Detailed Rationale

CRISIL Ratings has upgraded its rating on the long-term bank facilities of Varun Beverages Ltd (VBL; part of the Varun Beverages group) to ‘CRISIL AA+’ from ‘CRISIL AA’ and revised the outlook to ‘Stable’ from ‘Positive’. The rating on the commercial paper programme has been reaffirmed at ‘CRISIL A1+’.

 

The upgrade reflects expectation of strengthening of the group’s business and financial risk profiles over the medium term. The group’s performance during 2022 (January to December) is likely to benefit from favourable peak summer season, full potential of the territories acquired in 2019, and enhanced capacities in Bihar and Sandila plants which got operational in March 2022. Revenue was impacted in the peak summers of 2020 and 2021 amid the Covid-19 pandemic. Driven by strong cash accrual and accelerated debt repayment during the peak season, the group's debt to earnings before interest, tax, depreciation and amortisation (EBITDA) ratio is expected to reach below 1.2 times by June 2022 and is expected to remain below 1.5 times even after factoring in moderate debt-funded capital expenditure (capex) over the medium term. However, any higher-than-estimated debt-funded acquisition or capex would be a key rating sensitivity factor.

 

Revenue grew by 37% in 2021, over the previous year, due to relatively lower business restrictions amid the second wave of the pandemic during the peak season and low-base impact. CRISIL Ratings expects overall revenue growth of above 25% in calendar year 2022 as the group is likely to benefit from early onset of intense summer and waning impact of the pandemic, coinciding with the peak season. As per the management, VBL will be able to sustain the operating margins at historical levels despite inflationary pressure, however CRISIL Ratings expects margins to moderate marginally. While any steep reduction in margins would be offset by stocking of polyethylene terephthalate (PET) for the peak season, benefits of backward integration, continuous cost optimisation (reduced grammage of PET bottles) and operating leverage.

 

The financial risk profile continues to strengthen further, as indicated by interest coverage ratio improving to 8.4 times during 2021, compared to 4.2 times in the previous year. Strong financial flexibility is supported by cash surplus of around Rs 330 crore as on December 31, 2021, modest fund-based bank limit utilisation and ability to raise debt at attractive rates.

 

The ratings also reflect the leadership position of the group in the franchisee operations of PepsiCo, diversity in geographical reach, robust operating efficiency and strong financial risk profile. These strengths are partially offset by susceptibility of business to changes in regulations & customer preferences and inherent risk while integration of large acquired territory.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of VBL and all its subsidiaries, including Varun Beverages Lanka (Pvt) Ltd, Varun Beverages Morocco SA, Varun Beverages (Nepal) Pvt Ltd, Varun Beverages (Zambia) Ltd, Varun Beverages (Zimbabwe) (Pvt) Ltd and Lunarmech Technologies Pvt Ltd. All these entities, collectively referred to as the Varun Beverages group, have business and financial linkages.

 

CRISIL Ratings has adjusted the networth for intangible assets (from acquisition) and amortised goodwill and intangible assets over 20 years starting from calendar year 2017.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths

• Market leadership and geographical diversity in domestic and global markets

The Varun Beverages group is the second largest franchisee for PepsiCo in the world (outside US) being the largest franchisee in India and having the sole franchisee operations in Nepal, Sri Lanka, Morocco, Zambia and Zimbabwe. VBL incorporated a new subsidiary, Varun Beverages RDC SAS, in the Democratic Republic of Congo (DRC), in Africa. Consistent ramp-up in operations via organic and inorganic routes has helped to significantly strengthen the market position and enhance geographical diversity. Following the acquisition of the southern and western India territories of PepsiCo in 2019, VBL has presence in 27 States and 7 Union Territories in India (except Andhra Pradesh, Jammu & Kashmir and Ladakh), accounting for more than 85% of the beverage sales of PepsiCo in India. 

 

Benefits from the dominant position of VBL in the franchisee operations of PepsiCo in India and overseas geographies will continue to aid the business.

 

• Strong operating efficiency

The group continues to derive efficiency from backward integration of operations, with facilities to manufacture crown corks, PET pre-forms, corrugated boxes, shrink wrap sheets, plastic cap closures and plastic shells. Furthermore, presence in contiguous territories helps efficiently manage logistics and other operating costs and maintain economies of scale. Operating margin was healthy at 19.1% in 2021, supported by cost optimisation measures and strong growth in realisations in a few product segments.  As per the management, VBL will be able to sustain the operating margins at historical levels despite inflationary pressure, however CRISIL Ratings expects margins to moderate marginally. While any steep reduction in margins would be offset by stocking of polyethylene terephthalate (PET) for the peak season, benefits of backward integration, continuous cost optimisation (reduced grammage of PET bottles) and operating leverage. However, with cost optimisation measures and improved operating leverage, the operating margin is expected to improve over the medium term. Moreover, few territories remain relatively underpenetrated, and the volume and operating margin in these regions are expected to be at par with those for the current territories over the medium term, which will remain a key monitorable.

 

• Strong financial profile

With strong operating performance in the peak season of calendar year 2022, debt to EBIDTA ratio is expected to reduce to below 1.2 times as on June 30, 2022, compared with 1.9 times as on December 31, 2021. The company plans to undertake moderate capex of Rs 600-700 crore in its organic business, which the balance sheet can easily absorb. With accretive cash flow from previous acquisitions expected in 2022, debt to EBITDA ratio could sustain below 1.5 times over the medium term, despite continuous capex and moderate acquisition.

 

The Company has had a strong track record of improvement in its capital structure in the past. Debt protection metrics have strengthened because of increased cash flow following integration of previously acquired territories and the initial public offering proceeds (infusion of Rs 667.50 crore) received in 2016. Financial flexibility is adequate, as demonstrated by the ability to raise funds from debt as well as equity investors. In September 2019, VBL raised about Rs 900 crore through a qualified institutional placement to reduce the debt availed for funding acquisitions. Liquidity should be comfortable given the strong cash flow and drop in utilisation of the sanctioned bank limit.

 

Weaknesses

• Susceptibility of business to changes in regulations and customer preferences

The domestic beverage industry remains susceptible to regulatory changes regarding the content in soft drinks and increasing environmental concerns over ground water depletion and discharge of effluents by bottling plants in India. VBL restored water back to the ground equivalent to 2.28 times total annual water usage in 2021 through various water conservation programmes. Furthermore, 20 VBL facilities, accounting for 69 percent of total production in CY21, are classified as "Safe" by the Central Ground Water Authority of India. Evolving issues related to disposal of plastic bottles and of single use plastic straws in ready to drink beverages may also impact the industry. VBL recycled ~73% of its PET sold during the three months ended March 31, 2022, and has a target to scale it to 100% by 2023.

 

• Integration of acquisitions of large territories

VBL follows a growth strategy comprising organic and inorganic capacity expansions in the domestic and international markets. Acquisitions of PepsiCo India and third-party bottler territories was completed in the first half of 2019, and the full benefit was expected to flow in 2020. However, the pandemic hampered ramp-up in volume and market penetration in 2020 and 2021. As things normalise in 2022, VBL should benefit from economies of scale in these contiguous territories. Ability to successfully integrate and increase profitability will be a key monitorable for the group.  

Liquidity- Strong

Cash accrual is healthy, significantly aided by organic and inorganic expansion in the past. Accrual for calendar year 2021 was ~Rs 1,231 crore (Rs 1,012 crore in the previous year) against debt obligation of around Rs. 500 crore in 2021. With early onset of summer and a normalised peak season, the cash accrual is expected to remain above Rs 1,400 crore in calendar year 2022. Furthermore, given the seasonal nature of the beverage business, the working capital requirement is moderate. Cash and bank balance was around Rs 330 crore as on December 31, 2021. Utilisation of bank lines (sanctioned limit of Rs 475 crore) averaged 19% over the 12 months through March 2022.

Outlook Stable

CRISIL Ratings believes the Varun Beverages group will sustain improved business and financial risk profiles over the medium term, supported by EBITDA accretion from new territories and integration benefits as well as reduction in debt in the absence of any large, debt-funded acquisition plans.

Rating Sensitivity factors

Upward factors

• Significant and sustained improvement in operating performance, leading to higher-than-estimated cash accrual
• Debt to EBITDA ratio sustaining below 1 time in the absence of any large, debt-funded capex

 

Downward factors

• Lower-than-expected operating performance leading to a significant decline in the operating margin
• Weakening of the financial profile on account of large, debt-funded capex or acquisition leading to debt to EBITDA ratio deteriorating to 1.5-1.75 times on sustained basis

About the Group

VBL was established in 1995 by the promoter, Mr Ravi Kant Jaipuria, to cater to the beverage operations of PepsiCo in India. The company manufactures and distributes carbonated soft drinks, juice based drinks and packaged drinking water. It is the largest franchisee for PepsiCo in India. It has 31 manufacturing units in India: two each at Greater Noida and Sathariya in Uttar Pradesh and one each at Guwahati, Assam; Jodhpur and Bhiwadi, Rajasthan; Nuh and Panipat, Haryana; Kosi Kalan, Hardoi and Jainpur, Uttar Pradesh; Bazpur, Uttarakhand; Phillaur and Pathankot, Punjab; Cuttack, Odisha; Jamshedpur, Jharkhand; Mandideep, Madhya Pradesh; Goa; Kolkata, West Bengal; Bharuch, Gujarat; Mahul, and Paithan, Maharashtra; Sangareddy, Telangana; Sri City, Andhra Pradesh; Mamandur and Tirunelveli, Tamil Nadu; Nelamangala and Dharwad, Karnataka; Palakkad, Kerala; and Begusarai, Bihar.

 

Initially, it had exclusive franchise rights to manufacture, sell and distribute PepsiCo products in seven sub-territories in India. Over time, the promoters expanded franchisee operations in India through consolidation of its group companies as well as acquisition of new territories from third parties. In February 2015, VBL acquired the franchise rights for Punjab, Chandigarh, Himachal Pradesh and the remaining parts of Uttar Pradesh, Uttarakhand and Haryana, along with four manufacturing units—one each in Panipat, Sathariya, Jainpur and Bazpur from PepsiCo.

 

In 2017 and 2018, VBL acquired Bihar and parts of Madhya Pradesh, Chhattisgarh, Jharkhand and Odisha territories from third-party bottlers. With the acquisitions of franchise rights for southern and western sub-territories from PepsiCo India and third-party bottlers in 2019, VBL has expanded its presence to 27 States and seven Union Territories. VBL also increased its effective shareholding to 55% from 35% in Lunarmech Technologies Pvt Ltd, manufacturer of plastic closures for PET bottles, in September 2019.

 

Operations outside India includes franchise operations in Nepal under Varun Beverages (Nepal) Pvt Ltd; in Sri Lanka under Varun Beverages Lanka (Pvt) Ltd; in Morocco under Varun Beverages Morocco SA; in Zambia under Varun Beverages (Zambia) Ltd; and in Zimbabwe under Varun Beverages (Zimbabwe) (Pvt) Ltd. In 2017, VBL divested its 41% stake in Varun Beverages Mozambique Limitada and increased its stake in Varun Beverages (Zambia) Ltd to 90% from 60%.

 

For the three months ended March 31, 2022, revenue from operations was Rs 2,867 crore and profit after tax (PAT) was Rs 271 crore, against Rs 2,270 crore and Rs 137 crore, respectively, in the corresponding period of the previous year.

Any other information: Not applicable