Alcohol cos see no respite from high input costs

Informist, Monday, Jun 12, 2023

By Reshab Shaw

BENGALURU – Alcoholic beverage manufacturers will continue to be battered by high input costs, and the resultant impact on margins will be felt for at least two more quarters, according to industry observers.

Margins of companies like United Spirits Ltd, United Breweries Ltd and Radico Khaitan Ltd began coming under pressure from rising prices of raw materials like barley and of packaging material like glass a year ago.

While barley prices jumped because of the war in Ukraine, prices of other raw materials headed north in tandem with the overall inflationary scenario in commodities.

"The alcohol and beverages sector is under tremendous pressure with rising raw material costs, higher taxes and shrinking margins," said Prashanth Tapse, senior vice-president (research), Mehta Equities Ltd.

Tapse said the sector lacks the pricing freedom that many other sectors enjoy, where manufacturers are free to pass on rising costs to consumers.

Indeed, the cash profit margin of United Breweries fell 160 basis points to 0.8% sequentially in the Jan-Mar quarter, while the margin of United Spirits fell 29 bps to 11.47%, also sequentially. Compared to a year ago, operating profit margins are down by 3.2-12.3 percentage points.

Rising raw material prices and the inability of companies to pass on costs are "pinching the sector into a crisis", added Tapse.

In India, the government regulates the production, pricing, movement and sale of alcoholic beverages to various degrees, depending on the state. In recent comments made in the context of the March quarter results, companies expressed their inability to predict when the pressure would ease.

"We see inflation in our key commodities not abating yet... so we expect volatility to continue," Hina Nagarajan, managing director and chief executive officer at the country's largest branded liquor company United Spirits, noted. She added that these headwinds are affecting consumers more in the lower- and mid-priced products.

It's not just United Spirits that is being pinched by rising costs. "Q1 (Apr-Jun) is going to continue (to be) difficult for us in terms of margins," United Breweries Chief Financial Officer Radovan Sikorsky said when discussing the company's quarterly finances last month.

Prices of extra neutral alcohol, the primary raw material for making alcoholic beverages, have been on the boil since the beginning of last year.

Bottle prices have also gone up since the Ukraine war began in February 2022. Several glass factories in Ukraine have been destroyed or have shut. This, coupled with the sanctions imposed by the West on Russia, has disrupted supply chains, leading to a rise in bottling costs.

Yet another factor pinching the companies is the rising cost of converting barley into malt, no thanks to rising energy prices.

COST-CUTTING MEASURES

Tapse said companies have taken many steps to meet the challenge such as reducing promotion and marketing costs and dumping the boxes and cartons in which bottles used to be packed. But the need of the hour is for companies to raise prices, which looks difficult given the tight government control.

Interestingly, prices of barley, the main raw material for beer, are believed to have peaked in May 2022. In the Alwar market in Rajasthan, modal selling price of barley was 2,900 rupees per quintal on Apr 1, 2022, when companies first started reporting inflationary pressure on commodities. On Jun 1, 2023, the price of barley fell to 1,780 rupees per quintal. A quintal is one-tenth of a tonne.

The management of United Spirits agreed that it is seeing some moderation in glass prices too. The maker of premium liquor brands like Johnnie Walker and Black Dog said the recent intervention by the government in pricing of natural gas, which is used by glass makers, has also provided some support. "We are in discussion with suppliers if we can get some rollback on account of that," Chief Financial Officer Pradeep Jain told analysts.

Sikorsky of United Breweries was, however, more sombre in his assessment. "We still see in our Q1 bottling pricing (that there will) be an impact and even into Q2 on the bottle," he said. Barley prices might see improvement sooner than bottle prices "because of the supply in the market", he said.

The raw material pricing situation for Radico Khaitan, too, will remain volatile, said Chief Financial Officer Dilip Banthiya last month. Radico Khaitan produces popular vodka brand Magic Moments, among others.

Sikorsky said United Breweries, the Kingfisher beer-maker, is working with larger suppliers to mitigate the problem, but added that the picture will only improve in the medium to long term. "We see that in Apr-Jun, the bottling price will (have an) impact, and even into Jul-Sep," he said.

The United Breweries management has plans to address the supply issue with focus on the "returnability" of bottles already sold. But it's not an easy solution as collecting used bottles is a complex process and needs some infrastructure.

The managements of alcohol companies are betting on strong demand and fresh raw material supplies even as pricing pressure subsides in the next few quarters.

"We are working to get the new crop in," Sikorsky said. "We have started purchasing the new crop." The crop that arrived in April and will be used from July is looking good in terms of quality and quantity, United Breweries said.

In India, barley is usually sown in October or November in the rabi season and harvested in March or April.

Sugandha Sachdeva, executive director and chief strategist at Acme Investment Advisors, said continued strong consumer demand will eventually help the companies' margins to recover as inflationary pressures subside. What remains to be seen is when that happens.

Today, shares of United Spirits ended 0.8% lower at 880.75 rupees on the National Stock Exchange, those of United Breweries ended 0.4% higher at 1,482.40 rupees, and Radico Khaitan closed flat at 1,191.40 rupees. End

Edited by Rajeev Pai

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