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Is it wise to invest in vice?

Pallavi Rao in Mumbai | September 20, 2004 10:13 IST

Show me the way to the next whiskey bar..., sang Jim Morrison way back in the 60s. With a growing number of people joining the booze brigade, the song is as relevant today as it was more than three decades ago.

Had Morrison been alive today, he would have inspired Indians more than his fans elsewhere: with over 50 per cent of the population of over one billion averaging the age of just over 24, India has one of the larger liquor consuming crowds in the world.

Though concerns exist, analysts and industry people seem convinced that the domestic liquor sector is slated to grow substantially from the current levels.

The main growth driver for the industry will be the country's demography. "We are slated to witness a boom in consumption quantities given the young population in India," says stock broker Ramesh Damani who is gung-ho about liquor stocks in a long-term horizon.

The country's per capita consumption is just about 0.6 litres per annum, which is among the lowest in the world. This leaves tremendous scope for growth in the industry.

The sector, which recorded sales of 112 million cases last year (organised segment), is growing at an average rate of 8 per cent per year.

Analysts peg the size of the market at Rs 3,600 crore (Rs 36 billoion) of which the organised market constitutes around 70 per cent (McDowell & Co commands a share of 31 per cent, Shaw Wallace 22 per cent, Radico Khaitan 9 per cent and other players the remaining 8 per cent).

Of the total IMFL (Indian-made foreign liquor) consumers in the country, 55 per cent consume whisky, 28 per cent rum, 12 per cent brandy and the remaining 5 per cent gin, vodka and other liquor variants.

As the liquor market is set to grow, the biggies in the business should see disproportionate gains. The clincher is the mandate by the government disallowing direct advertisements in the country. This will prove to be a deterrent to new players who will be unable to create brands.

Obviously, existing brands will demand a premium since they are already well-established. Analysts agree that this will be a major hurdle for new players. The way out for them may be to enter into tie-ups with existing companies, thus promoting new brands under the flagship of existing ones.

The stocks of liquor-producing companies aren't doing badly either: McDowell & Co (a part of UB Group), Shaw Wallace and Radico Khaitan, the three major players in the industry, have seen their scrips record impressive year-to-date gains.

McDowell & Co's stock fell by around 4 per cent to levels of Rs 66. However, after a steeper fall in the past quarter, the stock recovered about 24 per cent in the last month.

Analysts feel that the scrip had witnessed a huge run in the last three months of 2003 and was only consolidating. Scrips of Shaw Wallace and Radico Khaitan rose 78.4 per cent and 124.7 per cent to Rs 125 and Rs 163 respectively.

The hitch here is that investors should not look forward to dividends, which are not paid regularly (except in case of Radico Khaitan which pays dividends religiously). Therefore, stocks may be viewed in terms of capital appreciation alone. While the long-term prospects look good, there are some temporary glitches.

Raw material woes

According to analysts, raw material costs remain a concern for the industry. Prices of molasses, the main ingredient for the production of liquor, surged five-fold in the last one year.

Besides, central excise and countervailing duties continue to be substantially high, preventing smaller companies from gaining a sizeable foothold in the market.

The cost of domestically produced molasses has gone up to Rs 5,000 per metric tonne from Rs 1,000 within the last 12 months. The sharp rise in prices has been attributed to the declining spread of the cane crushing belt, which includes states like UP, Maharashtra, Karnataka and Tamil Nadu.

Crushing capacity of the sector as a whole is expected to fall at least 40 per cent during the next sugar year starting October.

Besides, the government has made blending of 5 per cent ethanol (ethyl alcohol, which is derived from molasses) in petrol mandatory in nine states and four Union territories.

This has led to a decline in the supply of potable ethanol, which is used for the manufacture of liquor, resulting in an abnormal rise in prices.

Currently, around 85 per cent of the molasses produced in the country is used for brewing alcohol for industrial and potable purposes. However, the excise duty structure favours use of molasses for producing ethanol instead of IMFL.

Molasses used to produce ethanol is cenvatable (excise duty paid on molasses can be used to claim cenvat credit on excise duty paid on ethanol), which is not the case for molasses used in the manufacture of IMFL.

So the effective cost of molasses for IMFL producers is more than that for ethanol producers. Agrees Vijay Rekhi, president, spirits division, UB Group, and managing director of McDowell & Company, "An unprecedented hike in costs of basic inputs and restriction on raising prices plague the industry," he says.

Regulatory hiccups

In India, excise duty on alcohol is levied at the state level. Hence, states control the excise duty structure and the distribution system of potable liquor.

Moreover, inter-state sale of IMFL attracts export duty in the state of manufacture and import duty in the state of sale. This results in high prices at the consumer level and acts as a big trade barrier.

Therefore, a manufacturer who wants to sell liquor in a particular state should have a manufacturing facility there. This leads to huge capital expenditure. State level levies prevent economies of scale, increase costs and hamper growth.

Distribution of IMFL is also regulated in some states through either auctions (as in Haryana, Rajasthan and Punjab) or government procurement agencies (as in Tamil Nadu and Andhra Pradesh). These regulations create a monopolistic environment, stifle the spirit of entrepreneurship and hamper growth.

However, things are changing for the better. Since the present distribution system is affecting collection of revenues, state governments have been forced to liberalise distribution.

Uttar Pradesh, where the distribution system was de-regulated two years ago, has seen a rise in excise revenues. Madhya Pradesh has also de-regulated the IMFL distribution system recently to improve collection of revenues.

Besides, there have been talks about introducing uniform excise duty across states and revenue-sharing agreements for inter-state sales. Though not much progress has been made on this front, analysts argue that the industry is in for better times ahead.

"Regulations, once put in place, will provide a stimulus for the growth of the domestic liquor industry," says an analyst with a domestic brokerage and research house.

The following companies look best placed to benefit:

McDowell & Co: The UB Group company needs no introduction. Vijay Mallya's flagship firm commands the highest marketshare of above 30 per cent in the spirits division.

McDowell  & Co has a portfolio of 53 brands including Bagpiper, Blue Riband and Romanov besides the McDowell portfolio. The company is the largest liquor exporter and has a strong presence in the Middle East, the Far East, Africa and Australia.

McDowell & Co posted a healthy growth in its net profit for the first quarter of FY05 - an increase of 32.69 per cent to Rs 5.48 crore (Rs 54.8 million). Net sales, too, recorded an increase of 16.23 per cent to Rs 298.98 crore (Rs 2.99 billion).

For FY04, the company's profit rose 1.23 per cent to Rs 21.35 crore (Rs 213.5 million) while net sales increased 11.59 per cent to Rs 1115.42 crore (Rs 11.15 billion). McDowell & Co has a market cap of Rs 344.20 crore (Rs 3.44 billion) and currently quotes at a P/E of 15.9 times.

Shaw Wallace: Shaw Wallace Distilleries, an arm of  Shaw Wallace, has a total capacity of 25 million cases per annum, of which 15 million cases are manufactured at its own units, while the remaining 10 million cases are outsourced.

It's flagship brand, Royal Challenge, became the first premium whisky brand in India to clock sales of one million cases in FY04. The company also plans to reduce the number of its brands to 20 from 80.

Shaw Wallace has re-launched many of its old products like Antiquity, Royal Challenge, Director's Special, DSP Black, Old Tavern Whisky, White Mischief vodka and London Lime gin. It has a presence in markets like the US, Latin America, the Middle East, Korea, Mongolia and Singapore.

For Q1FY05, it reported a 31.03 per cent rise in net profit while it cut down staff costs (down 19 per cent to Rs 1.84 crore) and other expenses (on a standalone basis). Sales (net of excise) posted a growth of 16.62 per cent to Rs 31.78 crore (Rs 317.8 billion).

For FY04, it posted a loss of Rs 17.19 crore (Rs 171.9 million) against a profit of Rs 0.27 crore in the previous year while net sales fell 26.98 per cent to Rs 124.60 crore (Rs 1.25 billion).

The consolidated earnings for Shaw Wallace for FY04 stood at Rs 174.61 crore (Rs 1.75 billion) against a loss of Rs 10.74 crore (Rs 107.4 million) in the previous year mainly due to a rise in interest income to Rs 10.28 crore (Rs 102.8 million) from Rs 0.47 crore. Revenues fell over 30 per cent to Rs 970.50 crore (Rs 9.7 billion). The company has a market cap of Rs 588.36 crore (Rs 5.88 billion).

Radico Khaitan: The company recently set up a bottling unit in Rajasthan with a production capacity of 15 lakh (1.5 million) cases per year. It has also bought a bottling plant in Andhra Pradesh with a capacity to bottle one million cases a year.

With this, its liquor production capacity has increased to 10 million cases. Radico Khaitan's main distillery located in Rampur is one of the leading manufacturers of rectified spirit and extra neutral alcohol. The distillery's annual production is expected to touch 45 million litres.

The company owns well-known brands like Special Appointment, 8PM whisky and the Contessa portfolio. Besides, it is one of the major suppliers of country liquor in UP. It exports its products to countries in the Middle East and Africa.

For Q1FY05, Radico Khaitan's net profit jumped 56.25 per cent to Rs 8.5 crore (Rs 85 million) despite a modest 7.8 per cent growth in sales to Rs 85.22 crore (Rs 852.2 million), on the back of a fall in selling and distribution expenses (down 7 per cent to Rs 16.02 crore) and other expenses (down 14 per cent to Rs 16.88 crore).

For FY04, the company clocked an increase of 13.47 per cent in net sales to Rs 309.99 crore (Rs 3.10 billion) while net profits grew 38.24 per cent to Rs 25.68 crore (Rs 256.8 million). It has a market cap of Rs 307.96 crore (Rs 3.08 billion) and currently quotes at a P/E of 12.1 times.

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