>UNITED SPIRITS: Less Bulk, More Brands (CITI)

■ W&M: Brand focused — Mgmt noted that W&M will focus on emerging markets and branded scotch, moving away from its current bulk business. We believe this is a long-term positive. The new business model is in keeping with W&M’s status as a leading global scotch manufacturer. Execution will remain a key imponderable In the near term; earnings will be affected – mgmt has guided to EBITDA of £33m (-40%) in FY11 on a revenue base of £110m (3.5-4m cases). Mgmt expects EBITDA growth of ~15% CAGR over the next 2 years. W&M's scotch inventory of 103m litres is valued at £430m as of June 2010.

■ Domestic business: Directionally positive — Wet goods costs have softened to Rs143/case in 1QFY11, down from ~Rs151-152/case in 1QFY10 and Rs148/case in 4QFY10. Mgmt expects input costs to remain at current levels during 2Q before softening in 2HFY11. However, mgmt noted that glass prices (~20% of COGS) are expected to harden in August by ~7%. Lower input costs coupled with better fixed cost mgmt and controlled BTL spends should ensure EBITDA margins remain ~20%. Volume growth is expected to continue at a healthy pace of 12-15% Y/Y.

■ Capital structure: Remains challenged — Overall, gross debt is Rs56.8bn end June, up ~Rs2bn Q/Q, driven by higher requirements of working capital (~Rs1.8bn), and investments in 3 tie-up units (~Rs1.6bn). We don’t expect debt levels to meaningfully reduce, despite strong profit growth, in the backdrop of: a) elevated capex spends over the next 3 years (Rs11bn – firmed up from ~Rs7-8bnearlier), and b) uncertainty on working capital/NCA. From a cash flow/debt servicing perspective, UNSP is comfortably poised. The option of selling treasury shares (8.4m shares, value of Rs11.6bn) and reducing debt is a tangible positive.

■ Maintain Buy — Given the recent run-up in the stock, we might not see meaningful stock price appreciation in the near term, especially in the context of W&M’s revised forecasts. We note W&M’s EBITDA cut of ~40% could adversely impact our consolidated PAT estimates by ~13-18% over FY11-12E.

To read the full report: UNITED SPIRITS