Varun Beverage (VBL) is PepsiCo’s second-largest franchisee in the world (outside US) and has been associated with Pepsi for the last 30+ years. The company is well-positioned and has multiple levers to now grow at over 20% topline cagr for the next several years. VBL is probably Pepsi’s best run franchisee with VBL able to improve the market share in its territories much higher than the global average for PepsiCo. Covid disrupted not just volume growth but also its distribution expansion and backward integration plans, but the company is now back on track to drive the next leg of growth.
Company info:
VBL has over 90% of distribution coverage in India. Additionally, it also has bottling operations in Sri Lanka, Nepal, Morocco, Zambia and Zimbabwe. Carbonated sweet drinks (CSD) are about 70% of volume, packaged drinking water is about 23% and juices are about 7%. White and colored drinks are more popular in India vs dark cola drinks and hence Mountain Dew and 7UP constitute about 45% of the volumes and Pepsi-cola only about 15%. VBL has been associated with Pepsi since 1990s and over the years Pepsi has been awarding VBL more territories and consolidating its operations since VBL has been doing a very good job at increasing the market share in the areas awarded.
VBL pays out roughly 20% of its revenues to Pepsi out of which 8% is for concentrate, 6% for above-the-line marketing, and another 6% for below-the-line marketing. For non-concentrate products like drinking water, VBL pays about 1-1.5% as royalty.
VBL and Pepsi in India currently have an advantage over Coke since PepsiCo has consolidated its franchisee, which is leading to faster decision-making and better control over its operations. Coke on the other hand has about 13+ franchisees in India.
Investment thesis: VBL has a number of avenues to increase its top line and they include:
VBL is PepsiCo’s preferred bottling partner: with Pepsi awarding more geographies to VBL over the years. VBL has done an excellent job in the territories it has been awarded by investing heavily in building up the infrastructure, expanding distribution (by adding depots and distributors), setting up manufacturing plants to reduce travel distance, and supporting its retail network by providing visi-coolers. For example, VBL used to cover 28% of Pepsi’s revenue in CY15 but currently, it covers over 90%. Additionally, VBL has been getting more territories internationally in Asia and Africa.
Focus on expanding distribution network in India: Currently, VBL has a distribution network of about 1.8m outlets in India compared to 2.6m outlets for Coca-cola out of the overall 9-10m outlets available in the country. Hence, the opportunity for expansion in its current territory itself is huge. Currently, VBL plans to add over 100k retail outlets per year and add 40-50k visi-coolers per year at the retail outlets.
Immense opportunity in newly acquired geographies of South and West India: VBL was awarded newer territories in South and West India in May 2019, which makes up for about one-third of its current volumes. In these new territories, Pepsi commands about 25% market share compared to about 35-40% in rest of India which have been under VBL’s network previously. The South and West regions were poorly managed previously and so Pepsi awarded these regions to VBL to improve its market share. VBL has been working hard on improving the market share in this region by aggressively expanding its retail network, adding visi-coolers, and backward integrating some of its operations. The expansion operations were impacted due to covid in the last 2 years but the company is now back on track to achieve the goals it has set out for the region.
Carbonated sweet drinks (CSD) are currently highly under-penetrated but a fast-growing category in India and other regions under VBLs network: The current per capita consumption of 5 liters per year for VBL’s geographies is far lower than the global average of about 30 liters. With increasing disposable income and shift towards packaged products (more hygienic), the CSD and packaged drinking water category itself has huge potential to grow.
New non-cola drinks afford another huge opportunity for VBL to grow its top-line for many years to come: Company has been focusing on adding non-cola carbonated drinks like lime, orange, and mango in the last few years. Recently, the company has also added energy drinks and dairy products. While in India, energy drink is a small category in India, dairy is a huge category and there is a big opportunity by introducing value-added products in the segment.
Bottomline growth to exceed topline growth due to margin expansion and reducing debt levels: VBL is razor-focused on steadily improving margins. The company has done an excellent job in expanding its margins over the years prior to covid disruption. Gross margins have improved from 43% in cy13 to 56% in cy21 and EBITDA margins have increased from 13.8% in cy13 to 20.3% in cy19 (CY20 and CY21 were impacted due to lower volumes in covid period) and have stayed around 20%. Margins will potentially increase further after volumes fully recover to Pre covid levels and capacity utilization starts to increase. Additionally, the company has also done some backward integration and added manufacturing plants in the last 2 years, the benefits of which are not reflected due to the covid disruption. On top of this, some newly acquired international regions are not fully contributing to their full potential currently but should do so over the next few years. Separately, debt levels had peaked at about Rs 30b in CY19 post the acquisition of the South and West territories but the management expects the company to be debt-free in another 2-3years due to its strong cash flows.
Valuation is attractive compared to its peers: VBL currently trades at around 28x CY23 earnings compared to >45x other consumer staple peers in India. VBL has one of the highest organic top and bottom-line growth cagr potential for the next 5 years compared to its peers making it a strong candidate for rerating. Even if the company maintains its current PE multiple, the stock should appreciate at over 20% cagr for the next few years.
Risks:
Increased competition, seasonality, new pandemic wave
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