Varun Beverages IPO Review: Cold drink, hot prospects

Varun Beverages – the second largest global bottler of PepsiCo – is coming up with its IPO which will open for subscription on 26 October and will close on 28 October 2016. Through this Varun Beverages IPO review, we try to find out if retail investors shoudl subscribe to the public offer which is one of its kind.

The company plans to sell 25,000,000 shares through the upcoming IPO which is priced in the range of INR440 – 445 per share. In total, the IPO will mobilize INR1,112.5 crore (INR11.12 billion) at the upper end of its price band. Investors can apply minimum lot of 33 shares and in multiples thereafter. 500,000 shares in the IPO have been reserved for eligible employees. The shares of Varun Beverages are proposed to be listed on BSE and NSE and trading in shares is expected to start on 8 November 2016.

Ravi Jaipuria offloading some shares

The forthcoming IPO of Varun Beverages will involve a fresh issue of 15 million shares while 10 million shares will be sold by existing shareholders through an offer for sale (OFS). This includes 5 million shares by promoter Ravi Jaipuria while another 5 million shares will be sold by Ravi Kant Jaipuria & Sons (HUF), and Varun Jaipuria and Ravi Kant Jaipuria & Sons (HUF).

Promoters and promoter group own 86.3% equity in the company but Varun Beverages counts private equity (PE) players Standard Chartered Private Equity and Aion Capital Partners among its investors. Aion Capital Partners – a joint venture of Apollo Global Management and ICICI Venture – invested in 2015 while Standard Chartered Private Equity made its first investment in Varun Beverages nearly five years ago. Standard Chartered owns 12.84 million shares or 7.69% stake while Aion holds 8.18 million shares or 4.9% stake. However, none of the PE investors will sell their shares in the IPO. Continued investment by private investors shows that external shareholders have high degree of confidence in the business. No surprises, this is something we like immensely. 

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By issuing fresh shares, the company will raise INR667.5 crore which it intends to use towards reducing indebtedness and general corporate purposes. While INR540 crore will be used to pay back loans, the remaining amount will be used for general corporate purposes. As on 30 June 2016, Varun Beverages had indebtness of INR2,046.1 crore on consolidated basis, representing a debt to equity (D/E) ratio of 1.54. As we have seen in our analysis pieces before Varun Beverages IPO review, debt reduction from IPO proceeds almost always works in favor of companies.

Varun is all about beverages

Varun stands for water in Hindi language and the company bearing this name has the group’s business related to beverages. Varun Beverages is the flagship company of Ravi Jaipuria’s RJ Corp which has interests in fast-food restaurants, education and hospitality. The fast-food business is housed under Devyani International in which Temasek has about 15% stake.

As described above, all beverage business of the group is housed under Varun Beverages. This includes Pepsi, D7UP, Evervess Soda, Tropicana Slice and packaged drinking water under the brand Aquafina. Varun Beverages has nearly 26 years of relationship with PepsiCo and this long history has helped the company in bagging franchise for various PepsiCo products in Sri Lanka, Morocco, Mozambique, Zambia, and Zimbabwe.

Despite its growing overseas exposure, Varun Beverages continues to remain highly focused on India which generated 84.38% of its revenues from operations in 2015.

Varun Beverages IPO Review – Financial performance

Even though the company has a long relationship with Pepsi and has grown tremendously through the collaboration, the financial performance of Varun Beverages has been inconsistent. The company has posted loss in two of the last four years. However, it recovered to profits in the year ended 31 December 2015. On the positive side, it has managed to grow its revenue in each of the last four years.

The company has put a much better show in the six months ended 30 June 2016. With net profit after tax of INR209.7 crore in the six months, Varun Beverages registered net profit margin of 8.3% in the period.

Does it make sense to subscribe to Varun Beverages IPO?

In terms of financial performance, Varun Beverages is hardly impressive. Going by the diluted EPS of INR5.27 post conversion of CCPS (Compulsorily convertible preference shares) for 2015, the IPO is priced at a PE ratio of 84.4 times. Diluted consolidated EPS for the six months is much better at INR12.61. However, let’s not forget that the company’s business has a very strong seasonality factor to it and first six months of a year have been strong almost always. Our back of the envelope calculation indicates the company’s full year EPS may stand at around INR22.06 which puts the IPO upper price band at a comfortable PE ratio of 20.1.

Peer comparison is not possible as the company has no listed competitors with the range of similar business operations. While this is true to an extent, there are some benchmarks available. Last year, Manpasand Beverages came with its IPO at aggressive valuations and was still received very well by the market. The company, which is not into carbonated drinks, largely focused on small and tier-two towns. There are some similarities between the operations and approaches of these two companies, even though their products don’t conflict with each other. Manpasand and Varun both have demonstrated ability to grow their revenues consistently.

Manpasand’s growth came from underpenetrated markets and a similar trend, to a lesser extent, is visible in consumption of rural markets. The gap in rural and urban India is shrinking with regard to soft drink sales. According to a Euromonitor report, rural markets accounted for 21% of soft drinks sales in 2010 but the figure jumped to 24.3% by 2015. This makes PepsiCo a leading contender in rural markets, in turn benefitting bottlers like Varun Beverages.

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A popular misconception is regarding soft drinks and carbonated soft drinks. The difference between the two categories isn’t clearly acknowledged and the two are often confused as synonyms. As a result, the negativity around carbonated soft drinks often extends to players like PepsiCo even though these companies may have other product categories. PepsiCo has other products such as packaged drinking water (Aquafina) and non-carbonated beverages (Tropicana, Nimbooz) which make nearly a fifth of Varun Beverages’ annual sales. While it is true that cola consumption is growing at a slower pace in urban India due to health concerns, PepsiCo keeps on bringing new products to compensate for this loss. Additionally, there are new markets which are added to the pipeline as consumers in rural areas become brand-conscious in soft drinks.

In total, Varun Beverages IPO needs to be seen in the light of growing consumption in India. If seen through valuations lens, it does not stand a chance; however, as exclusive bottler of PepsiCo and as a leading player to benefit from the untapped consumption, Varun Beverages may not be a bad investment decision. A deep dive in the books and an in-depth Varun Beverages IPO review reveals there is lot of promise in the company, although it may take some time for this to materialize.