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Britannia: Input cost worries - Views on News from Equitymaster

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Britannia: Input cost worries
Aug 2, 2006

Performance summary
Indian biscuit major, Britannia had recently announced mixed results for the first quarter of FY07, reporting a topline growth of 19% (YoY). However, on the back of substantially higher raw material and other costs, the operating profits have declined by nearly 44% YoY. Consequently, operating margins have witnessed a sharp contraction. The effect has been seen in the bottomline, which declined by 23% YoY. But for higher other income and lower tax expenses, the net profit decline would have been greater.

Financial performance: A snapshot...
(Rs m) 1QFY06 1QFY07 Change
Net Sales 4,054 4,828 19.1%
Expenditure 3,474 4,502 29.6%
Operating Profit (EBDITA) 580 326 -43.8%
EBITDA margin (%) 14.3% 6.8%  
Other income 24 119 395.8%
Interest 8 7 -12.5%
Depreciation 53 57 7.5%
Profit before tax 543 381 -29.8%
Extraordinary expense 34 (23)  
Tax 186 55 -70.4%
Profit after tax 391 303 -22.5%
Net profit margin (%) 9.6% 6.3%  
Effective tax rate (%) 34.3% 14.4%  
No. of Shares (m)   23.9  
Diluted earnings per share* (Rs)   57.6  
Price to earnings ratio (x)   19.0  
* Trailing 12 months

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 1QFY07?
Topline growth continues: Britannia posted an impressive 19% YoY growth in net sales during 1QFY07, which has been the highest in the past five quarters. Growth in sales would have been much higher but for a one-time adjustment made on the excise duty front (with effect from 4QFY06) in order to equate the reporting of excise duty relating to outsourced products in line with that of in-house manufactured products. Excluding this impact, the growth in topline would have been higher. Though competition is expected to intensify going forward, we draw comfort from company’s ability to launch new products on a consistent basis and thereby outpace the industry growth (as it has over the past few years).

Cost break-up
Expenses as a % of sales 1QFY06 1QFY07
Cost of goods* 66.7% 70.9%
Staff cost 4.6% 3.4%
Other expenditure 14.4% 18.9%
*includes cost of raw materials, packing materials
& conversion cost
Margins under pressure: Substantially higher input costs have impacted Britannia’s operating margins during 1QFY07. Cost of goods, as a percentage of sales, increased from 66.7% in 1QFY06 to 70.9% in 1QFY07. This was primarily on account of rise in the cost of inputs like sugar, wheat, fats and oil. However, with the commencement of its new plant at Uttaranchal, Britannia’s dependence on third party purchases have been dwindling. This is reflected in the increase in raw material costs and, at the same time, decrease in conversion costs and cost of finished goods. Other expenditure, which includes advertising and promotional expenses, also witnessed a sharp increase. Staff cost for the quarter, however, declined by 120 basis points (to 3.4%) due to VRS and other restructuring initiatives undertaken by the company. We believe that the fall in operating margins during 1QFY07 is just a blip and we expect the same to improve and hover at around 11%, once the price of raw materials cool off (especially wheat prices).

Other income and lower taxes rescue bottomline: Despite the 44% YoY plunge in operating profits, the decline at the net profit level was lower due to increase in other income (up 396% YoY). Also, the effective tax rate (calculated as a percentage of PBT) for fell from 34.3% in 1QFY06 to 14.4% during the quarter, due to tax benefits available for the company on its Uttaranchal plant (100% tax benefit for a 10-year period).

Over the past few quarters
  1QFY06 2QFY06 3QFY06 4QFY06
Sales growth (YoY)* 2.9% 8.3% 16.7% 22.9%
Operating profit margin 14.0% 13.7% 11.9% 5.0%
Net profit growth (YoY)** -44.0% -15.3% 18.5% 3.2%
Net profit margin 9.5% 9.3% 7.8% 5.8%
*Gross sales
**excluding extraordinary items

What to expect?
At the current price of Rs 1,092, the stock trades at a price to earnings multiple of 12.7 times our estimated FY08 earnings. We believe that the decline in profitability for the quarter is transient in nature and we expect Britannia to report better numbers going forward. Though we expect margins to decline marginally over the next few years, we are positive on the volumes front (substantiated by the strong growth in topline in the past few quarters). Raw material costs, however, remain the principal risk to our assumptions.

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