Karnataka, in the 2017-18 Budget, announced a revision in the additional excise duty (AED) on liquor. While the underlying excise slabs remain the same, the AED has been increased by 6-16%. In addition, VAT of 5.5% on spirits, beer and wine has been removed.
There will be no change in the net sales realisation for liquor manufacturers. However, the revision in AED will result in a retail price increase for brands. Based on our calculation, the retail price of Old Tavern and McDowell’s No.1 whisky will rise by 10% and 12%, respectively.
Our calculations suggest that operating profit margins for USL in Karnataka (for its Old Tavern brand) increased from ~12% to ~17%, post the price hike. With Karnataka contributing 20% to overall USL volumes, we think this price hike alone will drive ~100bps of EBITDA margin flexibility for USL in a full fiscal year.
We also note the VAT was applicable only to the sale of liquor in clubs, hotels and bars and hence will not affect retail liquor sales. We derive our price target of R2,900 from a residual income (RI) model, probability weighted: 20% bull case, 75% base case, 5% bear case.
The higher weight assigned to our bull case reflects high conviction in our theory of a potentially sharp rise in profit pools for the liquor industry in India.
Key assumptions in our RI model: cost of equity 11.6% (risk-free rate 8.0%, market premium 6.0%, beta 0.6), ROE for F15-30e of 22.9%, terminal ROE of 65.0%, and terminal growth rate of 6.0%. Downside risks to our price target are a sharp increase in input costs. Increase in innovation and advertisement costs may crimp earnings in the near term.
