Earnings Report /
Sri Lanka

Distilleries Company of Sri Lanka: Volume slowdown in 4Q amidst low demand conditions

    Asia Securities
    13 February 2020
    Published byAsia Securities

    We maintain our target price at LKR 17.00/share and including a DPS of LKR 0.70 in FY21E, we derive a total return of +1.1%. HOLD. DIST reported a 3Q FY20 recurring net profit to equity holders of ~LKR 1.5bn, up 14.5% YoY, in line with our estimates. Gross revenues were up 6.4% YoY, mainly aided by price. Gross margins improved by 3.0pp YoY as DIST sourced more local ethanol which is relatively less costly. Looking at 4Q FY20E, we expect flat to down volume growth as a result of low demand conditions in the market. On the other hand, should the proposed corporate tax rate revisions pass through, we will revise our estimates for FY21E. As of now, our calculations show a potential LKR 0.25-0.30/share upside to FY21E EPS.

    4Q volumes tracking low amidst low demand conditions in the market

    Gross revenues were up 6.4% YoY in 3Q FY20 mainly aided by price. Despite an election in November 19 and a post-election boost to consumer sentiment, overall quarter saw mild volume growth. Looking at 4Q, DIST notes that demand remains somewhat slow. We remind that despite the VAT reduction in November 19, the government concurrently increased excise duties, offsetting any benefit. As such, DIST was unable to reduce prices. Our channel checks also indicate that there is a slowdown in alcohol production as a result of the slow demand alluded to by DIST. We note that regular consumers of DIST products are mainly daily wage earners who do not largely benefit from the personal tax benefits granted. Also, particularly in the construction sector, our channel checks reveal that the threat of the coronavirus has kept many of the local workers away from the sites, adding to lower purchases. Moreover, with food inflation running high (+11.7% in Jan), we believe many of these consumers are rationalizing spending on alcohol. As a result, we expect flat to down low single digit volume growth in 4Q FY20E. While there will be no budget reading till August (post-general elections), the recent excise duty increase shows that the government will not refrain from another duty increase if required. Any further changes to duties will result in revisions to estimates.

    Local ethanol sourcing aids margins; however risk of ethanol shortfall ahead

    Gross profits for the quarter improved by 3.1pp YoY as DIST sourced more local ethanol which is 2.0-3.0x less costly than imported ethanol. This also enabled to offset some slight increases in operational costs, resulting in an EBIT margin improvement of 1.9pp YoY. Looking ahead, we believe the restriction on imported ethanol imports will compel DIST to source more locally, which will benefit margins. We expect EBIT margins to settle at 35.8% (+2.9pp YoY) in FY20E. While DIST holds imported ethanol stocks, the real test on supplies and production will be when this stock runs out in a few months resulting in a shortfall of raw materials as local supplies are not sufficient to meet demand.

    We maintain our target price at LKR 17.00/share and HOLD rating

    The stock is down 5.4% YTD and up 10.8% YoY. With FY20E drawing to a close, we roll forward our valuations and the stock is trading at 12.5x our FY21E earnings. We maintain our DCF valuation based (WACC 12.9%) target price of LKR 17.00/share. Including a dividend of LKR 0.70/share in FY21E, we derive a total return of +1.1%. HOLD.