We use a 3-stage DCF model and arrive at a fair value of LKR 22.00/share (+38.4% upside; +55.3% TSR). DIST reported an EPS of LKR 0.81 for 1Q FY23 up 73.9% QoQ (+155.0% YoY). Revenues of LKR 12.6bn were up 30.8% QoQ (+85.7% YoY) mainly as successive price increases offset the impact of declining volumes. We expect short-term demand pressure in 2Q FY23E followed by a pickup in volumes during 2H. EBIT margins of 48.6% were up sharply by 15.1pp QoQ; however, we expect 1) rising raw material costs and 2) normalising operations to result in some margin erosion. DIST trades at a sizable discount to its 3-year P/E multiple average, we rate BUY.
Price increases offset volume loss in 2Q; recovery expected in 2H FY23E
Revenues of LKR 12.6bn were up 30.8% QoQ (+85.7% YoY), despite consumers cutting back on discretionary spending amid rising inflation. While overall consumption of legal alcohol has declined, 1) successive price increases and 2) increased consumption of higher end local products by high/middle income consumers has benefitted DIST. These factors helped offset the impact of declining legal alcohol consumption among lower income consumers. As the market leader in legal spirits (approx. 70.0% share), DIST is well positioned to weather a downturn in discretionary spending in our view. Looking ahead, we expect volumes to recover during 2H FY23E with improved economic conditions amid a recovery in the tourism and agriculture sectors.
EBIT margins up sharply; we forecast a decline from current levels
Gross margins of 54.2% were up sharply by 10.8pp QoQ (+13.9pp YoY); management noted that this was due to price increases taken in anticipation of rising ethanol costs. With 1) ethanol production concentrated among a few local suppliers and 2) import restrictions on ethanol, we expect rising costs to erode gross margins from current levels. Operating costs were also down significantly QoQ; we believe fuel price hikes are not fully reflected in results as fuel shortages impacted product distribution in 1Q. Alternate distribution arrangements made shifted the cost to DIST’s customers. We expect a pickup in operating costs in 2Q FY23E; however, to be offset by improving volumes during 2H FY23E. We forecast EBIT margins at 40.2% for FY23E (+0.7pp YoY).
Tax increases on alcohol manufacturers likely through budget reading
Given the increased financing needs of the government, we believe DIST faces a strong likelihood of further tax increases in FY23E. We do not factor a tax increase into our estimates at this stage. We will revisit our estimates with further visibility.
We use a 3-stage DCF model and arrive at a fair value of LKR 22.00/share
We use a 3-stage DCF valuation to reflect the uncertain macro environment and arrive at a fair value of LKR 22.00/share (+38.4% upside; +55.3% TSR). This target price corresponds to an implied P/E multiple of 7.3x FY23E EPS, at a sizable discount to DIST’s 3-year P/E multiple average of 11.7x. We rate DIST a BUY on attractive valuations. Key risks: 1) prolonged recovery in discretionary spending, 2) delayed pickup in the tourism and agriculture sectors and 3) further steep currency depreciation which will impact raw material costs.