Diageo India: The largest spirits company in India

United Spirits Ltd (USL), a group company of Britan’s Diageo Plc, is the largest Indian spirits company involved in the manufacture, sale and distribution of beverage alcohol. USL produces and sells around 120 million cases of Scotch whisky, IMFL whisky, brandy, rum, vodka, gin and wine. It has 88 manufacturing facilities across 23 states in India.

Key Facts:
– USL is the market leader in the spirits category with 40% market share
– Diageo is the global giant in beverage alcohol
– USL’s portfolio includes brands such as McDowell’s No.1, Royal Challenge, Signature and Antiquity
– USL imports, manufactures and sells Diageo’s iconic brands such as Johnnie Walker, VAT 69, Black & White, Smirnoff and Ciroc in India
– USL enjoys strong brands across categories and price points
– USL operates in three segments such as popular, prestige & above and super premium
– The popular segment includes brands like McDowell’s Brandy and Rum, Bagpiper, Old Tavern and Director’s Special Whiskey
– The prestige & above segment includes brands like McDowell’s No.1 Whisky, Royal Challenge, Signature, Antiquity and Black Dog
– The super premium segment includes brands like Johnnie Walker, VAT 69, Black & White and Smirnoff
– 49% of its revenue comes from popular segment, and the remaining 51% comes from prestige and super premium
– USL has 4 brands that sell more than 10 million cases annually
– USL has 14 brands that sell more than a million cases each year
– USL’s top 21 brands have grown at a CAGR of 8% in the past 5 years
– USL exports its brands to 37 countries across the globe
– USL has a strong distribution network of 81,000 outlets across India
– USL is a major contributor to state excise revenues with a contribution of over Rs 35,000 crores annually
– South India prefers Brandy & Rum whereas North India prefers Whisky
– USL is moving towards a franchise based model similar to Pernod Ricard (PR)
– USL is focusing on more profitable premium and super premium segment

Management:
– Mr. Anand Kripalu, MD & CEO of USL, has a Bachelor’s degree from IIT, Chennai and an MBA from IIM, Kolkata, and has completed the Advanced Management Program from Wharton Business School. He was formerly president of Mondelez and MD of Cadbury India. He worked at HUL for 22 years. Mr. Anand is leading USL’s transformational journey
– Mr. Mahendra Kumar Sharma, Chairman of USL, has completed the Advanced Management Program at the Harvard Business School. He worked at HUL for 33 years. He is on the board of reputed companies such as Wipro, Asian Paints, Blue Star and ICICI Bank also member of the Executive Board of the Indian School of Business
– Diageo is bringing in better processes, better control and better corporate governance
– Able and honest management

Investors:
– Diageo Plc holds close to 55% of the company
– FIIs hold close to 23.7% of the company
– Mutual Funds hold close to 5.3% of the company

Stock Picks: Wipro Ltd

Wipro is the 4th largest IT Services company in India. It has 170,000 employees in 55 countries with revenues of $7.3 billion in FY16.

Key Facts:
– Wipro’s revenue has grown from $2.6 billion in FY07 to $7.3 billion in FY16 at a CAGR of 12%
– Diversified business portfolio, with no vertical contributing more than 27%
– 52% of its revenue comes from the Americas, 25% from Europe and remaining from other regions
– Wipro has taken initiatives to enter the market of future disruptive technologies including Digital, Analytics and Cloud

Clients:
– Top 10 clients accounted for 20% of its total business
– 9 clients in the $100-million category
– 18 clients in the $75-million category
– 33 clients in the $50-million category

Management:
– Able and trustworthy management
– Chairman, Azim Premji is India’s richest tech tycoon. Under his leadership, Wipro’s revenue grew from $2 million to $7 billion in FY16. Asia’s most generous person who has given away shares worth $4.4 billion
– Consistent dividend payout

Opportunity Size:
– India is the world’s largest outsourcing destination for the IT industry, accounting for approximately 67% of the total $110 billion market
– The IT offshoring market is expected to grow at a CAGR of 14% for the next 9 years
– The IT offshoring market is expected to triple from $110 billion to $350 billion by FY 2025
– Revenues from Digital technologies are expected to represent 23% and 38% share of the total revenues by 2020 and 2025

Risks:
– Highly competitive and rapidly changing industry
– Top line growth is not improving
– The business model of IT is changing very rapidly. Artificial Intelligence, Robotics, Cloud Services are reducing the head count of employees around the globe
– 28% of Wipro’s revenue comes from Infrastructure service and 9.8% revenue comes from BPO services. These 2 service lines are at high risk due to the recent disruption from Cloud Services, Automation and Robotics

Investors:
– LIC owns 2.3% of the company
– JP Morgan Chase owns 2% of the company
– Mutual Funds own close to 1.9% of the company

Valuation:
At current price of Rs 479, the rate of return is 10% based on pre-tax earnings to market cap with dividend yield of 1.5% and $4.8 billion in cash. The RoE and RoCE is more than 17% for the past 10 years. Wipro is trading at a historic low P/E of 13.3x as on Sep 16, 2016.

Detailed Analysis:
1. Is the business simple and understandable?
Yes. Wipro provides application development and maintenance services to global clients. The services are provided on a time and material (T&M) or fixed-price basis. 56% of Wipro’s revenues comes from fixed price model. The revenue growth is linked to increase in number of employees. It is a very linear model. Increasing the number of clients and projects can boost the revenue of the company.

2. Does the company have a consistent operating history?
Yes. The company has been consistently increasing its revenue for the last 25 years.

3. Does the business have a sustainable competitive advantage?
Long-standing customers are reluctant to switch IT vendors due to high switching costs. Wipro has taken initiatives to take advantage of the disruption technologies like Digital, Analytics and Cloud. Wipro has strategic alliance with market leaders like Amazon, Salesforce, SAP and IBM to position itself in the digital technologies.

4. How good is management at allocating capital?
Very Good. The return on capital is more than 17% for the past 10 years.

5. What are the risks?
The risks are highlighted above under section ‘Risks’.

6. Does the business operate in a good or bad industry?
Most companies rely on IT applications to efficiently run their business operations. IT services companies help these businesses maintain and improve the availability of IT.

7. Does the company earn high profit margin?
Yes. The profit margin of Wipro is 20% for the past 15 years.

8. Does the company generate strong free cash flow?
Yes. The company has generated Rs 8000 crore of free cash in FY16.

9. Can you sensibly estimate future earnings for next five years?
Since the IT business model is changing, it would be difficult to estimate future earnings. We believe that the top 4 IT players are in a position to take advantage of the future disruption technologies like Digital, Analytics and Cloud.

10. What is the reasonable buy price?
Check the reasonable price under section ‘Valuation’

Disclaimer:
MyValuePicks is not a registered investment advisor or broker. Readers are advised that the material contained herein should be used solely for informational purposes. MyValuePicks does not accept responsibility for consequences of financial decisions taken by users on the basis of information provided herein. The aim is to provide a reasonably accurate picture of financial and related opportunities based on information available with us.

Stock Picks: Mindtree

Mindtree is a mid-size IT services company.

Strategy:
– Focus on large clients and increase revenue from each client
– Focus on building long-lasting relationships with major clients
– Focus on 4 key business segments
– 35% of its revenue comes from digital business
– Growth from its top clients is one of the best in the industry

Clients:
– Top 10 clients accounted for 46% of its total business
– 6 clients in the $25-million category
– 15 clients in the $10-million category
– Microsoft is one of its top clients
– Key clients in the digital space include Microsoft, Unilever and P&G
– Key clients in the Salesforce space include Nike, Honeywell and Cargill

Management:
– Trustworthy and reliable management
– Growth rate is better than industry average
– 5x return in the last 5 years
– Exited mobile handset business (wrong bet)

Employees:
– Employee friendly company
– Attrition rate is one of the lowest in the industry

Acquisitions:
– UK based Bluefin Solutions, specializes in SAP HANA
– US based Relational Solutions, an analytics provider, primarily for consumer goods
– US based Magnet 360, a Salesforce consulting partner
– India based Aztecsoft, a product engineering business

Risks:
– Indian IT is at an inflection point
– Highly commoditized industry
– Highly competitive market
– Industry growth is slowing down

Valuation:
At current price of Rs 565, the rate of return is 8.4% based on pre-tax earnings to market cap and the dividend yield is 2.8%.

Appendix:

Scorecard:
mindtree-score

10-Year Analysis:
mindtree-10-year
Disclaimer:
MyValuePicks is not a registered investment advisor or broker. Readers are advised that the material contained herein should be used solely for informational purposes. MyValuePicks does not accept responsibility for consequences of financial decisions taken by users on the basis of information provided herein. The aim is to provide a reasonably accurate picture of financial and related opportunities based on information available with us.