The Rising Share Price of United Breweries- What’s brewing inside?

With liquor outlets shut and taxes on the rise, beer stocks are the last thing you would expect to rally! However, the maker of Kingfisher, UBL, had a spectacular rally! Strange, right?

Okay, before we delve into that, here’s a bird-eye view of India’s beer market.

Next to only spirits, Beer is the second-most consumed alcoholic beverage in India. To add to its sheer size, the beer market is expected to nearly double in just five years to reach a volume of a whopping 9000 Million Litres by 2025! (Urbanization, societal paradigm shift, or technological advancements, whatever you attribute it to.)

Having said that, beer sales as a percentage of total alcohol sales in India is about 20%, quite a small proportion in comparison to 87% in most other countries! This is why, in India, beer's a huge market for the taking.

While 140+ brands are competing to take the market, United Breweries Ltd (UBL), with more than half of the beer market share, is all set to be the cream of the cake.

Anyway, if the pandemic dealt a death blow to the liquor industry as most of them had to close shutters, how did UBL’s shares exhibit a ~35% rally in a year and about 20% in June alone?

So, let's decode what's fueling UBL's share price rally. But before that, some storytelling...

The Beermaker’s Tragedy

Headquartered in the lavish UB City of Bangalore, United Breweries Ltd is a leading manufacturer and distributor of alcoholic beverages. Powered by its most popular brand Kingfisher, the UB Group has come a long way to capture more than 50% of India’s beer market. Besides, it’s one of the very few profitable companies in this industry.

However, most of its misfortune stems from the group’s Chairman, the most famous fugitive of India, Vijay Mallya, who fled the country in 2016 with boatloads of debt on his head. And now, banks are struggling to recover the dues by selling the assets of Mallya’s companies! But wait, that’s not all.

The beverage business looks so fancy and gorgeous. So, it must be very lucrative, right?

Well, NO. It suffers from the problem that all ‘sin products’ are vulnerable to - uncertainty. Each state has its own rules and regulations. You never know when a state where you’d invested crores in setting up a brewery, will ban liquor! Your sales will be seasonal. Speaking of beer, it’ll be on-demand in summer, but in other seasons, you’ll be left with plenty of unsold stocks.

And of course, a year like 2020 would be a death blow!

Lower incomes and prioritization of necessities would deter people from splurging on alcohol. Bars, pubs & clubs would be the first places to shut down to avoid crowds. Although online delivery could work, government-controlled pricing would limit the growth. Besides, unlike other e-commerce offerings, online delivery of liquor won’t bring in a new set of customers, who will simply drink just because it’s available.

So, does it make much business sense?

The Beer Bottle(-neck)

You see, breaking down the operations of a beer company, you’ll have two essential processes - brewing (manufacturing beer) and packaging. While the former holds primary importance, the significance of packaging can’t be overstated. The quality of a beer bottle, if not more, is an equally important product differentiator as the taste of the beer itself. Thus, it makes sense for breweries to use good-quality glass for the packaging. Doesn’t it?

But that comes with a price. The cost of glass packaging makes up as high as 50-55% of the total input costs for UBL. Only to add weight to the pain, the prices of glass are skyrocketing!

Due to the rising crude oil, gas, and transportation costs, reports say that glass prices have increased by 15-20%. And this has serious implications. For instance, according to UBL’s FY20 Annual Report, packaging materials for bottles cost it around Rs 1870 Cr, which alone eats up 30% of its sales revenues!

When in need, tax thy liquor!

Excise duty is a tax charged by the Government, the moment a product leaves the factory gate. And alcoholic drinks are regarded as ‘sin products’ for taxation purposes. Meaning, the government can extract as much taxes from these products, all in the name of public interest. Or simply stated, “when the government’s in need, the drunkards have to pay.”

For instance, in 2020, when the Government badly needed money to uplift India from the mess, it raised the excise duty. Moreover, a new ‘Covid cess’ was collected on sin products. Reports claim that these taxes, which amounted to ~70% of a beer bottle’s price, ate up more than half of companies’ sales revenues!

Now you would be like - why can’t these companies just hike the price of beer?

Because alcohol prices are regulated. States won’t allow you to raise the price of beer the way you like. And even if they allow, passing on the burden to your customers and pushing too far will make them switch to better value proposition drinks like Whiskey.

That’s why the beermaker has to endure the burden of rising input costs and taxes all by itself, thus taking a hit on the margins! No wonder -

(Source of data: Ticker)

What’s up with UBL?

2020 was bad. 2021 could be worse. So, you think it was a misfortune, eh?

Well, UBL’s problem didn’t begin in 2020. In fact, its sales volume has been static for a long time, and there has been no exponential growth. What 2020 did, though, was turn it down.

(Source of data: Company filings)

Not only this, take up any metric. Its EPS has been falling more than 20% every year for the last five years. United Breweries, a company that retains over 87% of its earnings (payout ratio 13%) and reinvests it in the business, makes a return on equity (ROE) of a mere 3.2%, as against 12% in the industry! Naturally, its reinvestments aren’t bearing fruit.

Then, why is UBL’s share price rising?

Splurging on a beer(company)

Heineken (UB Group’s promoter entity) bought an extra 15% stake in UBL from the fugitive tycoon Vijay Mallya, thus becoming a 61% stakeholder in the company. This was initiated by the debt recovery tribunal to compensate Mr. Mallya’s lenders.

In most cases, when the seller initiates a block deal, it’s usually at a discount from the stock’s last closing price; but here, it’s a premium. Acquisition of 39.6 million shares at a record-high of Rs. 1471.25 each, shows Heineken’s confidence in UBL.

So, here's the answer to the question you've been reading this blog for :

But then, the essential question is - why would the world’s second-largest beer company be gung-ho about buying such a large stake in a beer company with no substantial growth in the past?

Champagne taste on a beer budget?

UBL holds about 52% market share in India’s beer industry. In terms of volume, UBL’s Kingfisher & Carlsberg’s Tuborg make a large chunk in the strong beer segment, which makes for 85% of India’s beer market. Besides, UBL is all set to be a market leader in the fastest-growing super-premium beer segment, which is poised to grow at a CAGR of ~30%.

Its recent annual report indicates investments in the premium segment & value brands, substantial savings in fixed costs, and increased initiatives for water conservation and carbon footprint reduction.

Moreover, for the next 3-5 years, UBL’s revenue is expected to grow at 22.4% per year, and earnings, at an incredible 49.51% per year!

So, it does make sense for Heineken to increase the stake, right? A ‘champagne taste’ indeed.

But was it ‘on a beer budget'? Given the company’s current state, it is probably hard to agree (UBL’s PE ratio is 334.83x, industry PE is 33.7x)! However, as Emkay estimates UBL’s current valuation at 49x FY23 EPS, Heineken does have a point here. Doesn’t it?

And what does UBL stand to gain, you ask? As it already has access to Heineken’s global portfolio, it may not gain much out of a higher stake, other than a reputational repair if Vijay Mallya is made to step down from his Chairman position by Heineken (rumor has it).

So, there you are.

The Bottom Line

Heineken once noted this - “India has a total of 90,000 outlets selling beer. China, on the other hand, has over 44,00,000. While an Indian has to work 46 minutes to buy a bottle of beer, a Chinese national in Guangdong can buy one after working for only 10 minutes.”

In short, there are much fewer outlets selling beer, and it’s getting increasingly expensive, thus, companies are losing customers. As states obtain 15-20% of their revenues from excise duty on alcohol, they, naturally, have an incentive to cut down taxes & make it affordable. Some states like Rajasthan are already doing it. Besides, there’s no Covid cess anymore.

So, companies can unleash untapped potential in the beer segment if the government regulations turn out to be in favor.

In the present scenario, however, everything boils down to the rage of subsequent waves of the pandemic. So yes, only time will tell…

Anyway, what do you think the future holds for UBL? Tell us in the comments.