High valuation, shaky financials and lack of triggers for any value addition or expansion in margins, make the initial public offer of Varun Beverages, unattractive. The company manufactures, packages and sells Pepsi Co’s products such as carbonated drinks (Pepsi, 7Up, Mountain Dew, etc), juices (Tropicana) and water (Aquafina).

The company plans to raise up to ₹667.5 crore to repay a portion of its debt; promoters also expect to receive ₹445 crore from an offer-for-sale. At the price band of ₹440-445, the company discounts its trailing 12-month consolidated earnings by about 62 times on a post-issue basis (57 times on pre-issue basis). The pricing seems to have been influenced by the stiff valuations that FMCG companies trade at today, thanks to their ‘defensive’ tag and the expectation of revival in consumption. With no proprietary products and riding solely on Pepsi’s brand value, Varun Beverages is not an FMCG company. The company has probably taken a cue from Manpasand Beverages, which listed last year and is now trading at 65 times.

Business and rospects

The company has exclusive franchise rights to operate in 17 States and Union Territories predominantly in the North and North-East, with a 44 per cent volume market share in the sale of Pepsi Co’s soft drinks in India. It also has subsidiaries in Sri Lanka, Nepal and some African countries, which together bring in 15-20 per cent of the total revenues.

With per capita consumption of soft drinks at 9.4 litres in India in 2015 compared with the world average of 91.9 litres, statistics favour good volume growth over the next few years. The increasing awareness about water borne diseases will also keep the demand for packaged drinking water robust. But there are weak links in the chain.

Weak links

For one, the carbonated soft drinks segment brings in about 80 per cent of the revenues and the company does not expect this proportion to change substantially in the foreseeable future. But consciousness about the ill-effects of these drinks is on the rise, with people preferring fruit juices, which are considered less sinful and more healthy. Hence, volume growth for this segment may not be as strong as for juices in times to come.

Secondly, the scope for enrichment in the product mix or an improvement in the operating margins seems constrained since positioning and pricing of new products is influenced by Pepsi Co. Like it has done in the last few years, cost efficiencies is the only way through which it can improve margins. Margins have improved to 18.6 per cent in the year ended December 2015 from 12.6 per cent in the year ended December 2012. Further room to cut costs may not be as easy.

Thirdly, Varun Beverages clocked a CAGR of 23.5 per cent in revenues since 2012 to ₹3,394 crore in the year-ended December 2015. Net profit has grown 51 per cent to ₹87 crore for the same period. But much of the growth has been influenced either by the acquisition of new territories in India or abroad in these years and hence, the numbers may not strictly be comparable.

The company made losses at the standalone level in 2013 and at the consolidated level in 2013, 2014 and in the second half of 2015 due to various factors, such as seasonality of the business, higher depreciation and interest costs due to newly acquired territories/ capacity expansion and losses made by subsidiaries. It may take a year or two for the financials to stabilise.