Global investment bank UBS on Friday downgraded United Spirits to "sell" from "neutral" with a target price of Rs 1,800. The downgrade comes after a sharp run-up in the stock following the announcement of a $2.1 billion deal with U.K.-based spirits major Diageo last week. United Spirits shares have gained over 35 per cent in the last three trading sessions on the back of upgrades from several analysts, who called the deal "transformational" and a "game changer" for the Indian liquor maker.
Here are five reasons why UBS has downgraded United Spirits
- Diageo wants to de-emphasise USL's top sellers: Sunita Sachdev, executive director at UBS, told NDTV that Diageo wants to push higher end brands in the markets at the cost of USL's volume toppers such as Bagpiper. “The brands it wants to de-emphasise... the volume market share in these brands is over 35-45 per cent and they all sell huge volumes,” she added. The problem with India and having such large market sizes is that it is difficult trimming down these positions because you have upstream and downstream commitments and a regulated industry, Ms Sachdev said.
- Diageo's push for higher ad spend, working capital at the cost of paring debt: The entire industry is assuming that the fund infusion will be used to repay (USL’s) debt, Ms Sachdev said. Diageo has clearly said it wants to pare down debt, but also wants to support business with higher working capital. "This nullifies the interest cost saving that the Street is building in," Ms Sachdev added.
- Diageo's premium brands to be rolled through subsidiary: A 100 per cent privately held subsidiary, Diageo India Private Limited, will be used as the launch vehicle for Diageo's brands like Black Label and Smirnoff. "This is a risk to (the) minority shareholder interest in USL," Ms Sachdev said.
Explaining the reasoning, Ms Sachdev says the key difference between say an acquisition of Heineken or the 37 per cent holding that Heineken has in UB is that Heineken has launched the brand Heineken within the UB product portfolio and so it has a much higher multiple.
"You will not see a Black Label being launched within the USL network and that's the key differential," she said.
- Valuations: The stock is trading at 40-times FY14 earnings -- a huge premium to the sector. UBS says United Spirits should trade at 30-35 times but not 42 times FY 14 earnings and the fair price on the stock should be Rs 1,800 for FY14 and between Rs 1,800 and Rs 2,000 for FY15.
- Margins to kick in much later: Although the stock has run up sharply, the big margin kicker will come in at the end of FY15 and over FY16 and FY17.
"Our estimates are going up by 20-25 per cent in FY15 and FY16... and that's when we see margin kicker coming in terms of strategy playing through in higher end brands," Ms Sachdev said.