The Hindu Business Line : Britannia Industries: Book profits

Influenced by factors such as excise duty exemptions and an improving earnings outlook, the Britannia Industries stock saw a 17 per cent appreciation in price over the past month. Investors can use the recent price appreciation to book profits on part of their holdings.

Though the earnings over the next two years are likely to improve on the back of recent excise duty exemptions, price hikes and new launches, the current valuations for the stock seem to capture improved earnings prospects.

At 21-22 times its expected earnings for FY08, Britannia Industries trades at a significant premium to its historical valuations.

What is more, this valuation places Britannia on a par with FMCG companies such as Marico Industries and Hindustan Lever though the company has a lower margin profile and a narrower product portfolio.

Persistent pressures on raw material costs and competition also continue to pose risks to the earnings growth.

Lower margin profile

Britannia Industries is the leading player with roughly a 30 per cent share of the domestic biscuits market. Dairy and bakery products account for a small proportion of its overall revenues. The narrow product portfolio makes Britannia's profit margins more sensitive to fluctuations in raw material costs and competitive pressures, than is the case with many of its FMCG peers.

Over the past year, Britannia's profit margins have been under pressure from rising raw material costs (due to spiralling wheat and milk prices) accompanied by considerable competitive pressures (from ITC through its Sunfeast range and several local brands).

In the 12 months ended December 2006, Britannia's net profits fell 25 per cent, even as sales growth accelerated by a strong 21 per cent. Operating profit margins dropped to 6.7 per cent from 13.2 per cent, as rising material costs were unmatched by price increases on products.

Improving outlook

The earnings picture is likely to improve on the back of company initiatives as well as some external factors. Britannia's recent move to rationalise pack sizes and raise prices on select brands should improve unit realisations in the coming quarters. The recent amendment to the Budget proposals to exempt certain categories of biscuits from excise (biscuits costing Rs 100 a kg, instead of the earlier Rs 50, will now be exempt from excise duty) will also deliver a one-time boost to margins over the next year.

After sluggish new launch activity over the preceding years, Britannia also stepped up new launches in recent months — rolling out products, Treat Fruit Rollz and NutriChoice Sugarout. Efforts are also on to broadbase the product portfolio through the acquisition of a 50 per cent stake in Daily Bread, a specialty bread manufacturer.

Acquisition of a bakery business in West Asia may help the company broadbase its geographical footprint.

Input Price Pressures

Though these factors point to strong revenue growth for Britannia Industries and a recovery in earnings over the next fiscal, certain risks to the earnings picture remain.

For one, though Britannia has already taken a few price increases on its products to offset input cost pressures, input prices are likely to continue on their uptrend.

Firm trends in prices of wheat and milk, key inputs for Britannia, appear likely to persist over the next few quarters. The significant domestic supply deficit for wheat in the face of growing demand and possible legal hurdles to imports, suggest that wheat prices will remain firm.

Milk process similarly are likely to remain upward bound on global influences as well as domestic shortages. Second, competitive pressures from ITC and other local brands in the core biscuits business are unlikely to abate to any significant extent.

Despite VAT issues pressuring ITC's core cigarette business, thanks to its diversified profile, the company's cash coffers may remain healthy enough to fund its investments in its FMCG businesses.

Keeping these factors in mind, current valuations for the Britannia Industries stock already appear to capture much of the likely improvement in earnings. Institutional buying related to the stock's inclusion in the MSCI index also drove some of the recent appreciation in the company's stock price. With these influences waning, the stock price could cool off in the near term. Investors could wait for future opportunities to re-enter the stock, if there is a significant decline in valuations.

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