Deconstructing the Valuation of Varun Beverages: Is It Overhyped or Undervalued?

Varun Beverages (VBL), the key bottler for PepsiCo in India and other select regions, has been a darling of the Indian stock market for quite some time. Its consistent revenue growth, expanding distribution network, and strong brand association have fueled significant investor interest. But with the stock price reflecting this optimism, a crucial question arises: Is VBL's valuation justified, or is it currently overhyped? Let's delve deep into the numbers to find out.

Varun Beverages Productline

Company Overview

Varun Beverages Ltd. (VBL) is a large-cap company and is the second largest franchisee in the world (outside US) of PepsiCo. It produces and distributes a wide range of PepsiCo beverages across India and six other countries.

Recent Performance and Key Drivers

VBL has demonstrated impressive financial performance in recent years.

• Revenue Growth: VBL has consistently delivered strong revenue growth. In FY23, the company's revenue was up 35.9% YoY to INR 16046 Cr.

  
  

• Profitability: VBL has improved its profitability over the years. PAT in FY23 grew by 68.9% YoY to INR 1601 Cr.

  
  

• Volume Growth: In FY23, VBL saw a volume growth of 23.7% YoY to 848 million cases.

Valuation Metrics: A Deep Dive

To assess VBL's valuation, we'll analyze several key financial ratios and valuation methodologies:

1. Price-to-Earnings (P/E) Ratio

• Current P/E: As of 18 Feb 25, VBL's trailing twelve-month (TTM) P/E ratio is approximately 68.

  
  

• Historical P/E: Historically, VBL's P/E ratio has fluctuated. Over the past 3-5 years, the average P/E has been around 60-65.

  
  

• Peer Comparison: Compared to its peers in the beverage industry e.g., Nestle India, Britannia], VBL's P/E ratio is Higher. For instance, Nestle India currently trades at a P/E of 63 and Britannia at 56. This suggests that investors are currently assigning a Premium to VBL's earnings.

  
  

• Analysis: A high P/E ratio indicates that investors have high expectations for future earnings growth. Whether this expectation is justified requires further investigation.

  
  

• Important Note: Using standalone P/E in isolation can be misleading. We need to consider growth prospects.

2. Price-to-Earnings Growth (PEG) Ratio

• Earnings Growth Rate: VBL's earnings have grown at a CAGR of approximately 40% over the past 5 years. Analysts are projecting earnings growth of around 20% for the next few years.

  
  

• PEG Ratio Calculation: Based on the current P/E and estimated earnings growth rate , the PEG ratio is 2.62.

  
  

• Interpretation: A PEG ratio of around 1 is generally considered fair value. A PEG ratio significantly below 1 might suggest undervaluation, while a PEG ratio above 1 could indicate overvaluation. In VBL's case, a PEG ratio of 2.62 suggests overvaluation. However, the recent price drop has made the stock attractive.

  
  

• Caveat: PEG ratios rely on accurate earnings growth forecasts, which are inherently uncertain.

3. Discounted Cash Flow (DCF) Analysis

• Assumptions: A DCF analysis requires several assumptions, including:

  
  

  • Future Free Cash Flows (FCF): Estimating VBL's FCF for the next 5-10 years. This requires projecting revenue growth, operating margins, capital expenditures, and working capital requirements.

    
    

  • Discount Rate (WACC): Determining the appropriate discount rate to reflect the risk of VBL's cash flows. This typically involves calculating the Weighted Average Cost of Capital (WACC). Let's assume a WACC of about 10.6%.

    
    

  • Terminal Growth Rate: Estimating the growth rate of VBL's cash flows beyond the explicit forecast period. A conservative terminal growth rate of 3-4% is often used.

    
    

• Intrinsic Value: Based on these assumptions, a DCF analysis might suggest an intrinsic value of less than Rs 300 per share.

  
  

• Comparison to Current Market Price: Comparing the intrinsic value derived from the DCF to VBL's current market price helps determine if the stock is overvalued or undervalued.

  
  

• Sensitivity Analysis: It's crucial to perform sensitivity analysis by varying the key assumptions (growth rate, discount rate, terminal value) to understand the range of possible intrinsic values. For example:

  
  

  • If we increase the WACC to say 12%, the intrinsic value decreases.

    
    

  • If we decrease the growth rate, the intrinsic value decreases.

    
    

• Disclaimer: DCF analysis is highly sensitive to assumptions, and the results should be interpreted with caution.

4. Other Relevant Ratios

• Price-to-Sales (P/S) Ratio: VBL's P/S ratio is currently about 8.5%. This can be compared to its historical P/S and the P/S ratios of its peers.

  
  

• Return on Equity (ROE): VBL's ROE is about 27. A high ROE indicates efficient use of shareholder equity.

  
  

• Debt-to-Equity Ratio: VBL's debt-to-equity ratio is 0.67. A high debt-to-equity ratio can indicate higher financial risk.

Growth Opportunities and Risks

Growth Drivers:

• Increasing per capita consumption of beverages in India: Rising disposable incomes and changing consumer preferences are driving demand for beverages.

  
  

• Expanding distribution network: VBL is continuously expanding its distribution network, particularly in rural areas, to reach a wider customer base.

  
  

• New product launches: VBL regularly introduces new products and variants to cater to evolving consumer tastes.

  
  

• Acquisitions: VBL has a track record of strategic acquisitions to expand its market share.

Risks:

• Competition: The beverage industry is highly competitive, with the presence of both domestic and international players.

  
  

• Regulatory changes: Changes in regulations related to food safety, taxation, and environmental standards could impact VBL's business.

  
  

• Raw material price fluctuations: VBL is exposed to fluctuations in the prices of raw materials such as sugar, packaging materials, and concentrates.

  
  

• Economic slowdown: An economic slowdown could negatively impact consumer spending on beverages.

  
  

• Currency risk: VBL has operations in multiple countries, exposing it to currency risk.

Conclusion

Valuing a growth company like Varun Beverages requires a nuanced approach. While its strong growth trajectory and market leadership justify a premium valuation, investors should carefully consider the sustainability of its growth, the competitive landscape, and potential risks.

Ultimately, whether VBL is overhyped or undervalued depends on your individual investment horizon, risk tolerance, and assumptions about the company's future performance. Before making any investment decision, it's essential to conduct thorough research, consult with a financial advisor, and carefully consider all the factors discussed in this analysis.