Good days for Britannia investors

“Britannia’s margin-recovery process had commenced a quarter ahead of our expectation in Q2FY23; and this quarter (Q3FY23), the pace and extent of improvement that it delivered turned out to be way higher versus what one could have anticipated,” said analysts at JM Financial Institutional Securities in a report on 1 February.

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Britannia’s consolidated gross margin was at a multi-quarter high of 43.7%, expanding as much as 574 basis points (bps) year-on-year (y-o-y). Sequentially, the measure was up by 472bps. This was driven by pricing actions and cost efficiency measures.

Moreover, softening costs of commodities such as palm oil helped. Even so, the y-o-y expansion at the Ebitda (earnings before interest, tax, depreciation and amortization) margin level stood relatively lower at 438 bps, mainly owing to higher staff costs and increase in other expenses.

While inflation in India is slowing down gradually, it is still at elevated levels. In Q3, consumer food price inflation was 5.8%, compared to 7.7% in Q2. Wheat prices in India are still high. The strengthening of the US dollar is another concern.

Against this backdrop, it helps that the company is not seeing an adverse impact on revenue and volumes from demand weakness in rural markets, the management said in the earnings call. Note that some other FMCG peers are feeling the heat from the demand slowdown in the rural economy. The growth in rural markets is driven by Britannia’s efficient distribution strategies. This is one of the factors which helped the company gain market share on a consistent basis over the past 39 quarters.

However, given the competition, it remains to be seen if market share gains continue. The margin levels need closer attention, with Britannia expecting margin to cool off from the Q3 levels going ahead.

Also, investors would do well to monitor Britannia’s expansion into non-biscuit categories. As of now, revenue share from the non-biscuit segment, which includes cakes and dairy products, is 23%. The company aims at increasing the share to 45% over the next five years. It has entered into a joint venture with Bel SA to capitalize on the cheese business.

“The dairy portfolio is seeing increased traction and is a key growth driver for Britannia. An expanding presence here reduces the company’s dependence on the biscuit business, which does not have potential to grow at the same rate,” said Amit Purohit, analyst at Elara Securities (India). This gives investors’ confidence of Britannia’s progress towards becoming a total foods company, he added.

Overall, growth in volumes would be a key trigger for the Britannia stock given that further price hikes are unlikely.

In Q3, volumes are estimated to have risen by about 3-5% y-o-y. With the company taking price hikes to cover for inflation in the first half of FY23, revenue growth of 17% in Q3 was price-led.

For now, the strong Q3 results should lead to earnings upgrades. The stock has seen a re-rating in recent times on better-than-expected earnings. Shares have risen by about 26% over the last year. Valuations appear steep, and could limit meaningful near-term upsides. Britannia trades at almost 52 times its FY24 estimated earnings, according to Bloomberg data.