Radico Khaitan Ltd (RKL) is a leading manufacturer of Indian made foreign liquor (IMFL). It
has a strong pan-India presence with growing sales in the premium brands category.
Raw material prices expected to ease: We expect the price of extra neutral alcohol (ENA), a
key raw material for the company, to remain stable and potentially even decline going
forward. This is because sugar production during the October 2014 to May 2015 period
has risen by ~16% yoy to 27.9mn tonne, which is an 8-year high production level. As a
result ENA (a by-product of sugarcane) production too would be higher this year. Secondly,
demand for ethanol (a by-product of sugarcane) from Indian oil marketing companies for blending
with petrol, is also expected to be lower as the price of petrol is around ~Rs34/liter (excluding taxes)
and that of ethanol is around Rs48-49/liter, thus making it unviable to blend ethanol with petrol.
Pricing environment expected to be favourable for IMFL industry: Our interaction with liquor
companies suggests that the industry has now bottomed out. We expect the industry’s
pricing environment to likely get better going ahead mainly because there has not been any
significant price hike in products in recent times due to delay in approval by various state
governments. Hence, the industry is now expecting significant price hike in the coming
financial year. Also, the industry leader – United Spirits – has been facing pressure at the
operating level and the company has a huge debt on its balance sheet. Hence we believe that
the company’s new Management would shift focus on profitability over volume growth, which in
turn, would lead to increased scope for other liquor companies to hike prices.
Higher proportion of Premium products in volume mix to drive profitability: In the IMFL
segment, more than 20% of the company’s volumes come from prestige and above
products, which is a high margin business, and the balance volumes come from regular
and others brands. Since the last seven years, the company’s prestige and above brands’
volume has reported a CAGR of ~26% and their share in the product mix has increased
from 7.9% in FY2009 to 20.7% in FY2015. We expect volume contribution of prestige and
above products in the IMFL segment to increase further on back of higher ad spend. The
company has roped in Hrithik Roshan as its brand ambassador. Also, RKL’s presence in the
prestige Vodka segment is under penetrated which leaves scope for growth. Thus, this
would improve the overall margin for the company and result in higher profitability.
Valuation: On a trailing basis, RKL is trading at 1.2x EV/Sales, which is at a discount
compared to its close peers like United Spirits (trading at 5.9x EV/Sales). Further,
Tilaknagar Industries is trading at 1.5x EV/Sales in spite of it having lesser presence in the
premium brands segment and in spite of its small size and regional focus. Considering
consensus numbers of FY2017, RKL is trading at a 78% discount (in terms of P/E valuation)
to United Spirits, which is unjustified in our view. At the current market price, RKL trades at a
P/E of 12x FY2017E EPS. We initiate coverage on the stock with a Buy rating and target
price of Rs112 (17x FY2017E EPS), indicating an upside of ~37% from the current levels.

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