United Spirits (UNSP) is the top pick in our coverage universe. Bears on this stock believe that UNSP?s long-term earnings visibility is low. We disagree ? our in-depth work and conviction on profit pool growth for the Indian liquor industry aside, Diageo itself estimates more than 24% Ebitda CAGR for UNSP over the next five years. We are ?overweight? on the stock.
After the initial tailwinds following the change in management control, we expect the next leg of stock outperformance to be catalysed by increased confidence in higher long-term earnings growth.In its July 4 press release, following the completion of the share purchase agreement with United Breweries (Holdings), Diageo reiterated that ?the transaction is expected to be? economic profit positive in year 5, assuming a 12% WACC.?
Economic profit is the amount remaining after subtracting from total income the total monetary cost of all business activities, as well as the opportunity cost of profits. Here, we assume the opportunity cost for Diageo to be its capital employed to acquire the UNSP stake times its Weighted Average Cost of Capital. Diageo holds 25.02% of the enlarged UNSP share capital at an aggregate cost of R5,236 crore. Hence, to be economic profit positive in year 5, UNSP would likely have to generate over R2,510 crore of net profit after tax in FY18.
