Rating Rationale

Strengths
* Operational and technical support received from parent, Diageo: USL's credit profile benefits from being a part of Diageo group. Post take over, for all practical purposes USL is identified as 'Diageo India' by the group even though officially the name has not been changed.

Diageo has focused on improving product quality, channel management, and working capital efficiency, along with driving premiumisation of the portfolio. Moreover, USL is critical, as evidenced by focus of global management to reap benefits in the Indian market. Although USL currently contributes only 8.5% of group's net sales, USL is central to the group's growth strategy.

USL also receives strong management and operational support from Diageo in addition to the strong financial flexibility, business synergies and strengthened governance structure as reflected in common bankers and reducing interest and finance cost over the years.

Diageo, through a series of transactions and open offers, has acquired 54.78% stake in USL. Also, through one-time settlement of USD 75 million (approx. Rs.500 crores), the parent has ensured there is no board and management representation by UB group who now hold less than 4% in the Company's paid up capital. CRISIL takes comfort that, most of the past legacy issues have been resolved through accounting for provisions/write-offs and thus the new management has been formulating future strategy without any interference from past legacy issues.

CRISIL believes USL will remain strategically important to Diageo, and thus will continue to receive strong management and operational support from the parent. The rating of USL though will remain sensitive to the credit profile of the parent.

* Leadership position in the spirits industry in India: USL's strong brand equity, leading position in the Indian spirits markets, solid revenue base, and strong profitability, as well as its broad spread of products across categories and price points and well-balanced geographic presence, underpin our assessment of the group's business risk profile as excellent.

Owing to its comfortable business risk profile, performance in fiscal 2017 was resilient (leading to only 3% decline in volumes) despite various regulatory headwinds and change in business model adopted by the company. First half of fiscal 2017-2018 was also impacted by the highway ban and the one off impact of operating model changes and lead to 8% decline in reported net sales.

CRISIL expects revenue to grow at a healthy pace on the back of established position in the domestic spirits market, focus on premiumisation, favourable demand outlook and support from the parent.

* Strong and diversified product portfolio with established brands: USL benefits from strong brand awareness based on a diverse portfolio of well-recognised brands in diverse categories, and a growing volume share in the premium segment. The company has an outstanding portfolio of premium brands such as Johnnie Walker, Black Dog, Black & White, VAT 69, Antiquity, Signature, Royal Challenge, McDowell's No.1, Smirnoff, Captain Morgan and Four Seasons.

The same has led to sales of Prestige and Above (P&A) growing by 13% in fiscal 2017, leading to a higher proportion in the volume and value to 41% and 58%, respectively (from 37% and 53% in the previous fiscal, respectively). Moreover, operating margin has also improved by 75 bps on account of better product mix, franchising of the popular brands in non-priority states, and cost-saving measures undertaken (such as integration of supply chain and standardised bottles). In first half of fiscal 2018, the sales of P&A have improved by 2% excluding the one off impacts.

CRISIL expects the company to steadily improve its margins, as USL further leverages on its strategy of prioritising premium brands over regular brands.

Weaknesses
* Moderate though improving financial risk profile: Despite gradual improvement in profitability margins, accrual in the past few years has been impacted by provisioning undertaken by the management. The same had impacted net worth and debt protection metrics.

Post takeover by Diageo, the management has focused on deleveraging its balance sheet by divesting its stake in subsidiaries and sale of non-core assets (sale of United Breweries Ltd shares in fiscal 2016) over the past few years. CRISIL expects, the de-leveraging to continue as the management intends to sell further non core assets valued at around Rs 2,000 crores over the medium term. In first half of fiscal 2018 the net debt reduced by 540 crore to Rs 3,531 crore.

Moreover, with improving accrual, the de-leveraging is expected to continue thereby improving the overall credit metrics. Moreover, management's focus on improving working capital management (by gradually undertaking franchising of popular brands in certain states) and further divestment of non-core assets will likely aid the deleveraging process. Ability of Diageo to improve its working capital position and also timely monetize non-core assets, will be a key monitorable.

* Vulnerability to changing regulatory environment: Fiscal 2017 was a disruptive year for the industry on account of Bihar prohibition, demonetisation and ban on liquor vendors within proximity to highways. As a result, revenue in the popular segment declined 9% excluding the one off impact. Moreover, increase in taxes in certain states had an impact on margins. The Goods and Services Tax (GST) is also expected to adversely impact the alcobev industry as input tax credit will not be available.

However, USL has shown resilience to regulatory headwind, as reflected in improving profitability margins in fiscal 2017 on account of efficiency improvement initiatives, premiumisation drive, and shift to franchisee model in certain states.