Investors may contemplate selling shares of United Breweries Ltd (UBL), a major player in the beer industry and part of the global giant HEINEKEN Company, due to unsustainable premium valuations and ambitious consensus earnings expectations.

Despite the so-called under-penetration of alcoholic beer in the country, we believe that beer remains a beverage with moderate growth potential. Annual sales volume (340 million cases) and consumption (around 2.1 billion litres) have not kept pace with overall economic growth in recent years, with some consumers shifting their preferences towards wine and spirits innovations.

With the stock underperforming peer companies in the alcoholic beverage sector, such as United Spirits and Radico Khaitan, over 1- and 5-year periods and the company lacking a strong historical earnings growth, UBL’s valuation has become relatively expensive, standing at 126 times PE and 62 times EV/EBITDA based on FY23 figures. This represents a substantial premium compared to United Spirits, trading at 47 times PE and 51 times EV/EBITDA, or Radico Khaitan, with 72 times PE and 47 times EV/EBITDA multiples.

Globally also, UBL trades at a significant premium to peers like Ab InBev, Asahi, Kirin, and Carlsberg (14-19 times PE). Consequently, the likelihood of a downside outweighs the upside potential in UBL stock at the current price, making the risk-reward ratio unfavourable.

Industry and UBL

Beer, one of the world’s oldest beverages, faces stringent regulation in the Indian market with high taxation. Pricing of alcohol is firmly controlled by individual States. Despite these challenges, beer accounts for a significant portion of total alcohol consumption in India, with offerings categorised into strong and mild variants. Key States (by beer sales volume) are Telangana, Maharashtra, Uttar Pradesh, Karnataka, Tamil Nadu, Kerala and Andhra Pradesh.

Over recent years, numerous breweries have entered the beer market, expanding their product ranges to include craft beers. The primary raw materials for beer production are barley-malt, rice, hops, sugar, carbon dioxide, glass (for bottles), and packaging materials.

United Breweries has maintained its position as the largest beer manufacturer in India, with over 50 per cent market share. The company is engaged in the production and marketing of packaged drinking water, soda, beer, and non-alcoholic beverages, boasting well-known brands such as Kingfisher, Kalyani Black Label, Sandpiper, Heineken and more. UBL has 32 manufacturing units in India.

Despite beer gaining popularity in India due to its lower alcohol content and increasing acceptance in social settings, UBL’s historical earnings do not present an optimistic picture. Over the last decade (FY2014-2023), UBL on a consolidated basis achieved total revenues of ₹94,350 crore, but the company posted a net loss of approximately ₹1,600 crore during this period. While profits have improved in the last five years ( ₹3,700 crore), the average 14-15 per cent operating profit and around 8 percent net profit margin indicate the scope for improvements..

Back to the future

With the Indian beer market being significantly underdeveloped, a promising and potential-rich future for the industry has been cited. UBL’s status as major listed beer stock has contributed to its prominence and premium valuation. Future growth expectations serve as an attraction to keep investors engaged. Consequently, consensus estimates as per Bloomberg project a highly optimistic 50 per cent year-on-year adjusted earnings per share growth for UBL in both FY24 and FY25, despite sales anticipated to rise by only 8-12 per cent annually. Among frontline consumer stocks, UBL has already seen one of the sharpest downward EPS growth revisions (down 24.5 per cent) in last six months. More cuts could come as the street’s expectations meet reality.

Achieving these lofty projections, supported by a turnaround in margin performance, may be challenging, considering UBL’s historical single-digit topline compounded annual growth rate and modest bottom-line compounded annual growth rate (in the early to mid-teens) over 3- and 5-year periods.

Concerns arise from the lack of momentum in UBL’s quarterly beer volume growth (year-on-year) over the last 4-5 quarters, with a negative trend in Q1FY24 (a key summer season quarter), partly attributed to supply-chain constraints and subdued performance in Telangana, Andhra Pradesh, Delhi, and Haryana.

To meet the ambitious EPS growth estimates for FY24 and FY25, there would need to be a significant increase in beer consumption and a substantial reduction in raw material prices. Although beer is viewed as a low-alcohol beverage, it has struggled to keep pace with changing consumer preferences.

Furthermore, while Covid-induced premiumisation trends are observed in beer, increasing salience and changing price-mix is not a quick process in price-sensitive consumers of low-alcoholic beverages.

Decoding the fizz

Additionally, high/complicated taxation and licensing regimes, frequent route-to-market changes, and a tricky distribution set-up can lead to volatile earnings for companies like UBL.

For instance, Indian alcohol regulations historically treated all beverages uniformly, taxing beer (5–6 per cent alcohol) at the same rate as higher-alcohol spirits. Alcohol is governed by State excise policies, creating a complex, State-specific tax and licensing system.

Secondly, changes to route-to-market (RTM) strategy, including navigating distribution and State alcohol regulations such as excise policy, are critical. Such changes affected UBL markets such as TN, AP and Delhi in Q1FY24. In TN, RTM change impact would show up in November-December, while the same is baked in case of Delhi.

There is excessive optimism regarding supportive laws from some State governments, the recent appointment of a new MD & CEO, and buzzwords like ‘under-penetration’ and ‘promising outlook.’

Why book profit
Risk-reward equation unfavourable at current levels
Premium valuation based on lofty earnings expectations
Lack of momentum in beer volume growth

Despite being debt-free and net-cash positive, UBL’s low dividend yield (0.5 per cent) is uninspiring.

Considering these factors, investors may consider selling UBL shares for now and await better entry points.

Risks to our stance include sustained positive earnings surprises and unexpected softening of input prices, which could support the valuation premium.