INDIA: Diageo to bring United Spirits stability, but risks remain - analyst

Diageo will bring “much-needed” financial prudence to United Spirits Ltd (USL) by ending a “vicious” cycle of volume focus, high working capital and low profitability, an analyst has predicted. 

The UK group, which agreed a INR111.7bn (US$2.05bn) deal to take a majority stake in the Indian firm in November, will bring “profitable growth” and free-cash flow, Deutsche Bank said in a report today (23 January). “While the benefit of demographics (50% of the population is below 25 years-old) and a virtual monopoly status have always been a key investment argument for United Spirits, we believe the ownership change will bring in much-needed financial prudence and better returns to minority shareholders,” the report noted.

Deutsche Bank, which initiated its coverage of USL today, said the company has “under-performed” for two years. But, the analysts said that its management's hopes of achieving a 20% EBITDA margin will be a “gradual process”.

Deutsche also identified “key risks” for USL shareholders, including the fact that Diageo will be running two separate entities – USL and Diageo India. This could mean “the possibility of continuing to sell Diageo’s higher-margin brands through Diageo India and that USL is used only as a distillery (a low-margin business),” the report said.

Other risks include “a likely write-down of Whyte & Mackay assets/inventories, Indian Premier League assets and a longer-than-expected period for working capital improvement”, the analysts said. 

Earlier this month, Diageo played down fears the deal will be delayed as the timetable for acquiring public share has been revised. 

Deutsche Bank added that Diageo has created a "significant unassailable lead" over its competition in India with the deal. But it noted: “Pernod (Ricard) could also be looking at alcohol companies, distilleries in India, which would help it expand, access regions.”

Meanwhile, on the independent South African joint-venture between Diageo and the owner of USL's parent company, Deutsche said it was a “little surprised”, given that Diageo is already present in the country in the premium end.

"Diageo has declared it will invest US$36m in the venture, but it is not clear how much Vijay Mallya would invest or has invested,” the report said.