Britannia Industries. CMP: INR546 TP: INR605 Upgrade to Neutral Volume growth bottoms out; Upgrade to Neutral

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1 BSE SENSEX S&P CNX 19,016 5,783 Bloomberg BRIT IN Equity Shares (m) M.Cap. (INR b)/(usd b) 65.2/ Week Range (INR) 595/400 1,6,12 Rel. Perf. (%) 3/10/-13 Financials & Valuation (INR b) Y/E March 2013E 2014E 2015E Sales EBITDA Adj. PAT Adj. EPS (INR) EPS Gr. (%) BV/Sh.(INR) RoE (%) RoCE (%) Payout (%) Valuations P/E (x) P/BV (x) EV/EBITDA (x) Div. Yield (%) Shareholding pattern (%) As on Mar-13 Dec-12 Mar-12 Promoter Dom. Inst Foreign Others Stock performance (1 year) 22 April 2013 Update Sector: Consumer CMP: INR546 TP: INR605 Upgrade to Neutral Volume growth bottoms out; Upgrade to Neutral Premiumization strategy yielding benefits; non-biscuits margins improving Volume growth has bottomed out and should benefit from a favorable base ahead. Benefits of premiumization are reflecting in the margins despite higher input costs. See scope for re-rating as volume improves and margins expand 80bp over FY13E-15E. Upgrade to Neutral with a target price of INR605, a potential upside of 11%. Biscuits volume growth has likely bottomed out We believe Britannia's (BRIT) volume growth in its core biscuits category has bottomed out and will benefit from the favorable base effect, going forward. Though the processed foods segment is undergoing a slowdown, BRIT's consistent investments in the category should stand it in good stead, in our view. We expect it to post 8% volume growth in biscuits in FY14E, driven by premium portfolio. Premiumization strategy yields dividend; Glucose salience declines BRIT has focused to drive the premiumization strategy, given the business' low margin nature and inflationary trend in its RM basket. Company consistently innovated its portfolio and expanded the offerings in Health, Cookies and Creams segment, where the realization is 2-4x base variants. Thus, it managed to expand the gross margin by 150bp in 9MFY13, despite sharp input cost inflation. We expect BRIT to continue to expand its premium portfolio, in line with the broader category trend where contribution of Glucose is declining. We note the Glucose category has declined 4.5%, while Creams and Cookies segment has grown 21.8% and 5.5% respectively over CY10-12, as per industry data. Non-biscuits portfolio gains strength; Subsidiaries turning profitable BRIT's non-biscuits portfolio (Bread, Cake, Rusk, Dairy and International) is gaining size and is now an INR15b business on an annualized basis. Pertinently, profitability of international subsidiary and dairy subsidiary has been improving consistently since FY09. As these businesses gain size, operating leverage can provide margin upside, in our view. Underperformance discounts negatives; Worst is over; Upgrade to Neutral BRIT has underperformed the BSE FMCG index by 32%/20% in last 12/24 months due to deceleration in Biscuits volume and subdued profit growth. Going forward, we expect a volume recovery; with higher input costs in the base, margins should expand given the premiumization led by mix improvement. We estimate 21% earnings CAGR for FY13E-15E led by 16.5% sales growth and 80bp operating margin expansion to 5.8%. Given our expected improvement in operational performance, we believe valuations at 24.5x FY14E and 20.6x FY15E have a scope for re-rating, albeit modest. We value BRIT at 24x FY15E, peg the target price at INR605, an upside of 11%, and upgrade to Neutral. Spike in input costs and any adverse changes in premiumization trend are the key risks. 22 April

2 Biscuits volume growth bottoms out...disproportionate investments to drive premium portfolio mix Biscuits volume growth has decelerated for last six-seven quarters. Expect favorable base to aid volume growth ahead despite processed foods slowdown. Britannia's consistent investments to drive premiumization in portfolio. After decelerating for six to seven successive quarters, Biscuits volume growth recovered in 3QFY13 at ~5.5%. We expect this recovery to sustain partially aided by a favorable base effect. Notwithstanding the overall slowdown in processed foods segment, we believe BRIT's consistent and disproportionate focus to drive innovation and premiumization will cushion the volume. Volume growth to benefit from favorable base......and aggressive investments to drive premiumization Source: Company, MOSL Given that less than 9% of the Foods category is branded, management believes there is significant room for growth. Biscuits, despite being one of the largest processed foods category at USD2.2b and well penetrated, offer good opportunity as per capita consumption at 2kg in India is half of a Sri Lanka. Biscuits is the largest category in processed foods has posted 8% volume CAGR over CY10-12 Source: Industry, MOSL 22 April

3 Realization rose due to RM inflation Key category growth indicators Source: Industry, MOSL 22 April

4 Premiumization strategy yields dividend...industry data validates the underlying trend Britannia has focussed on driving premiumization given the RM inflation trends. Industry data confirms the underlying premiumization trend in the category. Glucose category salience for the industry has been declining consistently. BRIT has focused on the premiumization strategy given the low margin nature of business and inflationary trend in its RM basket. It consistently innovated the portfolio and expanded offerings in the Health, Cookies and Creams segment, where the realization is 2-4x base variants. We believe the Biscuits industry data for CY10-12 vindicates the underlying premiumization trend in the category. Following section explains the story in charts: While the Biscuits industry posted 8% volume CAGR Glucose category declined 4.5% in volumes Contribution of Glucose category declines BRIT has lost share in Glucose category Source: Industry, MOSL 22 April

5 so has ITC while Parle has gained Even in CY12 Glucose underperformed other categories in volume and value terms Source: Industry, MOSL 22 April

6 BRIT's premium portfolio has done well aiding gross profitability Premium portfolio has outperformed for Britannia Innovation sales index has gone up 2.5x since FY11. Britannia has expanded its health based offerings in the last 18 months. BRIT's premium portfolio (Marie Gold, 50-50, Nutrichoice, Treat etc) has outperformed the category growth and provided support to profitability. We note the innovation sales index has risen ~2.5x since FY11. BRIT's premium portfolio has done well... Innovation sales index up ~2.5x Source: Company, MOSL BRIT's premiumization efforts: moving up the value chain Good-Day Regular Good-Day Chocochip Good-Day Fresh Bake Regular Maska Chaska Snackuits Nutrichoice Digestive Nutrichoice Oats Nutrichoice Multigrain Thins 22 April

7 Company kept the innovation engine running and consistently unveiled new variants. According to management, BRIT enjoys 4x relative market share of its next competitor in health-focused biscuits (Nutrichoice) and is neck to neck with ITC in the premium cream segment. BRIT has clearly targeted the health and wellness plank with several launches in the space across categories - Nutrichoice Biscuits, Multigrain Breads, Slimz Milk and Cheese Slices (extra calcium). BRIT's recent innovations in Biscuits and other categories; Leveraging the health platform Premiumization strategy yields results; Gross margin up 150bp in 9MFY13 Company's premiumization strategy has started bearing fruits and is reflected in margins. Gross margin for 9MFY13 improved 150bp YoY to 36.7% after having already expanded 150bp in FY12 v/s FY11. For the quarter-ended December 2012, 18% sales growth was driven by a combination of 5.5% pricing, 6% volume and ~6% mix gains. Expect operating margin expansion of 80bps over FY13-15e...lead by improved gross margins due to lower RM inflation Source: Company, MOSL 22 April

8 Margin expansion despite sharp input cost inflation Gross margin expanded despite the sharp inflation in key raw materials - average wheat and sugar costs were up 21.7% and 13.8% respectively in FY13. The adverse impact of higher input costs was mitigated by a combination of price hikes, grammage change and mix improvement, in our view. Wheat and sugar price inflation resulted in incremental INR1.8b impact during 9MFY13. Rising diesel prices will lead to incremental cost of INR15m per month. However, prices of vegetable oil and skimmed milk powder have corrected. In our view, being a category with low operating margin and high competitive intensity, the only option to maintain profitability in the long term is through mix improvement in favor of niche offerings, which allows certain pricing power to the brand manufacturer. As mentioned earlier, the industry is moving towards premium segments in both urban and rural markets. Despite the gross margin expansion, operating margin declined 50bp YoY in 9MFY13 due to higher advertising spends to support new launches. Conversion costs rose 70bp. BRIT has undertaken several cost rationalization initiatives in the back-end to drive margin savings. It is setting up a new plant in Gujarat at Jhagadia to reduce the freight cost and is also undertaking process improvement in production through various measures - TQM, TPM, Kaizen etc. Wheat prices adversely impacted in FY13; down 12% from peak......sugar prices down 15% from peak Source: Bloomberg, MOSL SMP prices have remained flat Palm oil is down 30% YoY but up 10% from the low Source: Bloomberg, MOSL 22 April

9 Non-Biscuits portfolio gains in size and accretive to bottom line... International subsidiaries profitability improves Non-Biscuits is now tracking annual INR15b revenue. Profiability is consistently improving for all international subsidiaries. Expect operating leverage to play out. BRIT's non-biscuits portfolio Dairy, Cake, Rusk, Bakery is gaining in size led by portfolio expansion and differentiated offerings. Non-Biscuits coupled with International business is now an INR15b business on an annualized basis. Profitability in these businesses is on an improving trend and we expect the operating leverage to materialize, going forward. Robust sales growth in FY12 for non-biscuits portfolio PAT margin improves consistently PAT margin improves across subsidiaries even in International business (Al-Sallan + Strategic Foods Int) *We have considered four key subsidiaries - Dairy Products, Daily Bread, Strategic Foods, Al-Sallan. Source: Company, MOSL 22 April

10 Underperformance discounts negatives Worst is over; Upgrade to Neutral BRIT has underperformed the FMCG index by 32% in 12 months - second worst performing stock in our FMCG universe. Expect valuations to undergo modest re-rating as operational performance improves in FY14E and FY15E. Ugrading to Neutral with INR605 target price, 11% upside. BRIT has underperformed the BSE FMCG index by 32%/20% in last 12/24 months due to deceleration in Biscuits volume and subdued profit growth. On a 12-month basis, it has been the second worst performing stock in our FMCG universe relative to the BSE FMCG index. Going forward, we expect a volume recovery; with higher input costs in the base, margins should expand given the premiumization led by mix improvement. We estimate 21% earnings CAGR for FY13E-15E led by 16.5% sales growth and 80bp operating margin expansion to 5.8%. Given our expected improvement in operational performance, we believe valuations at 24.5x FY14E and 20.6x FY15E have a scope for re-rating, albeit modest. We value BRIT at 24x FY15E, peg the target price at INR605, an upside of 11%, and upgrade to Neutral. Spike in input costs and any adverse changes in premiumization trend are the key risks. Underperformed BSE FMCG index by 40% in a year and Sensex by 13% over 1 year (outperformed over 2 years) P/E chart P/B chart Source: Bloomberg, MOSL 22 April

11 BRIT is the worst performing stock in our FMCG universe in 12-month period Absolute Performance (%) Relative Performance to BSE FMCG(%) Company 3 M 6M 1 Yr 2 Yr 3 M 6M 1 Yr 2 Yr Asian Paints Britannia Inds Colgate-Palm Nestle India GlaxoSmith C H L Hind. Unilever ITC Dabur India Marico Godrej Consumer BSE FMCG April

12 Financials and Valuation Income Statement (INR Million) Y/E March E 2014E 2015E Net Revenues 41,983 49,470 55,396 64,691 75,451 Change (%) Raw Material Cost 27,643 31,798 35,017 40,598 47,066 Gross Profit 14,340 17,673 20,379 24,093 28,385 Margin (%) Advertising 3,042 3,810 4,819 5,628 6,564 % of Sales Other Expenditure 9,236 11,343 12,769 14,823 17,422 EBITDA 2,063 2,521 2,790 3,642 4,399 Change (%) Margin (%) Depreciation Int. and Fin. Charges Financial Other Income Operating Other Income PBT 1,981 2,524 2,814 3,646 4,323 Change (%) Margin (%) Tax ,146 1,357 Deferred Tax Tax Rate (%) PAT 1,453 1,867 2,051 2,538 3,009 Change (%) Margin (%) Reported PAT 1,453 1,867 2,051 2,538 3,008 Balance Sheet (INR Million) Y/E March E 2014E 2015E Share Capital Reserves 4,274 5,108 5,892 6,955 8,215 Networth 4,513 5,347 6,131 7,194 8,454 Loans 4,607 4, ,509 Capital Employed 9,120 9,674 6,942 8,045 9,963 Gross Block 5,936 6,386 7,636 8,886 10,136 Less: Accum. Depn. -2,899-3,379-3,926-4,562-5,285 Net Fixed Assets 3,037 3,007 3,710 4,324 4,851 Capital WIP 117 1, Investments 5,450 5,264 1,960 2,309 3,721 Deferred Liability Currents Assets 6,254 7,387 8,469 9,978 11,500 Inventory 3,112 3,741 4,155 5,175 6,036 Account Receivables ,116 Cash and Bank Balance ,062 1,219 1,557 Others 2,282 2,343 2,459 2,626 2,791 Curr. Liab. & Prov. 5,676 6,995 7,484 8,890 10,477 Account Payables 3,329 4,560 5,026 5,840 6,978 Other Liabilities 1,073 1,073 1,175 1,288 1,412 Provisions 1,274 1,362 1,283 1,761 2,087 Net Current Assets ,088 1,023 Net Assets 9,120 9,674 6,942 8,045 9,963 E: MOSL Estimates 22 April

13 Financials and Valuation Ratios Y/E March E 2014E 2015E Basic (INR) EPS BV/Share DPS Payout (%) Valuation (x) P/E EV/Sales EV/EBITDA P/BV Dividend Yield Return Ratios (%) RoE RoCE Working Capital Ratios Debtor (Days) Asset Turnover (x) Leverage Ratio Debt/Equity (x) Cash Flow Statement (INR Million) Y/E March E 2014E 2015E OP Profit 2,063 2,521 2,790 3,642 4,399 Financial Other Income Interest Paid Direct Taxes Paid ,146 1,357 Inc in WC CF from Operations 1,526 2,581 2,077 3,016 3,903 Extraordinary Items (Inc)/Dec in FA 475 1, ,250 1,250 (Pur.)/Sale of Investments , ,413 Other Non Rec Exp CF from Investments 1,018 1,147-2,804 1,598 2,664 Inc in Debt , Dividend Paid ,157 1,086 1,475 Other Item CF from Fin. Activity ,107-4,439-1, Inc/Dec of Cash Add: Beginning Balance ,062 1,219 Closing Balance ,056 1,219 1,557 E: MOSL Estimates 22 April

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