Can Pepsi versus Coke Battle Downgrade Varun Beverages? 

The tiff between Pepsi and Coca Cola has been the subject of countless television advertisements in India over the past decades.

It appears such a tiff between the two beverage giants is overdue in the Indian stock markets too.

Ravi Jaipuria the Chairman of RJ group started his career as a vendor for Coca Cola. But shifted his association to Pepsi in the 1990s.

The group's flagship company, Varun Beverages, manufactures soft drink bottles and distributes beverages. It is the largest bottling company of PepsiCo's beverages in the world outside the United States.

The company produces and distributes a wide range of carbonated soft drinks, non-carbonated drinks and packaged water sold under trademarks owned by PepsiCo.

The RJ group also controls Devyani International, which is a franchisee of Pizza Hut, KFC and Costa Coffee in India.

Interestingly, both the stocks have been on investors' radar.

However, it is Varun Beverages, with 1270% gains since April 2020 that has seen significant rerating.

From a P/E multiple of 35 times in 2020, the stock fetched a multiple of over 100 times in May 2024.

Devyani International's 47% gains since listing in September 2021, pales in comparison.

But does the stock of Varun Beverages deserve the rerating?

The company's monopoly as the only listed bottling vendor of a global beverage brand is certainly an advantage. But there is more to it.

The company's operations span 6 countries of which three are in the Indian subcontinent - India, Sri Lanka and Nepal. These contribute 85% to total revenues.

The other three are in Africa (Morocco, Zambia, Zimbabwe), which contributed balance 15% of revenues last fiscal.

Varun Beverages has an extensive network covering urban, semi-urban, and rural markets.

The company has 37 manufacturing facilities in India and 6 internationally. It also has a robust supply chain with 110 owned depots, 2,500 owned vehicles, over 2,400 primary distributors, and nearly a million currently installed coolers.

Its product profile is reasonably diversified with 70% volumes came from selling carbonated soft drinks, 23% from selling packages of drinking water, and the rest 7% from selling non-carbonated beverages. So far, 80% of sales volume is generated in India.

However, the company is trying to increase the share of international revenues. For instance, it is expanding its footprint in African continent via capacity expansion, acquisitions and licensing rights from PepsiCo.

Acquisition of BevCo in South Africa, and distribution rights in Namibia, Botswana, Mozambique and Madagascar over the company sufficient footprint. In addition, Varun Beverages will be entering into an agreement to manufacture Cheetos and Doritos in Morocco market.

As per estimates, the Indian soft drinks market is expected to grow about 5% annually on a compounded basis over the next four years to touch US$ 9 bn by 2027. So, to prepare for the incremental demand, the company has added new bottling plants in the Indian states of Uttar Pradesh, Maharashtra, and Odisha.

Varun Beverages has also established backward integration facilities to produce preforms, crowns, plastic closures, corrugated boxes, corrugated pads, plastic crates, and shrink-wrap films in certain facilities to ensure operational efficiencies and higher quality standards.

The company also owns a 55% stake in Lunarmech Technologies which produces and sells PET bottle caps and crown caps.

The company uses around 66,000 MT of PET resin as packaging material for its finished products annually. So, to rank higher on the ESG norms, Varun Beverages has engaged with GEM Enviro Management for phased implementation of 100% recycling of used PET bottles. This is through collection from end users by placing dustbins in reverse vending machines, direct collection from institutions, etc.

In addition the company has taken 15% stakes in two special purpose vehicles engaged in supplying solar power to the states of Maharashtra and Uttar Pradesh.

With compounded growth rate of 26% and 47% in sales and profits over the past five years and average return on equity of 25% over the same period, the stock ticks most fundamental boxes. The debt-to-equity ratio of 0.8 times does not put the balance sheet at significant risk.

But the biggest concern for a franchisee company is the life of the license agreement. Here too Varun Beverages offers sufficient visibility. In 2019, Pepsico extended the bottling appointment and trademark license agreement upto April 30, 2039.

So, what could then possibly hurt the valuations of the stock?

Enter Coca Cola.

Turns out the competitor is planning to sell a part of its wholly-owned bottling business, Hindustan Coca-Cola Beverages (HCCB). For this, it has approached the promoters of at least four corporate groups.

The corporate groups include Jubilant Group, Dabur, Pidilite Industries and Asian Paints. Coca Cola is eyeing an investment of about US$ 800 m to US$ 1 billion in a bid to grow its business in India.

Now the sale of stake in the bottling franchise could be a double-edged sword for Varun Beverages.

First it could allow Hindustan Coca-Cola Beverages to leverage the significant distribution networks of the said corporate groups. Secondly investors could choose to ride the upside in the distribution of yet another leading beverage brand through another stock.

As per reports, HCCB is also considering an initial public offering (IPO). So, Varun Beverages would certainly lose its monopoly.

Therefore, as much as the sharp run up in the stock of Varun Beverages looks enticing, investors must not forget that the downside risks are significant at current juncture.

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