net Debt/Equity (RHS) Working capital (% of sales) ROCE
100% 7.0 40%

6.0
50% 30%
5.0
0% 4.0 20%
-50% 3.0 10%

2.0
-100% 0%
1.0
-150% - -10%
FY15
FY16
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY21E
FY17E
FY18E
FY19E
FY20E
FY21E

United Spirits
Evolving into a ‘consumer company’ under

a global leader’s guidance
High level of regulatory constraints in the Indian alcobev space curtails all
the four key marketing parameters (Product, Price, Promotion and Place)
that are critical for a consumer company. USL, under the previous
management, witnessed a phase of aggressive growth through consolidation
in the industry. It also managed to create entry barriers and thwart
competition by managing the regulatory constraints to create an inefficient
but resilient business model. However, over time, some of these inefficiencies
became a tool for financing the erstwhile management's lifestyle and
ambitions. However, since Diageo took over, the focus has shifted to creating
and enhancing fundamental business capabilities by revamping products,
brands, route to market and engage with regulators with the aim of driving
profitability, improving balance sheet health and return ratios.
Exhibit 6: USL’s evolution from a market consolidator to inefficient operator to a true consumer company
Revenue (Rs mn) ROCE (RHS) Divested Whyte

Divested Bouvet
& Mackay
Acquired Whyte & Mackay Ladubay
120,000 Diageo acquired 20%
Bouvet Ladubay, France was 54.8% stake in UBL
100,000 acquired
10%
80,000
60,000 Acquires Shaw 0%

Wallace
40,000
-10%
20,000
- -20%
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
 Phase 1 (FY02-07) - Consolidating into a market leader: Through a series of

acquisitions, McDowell’s Holdings morphed into United Spirits. This enabled the
company to attain an undisputed market leadership in the Indian Spirits industry
with a wide array of products across segments and price points. Revenues went
up 3.3 times and scale advantage combined with lower competitive intensity led
to RoCE moving up from 5% to 16%.
 Phase 2 (FY08-14) - Frittering away the advantages: USL stretched itself by
moving into international markets through Whyte & Mackay acquisition. This
provided sales boost (up 2.3 times) but RoCE declined sharply. Downward
trajectory of RoCE continued as the balance sheet size continued to balloon to
fund promoter’s ambition and lifestyle.
 Phase 3 (FY15 onwards) - Diageo leading a transformation: The current
phase of transformation began in FY14 after Diageo acquired controlling stake in
USL. Product, brand, geographic reach and channel rationalisation led to revenue
moderation (down to 0.8x) but RoCE started to improve sharply as balance sheet
was cleaned up and business started returning to inherent profitability and return
ratios.

United Spirits
USL has incumbent’s advantages in a controlled sector

While we believe the industry construct remains weak for alcobevs in India due to
regulatory constraints, these also act as entry barriers and reduce competitive
intensity. This combined with habit-forming nature of the product, makes this industry
attractive for incumbents. However, the bargaining power of both suppliers and
buyers is high due to regulatory issues which force fragmentation of manufacturing
footprint and restrict pricing power of the companies. On a net basis, one can expect
to maintain a steady state of growth with reasonable profitability and return ratios as
manufacturing inefficiencies and lower pricing power get offset to some extent by
lower competitive intensity. USL, in particular, as a market leader with larger scale
and a wide portfolio of market-leading brands as compared with peers should be
able to mitigate, to some extent, the bargaining power of both suppliers and buyers.
This makes us believe that with Diageo’s current strategy, USL can potentially achieve
profit leadership which rightfully belongs to it.
Exhibit 7: Porter’s Five Forces analysis shows alcobev industry is good for incumbents
Entry Barriers Substitutes

++ ++
 Brand building is difficult due to restrictions on  Beer is 4x more expensive than Spirits and
advertising and promotions culture/taste for wine is underdeveloped in
India. Spirits likely to remain key form of
 Scaling up across states is constrained by high
intoxication
entry/exit taxes which necessitate pan-India
manufacturing footprint  Country liquor is a weak substitute given IMFL
is significantly better in quality and taste
 Investments in working capital are high due to
high receivables from Government agencies  On premise consumption can see substitution
Rivalry
+
 Market-share movement has largely been

within a narrow band
 Only ABD has been able to ramp up in spirits

meaningfully
 Players focus more on countering Government

regulations than compete with each other
Bargaining power of Suppliers Bargaining power of Buyers

- --
 Reliance on third-party distillers is high to fulfill  End consumer is fragmented and habit-
requirement for pan-India manufacturing forming nature of alcohol makes them price
inelastic
 A key raw material like ENA has alternate uses
like fuel blending which causes supply volatility  However, 70% of revenues come from states
where Government is the distributor and price
 Glass bottle manufacturers are consolidated in setter which moves pricing power from
India and tend to exert pricing power companies to Governments
Improving Unchanged Deteriorating

United Spirits
Exhibit 8: SWOT analysis

Strengths Weaknesses
 Wide array of products and brands (15 brands with 1mn cases/year  More than 60% of sales come from the lower-end popular brands; many
sales) across all segments and price points help in capturing of which are slow growing and drag down overall growth of the company
consumers across different strata  Resetting of relationships with Trade, Regulators and State Governments
 Market-leading scale (40% volume share, 74 distilleries) provides post acquisition by Diageo could take time and adversely impact business
bargaining power against raw material suppliers and third-party in the interim as seen in rise in receivable days from 62 in FY12 to 82 in
distillers. It also provides resources to have best sales force to carry out FY16
Point of Sale management across all 86,000 outlets in India
Opportunities Threats
 Drive premiumisation through faster growth of high-end brand riding  Toughening regulatory environment and adverse judicial rulings can
on Diageo’s expertise and brand portfolio impact revenues and profitability
 Gain market share through higher focus on select brands and  Aggression by Pernod Ricard at the premium end can limit potential gains
geographies while maintaining overall scale of business by franchising through premiumisation for USL. Pernod has gained 4% market share
out non-core brands over 2011-15
USL while being the largest Spirits company in India has key advantages of: 1) scale;
2) diverse product/brand portfolio straddling all segments and price points; and 3)
wide distribution network. However, it has been weak in terms of: 1) maintaining
market share where Allied Blenders & Distillers’ (ABD) Officer’s Choice has done a
great job (15% CAGR over the last 5 years) with 5% market-share gain; 2) profitability
where Pernod Ricard is the leader despite selling one-third the USL’s volumes; and 3)
innovation where Pernod’s marketing and Radico’s new launch pipeline have been
more impressive.
Exhibit 9: USL is the largest spirits player in India but lags peers on several parameters
Pernod Radico
USL ABD Remarks
Ricard Khaitan
USL is the market leader with 38% share but has been losing share (-4%) to Pernod
Market share
(+4%) and ABD (+7%) since 2011
USL covers all 86,000 outlets given its scale with Pernod and ABD also at similar
Reach
levels. Radico with its limited scale covers only 64,000 outlets
USL has the widest distillery network (74) followed by Pernod (32) and ABD (40),
and Radico (34) is weaker in West
USL is gradually moving up the margin curve with Pernod already earning margins
Profitability (20%+) close to global levels. ABD and Radico due to mass-end portfolio are weak
on margins (10-12%)
USL has mainly focused on re-launches while Pernod has been innovative in its On
Innovation Premise focused brand building. ABD remains one trick pony while Radico’s launch
of 8PM and Magic Moments is worth noting
USL is catching up on premiumisation (40%) while Pernod already runs a premium
Premiumisation portfolio (100%). ABD is unlikely to move up (20%) rapidly while Magic Moments
Vodka should aid Radico to improve (24%)
However, it requires change in management to make

the best use of these advantages
Diageo, since acquiring USL, has worked on a complete revamp of the products,
brands, channels, systems, processes, culture and workforce of the company. It has
also got together with other players in the industry to engage with the regulators and
State Governments to professionalise the set-up as much as possible. While in the
near term, this may lead to sales decline, market-share loss and lowering of entry
barriers that were in place due too system inefficiency, in the longer run it will lead to
creation of a true consumer company set to win based on a high quality product and
brand portfolio, proper route to market, better customer connect and predictable and
efficient regulatory environment. This will help elongate longer term growth ramp,
improve profitability and improve balance sheet health.
 Revamping products: Traditionally, most spirits in India have been made using
Extra Neutral Alcohol (ENA) derived from molasses. After the takeover, Diageo
moved some of the key brands like McDowell’s No.1, Signature and Royal
Challenge to grain-based ENA, which is a more premium form of ENA and
improves the product quality perceptibly.

United Spirits
Exhibit 10: Innovation pipeline has picked up since Diageo took over USL
No of % of Total
Year New Launch Re-launched
Launches Volume
Royal Challenge, McDowell's No. 1,
FY16 3 >30%
Signature
FY15 Royal Challenge 1 ~4%
FY14 NA NA NA
FY13 NA NA NA
FY12 McDowell’s No.1 Cariba Rum Royal Challenge 2 <2%
McDowell's No. 1 Platinum Whiskey,
FY11 3 ~1%
McDowell's VSOP Brandy, Signature Premier
FY10 Black Dog 18 Year Old Whiskey 1 <1%
FY09 Romanov Red, Whyte & Mackay Special Royal Challenge, McDowell's No. 1 4 <1%
FY08 NA NA NA NA
Black Dog Whiskey - Low Priced, Antiquity
FY07 McDowell's No.1 Celebration Rum 3 ~1%
Blue - Super Premium
 Focused brand strategy: Diageo has also formulated a 14 power brands

strategy to ensure its key brands get the requisite management attention and
promotions push. Also, prioritising premium brands (Prestige and Above) over
regular/popular brands has become a key strategy.
Exhibit 11: USL’s 14 Power Brands in India

Size Contribution to 2010-15
Brand Type Segment
(in mn cases) total Volumes growth CAGR
Diageo Brands
Johnnie Walker Scotch Premium NA NA NA
Smirnoff Vodka Premium NA NA NA
VAT 69 Scotch Premium NA NA NA
Black & White Scotch Premium NA NA NA
USL Brands
Black Dog Scotch Premium NA NA NA
McDowell Signature Whisky Premium 1.7 2% 2%
Royal Challenge Whisky Premium 3.8 4% 28%
Antiquity Whisky Premium NA NA NA
McDowell’s No.1 Whisky Prestige 24.9 26% 12%
Director’s Special Black Whisky Prestige 2.5 3% -4%
Bagpiper Whisky Regular 8 8% -16%
Celebration Rum Rum Regular 17.8 19% 3%
White Mischief Vodka Regular NA NA NA
Romanov Vodka Regular 1.1 1% -7%
 Cutting down on inefficient markets: Diageo has also moved to franchising its
brands completely in Tamil Nadu and Kerala. Also, low profitability and low-
growth popular brands in few other states like Andhra Pradesh and Goa have
also been franchised out so that the company can just focus on high-margin and
high-growth brands and geographies.

United Spirits
Exhibit 12: States where USL is franchising out its brands
 Pricing power: Diageo decided to not pursue any price hikes for two years while
it was revamping its product offering and brand portfolio. Now it has resumed
price hikes and we expect 3-4% price hikes per annum going forward.
Exhibit 13: Price hike has decreased to zero in the past two years
Price hike
20%
15%
10%
5%
0%
FY11
FY12
FY13
FY14
FY15
FY16
-5%

United Spirits
 Channel management: Bringing in its global best practices and technological

systems and processes, Diageo has now launched an aggressive Point of Sale
(POS) management strategy. Given POS is the only place where promotion of
brands is allowed, this becomes a key branding tool. Diageo is now: 1) managing
inventory levels much better by using technologies like centralised MIS tools to
track trade inventory better; and 2) has launched a ‘Perfect Store’ programme to
improve the look and feel of the stores and do a better shelf space management
for its products versus competitors.
Exhibit 14: A traditional liquor store in India – not enough Exhibit 15: 20% of such stores in India converted to ‘Perfect
being done in terms of branding Stores’ by Diageo
 Workforce upgrade: Since taking over USL, Diageo has realigned its HR and
compensation policies in line with global best practices. Also, since it is
franchising out a significant part of its portfolio, it is rationalising workforce. Its
aim is to improve productivity by giving higher incentive to higher quality but
smaller workforce. Currently, it is in the midst of a Voluntary Retirement Scheme
(VRS) which will allow it to rationalise the workforce.
Exhibit 16: USL is rationalising its workforce but incentivising them better
No. of employees Pay per employee (Rs mn)
8,000 1.4
7,500
7,000 1.1
6,500
6,000 0.8
5,500
5,000 0.5
FY11 FY12 FY13 FY14 FY15 FY16

United Spirits
Working towards gaining profit leadership

The business transformation of USL that is being led by Diageo is largely
focused at driving the business to achieve its true profitability. Pernod with
20-25% of USL’s volume has been making higher profit for several years
now. This has been achieved mainly through: 1) higher contribution from
premium brands; 2) efficient operations; and 3) staying out of low
growth/profitability markets like Tamil Nadu and Kerala. We believe steps
being taken by Diageo for USL are in the right direction and should ensure
that over time USL gains its rightful position as the profit pool leader.
Profit leadership, not market leadership is the goal

USL has been losing market share as the company shifted its strategy from chasing
volume growth to aligning product portfolio for higher profitability. For this, the
company has franchised all its brands in the low growth and low profitability states
like Kerala and Tamil Nadu, and also low-profit, low-growth brands in a few other
states. Also, with a 14 Power Brands strategy, the company is focused on driving
premiumisation of portfolio which should aid profitability.
Exhibit 17: USL has been losing market share
48%
44%
44% 42% 42%
41% 42%
41% 40%
39%
40% 38%
37%
36%
32%
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
Market share trend
Pernod Ricard has been more profitable by taking a focused approach

Pernod remains the market leader in terms of profitability in India with a 75% share
(within 7 alcobev companies) despite having only a 13% share of volumes. Pernod
Ricard followed a three-pronged strategy to achieve this high level of profitability:
 Focus only on premium brands: Pernod Ricard’s portfolio in India mainly
consists of 3 brands – Imperial Blue (17.5mn cases), Royal Stag (17.3mn cases)
and Blender’s Pride (5.2mn cases). Of this, Imperial Blue is in the popular
segment, Royal Stag is in the prestige segment and Blender’s Pride is in the
premium segment. This skew towards Prestige & Above brands makes Pernod
Ricard more profitable
 Withdrawal from low-growth, low-profit markets: Pernod Ricard made a
conscious decision to not sell in states of Kerala and Tamil Nadu where State
Government acted as the distributor, held the pricing power and receivable days
were long. These states account for ~25% of India’s alcohol consumption by
volume and staying away from these States was a bold but profitable decision.
 Drive On Trade consumption: Although On Trade accounts for only 20% of
alcohol sales in India, it is an important branding tool. By dominating this
channel, Pernod created a high recall value for its products which also drove their
Off Trade sales. Also, On Trade channel tends to be more profitable given higher
pricing power.

United Spirits
Exhibit 18: USL has lowest GM and EBITDA margin among Exhibit 19: USL realisation has been lower than Pernod;
key spirits players, implying room for improvement ABD is lowest due to higher contribution from mass brand
Gross margin EBITDA margin (RHS) Realisation (Rs/case)
60% 22% 25% 2,000 1,764
20% 1,500
40% 12% 1,057
15% 1,009
10% 11%
1,000
10% 517
20%
500
5%
44% 57% 53% 56%
0% 0% -
USL Pernod Radico ABD USL Pernod Radico ABD
Ricard Khaitan Ricard Khaitan
Exhibit 20: USL (37%) does better than ABD (20%) and Exhibit 21: USL realisation CAGR has been ~6% over
Radico (24%) but Pernod (100%) is the best FY12-16, outpaced only by ABD (10% CAGR)
Prestige and above volume contribution to

Realsiation CAGR over FY12-16
total sales
12%
100% 10%
10%
80%
8%
6%
60% 6% 5%
40% 4%
20% 2% 1%
0% 0%
USL Pernod Radico ABD USL Radico Pernod ABD*
Ricard Khaitan Khaitan Ricard
Source: Ambit Capital research Source: Ambit Capital research; * ABD realisation CAGR for FY14-16
USL is franchising out lower end brands and low-profit markets

USL has been franchising out brands in low-growth and low-profit markets like
Kerala and Tamil Nadu. It has also been franchising out low-profit and low-growth
popular brands in Rest of India. The strategy is to retain complete brand portfolio
including popular in three key states of Karnataka (25% of revenues), Maharashtra
(15-20% of revenues) and West Bengal (~10% of revenues) given favourable
regulations, healthy pricing power and stronger growth potential. This leaves other
50% of popular brands (30% of the overall volumes) available for being franchised
out. The way franchising works and aids USL in its strategy is:
 It is gross profit neutral with some inflation built in: When a brand is
franchised out, USL is able to shed all associated costs of manufacturing and
marketing these brands. The company only charges a fixed/volume-based
variable fee (as the case may be) to the franchisee. An annual inflation of 2-8%
depending upon growth potential in a market and brand portfolio is also built
into the contract which are typically of 3-5 years duration. The fee is determined
in such a manner that the deal ends up being gross profit neutral for USL.
 Jump in absolute profit constrained for now: Given costs associated with
distribution, employees and Ad spending are required to be retained for Prestige
and Above brands, cutting down of operating costs despite franchising is likely to
be limited. Therefore, while profitability may look higher on a lower revenue
base, a jump in absolute profit level is unlikely.

United Spirits
 Balance sheet health likely to improve: While profitability improvement may

be lower, balance sheet health should definitely improve. Once a brand is
franchised out, working capital associated with the brand (loans and advances to
third-party distiller, receivables from trade and inventory levels) also get shed
away. This should help free up cash which can then be used for deleveraging.
Exhibit 22: Volumes franchised out by USL is increasing as a percentage of total sales
Volume franchise (in mn cases) % of total volume sales (RHS)
50 34%
30%
40
26%
30
22%
20 18%
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY21E
We find USL’s strategy better than
that of Pernod Ricard which has no
Premiumisation is not just optical but actual
presence in TN and Kerala. By
USL has managed to take up volume contribution from prestige and above brands to franchising out brands, USL has
57% from 38% in FY11. This has been driven by: 1) franchising out of popular brands ensured that brand recall for its
has reduced their contribution to overall sales; and 2) faster growth for prestige and products remains in these high
above brands versus overall growth for USL. Looking at growth rate of some key volume states. In case the market
prestige and above brands like McDowell’s No.1, Royal Challenge, Signature and dynamics improve, USL can opt to
Antiquity, we believe the case for premiumisation is strong even without the support bring brands in-house and benefit
from franchising. from such improved market
dynamics.
Exhibit 23: USL’s volumes of key brands (in mn cases) show Exhibit 24: USL’s growth rates for key brands
premium brands (McD Whiskey, RC) are gaining share
over mass brands (Bagpiper, Old Tavern)
30 McD
Volume growth CAGR 2011-15
Whisky 28%
25 McD Rum 30%
12%
20 10% 3%
Old Tavern 2%
15
-10%
McD -7%
10 Brandy -16%
-30%
5 Bagpiper
Old Tavern
McD Whisky
McD Rum
RC
McD Brandy
Bagpiper
0 RC
2011
2012
2013
2014
2015
Source: Ambit Capital research; McD stands for McDowell, RC for Royal Source: Ambit Capital research; McD stands for McDowell, RC for Royal
Challenge Challenge

United Spirits
GM gain was muted on external and internal factors

USL has seen GM fall by 100bps since FY14 post acquisition by Diageo. This decline
in profitability in the context of strong premiumisation trend is due to: 1) reinvestment
of gains for revamping products like shifting from molasses-based ENA to grain-
based ENA for P&A brands; 2) no price hikes over FY15-16 despite raw material price
inflation; and 3) one-off hit from tax hikes like Local Body Tax in Maharashtra. We
believe reasonably strong margin ladder exists from popular to prestige and luxury
brands. For example, our calculations suggest Diageo’s brands have on an average
5% higher GM vs overall GM for USL.
Raw material costs have gone up on shift from molasses to grain-based ENA
USL has taken a hit on GM due to raw material price inflation on two counts. Firstly,
there has been a 3% input cost inflation for molasses since FY13. Secondly, to
improve product quality, USL has shifted P&A brands from molasses-based ENA to
grain-based ENA. The cost differential between molasses-based ENA and grain-
based ENA can be as high as 50% depending upon the molasses cycle. While there
has been a hit to profitability in the near term, we believe this has also reduced the
risks in the business by:
 Reducing input cost volatility: Volatility in input costs for USL should come
down as grain prices tend to be much less volatile as compared to molasses
whose prices move according to sugarcane cycle which tends to be volatile.
 Ensuring a more regular supply of alcohol: With molasses-based ENA being
increasingly used for furl mixing, there have been instances of shortage in
availability of alcohol for the liquor industry. Now that crude oil prices are moving
up again, it will become economical to mix ENA in fuel. This is likely to again
create shortage of availability of molasses-based ENA.
Exhibit 25: Price inflation trend for molasses shows input Exhibit 26: Price inflation for glass has also stabilised
cost inflation is benign for now over last one year
140 120
130 115
120
110
110
105
100
90 100
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Sep-12
Sep-13
Sep-14
Sep-15
Sep-16
May-12
May-13
May-14
May-15
May-16
Apr-12
Apr-13
Apr-14
Apr-15
Apr-16
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Oct-12
Oct-13
Oct-14
Oct-15
Oct-16
Molasses Index Glass Index
Source: Bloomberg, Ambit Capital research; Index is based to 100 in 2005 Source: Bloomberg, Ambit Capital research; Index is based to 100 in 2005
We believe some of the benefit of this reduced price volatility is already visible as USL
has guided for only 3-4% cost inflation for ENA in FY17 despite molasses prices
running up by 7% during the year.
Price hikes were kept in abeyance during business revamp
USL did not implement any price hikes during FY14-16 as it was revamping its brand
and product portfolio while also resetting its relationship with Trade and Regulators.
In FY17, USL has taken price hikes in the range of 3-4% and we believe this trend is
now likely to continue especially given 50% of its sales now come from Karnataka,
Maharashtra and West Bengal – the three easiest states in terms of pricing power.
Also, removal of Tamil Nadu and Kerala, and reduction of exposure to Andhra
Pradesh due to franchising has reduced exposure to states with least pricing power.

United Spirits
Exhibit 27: Details of distribution mechanism in key states and related pricing power
Structure Description States Pricing
A business may apply for a licence at a set USL has
Maharashtra, West Bengal,
Open fee, provided that licences are available. In reasonable
Goa, Assam, Meghalaya,
Markets some states new licences have not been independence to
Arunachal and Tripura.
available for many years. take up prices
Monopoly by
Uttar Pradesh, Rajasthan,
state-appointed
Auction Licences are auctioned to the highest Madhya Pradesh, Bihar,
distributor(s)
Markets bidder. Punjab, Haryana and
curtails pricing
Chandigarh.
power of USL
The government-controlled markets have
With exception of
different models. Karnataka is the most
Tamil Nadu, Delhi, Kerala, Karnataka, all
Government open state, with the lowest trade margins.
Andhra Pradesh and other states
Controlled Whereas, in Delhi, Kerala and Tamil Nadu
Karnataka. strictly control
retail shops are run by the state
pricing
government.
Prohibition Gujarat, Manipur, Mizoram
Sales of alcohol are prohibited.
States and Nagaland.
True impact of premiumisation to be visible going forward

We believe GM expansion for USL will be visible strongly going forward as
investments behind revamping product are now largely done and price hikes have
resumed. Additionally, input cost inflation should be better manageable going
forward given shift to less volatile grain-based ENA. We are building in 250bps GM
gain over FY16-19E for USL largely driven by: 1) premiumisation as we expect P&A
brands to contribute 64%/51% of sales/volumes by FY19E vs 51%/37% in FY16; and
2) price hikes of 7% per annum on an average over FY16-19E.
Exhibit 28: USL’s gross margin to improve over FY16-21 Exhibit 29: Value contribution of P&A brands should
mainly due to premiumisation increase from 51% of sales in FY16 to 68% in FY21
48% Gross margin Prestige and Above (as % of sales)

47% 47% 68%
47% 70% 66%
46% 64%
46% 45% 46% 60%
60% 55%
44% 44% 51%
44%
50% 45%
43%
42% 40%
FY14
FY15
FY16
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY21E
FY17E
FY18E
FY19E
FY20E
FY21E
Operating margin gains to add to GM gains

While the key driver for USL’s profitability will be at gross margin level due to
premiumisation and renewed price hikes, we believe there are levers at operating
margin level as well. Key to note is that optical costs like employee expenses, A&P
spends and overheads can look higher as a percentage of sales given lower sales due
to franchising. However, once lower sales level is in the base and the new normal
level for these costs as a percentage of sales is established, there are drivers at each
level to drive improvement from there on. We are building in 2.5% OPM gain (vs
1.3% GM gain over FY17-19E).
 A&P spends moving up as percentage of sales is just optical: USL has been
consistently hiking its spending on A&P spends especially given revamp of key
brands like McDowell’s, Royal Challenge and Signature. As brand portfolio
becomes more focused and revamp/re-launch of brands subsides, we expect
some of this A&P spend intensity to moderate over time.
United Spirits
 Employee costs to come down on workforce rationalisation: Initial impact of

Diageo’s acquisition on employee costs has been inflationary as USL moved to
align wages and benefits in line with international best practices. However, as
franchising is picking up and as more efficient systems and processes are in
place. USL is carrying out workforce rationalisation. It is currently undergoing a
Voluntary Retirement Scheme (VRS) which has led to higher employee expenses
for FY17. We expect a steady improvement in employee expenses/sales ratio
going forward as focus will remain firmly on driving employee productivity.
 Cost saving and operating efficiency programmes to provide further
support: USL has guided for a 1-2% cut in costs every year with trend
accelerating with every passing year since FY15. We believe with Diageo’s global
best practices now in place, improving productivity and cutting costs should be
possible. Several of these costs would be related to certain unnecessary or
unprofessional expenses that have traditionally been associated with alcobev
industry in India. These expenses were encouraged by erstwhile management as
they helped it to maintain a competitive edge vs peers. Under Diageo, these
expenses are likely to be curtailed. We conservatively build in only 50bps
improvement each year.
Exhibit 30: EBIT margins to improve over FY16-19 for USL Exhibit 31: A&P spends to moderate over FY17-19
EBIT (in Rs mn) EBIT margin (RHS) A&P spends (in Rs mn)
15,000 20% A&P spends as % of sales (RHS)
15% 16,000 14%

10,000
10%
13,000 12%
5,000 5%
0%
- 10,000 10%
-5%
(5,000) -10% 7,000 8%
FY11
FY12
FY13
FY14
FY15
FY16
FY11
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY17E
FY18E
FY19E
Exhibit 32: Employee expenses as a percentage of sales will Exhibit 33: Overhead expenses as a percentage of sales will
decrease due to workforce rationalisation decrease over FY17-19; spurt in expense in FY14-15 was
due to extra provisioning of doubtful debtors
Employee expenses (in Rs mn) Overhead expenses (in Rs mn)

Employee expenses as % of sales (RHS) Overhead expenses as % of sales (RHS)
10,000 9% 30,000 30%
25,000 25%
8,000 8%
20,000 20%
6,000 7%
15,000 15%
4,000 6% 10,000 10%

FY11
FY12
FY13
FY14
FY15
FY16
FY11
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY17E
FY18E
FY19E

United Spirits
Deleveraging to also aid earnings growth

One of the key inefficiencies of USL under its erstwhile management was the
ballooning balance sheet as cash was diverted through loans and advances
and receivables outstanding. Since Diageo took over, it has written off
~`45bn to clean up the balance sheet and loans and advances have come
down from 81 days of sales in FY14 to 47 days by FY16. Working capital
remains an issue for the alcobev industry in India due to very high receivable
days though there is the benefit of lower inventory levels given no need for
laying down of stock for ageing. We expect overall working capital to remain
elevated though some improvement hereon is possible. Given low focus on
overall volumes, incremental need for capex is low. This combined with
reined-in working capital should improve operating cash and free cash flow
for USL. This additional cash will be used to pare debt (net debt/equity to
come down from 2x in FY16 to 0.6x by FY19) which will cut finance cost from
`4.6bn (48% of EBITDA) to `3bn (20% of EBITDA) by FY19E.
Exhibit 34: Write-offs/divestments by Diageo since it acquired USL (` mn)
Consolidated FY14 FY15 FY16
Profit / (loss) on disposal of subsidiaries 2,416 (570)
Provision on advances to related parties (9,955)
Profit on sale of investment 8,536
Provision for doubtful debts / advances / deposits written back 543
Provision on advances to associates (157)
Impairment in Goodwill (32,357) (1,209) (128)
Provision for doubtful advances (316)
Profit on sale of manufacturing unit 357
Total (32,357) (8,392) 7,909
Balance sheet improvements to reflect going forward

We believe the bulk of working capital improvement that Diageo could bring in is
already in the base now. Going forward, improvement through continuous efficiency
programmes should be possible. However, given the high working capital intensity,
any improvement has a meaningful impact on cash generation which aids
deleveraging. We believe true profitability of popular and below brands is even lower
than what one expects. The financing of working capital that is attached to these
brands is costly. Impact of ‘premiumisation’ is therefore not restricted just to gross
margins but also becomes visible in finance cost as franchising of these brands would
free up significant capital.
 Franchising in Kerala and Tamil Nadu to help: These receivables are
generally refund of excise duty in most states. In states where the Government is
the distributor (~70% of volumes), the receivables also include trade receivables.
In case of USL, we have witnessed worsening of receivable days since the
acquisition by Diageo due to impact of discontinuation of business practices that
used to result in timely release of payments and the cycle is now in line with
Pernod Ricard. However, we expect to see improvement as two states (Kerala and
Tamil Nadu) with longest payable cycles and accounting for ~25% of volumes
have now been franchised out.
 Reduced loans and advances since change of management to sustain:
Bulk of the clean-up in terms of loans and advances is now behind. From a peak
of 81 days in FY14, loans and advances have now come down to 47 days. These
loans and advances are related to advance payments or raw materials provided
to third-party bottlers and hence unlikely to come off meaningfully. We expect
them to sustain at similar levels though there is an upside risk from acceleration
in franchising of popular brands as that would bring down production by third-
party bottlers and lead to cut in loans and advances as well.

United Spirits
 Further improvement in inventory levels will be led by premiumisation:

Most of the inventory level correction happened when Whyte & Mackay was sold
along with its laid down stock of scotch, which resulted in high inventory levels.
Going forward, improvement in terms of days of COGS will largely be driven by
premiumisation and, hence, will be limited.
Exhibit 35: Net working capital days and net working Exhibit 36: Franchising in Kerala and TN to help cut
capital as percentage of sales to fall sharply over FY17-20 receivable days from 86 to 67 by FY20
Net working capital days Debtors days

Net working capital as % of sales (RHS) Debtors days as % of sales (RHS)
140 40% 90 25%
130 85
120 35%
80
110
30% 75 20%
100
90 70
25%
80 65
70 20% 60 15%
FY13
FY14
FY15
FY16
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY17E
FY18E
FY19E
FY20E
Exhibit 37: Loans and advances as a percentage of sales to Exhibit 38: Inventory days to reduce from 124 days in FY17
reduce from 12% in FY17 to 10% in FY20 to 112 days in FY20
Loans and advances days Inventory days Inventory as % of COGS (RHS)

Loans and advances as % of sales (RHS) 180 50%
90 25%
160 45%
70 20%
140 40%
50 15% 120 35%
30 10% 100 30%

FY13
FY14
FY15
FY16
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY17E
FY18E
FY19E
FY20E
Limited capex and sale of non-core assets to help FCF

generation
The support of rising profitability and improving balance sheet health is likely to drive
a significant improvement in cash flow generation for the company. Also, with
franchising of popular brands, USL is unlikely to require any further capacity addition
which will keep capex requirements in check. On a combined basis, this should lead
to FCF generation improving ahead of CFO generation. We expect the company to
generate cumulative ~`30bn of CFO and ~`23bn of FCF over FY17-19E.
Company sees no requirement for further capacity addition
USL has guided for an annual capex of `3bn, of which 60% will be spent on
capability enhancement through investments in technology, distribution infrastructure
and some upgrades of manufacturing facilities. 40% of capex will be spent on
improving environmental impact and safety standards. We build in capex at a lower
level of `2bn-2.5bn and only gradually move it up to `3bn by FY20 as we believe
some of the ‘good to have’ capex might not come through.

United Spirits
Exhibit 39: Capex as a percentage of sales to remain stable at ~2% over FY18-21
Capex (Rs mn) Capex as % of sales (RHS)
3,500 3%
3,000
2%
2,500
1%
2,000
1,500 0%
FY17E
FY18E
FY19E
FY20E
FY21E
FCF generation to turn healthy on positive CFO

We expect CFO to move up from cumulative `21bn over FY11-16 to `55bn over
FY17-21E. This along with limited capex should lead to FCF moving up from
cumulative `1.9bn over FY11-16 to `43bn over FY17-21E.
Sale of non-core assets could provide further support to deleveraging plans
The key impact of improved cash generation is the deleveraging of USL. Currently,
USL’s net debt/EBITDA is at an elevated level of 3.5x. We expect USL to become close
to debt free by FY21E with net debt/EBITDA coming down to 0.1x. This has significant
implications on earnings growth of the company as finance cost is expected to come
down from 48% of EBITDA to 20% of EBITDA over FY16-19E and further to 9% of
EBITDA by FY21E.
Exhibit 40: Net debt to equity to reduce from 2x in FY16 to Exhibit 41: Interest coverage ratio to improve from 57% in
0.3x in FY20 FY16 to 16% in FY20
Net Debt (Rs mn) Interest coverage ratio

80,000 Net Debt to Equity (RHS) 8.0 200% 108%
57% 47% 33% 23%
16%
60,000 6.0 0%
40,000 4.0 -200%

-389%-362%
20,000 2.0 -400%
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
- -
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
Interest coverage ratio
USL has also guided for sale of `20bn worth of non-core assets, which would further
aid deleveraging. These are mainly real estate assets which were used by the
erstwhile management for personal use as well as 3.5mn treasury shares which are
currently pledged with a bank. We have not included sale of these assets in our
investment case and any deleveraging from proceeds arising out of sale of these
assets will be a positive surprise. The reasons for our cautious approach are: 1)
financial institutions have till date for reasons unknown have been unable to sell any
real estate asset owned/related to erstwhile management; and 2) treasury shares are
currently under litigation and hence the timing of release of these is uncertain.

United Spirits
Return ratios to witness improvement as well

We believe USL is set to achieve the 20%+ RoCE and RoE level that has eluded it till
date. This will be driven by: 1) improved asset turns as revenue growth is driven more
by value than by volume; 2) rising profitability; and 3) more efficient balance sheet as
working capital is managed and incremental capex is minimised.
Asset turns set to improve on managed balance sheet size
We estimate USL’s asset turns to move up to 2.1x by FY19E as sales grow at 9%
CAGR while fixed assets grow by 5% CAGR over FY16-19E. Key to improving asset
turns is revenue growth being driven by premiumisation and price hikes and not
volume growth. Franchising of popular brands in several states and of all brands in
Tamil Nadu and Kerala is also creating revenues without commensurate capital.
RoCE and RoE to move up sharply as profitability improves
We expect USL’s RoCE to move up to 17% by FY19E from 7% in FY16. Also, RoE is
expected to move up to 24% by FY19E from 15% in FY16. A DuPont analysis
highlights that improvement is coming from all the key components – asset turns
moving up from 1.7x to 2.1x, operating margin moving up from 8.5% to 10.6% and
financial leverage moving from 2x to 0.6x.
Exhibit 42: RoCE and RoE trends to improve over FY16-20 Exhibit 43: RoE to improve from 10% in FY16 to 23% in
FY20 due to improving asset turns and higher PAT margin
40% 25% 40% 4.0

21% 24%
15% 16%
20% 3.0
22% 23%
-2% 19%
17% 20%
0%
7% 10% 13% 20% 15% 2.0
-3% 10%
-20% -4%
-9% 1.0
-32% -46%
-40%
0% -
FY16
FY17E
FY18E
FY19E
FY20E
-60%
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
PAT margin ROE

ROE ROCE Leverage (RHS) Asset turns (RHS)

United Spirits
Key assumptions
Exhibit 44: Summary of our key assumptions
FY15 FY16 FY17E FY18E FY19E FY20E Comments
Profit and Loss
Volume to decline over FY17-18 due to franchising of
Volume growth -3% -1% -3% -3% 4% 7%
popular brands and disruption from Supreme Court order
Realisation growth 2% 14% 8% 10% 9% 8% Realisation to improve with the premiumisation of portfolio
Sales (` mn) 93,350 93,793 98,803 107,598 122,545 141,557 Expect slow sales growth due to increase in franchises of
Sales growth -12.1% 0.5% 5.3% 8.9% 13.9% 15.5% popular brands in some states
Expect 130bps gross margin expansion over FY17-20 due
Gross margin 44.1% 44.0% 45.5% 46.0% 46.5% 46.8%
to increase in prestige and above contribution in total sales
Expect gradual reduction in employee cost due to
Employee cost (% of sales) 8.3% 7.4% 8.0% 7.7% 7.5% 7.3%
workforce rationalisation
A&P spends (% of sales) 11.3% 10.5% 11.0% 10.9% 10.8% 10.7% Expect fairly stable A&P spends
Expect gradual reduction in other expenditure due to cost
Other expenditure (% of sales) 24.1% 15.9% 16.8% 16.4% 16.1% 15.8% saving programmes of 1-2% of sales each year as guided
by the company
EBITDA (` mn) 330 9,569 9,583 11,835 14,851 18,402 Expects 330bps of EBITDA margin expansion above factors
EBITDA margin 0.4% 10.2% 9.7% 11.0% 12.1% 13.0% over FY17-20
PAT (` mn) (8,482) 1,780 3,193 4,901 7,122 9,658 PAT to grow by 53% CAGR over FY16-20
EPS (58) 12 22 34 49 66
Balance Sheet
Capex (` mn) (43,224) 176 2,000 2,500 2,500 3,000
Expects no major capex over FY17-20
Capital WIP (` mn) 1,141 2,828 2,828 2,828 2,828 2,828
Expects reduction in debtors day from 82 days to 67 days
Debtors days 79 82 86 76 70 67
due to exit from high regulated states
Expects reduction in inventory days from 124 days to 112
Inventories days 164 124 124 121 116 112
days due to increase in operating efficiency
Creditors days are expected to remain stable at current
Creditors days 92 54 53 53 53 53
levels
Reduction in debtors and inventory days leading to
Working Capital Days 157 119 111 106 103 101
reduction in overall working capital days
Reduction in working capital requirement and sale on non-
Net debt/equity 6.5 2.0 1.5 1.0 0.6 0.3
core assets lead to reduction in net debt-equity
Cash flow statement
Operating cash flow (` mn) (550) 4,286 9,848 12,552 14,702 16,414
Expect free cash flow to turn positive from FY17
Free cash flow (` mn) (4,036) (643) 6,275 7,638 8,694 8,657
Ambit vs consensus
Exhibit 45: Summary of Ambit vs consensus
Ambit Consensus Divergence Comments
FY18E
Net Sales (` mn) 107,598 104,384 3% We factor in higher contribution from prestige and above brands
EBITDA (` mn) 11,835 13,010 -9% We expect higher investments to continue as compared to consensus
EPS (`/share) 33.7 44.2 -24% We expect lower other income compared to consensus resulting in lower EPS
FY19E
Net Sales (` mn) 122,545 114,822 7% We factor in higher contribution from prestige and above brands
EBITDA (` mn) 14,851 15,478 -4% We expect lower margin expansion compared to consensus
EPS (`/share) 49.0 49.5 -1% We are marginally below consensus

United Spirits
Earnings growth to support rich valuation

USL is currently trading at 41x FY19E P/E, which is at a 24% premium to other Our assumptions for WACC
FMCG companies in India and at a 73% premium to global alcohol Item Value
companies. At our DCF-based TP of `2,575, it will trade at 53x FY19E P/E. We Cost of equity 15%
believe valuing USL based on near-term earnings multiples is unjustified Cost of debt 12%
given the business is currently earning below its potential as reflected in its
Debt/Equity 30%
EBIT margin of 8.5% (FY16) vs 20% average margin of global peers and
Pernod Ricard in India. We expect USL to double its profitability over the Corporate tax rate 30%
medium term as the investments made by Diageo since FY14 to transform all WACC 13%
aspects of the business yield results. DCF is, therefore, the best methodology Terminal growth rate 5%
to value USL as it helps capture the true economics of USL which will come to
the fore in the medium to longer run.
Initiate with BUY and DCF-based TP of `2,575

Given the cash-generative nature of the business, we use a three-stage DCF-based
model to arrive at a fair value for United Spirits. The assumptions for the weighted
average cost of capital and terminal growth rates are shown in the exhibit on the
right margin. We have assumed longer-term debt-equity ratio of 0.3 given its strong
cash position and free cash flow generative business. Hence, the company has
enough surplus cash available on its balance sheet for future capex.
Stage 1 (FY17-21): Over FY17-21, we expect USL’s revenue to grow by only 12%
CAGR due to increase in franchising of popular brands in some highly regulated
states. However, with the increase in the proportion of prestige and above brands in
total sales, EBIT margin will expand by 420bps from 8.1% in FY16 to 12.7% in FY21.
This will result in PAT growth of 49% CAGR and increase of RoE from 16% to 26%
over FY16-21.
Stage 2 (FY22-40): Over FY22-40, we assume that USL’s revenue growth will
moderate from 15% in FY22 to 10% in FY40. We assume a gradual increase in EBIT
margin from 13.5% in FY22 to 17.4% in FY30 due to higher contribution from
‘Prestige and Above’ brands. Beyond FY30, EBIT margin to remain stable at 17.4%
until FY40. We assume sales/EBIT CAGR of 12%/14% over FY22-40.
Stage 3 (FY40 onwards): Beyond FY40, we factor in terminal growth of 5%
assuming ~3% inflation and ~2% population-led volume growth.
Based on these forecasts, we estimate a DCF-based valuation of `2,575 (upside of
27%), implying FY18E P/E multiple of 53x.
Exhibit 46: USL’s return profile Exhibit 47: USL’s cash flow profile
30% 40% CFO (Rs mn) FCF (Rs mn)

20% 20%
20,000
10% 0%
15,000
0% -20%
10,000
-10% -40%
5,000
-20% -60%
-
FY11
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY21E
(5,000)
(10,000)
Sales growth EBITDA margin
FY11
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY21E
ROE (RHS)

United Spirits
Exhibit 48: Our assumption of operating metrics in the fade period of our DCF
FCF (Rs bn) EBIT margin (RHS) WACC (RHS) ROE (RHS)
200 30%
160 25%
20%
120
15%
80
10%
40 5%
0 0%
FY22
FY23
FY24
FY25
FY26
FY27
FY28
FY29
FY30
FY31
FY32
FY33
FY34
FY35
FY36
FY37
FY38
FY39
FY40
Historical valuation is not relevant

For USL, historic trends for P/E and EV/EBITDA are irrelevant given historical losses.
On P/sale basis, USL is trading at a slight discount to last 5-year average, which in
our view provides a case for re-rating given the earnings turnaround that is expected.
Exhibit 49: USL’s one-year forward price/sales
7.0
6.0
5.0
4.0
3.0
2.0
1.0
-
Oct-14
Jan-15
Oct-15
Jan-16
Oct-16
Jan-17
Jan-12
Oct-12
Jan-13
Oct-13
Jan-14
Apr-15
Apr-16
Apr-17
Apr-12
Apr-13
Apr-14
Jul-14
Jul-15
Jul-16
Jul-12
Jul-13
1 year fwd P/Sales 5 yrs average P/Sales +1 s.d. -1 s.d.
Premium to FMCG companies justified despite weaker industry construct

USL is trading at a 24% premium to other FMCG names under our coverage. This is
despite weaker industry construct, profitability and return ratios. However, given the
strong near-term EPS growth (45% CAGR over FY17-20E) and the transformation of
business on all key fronts like products, brands, channel and pricing, we expect the
premium to sustain/expand in foreseeable future.
Premium to global spirits companies justified on higher growth
USL’s 65% premium to its global spirits peers is justified given higher growth potential
at similar return ratios but lower profitability, which we believe will get addressed
over the medium to long term.
Exhibit 50: Relative valuations
CMP Mkt cap P/E EV/EBITDA P/Sales ROE (%) Div Yld (%) Sales CAGR EPS CAGR
Company Currency
LC (US$) FY18 FY19 FY18 FY19 FY16 FY17 FY16 FY17-19 FY17-19
Spirits
United Spirits Ltd INR 2,047 4,571 47.5 42.1 25.5 21.1 3.2 21.1 - 9% 30%
Diageo Plc GBp 2,287 71,611 21.7 20.0 16.6 15.4 5.3 26.1 3.1 9% 14%
Brown-Forman Corp-Class B USD 46 17,815 26.3 24.6 18.3 17.3 5.7 41.9 1.3 1% 5%
Pernod Ricard Sa EUR 112 31,641 19.8 18.3 14.3 13.4 3.5 10.1 1.7 3% 9%
Suntory Beverage & Food Ltd JPY 4,795 13,380 30.4 25.2 9.1 8.5 1.1 7.3 1.3 1% 18%
Remy Cointreau EUR 91 4,854 35.7 30.6 21.5 19.3 4.7 9.9 1.9 6% 16%

United Spirits
Key risks
Strict anti-alcohol policy by the Government: Recent court ruling of ban on sale
of alcohol within 500 metres of highway still remains un-quantified and can
significantly impact the sales of USL as ~40% of revenue comes from stores near to
highway. Also, increasing taxes and adverse regulatory policy by State Government
could adversely impact USL.
Increase in raw material prices: With the lack of pricing power by USL in most of
the states, any increase in ENA (extra neutral alcohol) key raw material prices will
impact the profitability of USL. However, volatility in profitability will reduce as the
company is shifting from molasses-based ENA (high volatile raw material) to grain-
based ENA (low volatile raw material).
Key catalysts
Premiumisation and increasing profitability: We expect increase in profitability
with the increase in premiumisation of the USL product portfolio. Premiumisation will
be led by: a) renovate and rejuvenating of existing brands; and b) introduction of
Diageo brands. Franchising of popular brands in some high regulated states and UT
will further drive the profitability of the company.
Deleveraging on improved cash generation: We expect positive cash generation
and sale of non-core assets to drive deleveraging for USL which will further support
higher EPS growth.
Sensitivity of our DCF-based TP to our assumptions

Exhibit 51: Sensitivity of TP to discount and terminal growth rates
Terminal growth rate
3% 4% 5% 6%
11% 3,484 3,715 4,021 4,451
12% 2,848 2,996 3,187 3,441
Discount rate 13% 2,356 2,453 2,575 2,732
14% 1,987 2,054 2,136 2,238
15% 1,689 1,735 1,791 1,859
Exhibit 52: Explanation for our accounting score

Segment Score Comments
USL scores low compared with its FMCG peers due to volatile cash conversion cycle and high contingent liabilities
Accounting AMBER
but scores high on depreciation rate and provision for doubtful debtors.
Predictability of earnings for alcohol business is low due to the volatility in raw material prices and Government
Predictability AMBER
regulations.
Earnings Momentum RED In the last 6 months, consensus has revised its EPS estimates downward by more than 10%.

United Spirits
Exhibit 53: Forensic score analysis Exhibit 54: Greatness score analysis
Source: Ambit ‘HAWK’, Ambit Capital research Source: Ambit ‘HAWK’, Ambit Capital research
Exhibit 55: Forensic score evolution Exhibit 56: Greatness score evolution
Source: Ambit ‘HAWK’, Ambit Capital research, Note: Using our ‘accounting Source: Ambit ‘HAWK’, Ambit Capital research, Note: On our ‘greatness
framework’, we categorise the market into deciles on the basis of their framework’, on a scale of 0 to 100, a small minority of outstanding companies
accounting quality with ‘D1’ indicating the best decile and ‘D10’ indicating the tend to score above 67 whilst most companies tend to have scores below 50
worst decile. Our analysis points towards a strong link between accounting
quality and share price performance.

United Spirits
Balance Sheet
Year to March (` mn) FY15 FY16 FY17E FY18E FY19E
Shareholders' equity 1,453 1,453 1,453 1,453 1,453
Reserves & surpluses 5,142 16,426 19,619 24,520 31,642
Total networth 6,595 17,879 21,072 25,973 33,096
Minority Interest 8 17 0 0 0
Preference share capital 0 0 0 0 0
Debt 47,709 37,313 34,313 32,313 30,313
Deferred tax liability -878 -1,235 -1,235 -1,235 -1,235
Total liabilities 53,434 53,974 54,150 57,051 62,174
Gross block 29,152 29,328 31,328 33,828 36,328
Net block 19,210 18,891 19,284 20,057 20,698
CWIP 1,141 2,828 2,828 2,828 2,828
Investments 2,164 1,989 1,989 1,989 1,989
Cash & equivalents 3,629 1,623 1,671 4,516 8,848
Debtors 17,515 24,532 22,146 22,644 24,111
Inventory 17,581 17,954 18,717 19,793 21,871
Loans & advances 11,325 12,574 12,046 12,529 13,598
Other current assets 5,444 3,975 4,961 5,403 6,153
Total current assets 55,493 60,659 59,542 64,885 74,581
Current liabilities 18,570 24,026 22,977 25,612 29,841
Provisions 6,004 6,367 6,516 7,096 8,081
Total current liabilities 24,574 30,393 29,493 32,708 37,923
Net current assets 30,920 30,266 30,049 32,177 36,658
Miscellaneous 0 0 0 0 0
Total assets 53,434 53,974 54,150 57,051 62,174
Income statement
Operating income 93,350 93,793 98,803 107,598 122,545
% growth -12.1% 0.5% 5.3% 8.9% 13.9%
Operating expenditure 93,020 84,224 89,220 95,763 107,694
Operating profit 330 9,569 9,583 11,835 14,851
% growth -124.0% 2800.0% 0.2% 23.5% 25.5%
Depreciation 2,229 1,577 1,607 1,727 1,859
EBIT -1,899 7,991 7,976 10,109 12,992
Interest expenditure 6,873 4,558 3,760 3,331 2,975
Non-operating income 811 449 550 538 613
Adjusted PBT -7,961 3,883 4,766 7,315 10,630
Tax 520 2,102 1,573 2,414 3,508
Adjusted PAT/ Net profit -8,482 1,780 3,193 4,901 7,122
% growth -32% -121% 79% 54% 45%
Extra Ordinary Items (8,392) 7,909 - - -
Reported PAT / Net profit -16,873 9,689 3,193 4,901 7,122
Minority Interest - - - - -
Share of associates 0 0 0 0 0
Adjusted Consolidated net profit -16,873 9,689 3,193 4,901 7,122
Reported Consolidated net profit -16,873 9,689 3,193 4,901 7,122

United Spirits
Cash flow statement

EBIT -1,899 7,991 7,976 10,109 12,992
Depreciation 3,438 1,706 1,607 1,727 1,859
Others 13,157 (7,313) - - -
Tax (1,413) (1,900) (1,573) (2,414) (3,508)
(Incr) / decr in net working capital (7,664) (6,455) 265 716 (149)
Cash flow from operations (1,963) 2,386 8,275 10,138 11,194
Capex (2,073) (3,029) (2,000) (2,500) (2,500)
(Incr) / decr in investments (0) 8,686 - - -
Interest/Dividend Received 389 62 550 538 613
Others 40,456 2,474 - - -
Cash flow from investments 38,772 8,192 (1,450) (1,962) (1,887)
Net borrowings (31,754) (1,716) (3,000) (2,000) (2,000)
Issuance of equity - - - - -
Interest paid (7,204) (4,615) (3,760) (3,331) (2,975)
Dividend paid (9) (3) - - -
Others (1,053) (5,453) 316 - -
Cash flow from financing (40,019) (11,787) (6,445) (5,331) (4,975)
Net change in cash -3,211 -1,209 381 2,844 4,332
Closing cash balance 2,629 1,290 1,671 4,516 8,848
Free cash flow (4,036) (643) 6,275 7,638 8,694
Ratio analysis
Year to March (%) FY15 FY16 FY17E FY18E FY19E
EBITDA margin (%) 0.4% 10.2% 9.7% 11.0% 12.1%
EBIT margin (%) -2.0% 8.5% 8.1% 9.4% 10.6%
Net profit margin (%) -9.1% 1.9% 3.2% 4.6% 5.8%
Dividend payout ratio (%) 0.0% 0.0% 0.0% 0.0% 0.0%
Net debt: equity (x) 6.5 2.0 1.5 1.0 0.6
Working capital turnover (x) 156.7 119.1 111.4 105.5 102.5
Gross block turnover (x) 1.8 3.2 3.3 3.3 3.5
RoCE (%) -2.7% 7.3% 10.3% 13.1% 16.7%
RoE (%) -45.9% 14.5% 16.4% 20.8% 24.1%
Valuation Parameters
EPS (`) (58.4) 12.3 22.0 33.7 49.0
Diluted EPS (`) (58.4) 12.3 22.0 33.7 49.0
Book value per share (`) 45.4 123.0 145.0 178.7 227.7
Dividend per share (`) - - - - -
P/E (x) (34.8) 165.8 92.4 60.2 41.4
P/BV (x) 44.8 16.5 14.0 11.4 8.9
EV/EBITDA (x) 1,028.1 34.6 34.2 27.3 21.3
Price/Sales (x) 3.2 3.1 3.0 2.7 2.4

United Breweries
SELL
INITIATING COVERAGE UBBL IN EQUITY April 07, 2017
It is a flat brew Consumer
Recommendation
UBL is likely to maintain the current slow rate of volume growth (3%) as
Mcap (bn): `204/US$3.1
affordability and accessibility remain constrained by high taxation,
controlled distribution and slow urbanisation. Moreover, UBL already 6M ADV (mn): `240/US$3.7
enjoys 100%+ of profit share; benefits of Heineken’s initiatives like CMP: `762
proprietary bottles, indigenous sourcing of barley and cost savings are TP (12 mths): `625
already captured in 380bps OPM gain over FY10-16. Fragmented Upside (%): 18
manufacturing and limited price/mix gain potential cap further
improvement. Competition in premium urban markets from craft beer Flags
is a rising threat. We find current valuation of 55x FY19E (65% premium Accounting: AMBER
to FMCG sector) unjustified given a weak 17% EPS CAGR over FY17-20E Predictability: RED
vs 19% CAGR for FMCG sector. Key risks: Easier regulations for beer Earnings Momentum: RED
and earnings surprise from weaker input costs.
Competitive position: STRONG Changes to this position: NO CHANGE Catalysts
Optimism on rapid consumption growth for beer is overdone  Continued weak volume growth
Volume will grow only 3% CAGR over FY17-21E vs market hope of double-digit of 2% over FY17-19
rate. Tailwinds like rising income, younger population, changing lifestyle and
 Tightening regulatory landscape;
hope of regulatory easing are overdone. Last five years’ volume CAGR of 4%
ban on sale near highways to
proves consumption remains low (1.8 litre/capita) as: 1) beer is costlier than
curb peak summer sales
spirits and other leisure activities; 2) distribution remains controlled and rural
penetration limited; 3) urbanisation (38% vs global average of 50%) and
women taking up drinking (abstinence is up by 0.5%) have disappointed. Performance (%)
Profitability to be structurally stunted despite leadership
130
Beer has high operating leverage and market leaders enjoy disproportionate
110
profitability (No.1/2 players ABInBev/SABMiller posted OPM of 46%/26%). UBL
with 52% volume share has 100%+ of profit share of beer industry in India. 90
Since Heineken’s entry in FY10, OPM rose 380bps on savings from proprietary 70
bottle programme and import substitution of barley. Further gains hereon will Aug 16
Oct 16
Apr 16
Apr 17
Jun 16
Dec 16
Feb 17
be capped by: 1) elusive scale efficiency due to fragmented manufacturing, 2)
restricted pricing power, and 3) weak premiumisation trends.
Issue of management control remains the joker in the pack UBL Sensex
Heineken’s shareholder agreement with UB Group denies it control of the

Source: Bloomberg, Ambit Capital Research
company despite larger stake (43% vs 30% of UB Group). While this is a
concern now, any changes in this respect could be positive as it would allow
Heineken to take transformational steps like Diageo did in USL.
A staid earnings trajectory is not supportive of current valuation
We believe UB’s premium of 32%, 158% and 65% to USL, global brewers and
FMCG sector is unjustified given its FY17-20E EPS CAGR of 17% which is lower
than USL (45%), FMCG sector (19%) and global peers (18%). We believe beer
is structurally disadvantaged in India vs Spirits; hence UB should trade at a Research Analysts
discount to USL. DCF capturing long-term growth of UB, gives a TP of `625.
Anuj Bansal
Key financials +91 22 3043 3122
Year to March FY15 FY16 FY17E FY18E FY19E anuj.bansal@ambit.co
Operating income (` mn) 46,881 50,758 50,753 51,159 58,567
Dhiraj Mistry, CFA
EBITDA (` mn) 6,217 7,241 6,936 6,838 8,472
+91 22 3043 3264
EBITDA margin (%) 13.3% 14.3% 13.7% 13.4% 14.5%
dhiraj.mistry@ambit.co
EPS (`) 9.8 11.2 10.7 9.9 13.9
RoE (%) 14.6% 14.9% 12.7% 10.7% 13.6% Ritesh Vaidya, CFA
RoCE (%) 11.1% 12.5% 11.4% 10.6% 13.9% +91 22 3043 3246
P/E (x) 77.4 68.2 71.3 76.7 54.8 ritesh.vaidya@ambit.co
United Breweries
Snapshot of Company Financials

Profit and Loss Company Background
Year to Mar (` mn) FY17E FY18E FY19E United Breweries Limited, the flagship company of UB
Net revenues 50,753 51,159 58,567 Group, is engaged in the manufacture and marketing of
beer. Heineken owns 44% of UBL as on December 2016.
EBITDA 6,936 6,838 8,472
United Breweries is India's largest producer of beer with a
Depreciation 2,644 2,881 3,184 market share of ~52% by volume.
Interest expense 591 232 211 Its product portfolio includes brands as Kingfisher Premium,
Adjusted PBT 4,301 3,997 5,591 Kingfisher Strong, Kingfisher Ultra, Kingfisher Ultra Max,
Tax 1,475 1,371 1,918 Kingfisher Blue, Bullet, Cannon 10000, Kalyani Black Label,
UB Export, Zingaro and London Pilsner. The company
Adjusted net profit 2,826 2,626 3,674
operates through 21 owned breweries and nine contract
Reported net profit 2,826 2,626 3,674 breweries.
Profit and Loss Ratios
EBITDA Margin (%) 13.7% 13.4% 14.5%
Net profit margin (%) 5.6% 5.1% 6.3%
EV/ EBITDA (x) 29.2 29.3 23.4
P/E on adjusted basis (x) 71.3 76.7 54.8
Price/Sales (x) 4.0 3.9 3.4
Balance Sheet Cash flow

Year to Mar (` mn) FY17E FY18E FY19E Year to March (` mn) FY17E FY18E FY19E
Total Assets 41,929 44,346 49,436 PBT 4,301 3,997 5,591
Fixed Assets 18,687 18,706 18,522 Depreciation 2,644 2,881 3,184
Current Assets 23,241 25,639 30,913 Tax (1,475) (1,371) (1,918)
Investments 1 1 1 Net Working Capital 418 (192) (803)
Total Liabilities 41,929 44,346 49,436 CFO 5,878 5,275 5,751
Total networth 23,563 25,715 28,504 Capital Expenditure (2,500) (2,900) (3,000)
Total debt 2,111 2,111 2,111 Investment - - -
Others 626 626 626 CFI (1,900) (2,628) (2,486)
Current Liabilities 15,628 15,893 18,195 Issuance of Equity - - -
Balance Sheet ratios Inc/Dec in Borrowings (2,000) - -
RoCE 11.4% 10.6% 13.9% Net Dividends (352) (474) (885)
RoE 13% 11% 14% Interest paid (591) (232) (211)
Gross Debt/Equity (x) 0.1 0.1 0.1 CFF (2,860) (707) (1,096)
Net debt (cash)/ Eq (x) 0.0 (0.0) (0.1) Net change in cash 1,118 1,941 2,169
P/B (x) 8.6 7.8 7.1 Closing cash balance 1,150 3,091 5,260
Beer has weaker industry structure than spirits UB dominates the beer industry
United
Spirits Beer SAB Miller ABInBev Carlsberg
Breweries
Affordability
Market Share
Premiumisation
Pricing Power Scale
Taxation
Distribution Reach
Leadership Manufacturing
Competitive Intensity footprint
Innovation Profitability
Management Control
Capital Intensity Innovation
Profitability Premiumisation
Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

United Breweries
Nothing exceptional or transformational

United Breweries is a market leader in the growing beer sector in India.
However, we believe there are structural issues like affordability, strict
regulations, curtailed distribution and limited scope for premiumisation for
beer in India which limits UB’s growth potential. Beer will remain inherently
less profitable in India due to: (a) fragmented manufacturing footprint which
prevents efficiencies from optimal scale, (b) product skew towards the mass
segment, and (c) limited ability to take price hikes ahead of cost inflation
(due to regulations and lack of affordability). We estimate a sales CAGR of
9%, EBIT CAGR of 13% and EPS CAGR of 17% over FY17-20E, in line with our
FMCG sector average. With Heineken having to share control of the company
with erstwhile management of United Spirits, Heineken’s ability to take
strong strategic measures like USL to transform the business is also limited.
Industry dynamics are worse in India than globally

We acknowledge exceptionally low per capita consumption of beer in India (1.8 litres)
even by India’s standards of low per capita consumption for other categories.
However, we believe there are structural reasons for such low level of consumption
which are unlikely to change soon. These are: 1) low affordability which favours
spirits consumption over beer consumption, 2) slower urbanisation, 3) stricter
regulations around distribution and points of consumption, and 4) limited scope for
premiumisation.
India will not witness topline growth like in China and Vietnam…
Key bull arguments in favour of beer consumption in India and hence for UBL have
been low per capita consumption levels, rising proportion of population taking up
drinking, especially the younger population and changing lifestyle that promotes on-
trade consumption. These trends were responsible for rapid growth in China and
Vietnam; but India will not live up to these expectations mainly due to: 1) higher
taxation, leading to lower affordability for beer; 2) rate of urbanisation (which is a key
driver of on trade consumption) being slower in India; and 3) restrictions around
distribution.
Exhibit 1: Per capita beer consumption for India, China and Exhibit 2: Rate of urbanisation in India is slower than
Vietnam China and Vietnam
50 Per capita beer consumption (in litres) 60 % of total population in urban area
40 50
40
30
30
20
20
10 10
0.6 0.7 0.9 1.0 1.1 1.2 1.4 1.5 1.6 1.7 1.8
0 -
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
1980
1985
1990
1995
2000
2005
2010
2015
China Vietnam India China India Vietnam
…but might go the US way if craft beer trend increases

While the drivers for volume growth of beer in India are weaker than expected, craft
beer is gaining popularity in India. India already has 100+ brew pubs and micro-
breweries and the largest selling craft beer (Bira) is available in 1000+ pubs. This is a
significant number given India has only ~21,000 bars/pubs/restaurants serving

United Breweries
liquor for on-trade consumption. Currently, only seven states (Maharashtra,

Karnataka, West Bengal, Haryana, Telangana, Goa and Punjab) accounting for 55-
60% of beer consumption allow micro-breweries to operate. Of these, only
Maharashtra, West Bengal and Goa (~25% of beer consumption) allow sales of craft
beer outside the premises where it is brewed. As regulations ease around production
and distribution of craft beer, its market share will increase in India. It is interesting to
note that in the USA, the share of craft beer has shot up from 6% to 22% in the last
eight years. Given beer is a youth focused urban premium drink in India, craft beer
consumption can rapidly rise.
Exhibit 3: Total and per capita beer consumption has Exhibit 4: …but the share of craft beer has been
remained stable in the US… increasing in the US
US (thousand kl) Value share of Craft beer in US

Per capita beer consumption (RHS) 25% 22%
24,500 77.0 19%
76.5 20%
24,300
76.0 14%
24,100 15%
75.5
23,900 10%
75.0 9%
10% 7% 8%
23,700 74.5 6%
23,500 74.0 5%
2010
2011
2012
2013
2014
2015
2008
2009
2010
2011
2012
2013
2014
2015
Premiumisation will not play out well as global brands are not ‘strong’
We see three reasons why premiumisation will remain weak for beer in India:
 Premium beers tend to be ‘light’: In India, 85% of beer consumed is strong
(>5% alcohol by volume) as it is considered more value for money. However,
globally, the share of strong beer is much lower and most premium brands tend
to be ‘light’. While this acts as an entry barrier for most global beer brands, it
also limits potential for premiumisation for UBL for whom Heineken’s iconic
global brands like Heineken and Amstel find it difficult to scale up in India.
Exhibit 5: Top 10 brands globally are light beers unlike India where the top brands
are strong beers
Major Global Market Alcohol
Brand Company Positioning
Market share Content
Global
Snow China Resources China 5.4% 4.0% Mass
Tsingtao TsingTao Brewery China 2.8% 4.7% Mid
Bud Light Ab InBev US 2.5% 4.2% Mid
Budweiser Ab InBev US 2.3% 5.0% Mass
Skol Ab InBev Brazil 2.1% 4.7% Premium
Beijing Yanjng
Yanjing China 1.9% 5.0% Mass
Brewery
Heineken Heineken Europe 1.5% 5.0% Premium
Harbin Ab InBev China 1.5% 4.8% Mass
Brahma Ab InBev Brazil 1.5% 4.3-5% Mid
US, UK, and
Coors Light Molson Coors 1.3% 4.0% Mid
Canada
India
Kingfisher Strong UBL India 40% 7.0% Mass
Haywards 5000 SABMiller India 15% 7.0% Mass
Knock Out SABMiller India 9% 8.0% Mass
Okocim Carlsberg India 5% 5.6% Mass

United Breweries
 Beer is already a premium product and further premiumisation becomes

difficult: To buy a pint of Kingfisher Strong in India (Mumbai) one has to forego
153 minutes of mobile talk time or a 7.7km taxi ride. At the cost of one meal for
two people or a pack of Marlboro or a movie one can have only 6, 1.8 or 2.5
Beer (500ml) respectively. This compares unfavourably with most other countries.
Expecting consumers to premiumise more would imply further skewing of the
beer price to utility ratio compared with other items in the consumption basket of
a consumer.
Exhibit 6: What can you consume instead of 500ml of beer?

India China Vietnam US UK Japan Thailand Germany Australia Brazil
Numbers of beers you can buy (lower the number worst it is)
Meal for 2 6.0 27.9 20.0 12.5 14.3 10.5 10.0 12.9 11.4 16.4
Pack of Cigarettes 1.8 3.6 1.1 1.6 2.6 1.2 1.7 1.7 3.6 1.3
Cinema (single ticket) 2.5 10.0 5.0 2.8 2.9 4.5 3.0 2.9 2.6 4.1
Things you forego for 1 beer
Taxi Ride (in Km) 7.7 2.2 1.7 2.5 1.7 1.2 6.0 1.8 3.2 2.2
Mobile Talk time (in mins) 153.0 18.3 12.6 40.0 24.3 9.2 34.6 37.8 31.6 4.7
 Spread of craft beer can create competition in the premium segment:

Craft beer tends to be at the premium end of the market due to its specialised
brew and unique, limited edition offering. Even in the US, craft beer accounts for
a 22% share by value but only 12% by volume. This gap of 10% has been
widening over the years, indicating that the popularity of craft beer is increasing
at the premium end at a faster rate. This makes craft beer a direct competitor to
premium beer, and the growing share of craft beer come at the cost of premium
branded beer.
Exhibit 7: Craft beer value market share is increasing at a faster rate than volume
share in the US
Volume market share of Craft Beer Value market share of Craft beer
25%
20%
15%
10%
5%
0%
2008
2009
2010
2011
2012
2013
2014
2015

United Breweries
How profitable can beer be in India?

Globally, beer tends to be a monopoly or duopoly industry across most countries
(with China being a key exception). The reason for this is the disproportionate benefit
that scale provides in terms of profitability. Grupo Modelo (erstwhile owner of
Corona) has guided in the past that doubling of capacity in a single location tends to
bring down cost of production by 40-50%. We believe lack of scalability due to forced
fragmentation of manufacturing to circumvent entry/exit taxes across states is the key
reason why beer cannot be as profitable in India as it is globally. Also, lack of pricing
power and weak premiumisation trends expose UBL to volatility in profitability in line
with volatility in raw material prices.
UBL has dominant market share but that is not enough
We agree that being a dominant market leader UBL should have a healthy
profitability. However, we would like to highlight that UBL is the only profitable beer
company in India. So UBL is already getting disproportionate benefit of being the
market leader wherein it has an over 100% profit share with only 52% volume share.
With the exception of ABInBev, which as the #1 player in North America and Latin
America generates 40%+ margins, most other players are low on profitability despite
being leaders in their geographies.
Exhibit 8: Profit margin of the #1 players in various markets
Company Geography Market Share EBIT margin (%) Change in 3 years (%)
Heineken Europe 38% 12 2
Carlsberg Eastern Europe 52% 18 (5)
AB InBev North America 46% 40 2
AB InBev Latin America 45% 46 (2)
Asahi Japan 36% 7 0
China Resources
China 25% 6 3
Beer
With SABMiller now part of ABInBev, it would also witness improvement in

profitability due to the ‘zero budgeting’ policy followed by ABInbev which has allowed
it to become the most profitable company globally. Also, it is important to note that
ABInbev on its own did not succeed in India and SABMiller also lost share to
Carlsberg which has done well by gaining ~15% market share within 5 years of
launch in India. So, while there is easing of competitive intensity from SABMiller,
Carlsberg’s aggression has kept the overall competition high. Hence, we do not
expect any margin improvement from lowering of competition.
Exhibit 9: Market-share trends for beer in India
60% 56% 57%

52% 51% 52% 52%
UBL
50%
40%
28% SAB Miller
26% 25% 26% 26% 26%
30%
20%
Calsberg
10% 17% 17%
7% 8%
0% 6% 7% Others
2011
2012
2013
2014
2015
2016

United Breweries
More breweries unlikely to achieve optimal production level soon

Unlike manufacturing of spirits, which is largely a bottling business (with the
exception of Scotch), brewing beer is a manufacturing intensive business which
benefits immensely from scale. Please refer to Appendix for comparisons between
manufacturing of spirits and beer. Globally, large branded players are moving
towards setting up mega breweries (defined as annual brewing capacity of over 10
million hector liters) as studies have proved that with doubling of capacity, cost of
production falls by 40-50%. Analysis of global peers in terms of profitability and
production per brewery shows a healthy positive correlation. UBL lags its peers
significantly with just 0.5mnhl/brewery. This is sub-optimal and is likely to cap its
profitability potential.
Exhibit 10: Globally, brewers have significantly higher volume of beer per brewery
Brewery/ Vol (mnhl)/
Company Volume (mnhl) Breweries Countries EBIT margin
country brewery
ABInBev 408 140 26 5.4 2.9 46%
China Resources 108 97 1 97.0 1.1 7%
SABMiller 207 70 34 2.1 3.0 26%
Heineken 188 165 70 2.4 1.1 15%
Carlsberg 135 79 26 3.0 1.7 12%
UB 14 30 1 30.0 0.5 9%
This low volume per brewery is shared by peers as well in India. This is due to
entry/exit taxes on cross-border movement of alcohol across states. Companies are
forced to choose between a sub-optimal fragmented manufacturing footprint or run a
concentrated optimal scale operation at the cost of being forced to sell beer at higher
prices due to cross-border taxes. Given beer is already an expensive product in India,
most companies choose to run fragmented operations which hurts profitability. We
believe only three breweries of UBL are running at 3mnhl+ levels, which make them
optimal in terms of profitability. Chances that the rest of the 17 breweries will hit the
optimal operations mark are limited as they operate in markets which do are not
large enough to provide such scale.
Exhibit 11: UBL brewery units in India Exhibit 12: Number of breweries for key players in India
Volume No. of Vol (mnhl)/
Company
(mn hl) breweries breweries
UBL 13.7 30 0.5
SABMiller 7.2 10 0.7
Carlsberg 4.5 7 0.6
AB InBev 0.6 2 0.3

United Breweries
Benefits of the Heineken takeover are behind

Heineken acquired a 37.5% stake in UBL as part of its joint buyout (with Carlsberg) of
Scottish Newcastle globally in 2008. Post stake hike, Heineken brought in some of
the best practices that it had been following globally, which aided healthy margin
gains. These steps were:
 Proprietary returnable bottles: Since over 80% of sales in India are in glass
bottles, glass is a key cost component. Most players use recycled bottles which
cost 1/3rd that of a new bottle. However, given the bottles were generic, any
player could buy recycled bottles and use them. During the summer months,
smaller players used to buy recycled bottles and UBL would face shortage which
they had to fulfill by seeding costlier new bottles. Since Heineken’s takeover, UBL
started using bottles with their logo etched into them. This made these bottles
unusable by peers and helped UBL as: 1) it had to seed fewer new bottles as
recycled bottles were available, 2) cost of recycled bottles went down as there
was no competitive bid for them, and 3) market share of the smaller players
suffered as they faced shortage of bottles during the peak months.
 Tie-up for barley procurement: Due to the quality of barley not being up to
the mark in India, UBL used to import it for the bulk of its malt requirements. With
Heineken’s support, a better strain of barley was seeded in India and a reliable
procurement mechanism through contract farming was established. This helped
the company by: 1) reducing price volatility, 2) reducing impact of the
depreciating rupee, and 3) ensuring regular supply of barley.
 Setting up of ‘mega brewery’: Heineken inspired UBL to set up a mega
brewery (by Indian standards) in Bihar with an annual brewing capacity of 1.1mn
hector litres to cater to Eastern India. The brewery would have been most
profitable for the company at peak capacity utilisation. However, prohibition in
Bihar has laid this facility to waste for now.
Exhibit 13: GM and EBIT margin trends for UB Exhibit 14: Trends for key cost lines as % of sales for UB
63% 10% 24.0% 8.0%
60% 21.0% 7.0%
8%
18.0% 6.0%
57%
15.0% 5.0%
54% 6%
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
A&P spends Other exps

Gross margin EBIT margin (RHS) Employee cost (RHS)
We believe the potential benefits to margins from steps taken by Heineken are now
in the base and improvement hereon will depend on scale efficiency and any cost
efficiency programmes that the company undertakes.
Premium brands remain too small to make an impact
We do not expect premiumisation or bringing in of Heineken’s global brands into
India as potential drivers of profitability. As highlighted above, the world’s top brands
tend to be ‘light’ beers with less than 5% alcohol content. In India, ‘strong’ beer
(more than 5% alcohol content) with 85% market share has been gaining share. This
limits the premiumisation potential of the industry. UBL has managed to grow its
share of premium brands through the reasonably successful launch of Kingfisher
Ultra and Heineken in India but premium brands remain 5-6% of its sales and are
too small to make an impact on the earnings of the company even if they continue to
grow faster than the base business.

United Breweries
Exhibit 15: Share of strong beer in India is increasing Exhibit 16: Share of premium brands for UB is increasing
at slower pace
Strong beer share in Indian beer industry Share of premium beer in total volume
86% 7%
84% 6%
82% 5%
80% 4%
78% 3%
FY11 FY12 FY13 FY14 FY15 FY16 FY12 FY13 FY14 FY15 FY16
Heineken unlikely to gain control soon

With UB Group retaining control over Board composition and powers to appoint the
Chairman and CEO, UBL is unlikely to record any material transformation of its
business as witnessed in the case of United Spirits after Diageo took over control from
UB Group. Historically, the presence of S&N and then of Heineken were considered
positive for UBL vs United Spirits (USL) as it would limit any possible divergence of
funds from UBL as was seen in case of USL (other entity controlled by UB Group).
However, now that USL is a subsidiary of Diageo with no control by UB Group while
UBL remains firmly in the control of UB Group, USL becomes a preferred play from a
management control point of view.
Shareholder agreement prevents total control by Heineken
Scottish Newcastle had a shareholder agreement in place with the Indian promoters
of UBL which gave powers to appoint the Chairman and CEO to Indian promoters
along with control of the Board. Scottish Newcastle had the right to appoint the CFO
and also appoint an Executive Director whose presence was mandatory in any Board
meeting in which any material decisions needed to be taken. After Heineken bought
out S&N stake, it had to get into a fresh arrangement with UB Group which retained
Heineken’s right to appoint the CFO and also nominate three members to UB’s
Board. Despite Heineken now becoming the largest shareholder in UBL with 43%
stake vs UB Group’s 32% stake, Heineken is bound to the shareholder agreement
and will not be able to gain more control of the company.
Exhibit 17: Shareholding pattern of UB Exhibit 18: Board composition of UB

Mutual Others, Name Appointed by
Funds, 4% 6% Chairman Vijay Mallya UB Group
Vijay
Mallya, CEO/MD Shekhar Ramamurthy UB Group
30% CFO Steven Bosch Heineken
FII, 16%
Non-Exec Director Ravi Nedungadi UB Group
Independent Director Chugh Pal UB Group
Independent Director Sunil Alagh UB Group
Independent Director Chhagan Jain UB Group
Independent Director Frans Eusman Heineken
Independent Director Kiran Mazumdar
Independent Director Madhav Bhatkuly
Heineken, Non-Exec Director Sijbe Hiemstra Heineken
44% Non-Exec Director Stephan Gerlich Heineken
Source: BSE India, Ambit Capital research Source: Company, Ambit Capital research

United Breweries
Any significant strategy shift unlikely under the current regime

Since taking over control of USL, Diageo has taken steps to transform the business in
terms of product quality, brand portfolio, geographic presence, business practices and
professionalisation of relationship with authorities and other members of the value
chain. This has provided USL multiple growth levers like premiumisation, higher
profitability, a more efficient balance sheet and lower leverage levels. UBL would not
be able to take any of these steps as it is still controlled by UB Group and, hence, is
unlikely to go through a transformation that can provide a long-term sustained
growth and higher profitability trajectory.

United Breweries
Key assumptions
Exhibit 19: Summary of our key assumptions
FY15 FY16 FY17E FY18E FY19E FY20E Comments
Profit and Loss
Volume growth 6% 3% 1% -4% 8% 5% Expect volume growth of 5% CAGR over FY17-20
Driven by low single digit price hikes and rest through
Price/ Mix Change 7% 8% -1% 5% 6% 6%
mix change
Expect sales CAGR of 9% over FY16-20 driven by 4%
Sales (` mn) 46,881 50,758 50,753 51,159 58,567 65,185
volume CAGR
Sales growth 10.8% 8.3% 0.0% 0.8% 14.5% 11.3%
Expect marginal gross margin expansion of 110bps
Gross margin 59.6% 60.7% 58.7% 59.2% 59.5% 59.8% over FY17-20 driven by operating scale as volumes
grow
Employee cost (% of sales) 6.4% 6.7% 7.3% 7.5% 7.4% 7.5% Expect gradual increase in employee expenditure
Expect slight moderation of A&P spends over FY17-20
A&P spends (% of sales) 16.5% 16.8% 16.8% 17.0% 16.8% 16.6%
due to rising scale efficiency
Other expenditure (% of Increasing operating efficiency lead to gradual
23.4% 23.0% 21.0% 21.4% 20.9% 20.8%
sales) decrease in other expenditure
Expects EBITDA CAGR of 8% over FY16-20 with
EBITDA (` mn) 6,217 7,241 6,936 6,838 8,472 9,755
70bps EBITDA margin improvement
EBITDA margin 13.3% 14.3% 13.7% 13.4% 14.5% 15.0%
Margin expansion to drive PAT CAGR of 11% over
PAT (` mn) 2,602 2,955 2,826 2,626 3,674 4,474
FY16-20
EPS 9.8 11.2 10.7 9.9 13.9 16.9
Balance Sheet
Capex is largely maintenance capex as no new
Capex (` mn) 4,100 2,228 2,500 2,900 3,000 3,500
brewery has been announced.
Capital WIP (` mn) 902 608 608 608 608 608
Debtors days 75 82 82 82 82 82 Expects no change in debtors days over FY17-20
Expects marginal reduction in inventories days over
Inventories days 108 111 103 109 108 106
FY17-20
Creditors days 66 70 69 72 73 74 Expects stable creditors days over FY17-20
Reduction in debtors and inventories days leading to
Working Capital Days 53 49 46 47 46 45 Net Working capitals days declining from 49 days in
FY16 to 45 days in FY20
Net debt/ equity 0.4 0.2 0.0 (0.0) (0.1) (0.2) Expects company to become debt free from FY17
Cash flow statement
Operating cash flow (` mn) 8,408 4,939 5,878 5,275 5,751 6,756 Expects healthy operating and free cash flow
Free cash flow (` mn) 4,339 2,509 3,378 2,375 2,751 3,256 generation over FY16-20
Ambit vs consensus
Exhibit 20: Summary of Ambit vs consensus
Ambit Consensus Divergence Comments
FY18E
We believe consensus is still to factor in impact of closure of liquor stores
Net Sales (` mn) 51,159 57,905 -12%
within 500m of Highways post the Supreme Court ruling
Operating deleveraging should cause negative margin surprise which
EBITDA (` mn) 6,838 8,282 -17%
consensus is not yet factoring in
Gap between EBITDA and EPS rising as we believe consensus is not
EPS (`/share) 9.9 14.0 -29%
factoring in lower other income from non-repetition of certain paybacks
FY19E
Net Sales (` mn) 58,567 66,281 -12% We are below consensus due to carry over of our gap from FY18E
EBITDA (` mn) 8,472 9,726 -13% We are below consensus mainly due to lower sales
Gap between EBITDA and EPS rising as we believe consensus is not
EPS (`/share) 13.9 17.4 -20%
factoring in lower other income from non-repetition of certain paybacks

United Breweries
Earnings growth to support rich valuation

UBL is currently trading at 55x FY19E P/E. While this is at a steep 40%
discount to historical levels, it is at a premium of 65% to FMCG sector and
158% to global peers for earnings growth that is in-line or weaker.
Structurally, growth, profitability and return ratios will be limited for beer in
India vs FMCG sector as well as global peers. A weak industry construct with
high taxation, limited pricing power, controlled distribution, weak
premiumisation trends and fragmented manufacturing are the key reasons
for this. We acknowledge that given low consumption levels of beer in India,
growth ramp is likely to be long. Hence, we use DCF to value UBL to capture
its long-term growth potential. Our DCF-based TP is `625 implies 18%
downside.
Initiate with a SELL and DCF-based TP of `625 Our assumptions for WACC
Item Value
Given the cash-generative nature of the business, we use a 3-stage DCF-based
Cost of equity 15%
model to arrive at a fair value for UB. The assumptions for the weighted average cost
of capital and terminal growth rates are shown in the exhibit on the right. We have Cost of debt 12%
assumed longer-term debt:equity ratio of 0.3 given its strong cash position and free Debt/Equity 30%
cash flow generative nature of its business. Hence, the company has enough surplus Corporate tax rate 30%
cash available on its balance sheet for capital expenditure in the future. WACC 13%
Stage 1 (FY17-21): Over FY17-21, we expect UBL revenue/EPS growth of CAGR Terminal growth rate 5%
9%/17%. We expect EBIT margin expansion of 160bps from 8.5% in FY17 to 10.1% in
FY21 and increase of ROCE from 11% to 18% over FY17-21.
Stage 2 (FY22-40): Over FY22-40, we assume a gradual increase in EBIT margin
from 11% in FY21 to 14% in FY30 due to improving operating efficiency and
premiumisation of product portfolio. Beyond FY30, EBIT margin would remain stable
at 14% till FY40. We assume sales/EBIT CAGR of 9%/11% over FY22-40.
Stage 3 (FY40 onwards): Beyond FY40, we factor in terminal growth of 5%
assuming ~3% inflation and ~2% population-led volume growth.
Based on these forecasts, we estimate a DCF-based valuation of `625 (downside of
18%), implying FY18E P/E multiple of 45x
Exhibit 21: Return profile of UBL Exhibit 22: Cash flow profile of UBL
Sales growth EBIT margin CFO (Rs mn) FCF (Rs mn)
ROE EPS growth (RHS) 10,000
20% 50% 8,000
40% 6,000
15%
30% 4,000
10% 20%
2,000
5% 10%
0% -
0% (2,000)
-10%
-5% -20% (4,000)
FY12
FY13
FY14
FY15
FY16
FY12
FY13
FY14
FY15
FY16
FY17E
FY18E
FY19E
FY20E
FY21E
FY17E
FY18E
FY19E
FY20E
FY21E

United Breweries
Exhibit 23: Our assumption of operating metrics in the fade period of our DCF
FCF (Rs bn) EBIT margin (RHS) WACC (RHS) ROE (RHS)
50 35%
40 30%
30 25%
20 20%
10 15%
0 10%
FY22
FY23
FY24
FY25
FY26
FY27
FY28
FY29
FY30
FY31
FY32
FY33
FY34
FY35
FY36
FY37
FY38
FY39
FY40
Historical valuations are not relevant

Comparing UB’s current valuation with it historical five-year average creates a sense
of emergence of value. However, we believe this is misleading as historical valuations
were unjustified and were high mainly on account of earnings disappointment and
not due to re-rating in reaction to positive earnings surprise. Over FY12-17, the
Street cut its earnings estimates for UBL by 45% spread over ~20 cuts. We believe
continued disappointment on earnings will lead to further de-rating and, hence,
comfort from the discount to historical valuations is not relevant.
Exhibit 24: UBL’s one-year forward P/E band Exhibit 25: UBL’s one-year forward EV/EBITDA band
130 50
110
40
90
30
70
50 20
Jan-14
Jan-15
Jan-16
Jan-17
Jan-12
Jan-13
Sep-14
Sep-15
Sep-16
Sep-12
Sep-13
May-14
May-15
May-16
May-12
May-13
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Sep-12
Sep-13
Sep-14
Sep-15
Sep-16
May-12
May-13
May-14
May-15
May-16
1 year fwd P/E 5 yrs average PE 1 year fwd EV/ EBITDA 5 yrs average EV/EBITDA
+1 s.d. -1 s.d. +1 s.d. -1 s.d.
Premium to FMCG companies unjustified due to weaker profitability

UBL is trading at a 65% premium to other FMCG names under our coverage despite
being in a weaker industry construct. Given the weak sales/EPS growth of 9%/17%
compared to 15%/19% for FMCG over FY17-20, we believe the current premium
valuation to FMCG is unjustified.
Premium to global beer companies is unjustified on weak growth
UBL is trading at a 158% premium to global beer companies, which is unjustified as
revenue/EPS growth has been only marginally ahead of that of global peers. Even
going forward, UB’s 17% EPS CAGR is below expected growth for global peers (18%).
The gap could be narrower if one accounts for the stricter regulatory environment
and weaker industry construct for beer in India. Globally, RoE looks weaker due to a
slew of M&A activity in the sector (acquisition of SABMiller by ABInBev). Structurally,
we believe the global beer industry is more profitable and generates higher returns
than in India due to consolidation and ability to drive price/mix gains and create
scale efficiencies by moving towards mega breweries.

United Breweries
Exhibit 26: Relative valuations of UBL vs global players

CMP Mcap P/E EV/EBITDA P/Sales ROE (%) Div Yld (%) Sales CAGR EPS CAGR
Company Currency
LC (US$) FY18 FY19 FY18 FY19 FY16 FY17 FY16 FY17-19 FY17-19
Beer
United Breweries Ltd INR 762 3,107 60.2 41.4 27.7 21.9 4.0 13.0 0.2 9% 17%
Heineken Nv EUR 80 49,200 20.3 18.6 11.0 10.1 2.2 14.1 1.7 5% 8%
Anheuser-Busch Inbev Sa/Nv EUR 104 223,787 22.9 20.3 15.1 13.9 4.8 11.5 3.1 15% 22%
Asahi Group Holdings Ltd JPY 4,273 18,660 18.8 16.3 14.1 12.3 1.1 10.1 1.3 4% 19%
Carlsberg As-B DKK 647 14,088 19.5 17.7 9.2 8.6 1.5 9.8 1.5 3% 14%
Tsingtao Brewery Co Ltd-H HKD 35 6,285 32.3 30.2 14.1 12.7 1.9 8.9 1.2 2% 1%
China Resources Beer Holdin HKD 18 7,592 28.8 24.8 13.1 11.4 1.7 6.3 - 4% 41%
Key risks
Divergence in Government policy for beer: The Government policy for beer has
been as stringent as for spirits. However, going forward, like in many countries, any
liberal policy in favour of beer will be a key risk to our thesis.
Decrease in raw material prices: With the beer industry not having any history of
downward revision in prices when input costs turn deflationary, any decrease in key
raw materials like barley/hops/glass will flow though directly to the bottom line and
positively surprise in terms of earnings.
Key catalysts
Volume decline in 1QFY18: After a recent order from Supreme Court, liquor vends
within a 500m radius from National and State highways have shut down. This has
impacted almost 40% of sales. While we believe shifting of vends will make this a
non-issue in the longer run, for beer the crucial summer months (1Q accounts for
~35% of sales) are likely to be severely impacted.
Stringent Government policy: We expect the Government to continue with its
tough policy for the alcobev industry with no divergence for beer from that of spirits.
The stringent policy will continue to limit revenue growth and profitability of UBL.
Accounting forensic
Exhibit 27: Explanation for our accounting score
Segment Score Comments
UBL scores in line with its FMCG peers on cash conversion cycle and provision for doubtful debtors but
Accounting AMBER
scores low on contingent liabilities as percentage of net worth.
Sudden unforeseen regulatory changes cause frequent disruptions and impact earnings significantly. Hence,
Predictability RED predictability of earnings for UBL in past 5 out of 6 quarters earning deviation has been more than 10% than
consensus.
Earnings Momentum RED In the last three months, consensus has revised EPS estimates downward by more than 20%.

United Breweries
Exhibit 28: Forensic score analysis Exhibit 29: Greatness score analysis
Source: Ambit ‘HAWK’, Ambit Capital research

Source: Ambit ‘HAWK’, Ambit Capital research
Exhibit 30: UBL forensic score evolution Exhibit 31: UBL greatness score evolution
Source: Ambit ‘HAWK’, Ambit Capital research, Note: Using our ‘accounting Source: Ambit ‘HAWK’, Ambit Capital research, Note: On our ‘greatness
framework’, we categorise the market into deciles on the basis of their framework’, on a scale of 0 to 100, a small minority of outstanding companies
accounting quality with ‘D1’ indicating the best decile and ‘D10’ indicating the tend to score above 67 whilst most companies tend to have scores below 50
worst decile. Our analysis points towards a strong link between accounting
quality and share price performance.

United Breweries
Balance Sheet
Shareholders' equity 264 264 264 264 264
Reserves & surpluses 18,242 20,825 23,299 25,451 28,239
Total networth 18,506 21,089 23,563 25,715 28,504
Minority Interest 22 24 0 0 0
Preference share capital 0 0 0 0 0
Debt 6,992 4,111 2,111 2,111 2,111
Deferred tax liability 663 626 626 626 626
Total liabilities 26,182 25,851 26,301 28,452 31,241
Gross block 32,496 34,724 37,224 40,124 43,124
Net block 18,358 18,222 18,078 18,098 17,914
CWIP 902 608 608 608 608
Investments 1 1 1 1 1
Cash & equivalents 131 139 1,150 3,091 5,260
Debtors 9,643 11,431 11,430 11,521 13,189
Inventory 5,591 6,058 5,919 6,246 6,990
Loans & advances 3,562 4,243 4,103 4,136 4,735
Other current assets 658 640 640 645 738
Total current assets 19,585 22,510 23,241 25,639 30,913
Current liabilities 11,410 14,247 14,384 14,640 16,759
Provisions 1,254 1,244 1,244 1,254 1,435
Total current liabilities 12,663 15,491 15,628 15,893 18,195
Net current assets 6,922 7,020 7,613 9,746 12,718
Miscellaneous 0 0 0 0 0
Total assets 26,182 25,851 26,301 28,452 31,241
Income statement
Operating income 46,881 50,758 50,753 51,159 58,567
% growth 10.8% 8.3% 0.0% 0.8% 14.5%
Operating expenditure 40,664 43,517 43,817 44,321 50,095
Operating profit 6,217 7,241 6,936 6,838 8,472
% growth 4.1% 16.5% -4.2% -1.4% 23.9%
Depreciation 2,075 2,436 2,644 2,881 3,184
EBIT 4,142 4,805 4,292 3,957 5,288
Interest expenditure 728 759 591 232 211
Non-operating income 377 451 600 272 514
Adjusted PBT 3,790 4,497 4,301 3,997 5,591
Tax 1,188 1,542 1,475 1,371 1,918
Adjusted PAT/ Net profit 2,602 2,955 2,826 2,626 3,674
% growth 15% 14% -4% -7% 40%
Extra Ordinary Items - - - - -
Reported PAT / Net profit 2,602 2,955 2,826 2,626 3,674
Minority Interest - - - - -
Share of associates 0 0 0 0 0
Adjusted Consolidated net profit 2,602 2,955 2,826 2,626 3,674
Reported Consolidated net profit 2,602 2,955 2,826 2,626 3,674

United Breweries
Cash flow statement

EBIT 4,142 4,805 4,292 3,957 5,288
Depreciation 2,075 2,436 2,644 2,881 3,184
Others (132) 66 0 0 0
Tax (1,423) (1,606) (1,475) (1,371) (1,918)
(Incr) / decr in net working capital 3,381 (1,209) 418 (192) (803)
Cash flow from operations 8,408 4,939 5,878 5,275 5,751
Capex (4,069) (2,430) (2,500) (2,900) (3,000)
(Incr) / decr in investments 0 0 0 0 0
Interest/Dividend Received 85 21 600 272 514
Others 690 (43) 0 0 0
Cash flow from investments (3,295) (2,452) (1,900) (2,628) (2,486)
Net borrowings (3,958) (1,400) (2,000) 0 0
Issuance of equity (715) (772) 0 0 0
Interest paid (715) (772) (591) (232) (211)
Dividend paid (303) (344) (352) (474) (885)
Others (25) 772 82 0 0
Cash flow from financing (5,717) (2,516) (2,860) (707) (1,096)
Net change in cash (604) (29) 1,118 1,941 2,169
Closing cash balance 61 32 1,150 3,091 5,260
Free cash flow 4,339 2,509 3,378 2,375 2,751
Ratio analysis
Year to March (%) FY15 FY16 FY17E FY18E FY19E
EBITDA margin (%) 13.3% 14.3% 13.7% 13.4% 14.5%
EBIT margin (%) 8.8% 9.5% 8.5% 7.7% 9.0%
Net profit margin (%) 5.6% 5.8% 5.6% 5.1% 6.3%
Dividend payout ratio (%) 10.2% 10.3% 10.3% 15.0% 20.0%
Net debt: equity (x) 0.4 0.2 0.0 (0.0) (0.1)
Working capital turnover (x) 69.4 50.1 52.6 61.9 70.0
Gross block turnover (x) 1.5 1.5 1.4 1.3 1.4
RoCE (%) 11.1% 12.5% 11.4% 10.6% 13.9%
RoE (%) 14.6% 14.9% 12.7% 10.7% 13.6%
Valuation Parameters
EPS (`) 9.8 11.2 10.7 9.9 13.9
Diluted EPS (`) 9.8 11.2 10.7 9.9 13.9
Book value per share (`) 70.0 79.8 89.1 97.3 107.8
Dividend per share (`) 1.0 1.2 1.1 1.5 2.8
P/E (x) 77.4 68.2 71.3 76.7 54.8
P/BV (x) 10.9 9.6 8.6 7.8 7.1
EV/EBITDA (x) 33.5 28.4 29.2 29.3 23.4
Price/Sales (x) 4.3 4.0 4.0 3.9 3.4

United Breweries
Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Ambit Capital Private Limited (022) 30433174 saurabh.mukherjea@ambit.co
Pramod Gubbi, CFA Head of Equities (022) 30433124 pramod.gubbi@ambit.co
Research Analysts
Name Industry Sectors Desk-Phone E-mail
Nitin Bhasin - Head of Research E&C / Infra / Cement / Home Building (022) 30433241 nitin.bhasin@ambit.co
Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 aadesh.mehta@ambit.co
Abhishek Ranganathan, CFA Retail / Consumer Discretionary (022) 30433085 abhishek.r@ambit.co
Anuj Bansal Consumer (022) 30433122 anuj.bansal@ambit.co
Aditi Singh Economy / Strategy (022) 30433284 aditi.singh@ambit.co
Ashvin Shetty, CFA Automobiles / Auto Ancillaries (022) 30433285 ashvin.shetty@ambit.co
Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 bhargav.buddhadev@ambit.co
Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 deepesh.agarwal@ambit.co
Dhiraj Mistry, CFA Consumer (022) 30433264 dhiraj.mistry@ambit.co
Gaurav Khandelwal, CFA Automobiles / Auto Ancillaries (022) 30433132 gaurav.khandelwal@ambit.co
Girisha Saraf Home Building (022) 30433211 girisha.saraf@ambit.co
Karan Khanna, CFA Strategy (022) 30433251 karan.khanna@ambit.co
Mayank Porwal Retail / Consumer Discretionary (022) 30433214 mayank.porwal@ambit.co
Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 pankaj.agarwal@ambit.co
Paresh Dave, CFA Healthcare (022) 30433212 paresh.dave@ambit.co
Parita Ashar, CFA Cement / Metals / Aviation (022) 30433223 parita.ashar@ambit.co
Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 prashant.mittal@ambit.co
Rahil Shah Banking / Financial Services (022) 30433217 rahil.shah@ambit.co
Ravi Singh Banking / Financial Services (022) 30433181 ravi.singh@ambit.co
Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 ritesh.gupta@ambit.co
Ritesh Vaidya, CFA Consumer (022) 30433246 ritesh.vaidya@ambit.co
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 ritika.mankar@ambit.co
Sagar Rastogi Technology (022) 30433291 sagar.rastogi@ambit.co
Sudheer Guntupalli Technology (022) 30433203 sudheer.guntupalli@ambit.co
Sumit Shekhar Economy / Strategy (022) 30433229 sumit.shekhar@ambit.co
Utsav Mehta, CFA E&C / Infrastructure (022) 30433209 utsav.mehta@ambit.co
Vivekanand Subbaraman, CFA Media / Telecom (022) 30433261 vivekanand.s@ambit.co
Sales
Name Regions Desk-Phone E-mail
Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7886 2740 sarojini.r@ambit.co
Dharmen Shah India / Asia (022) 30433289 dharmen.shah@ambit.co
Dipti Mehta India (022) 30433053 dipti.mehta@ambit.co
Krishnan V India / Asia (022) 30433295 krishnanv@ambit.co
Nityam Shah, CFA Europe (022) 30433259 nityam.shah@ambit.co
Punitraj Mehra, CFA India / Asia (022) 30433198 punitraj.mehra@ambit.co
Shaleen Silori India (022) 30433256 shaleen.silori@ambit.co
Singapore
Praveena Pattabiraman Singapore +65 6536 0481 praveena.pattabiraman@ambit.co
Shashank Abhisheik Singapore +65 6536 1935 shashankabhisheik@ambitpte.com
USA / Canada
Ravilochan Pola – CEO Americas +1(646) 793 6001 ravi.pola@ambitamerica.co
Hitakshi Mehra Americas +1(646) 793 6002 hitakshi.mehra@ambitamerica.co
Achint Bhagat, CFA Americas +1(646) 793 6752 achint.bhagat@ambitamerica.co
Production
Sajid Merchant Production (022) 30433247 sajid.merchant@ambit.co
Sharoz G Hussain Production (022) 30433183 sharoz.hussain@ambit.co
Jestin George Editor (022) 30433272 jestin.george@ambit.co
Richard Mugutmal Editor (022) 30433273 richard.mugutmal@ambit.co
Nikhil Pillai Database (022) 30433265 nikhil.pillai@ambit.co

United Breweries
United Spirits Ltd (UNSP IN IN, BUY)
4,600
4,100
3,600
3,100
2,600
2,100
1,600
1,100
600
100
Mar-14
Mar-15
Mar-16
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Sep-14
Sep-15
Sep-16
May-14
Nov-14
May-15
Nov-15
May-16
Nov-16
United Spirits Ltd
United Breweries Ltd (UBBL IN IN, SELL)
600
500
400
300
200
100
Mar-14
Mar-15
Mar-16
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Sep-14
Sep-15
Sep-16
May-14
Nov-14
May-15
Nov-15
May-16
Nov-16
United Breweries Ltd

United Breweries
Explanation of Investment Rating

Investment Rating Expected return (over 12-month)
BUY >10%
SELL <10%
NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation
UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events
NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock
POSITIVE We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs
NEGATIVE We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs
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United Breweries
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Ambit Capital - Alcoholic Beverages (Consumer)

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Ambit Capital - Alcoholic Beverages (Consumer)

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CONSUMER

Sin hard if you must

Anuj Bansal Dhiraj Mistry, CFA

Ritesh Vaidya, CFA

Alcoholic beverages industry in India ……………………………………………..4

Missing 4Ps override macro tailwinds ……………………………………………..5

Regulatory/taxation environment is tough and unpredictable ……………….12

USL vs UB: Is one better than the other? ………………………………………..16

Valuation not justified in case of business as usual ……………………………22

United Breweries (SELL): It is a flat brew …………………………………………55

April 07, 2017 Ambit Capital Pvt. Ltd. Page 2

Sin hard if you must Key Recommendations

Alcoholic beverages at best a quasi-consumer sector in India

Regulatory environment is going from bad to worse

Dhiraj Mistry, CFA

Alcoholic beverages industry in India

6 Tobacco Tobacco Fut

5 HPC Fut HPC

4 Paints F&B Fut

3 AlcoBev Fut Paints Fut F&B

Exhibit 2: USL set to outgrow UB in the near and long term

Exhibit 3: Qualitatively USL is better placed vs UB

April 07, 2017 Ambit Capital Pvt. Ltd. Page 4

Missing 4Ps override macro tailwinds

Socio-economic demographic tailwinds overplayed

Source: WHO, Ambit Capital research Source: Ambit Capital research

Per capita consumption of alcohol remains low

April 07, 2017 Ambit Capital Pvt. Ltd. Page 5

April 07, 2017 Ambit Capital Pvt. Ltd. Page 6

Tax as % of MRP - Spirits Tax as % of MRP - Beer

Source: OECD, Ambit Capital research

Price CAGR over 2009-16

Source: Ambit Capital research

April 07, 2017 Ambit Capital Pvt. Ltd. Page 7

Changing lifestyles and rise in alcohol consumption by women not supported

India Women Lifetime Abstainers (%) India Lifetime Abstainers (%)

60 2.7 3.0 100

Source: Ambit Capital research Source: Ambit Capital research

April 07, 2017 Ambit Capital Pvt. Ltd. Page 8

The missing 4Ps – Product, Price, Promotion and Place

Price CAGR over 2008-15 Price CAGR over 2008-15

Source: Ambit Capital research Source: Ambit Capital research

April 07, 2017 Ambit Capital Pvt. Ltd. Page 9

USL Total Volume Royal Challenge Volume

Source: Ambit Capital research Source: Ambit Capital research

Place: Both quantity and quality are issues

April 07, 2017 Ambit Capital Pvt. Ltd. Page 10

Source: Ambit Capital research Source: Ambit Capital research

 Buying experience is a deterrent: Bulk of liquor vends in India tend to be

Source: Ambit Capital research Source: Ambit Capital research

April 07, 2017 Ambit Capital Pvt. Ltd. Page 11

Regulatory/taxation environment is tough

Tax structure is complex for alcohol in India

April 07, 2017 Ambit Capital Pvt. Ltd. Page 12

Key issues with taxation on alcohol in India:

Taxation structure in India is more damaging to beer than spirits

Regulatory environment is getting tougher

April 07, 2017 Ambit Capital Pvt. Ltd. Page 13

Source: Ambit Capital research

April 07, 2017 Ambit Capital Pvt. Ltd. Page 14

Alcohol excise tax revenue as a % of 4 State fiscal deficit (in %)

State fiscal deficit (in %)

Courts are adding to the misery