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Britannia: Margin woes continue! - Views on News from Equitymaster
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Britannia: Margin woes continue!
Jan 29, 2007

Performance summary
Bakery products major, Britannia, announced mixed results for the third quarter and nine months ended December 2006. While topline growth has been enthusing, margin contraction of 740 basis points, along with higher interest charges has resulted in the company posting a 55% YoY fall at the PBT level. Inspite of a considerably lower tax outgo and higher other income, the bottomline has declined by 54% YoY.

(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Gross sales 4,552 5,967 31.1% 13,389 16,876 26.0%
less: excise duty 54 294 444.4% 207 878 324.2%
Net sales 4,498 5,673 26.1% 13,182 15,998 21.4%
Expenditure 3,956 5,412 36.8% 11,415 15,123 32.5%
Operating profit (EBDITA) 542 261 -51.8% 1,767 875 -50.5%
EBDITA margin (%) 12.0% 4.6%   13.4% 5.5%  
Other income 17 50 194.1% 95 196 106.3%
Interest 11 23 109.1% 28 46 64.3%
Depreciation 57 65 14.0% 160 186 16.3%
Profit before tax 491 223 -54.6% 1,674 839 -49.9%
Extraordinary item (33) (37) 12.1% - (86)  
Tax 101 22 -78.2% 488 74 -84.8%
Profit after tax/(loss) 357 164 -54.1% 1,186 679 -42.7%
Net profit margin (%) 7.9% 2.9%   9.0% 4.2%  
No. of shares (m) 23.9 23.9   23.9 23.9  
Diluted earnings per share (Rs)*         40.0  
Price to earnings ratio (x)*         28.5  
* 12 month trailing earnings            

What is the company’s business?
Britannia, promoted by the France based Danone and Nusli Wadia, is the second largest biscuit manufacturer in India, next only to Parle. Danone is the world's largest producer of fresh dairy products and the second largest producer of biscuits and mineral water. Britannia hived off its dairy business in March 2002 to Britannia New Zealand Foods Pvt. Ltd., a joint venture with Fonterra Group, New Zealand. The primary business of the company is now bakery, which consists of biscuits, bread and cakes. Biscuits account for 92% of the company's FY06 revenues. The company’s market share stands at nearly 38% in value terms and 31% in volume terms.

What has driven performance in 3QFY07?
Robust growth: Revenue growth of 31% YoY during the quarter was the highest in the past five quarters, which has been aided by the company’s strong volume growth. Britannia is the market leader in the Rs 50 bn biscuit segment with over 39% market share in value terms (it has a value leadership in 6 of the 7 categories in the biscuit market) and 32% in volume terms. Although the market share had come under pressure in recent times, the company is clawing its way back by making new launches, better distribution and newer formats which is visible from its strong topline performance over the last few quarters.

Margin woes continue: The company yet again reported a fall in the operating profits (down 52% YoY). The EBITDA margins for 3QFY07 shrunk by 740 basis points to 4.6%. The spike in raw materials cost by a huge 15% to 20%, especially that of wheat, sugar and edible oils has been the major culprit. The raw material prices as a percentage of sales, increased from 55% in 3QFY06 to 66% in 3QFY07. The margin fall would have been higher but for the lower staff costs and other expenditure (as percentage of sales).

Consolidated cost break-up
As a % of net sales 3QFY06 3QFY07 9mFY06 9mFY07
Total Cost of goods 55.4% 66.3% 55.2% 64.5%
Staff Cost 3.9% 3.1% 4.1% 3.4%
Other Expenditure 28.7% 26.0% 27.2% 26.7%

Declining profits: Declining operating profits and higher interest cost (up 109% YoY) resulted in a 54% YoY drop in the net profits for the quarter (including extraordinary item). The extraordinary item to the tune of Rs 37 m is relating to the compensation and amortisation of VRS cost. Excluding this, the net profits have declined by 43.7% YoY. The bottom line would have been bleaker, but higher other income and lower tax outgo saved the day. The effective tax rate (calculated as a percentage of PBT) fell from 21% in 3QFY06 to 10% during the quarter due to tax benefits available to the company on its Uttaranchal plant (100% tax benefit for a 10-year period).

What to expect?
At the current price of Rs 1,142, the stock is trading at a price to earnings multiple of 12.5 times our estimated FY09 earnings. Britannia’s margins in recent quarters have been severely dented by a huge rise in input prices. As a consequence, the bottomline of the company has been reasonably hurt. However, we believe the reaction to this has been unreasonably pessimistic and feel that once the input cost pressures ease, margins would improve, thus enabling it to translate the buoyant topline growth into equally buoyant bottomline numbers. Also, its acquisition of 50% stake in Daily Breads (manufacturer and retailer of high-end bakery products) will act as a vehicle to supplement its core business with a fast growing high margin line of products. We maintain our HOLD recommendation on the stock.

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