BRITANNIA RESEARCH REPORT

BRITANNIA INDUSTRIES: A FAST FOOTED FMCG: Healthy investment to better your wealth….

Britannia Industries (Britannia) is one of the leading producers of biscuits and other bakery products in India. The company’s major brands in biscuits include Tiger, Good Day, Mari Gold, 50-50, Treat, Milk Bikis and Nutrichoice Sugar Out. Each of these power brands are estimated to be valued at around 250-300 crore constituting around 92% of the topline of the company for the year ended FY 07. The company is the market leader in the biscuits segment with a market share of 40% followed by the Parle group at 33% in value terms. Surya Food Agro, ITC and the vast league of unorganized players make up the rest of the market.

Group Ownership Pattern:France’s leading cookies and dairy products firm “Group Danone” and India’s Wadia group (with interests in textiles, aviation and agro processing) control a majority stake in Britannia Ltd. through a holding company Associated Biscuits International Ltd. (ABI) which owns 51% stake in Britannia. Group Danone and the Wadia’s hold equal stakes in ABI. Relations between the two stakeholders have turned sour over the recent months, the details of which are discussed separately in this article. The way this ownership tussle pans out can have a telling impact on the valuations of Britannia Ltd and assumes paramount significance to investors and traders alike. LIC, HDFC, and HSBC mutual funds have also been accumulating positions in Britannia over the last few quarters.

Business Profile:
The primary business segment of the company is bakery, which consists of Biscuits, cakes, bread and rusk. Overall sales of the company has grown at a brisk pace of 20% and above in the last one year due to greater buoyancy in the biscuit market reflected from growing consumerism in India and increased market penetration efforts by the company into rural areas. The company has identified each brand as a profit center and the role of these brands are clearly delineated. The company has also been working on new variants, product innovations and in line with its strategy a slew of new launches have been made to widen the product profile in a highly competitive business environment. The company has been rated the No.1 most trusted food brand in India as per a recent survey conducted across all metros (Source: AC Nielsen ORG – Marg) and has a tremendous brand recall among the general public at large. The company is the market leader in all biscuit categories except the glucose segment where Parle has its nose slightly ahead. All the categories and brands of Britannia are growing at double-digit rate. The key to unlock business potential and opportunities in this industry lies in keeping a tab on the changing consumer tastes and preferences and addressing multiple taste preferences of various sections of consumers. Food business being a fickle category, adequate branding and advertising for all its products, pioneering efforts to migrate consumption patterns from unbranded to branded products, addressing nutritional, health and wellness issues and establishing an emotional connect with the customer is of utmost necessity to stay ahead of competition and take a larger share of the consumer’s wallet.

Business Risk Profile:
Britannia until FY 2006 can be best described as a sleeping giant of the packaged food segment. The company had lost its sales growth momentum from FY 02-06 and its operating margins had almost halved during this period due to the unprecedented rise in input commodity prices, under investment in core brands and weak product innovation. The company did not embark on major capacity expansion plans during this period inspite of robust internal accruals. The company had to take on competition from aggressive players like ITC (Sunfeast) and Surya Agro (Priya Gold), which resulted in pricing pressures across product categories, and led to substantial erosion in its market share coupled with a downward spiral in it’s profitability margins. The company was also affected by frequent changes in the top management and high attrition levels among the top level executives leading to a lack of clarity on policy matters. But ever since 2005 when Ms.Vinita Bali took over the reins, the company has been clawing back to retain its pre-eminent position in the market through a spate of multiple launches under the six umbrella brands, various brand restructuring initiatives and improved sales promotion and distribution efforts in rural areas.

The company has launched new packaging formats with reduced weights at attractive price points. The company has also effected marginal price hikes in certain power brands which have shown robust sales growth on a sequential basis QoQ (quarter on quarter). The government in its recent budget has also reduced the excise duty on biscuits from 8% to Nil on products where the MRP (Maximum retail price) is less than Rs.50 per kg. The company has also commissioned its manufacturing plants at Uttranchal towards the end of 2005 and this being a tax free facility will definitely have a positive impact on the margins of the entity over the medium to long term horizon. However a rationalization of the VAT structure for the biscuits industry may be required as the sector pays a higher rate of 12.5% compared to other food segments. The cumulative tax incidence for the industry including the import duties on wheat and fats works out to 25% and a decrease in VAT rates can go a long way in reducing prices and increasing consumption trends among the rural masses and low income groups of our country.

During the current financial year, the company has embarked on an Rs.100 crore expansion plan to develop new products for the rural markets where the penetration levels are pretty low. This should trigger the earnings growth rate at a faster clip going forward. Capex plans have been steady over the last few years.

Increased and intense competition both at the national and regional level has stimulated the biscuits market growth. Most of the organized industry players are bunching up their capacities following it up with an aggressive pricing and sales promotion policy thereby depressing the industry margins overall. Managing profitable growth in such a scenario will be contingent upon continuous brand investment, improving supply chain efficiencies and effective cost management.

Financial Risk profile:

The company has a fairly strong financial profile characterized by its leadership in the biscuits business, substantially free cash flows, high liquidity cushion and comfortable debt protection ratios. Sales growth and profit growth has witnessed lumpiness over a five-year period (FY 02-07) with the topline growing at a moderate CAGR of 11.3% and bottomline at a meagre 3%. But the financial metrics have shown a remarkable improvement since FY 06-07 as a result of the restructuring of the business model with sales showing a robust increment of 28% YoY and margins indicating a recovery from the fourth quarter. Margins have sustained the rising trend well into the June Quarter (Q1’08).

Over the years, the major dampener for the financials of the company has been high input costs of edible oil, sugar, Wheat flour and baking fuel. However the fall in headline inflation in primary products and the global meltdown in sugar prices due to supply glut augurs well for the company. The recent rise in crude oil prices is a major concern that can have a spill over effect on the price of baking fuels and logistics costs. The prices of these input commodities are forecasted to be stable and firm for the rest of the year. The company also has also resorted to hedging in the commodities market to mitigate the impact of spikes in input prices to protect its margins.

Export revenues for the company form a very minuscule portion of the total turnover at less than 10% for FY07 albeit growing at more than 50% in the last couple of years. The interest expressed by Kraft foods Inc of the US to pick up Group Danone’s stake in the company assumes high significance. If the deal materializes, the company can ramp up its exports and set foot into the global arena leveraging on Kraft foods multiple distribution networks all across UK and US.

Britannia has huge surplus cash reserves that are currently invested in Mutual funds and marketable securities and can be drawn upon for pursuing inorganic growth opportunities. The company has also been buying back shares from open market until 2005 using its idle cash and has been doling out liberal dividends at 150% over the last three years. However the dividend yield has much scope to improve going forward. The balance sheet of the company is lowly geared with a modest short-term debt and zero long-term debt.

Dispute with Group Danone:
As discussed above, Group Danone and Wadia’s together hold controlling stake in Britannia through a holding company Associated Biscuit International (ABI). The dispute between the two stakeholders arose over the alleged misuse of “Tiger” Brand By Danone in several countries. Group Danone has registered the tiger brand as its own brand in several countries without obtaining the consent of the Britannia board. The standoff has now resulted in Britannia initiating legal action against Group Danone and demanding compensation to the tune of 15 crore. In certain circles, this act is also being seen as a form of takeover defence to prevent Danone from selling its stake in Britannia to Kraft Foods albeit the Wadia’s have the first right of refusal on Danone’s stake sale in Britannia.

Share Performance: The stalemate between the two stakeholders over solving their differences has been a major constraint on the growth prospects of the company and is also one of the main reasons for the underperformance of the scrip on the bourses. The scrip has moved up by 22% ever since the market crash witnessed in May –June 06 as compared to the BSE sensex up move by more than 80%. The scrip has clearly been a laggard on the bourses despite strong fundamentals

Recent developments and implications for Britannia
The management of Group Danone has made a policy decision to exit its global biscuit and cereals business to focus on its core business of dairy products and beverages. Group Danone is in exclusive talks with American Kraft Foods Inc, the worlds largest cookie maker, to sell its global biscuits business though the deal doesn’t include the company’s stake in Britannia. But the management of the company has recently made its intentions clear to exit Britannia too and is waiting for the no objection certificate from Wadias for selling its stake to Kraft foods Inc. Danone wants to set up its dairy products and beverages business in India separately and unlocking its investment in Britannia will provide the necessary funds for setting up its shop in India.
This complex situation throws up interesting scenarios for traders and Investors. Lets have an insight into the various possible scenarios:
Scenario 1:
Danone selling its stake to Wadias:
This event, if it materializes will prove to be favourable to the Wadias who are negotiating with Danone for a possible acquisition of their 25.5% stake at a discount to the current market valuations. This will give the Wadias a majority control over Britannia.
Scenario 2:
Danone and Wadia both selling their stake in Britannai to Kraft Foods Inc:
This scenario though a possibility in the long term seems highly unlikely at the moment. American Kraft Foods Inc has expressed its interest to pick up Danone’s stake in Britannia. The advantage to Kraft Foods Inc will lie in tapping the huge consumption market and reaping the benefits of the country’s diverse demographic profile. Wadias have however remained tight lipped on selling their stake to Kraft foods Inc. They would not prefer to exit a cash rich company and lose out on the long-term growth story that this sector offers.
Scenario 3:
Three-way agreement between Kraft foods, Danone and Britannia
A three-way workable agreement between the Wadias, Danone and Kraft may not only mean an end to litigation but could also add synergy and firepower to Britannia’s portfolio of brands. Kraft’s arsenal boasts of brands such as Toblerone (chocolates), Tang (fresh drink concentrate), Fresh (beverage) and Oreo, the world’s largest selling cookie brand. For Danone, such an agreement along with annulment of the Wadia joint venture could mean freedom to enter the dairy and beverages business in the country independently, which it is keen on. This scenario seems a highly likely possibility in the next few months, as Danone does not prefer to sell its stake to the Wadias at a discount to the fair value for Britannia.


Valuation:
Now coming to the most important aspect that has high implications for shareholders and investors - At what price will Danone possibly exit Britannia?As discussed above already, Group Danone is in exclusive talks with Kraft Foods Inc to sell its global biscuits business (excluding its stake in Britannia). The global biscuits business of Danone has generated sales of 2.2 Billion euros last year and the business has been valued by Kraft foods at 5.3 billion euros. The offer price is almost 2.4 times the annual sales generated last year. The valuation has been arrived at taking into account the fact that the European markets where Group Danone has a major presence are growing at less than 3%. With the Indian biscuits market registering double-digit growth rates and with Britannia outperforming the market by growing at 28% last year, the valuation multiple should be much higher than 2.4 times. Even on a conservative estimate applying the proxy valuation to Britannia, the valuation per share comes to Rs.2200.

But since the Indian market has high growth rates, Danone will demand a much higher valuation than the enterprise value arrived above. Britannia’s high Cash EPS and cash reserves also pushes up its valuation parameters. In all the three scenarios discussed above there has to be a compulsory open offer by the purchaser (whether Kraft foods or Wadia group) at a much higher rate than the price paid for acquisition of Danone’s stake as per SEBI guidelines. This is to protect the interest of minority shareholders in Britannia, as it would help them unlock their investments at fair valuations.
Whichever way the control flows, Britannia would do well to have a single promoter or two friendly promoters who can concentrate their efforts in growing the business and capitalizing on the opportunities in the food processing industry rather than engage in mud slinging matches and long drawn legal battles with one another to the detriment of the hapless investor.
Britannia is expected to post an EPS of 72 for the year ended FY 08. The share price is currently trading at 1470 which discounts its forward EPS by a PE of 20 times. The share price looks attractive at current levels given the fact that most FMCG players are trading at much higher valuations and Britannia is on a fast track growth trajectory. Also adding pepper to the undervalued story is the possibility of the changes in ownership and shareholding pattern that can throw up many positive surprises in the near term.

Last but not the least, as the old adage goes “One must buy when everyone is selling and sell when everyone is buying.” Biscuits are a small part of people’s lives and Britannia is one such brand that has found its way into every Indian household over the past few decades. So what’s stopping u from allocating a small portion for this scrip in your portfolio? Take a calculated bet on this stock at current levels and wait for these interesting developments to pan out in a positive manner.

Safe Harbor Statement: This report should not be construed as a recommendation to invest in the scrip/company discussed above. Investments are subject to market risk. Informed judgment and discretion of the individual investor is of utmost importance while taking positions in any stock.