Too early to say cheers: Liquor stocks face risks over extended lockdown

Liquor is exposed to the risk of excise duty increases as many states stare at large fiscal deficit.
The lockdown extension on Tuesday till May 3 will prove to be a bad hangover for liquor companies, even as their stocks bounced back recently amid expectations of some relaxation in rules governing store reopenings/distribution and a sharp fall in valuations.

After falling 26-35 per cent over a month until March, the share price of major liquor players — United Breweries (UBL), United Spirits (USL), and Radico Khaitan — has gained up to 18 per cent in April, outperforming the 4-per cent rise on the Nifty FMCG index. However, there are downside risks, which could play spoilsport for liquor companies.
Besides discretionary consumption, liquor is exposed to the risk of excise duty increases, as many states stare at a large fiscal deficit, following the coronavirus outbreak.

UBS Securities believes that despite the sharp correction in UBL and USL stocks over the last three months, rerating is unlikely, given the potential tax increases from states to bridge their deficit. According to Dolat Capital, states like Maharashtra, Karnataka, and Telangana earn 12-20 per cent through liquor tax.

 

 
A sharp rise in excise duty could hurt liquor volumes. UBS has slashed its target price for UBL and USL by 20-23 per cent, following 12-27 per cent cut in 2020-21 earnings estimates.

There could be another round of earnings downgrade after the announcement on Tuesday of Lockdown 2.0. While some analysts do not see sharp tax increases, as this could impact the overall liquor sales and, in turn, hurt states’ revenue, the jury is out on this.

As is the case with other companies, labour shortage and the overall supply chain disruption will hurt liquor volumes, even if some relaxation on store reopening happens. “Though prices of key raw materials, such as extra neutral alcohol, have come down, providing better margin outlook, the overall supply chain disruption, including production process, would remain a concern for some time, even after the lockdown,” says another analyst at a domestic brokerage. Closure of hotels and restaurants would further hurt overall liquor sales.

Even as demand for items such as liquor or cigarettes is relatively inelastic, lower incomes (with salary cuts and job losses) are likely to hurt liquor consumption. Some analysts expect customers to switch to lower-priced brands, hurting revenues and margins of companies.

While there are hopes that the liquor ban by some states may not materialise now and raw material prices may remain benign, investors are recommended to stay away until the supply chain normalises and clarity emerges on the tax front.


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