CLSA Raises Varun Beverages to 'High Conviction Outperform,' Predicts 70% Upside Potential

Hong Kong-based brokerage CLSA has upgraded its rating on soda bottler Varun Beverages Ltd. to a 'high conviction' outperform, an improvement from its previous 'outperform' rating. This upgrade reflects CLSA’s strong confidence in the company’s growth trajectory despite recent challenges and heightened competition in the market.

However, despite the rating boost, the brokerage has slightly lowered its target price for Varun Beverages to ₹770 per share from its earlier estimate of ₹802. The adjustment accounts for certain short-term risks, including pricing pressures and increased capital expenditure. Nevertheless, CLSA remains optimistic about the company’s long-term prospects, emphasizing that the risk-reward ratio remains highly attractive. The revised target still suggests a substantial upside of nearly 70% from current levels.

As of 12:00 PM IST,  Varun Beverages share price was at ₹471, up 3.04% from its previous close.

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Market Trends and Financial Performance

Current pricing trends indicate a potential 5% EBITDA decline for CY25, reflecting some cost pressures and shifting market dynamics. Additionally, capital expenditure as a percentage of sales peaked in CY23, suggesting that the company’s heavy investment cycle may be tapering off. CLSA believes that capex intensity could ease moving forward, allowing the company to focus on profitability and operational efficiency.

Varun Beverages operates in a rapidly expanding market, with the soft drink sector as a whole experiencing significant growth. Rising disposable income, increasing urbanization, and changing consumer preferences continue to drive demand for carbonated beverages. The company’s extensive distribution network and strong partnership with PepsiCo position it well to capitalize on this growing demand.

Stock Performance and Valuation

Over the past three months, Varun Beverages’ stock has witnessed a notable correction of 28%, leading to a significant reduction in its valuation. The 12-month forward price-to-earnings (PE) multiple has declined from 62.8x to 43.8x, making the stock more attractive from a valuation perspective. CLSA sees this as an opportunity for investors, as the stock is now trading below its historical average multiple.

The recent underperformance in the company’s shares can be attributed to several factors:

Rising competition: The re-entry of Campa Cola into the Indian market with its ₹10 pricing strategy has intensified competition, posing a potential challenge to Varun Beverages.

Coca-Cola’s restructuring: The ongoing restructuring of Coca-Cola’s bottling arm, Dodi, has also added uncertainty to the competitive landscape.

Higher capital expenditure and urban consumption concerns: Investors have expressed apprehension over the company’s capex guidance and concerns about a slowdown in urban consumption trends in India.

CLSA’s Outlook

Despite these challenges, CLSA believes that investor concerns are overblown. The brokerage remains confident in Varun Beverages’ ability to sustain its growth momentum, backed by strong brand equity, an expanding market, and improving operational efficiencies. With its stock trading at an attractive valuation, CLSA expects strong returns for investors in the medium to long term.

As the beverage market in India continues to expand, Varun Beverages remains well-positioned to leverage this growth and deliver consistent financial performance.