Globus Spirits is another stock that has taken a severe beating in the last 2-3 months. From a high of 194 in Nov 2010, the stock is down by half quoting at 111 (almost at IPO levels) CMP, Feb 11, 2011 after appreciating 8% from yesterdays low.
There may be merit in examining whether the stock actaully deserves this beating or represents a good opportunity.
Please take the discussion forward.
Globus Spirits Stock Story
GSL is engaged in the business of manufacture, marketing and sale of Industrial Alcohol comprising Rectified Spirit and Extra-Neutral Alcohol, Country Liquor, and Indian Made Foreign Liquor (IMFL). GSL has established its identity in Country Liquor and IMFL business with steady growth and production of high quality liquor.
GSL has a brand portfolio of its own in the Country Liquor segment, and caters to reputed Indian brands in the IMFL segment. GSL has already launched its own IMFL brand (Country club) in some 7 states.
GSL has two modern distilleries at the following locations:
Behror, District Alwar, Rajasthan: The facility is built on an area admeasuring 17.97 acres of land. The unit has its own captive supply of water and power.
Samalkha, District Panipat, Haryana: The facility is built on an area admeasuring 16.575 acres of land. The unit has its own captive supply of water and power.
At present both the units are capable of manufacturing alcohol from both molasses and grain. Both the Units have licensed and installed capacity of 144 lakh Bulk Litres (BL) p.a. each aggregating to 288 lakh BL. This capacity has recently been expanded to 70 mn bulk liters. It is in the process of merging another distillery ADL with a capacity of 14.4 mn. Total capacity ios slated to go up to 84.4 mn soon.
Main Customer Industries
- The important end users are institutional (e.g. Armed Forces) and retail buyers. Company has tie-ups for bottling IMFL products for other brand owners.
- **Capacity doubled; commercial production to start soon -**GSL has increased its capacity to 70mn litres from around 28.8mn litres, and the expanded capacity was reported to be ready to start commercial production by Q4FY11. The full impact of the expansion will be seen in FY12, when the company expects full capacity utilization.
- **Strong Balance sheet to fund future growth -**GSLâs balance sheet is one of the strongest among its peers with 1HFY11 d/e at 0.2x. With increasing cash flows expected from the business, the company is in a position to leverage its balance sheet to fund an investment-driven future growth (brand-building, distribution network, expanded capacities with newer technology) both organic as well as acquisitive.
- **Company Branded IMFL is a key focus segment -**Branded IMFL is a key focus segment. The company launched a whisky brand Country Club, which has got good response. It plans to launch another brand in the semi premium segment in 3QFY12. The company hopes to build a pan India distribution network on the back of these brands and other such launches. This segment comprised 7% of Sales in Q1/Q2 FY11 and has gone up to 13% of Sales in Q3 FY11. IMFL segment enjoys the highest margins in GSl business (15%-16%), however brand building and setting up pan-Indian distribution network will entail significant investments and may pressurize margins in the near term.
- **Franchisee IMFL & Bottling may see strong growth -**Franchisee IMFL and bottling accounts for 30% of the revenue mix and will see strong growth in FY12 as a result of the acquisition of Associated Distillers which will take the total capacity to 84.4 Mn from 70 Mn. ADL has a bottling tie-up with Jagatjit Industries, which will supplement GSLâs bottling tie-up with Jagatjit in another state. Together, GSL has a tie-up to bottle 1mn cases for Allied Breweries and 1.2mn cases for Jagatjit. Deepening relationships with these players itself should result in good growth for this segment for GSL. The company supplies bulk alcohol and bottles for these clientele, resulting in capturing higher overall margins.
- **Country liquor is the bread & butter business -**Country Liquor is the bread and butter business for GSL accounting for over 40% of the revenue mix. GSL is the market leader in the North India in country liquor. Volume growth has been in double digits in FY10 and GSL has outperformed in its markets the overall CL growth. Management seemed quite confident of the country liquor remaining a strong market for the coming times. It continues to strengthen its presence in the CL market by adding new variants and flavours.
- **Establishing IMFL brand presence fraught with execution risks -**The company as of date has only 1 brand in the IMFL segment and has a limited distribution network in a few states. Planning to launch another brand by Q3 FY12 which is a year away. Distribution network cannot ride on a single brand! Establishing new brands and a strong pan India distribution network will entail significant costs, cannot be achieved overnight, and may take atleast 2 years to reach any scale. Entry of more domestic and multinational players in the IMFL industry may force the Company to reduce the prices of its products which may reduce its revenues and margins which could have a materially adverse effect on its business.
- **Enhanced Bulk Alcohol capacity will be a drag on margins -**With the increased capacity of 70 Mn available from Q4 FY11, the share of bulk alcohol in the revenue mix will go upto over 30% from current ~14%. Bulk alcohol segment is the lowest margin segment (8-10%) and this is bound to drag down overall margins because of the larger share. The IMFL segment is incurring heavy investments for launching new whiskey brand (Country club) which may further impact margins.
- **Constraint in the availability and volatility in prices of raw materials -**The Company is exposed to possible unpredictability in the supply of raw materials and price volatility, be it molasses or grain. Despite the companyâs claims of risk diversification by being present in all segments, margins were hit in 1HFY11 largely because of lower realization from Bulk alcohol. Lower molasses price has led to downward pressure on bulk alcohol, and has therefore hurt GSLâs realizations too. Disruption in the supply of raw material may lead to hampering of the production process flow. Uncertainty over the availability of raw materials may impact business prospects. Shortage of sugar cane and drought like conditions may result in higher prices of molasses and grains.
- **Equity dilution on account of merger of Associated Distilleries Ltd -**The company will be issuing 3.23 million additional shares to existing shareholders of ADL for the swap to GSL. The no of shares of GSL will go up to 22.99 Mn from 19.75 mn. While earnings per share will see a marginal increase, this will result in equity dilution of ~16% for ordinary shareholders. The scheme is pending direction of the court.
- **Alcohol industry is heavily regulated by the Government -**The business of the Company is subject to the respective State governmentâs policy on excise. Changes in the fiscal policies of the Government could have an adverse impact on the profitability of the Company. A significant change in the Government liberalization and deregulation policies could affect business and economic conditions in India and the business of the Company in particular. Adverse changes in other regulation such as the distribution norms may affect the operations of the Company. States mayindividually decide to impose prohibition on the sale of alcoholic beverages including IMFL, as has been done in the past in a couple of states.
- The Indian alcohol market has high entry barriers largely due to government regulations. In most of the States, the distribution of alcohol is regulated by the concerned State Government. Being a state subject; within India itself, the policy on alcohol retail differs from state to state. Distribution of IMFL is also regulated in some states either through auctions or through government procurement agencies (as in Tamil Nadu and Andhra Pradesh etc.)
Indian Alcohol Industry
The Indian potable alcohol market has high entry barriers, largely due to government regulations. The policies and levies on alcohol vary from State to State. In most of the States, the distribution of alcohol is regulated by the concerned State Government. Being a state subject; within India itself, the policy on alcohol retail differs from state to state. While some states such as Maharashtra, Uttar Pradesh, and Tamil Nadu have a liberal policy, other states such as Haryana and Andhra Pradesh have had very bitter experiences intrying to make these states dry and have eventually had to withdraw the policy.
Each State levies taxation and duties on alcohol at its own decided rates. Each State also levies excise duties and also regulates distribution channels of alcohol in its own way. Liquor happens to be a major contributor to the stateâs exchequer. Some states, have, in the past, taken firm action in terms of banning the sale of alcohol within their state, but their decision had its own political fallout, and the ban had to be withdrawn.
Currently the industry is dominated by 3 brewers, the United Breweries, Shaw Wallace and Mohan Meakins. However, a number of international brewers are starting to become established. Joint ventures could continue to be more important as the distribution network in India is complex.
India is the largest producer of sugarcane in the world and sugar industry is the second largest agro-based industry of India, textiles industry being the largest. Production of molasses has increased from 0.4 million tonnes in 1950-51 to 8.29 million tonnes in 1995-96. The Government has already decontrolled the prices and movement of molasses. (Source: Financial Appraisal Report of SBI dated September 5, 2008)
Advertising of alcohol and alcohol-related products is officially banned and considered illegal. Major liquor manufacturers, however, spend heavily on surrogate brands under the same brand names such as glasses, mineral water, music items, fashion articles etc. Satellite and cable television however, being uplinked from outside India, have allowed liquor advertising by Indian brands.
As regards the distribution system, all outlets have to be licensed; Wholesalers, Retailers, Bars and Restaurants, and Bonded Warehouse operators. The Distribution system is still the same for Beer as for Spirits and Wine. They pay the, varying, States licence fees. These can, at present, only sell Indian-made Liquor over most States. It continues to be expected that Beer and Wine may shortly be permitted to sell in more outlets.
The liquor industry is suffering from over-taxation and over-regulation, which has impeded the profitability even in the face of continuing growth in demand for liquor products. Further widening the scope of service tax and increase in the rate of service tax has had a direct impact by way of increased expenditure on the Company.
Distribution of IMFL is also regulated in some states either through auctions or through government procurement agencies (as in Tamil Nadu and Andhra Pradesh etc.) These regulations create monopolistic environment, stifle entrepreneurship spirit and hamper growth. The present distribution system is affecting the revenue collections of the states, and the state governments are increasingly looking to liberalize the distribution system. Uttar Pradesh is a good case in point where the excise revenues witnessed a substantial jump once the distribution system was de-regulated in financial year 2001-02. Stagnating excise revenues (from liquor) are also forcing state governments to re-look at archaic systems.
Future Demand Drivers and Outlook
With rapid growth in the middle class segment, increasing consumerism, rising disposable income levels, rising standards of living, increase in number of discerning customers, and increase in the number of liquor brands and categories available to the consumer, there will invariably be an increased growth of all segments of liquor industry.
The foreign players are likely to have market grip over the super premium and premium segments and the Indian manufacturers would see a reduced market share. The domestic majors will nevertheless upgrade the large Country Liquor market into IMFL. Local players have all along dominated the Country Liquor segment wherein there are no large players or multinationals coming in to this specific segment.
Even amongst the various IMFL segments, Vodka, White Rum, and Brandy are expected to grow at above-industry growth rates albeit on a very low base.
The demand for Alcoholic Beverages has been growing at a steady pace of approximately 10% p.a. and (this growth rate) is expected to continue to grow at this rate in the future. Supply is expected to match the demand over the medium term. The overall profitability of the industry would continue to be subject to the prices of molasses and the extent of competition besides the duties levied by State Governments. (Source: Financial Appraisal Report of SBI dated September 5, 2008)