After United Spirits Ltd (USL) announced its June quarter results, its share fell, dropping from Rs.3,788 to around Rs.3,000. The September quarter results got a different reception, with its share rising sharply; it’s now back to Rs.3,512.20. What explains this enthusiasm?
An improvement in profitability is the main reason. Operating profit not only increased by 36.1% over a year ago, but also by 57.3% sequentially. That contributed to a 3.3 percentage point increase in profit margin over a year ago. Some of this was the result of USL desisting from making payments under related party agreements. This is a legacy issue and these payments were stopped from November 2014 after shareholders voted against them.
But better margins are also partly attributable to volume growth and a better mix. The company’s mass-market brands saw volumes decline by 5% in the first half, over a year ago. But its higher-end brands saw volumes grow by 7%. In the first quarter, growth in this segment was 5.7%. Some of this improvement is explained by the September quarter being the first full quarter when USL had sales from Diageo Plc’s brands. The higher-end category is now nearly 40% of total volumes, up three percentage points over a year ago.
The second half of FY16 may not see margins increase as much, due to a base effect since related party payments stopped from November. But even if margins are maintained at current levels, they are healthy, and sales growth and mix can take over to drive growth.
Mass-market volumes were hit by a temporary disruption in Karnataka. This should pick up in future quarters. But even then, USL is targeting low single-digit growth from this segment. It wants double-digit growth from the higher-end brands. The objective is to have a good mix of healthy sales growth and good profitability levels.
Current trends do seem encouraging. The management is also implementing a plan to raise productivity, which if successful, should lead to better margins in the longer run. Selling non-core assets is also likely to release more funds, which can be used to reduce debt.
Last year, both the management and investors were distracted by governance-related issues. Those issues haven’t been resolved completely, but are being tackled and look less threatening. Now that there is evidence that management attention is back on the business, and is showing good results, investors may be hoping that this is just the beginning.
The writer does not own shares in the above-mentioned companies.