Why Britannia won’t cede margins

Shares of the biscuit-maker closed 3% higher on Thursday.
Shares of the biscuit-maker closed 3% higher on Thursday.

Summary

  • Driven by lower costs, consolidated Ebitda margin expanded 343 basis points (bps) year-on-year and 250 bps sequentially to 19.7%.

Britannia Industries Ltd’s flattish volume growth during the September quarter (Q2 FY24) is a damp squib. But investors seem to be enamoured with the stellar margin show. Shares of the biscuit-maker closed 3% higher on Thursday.

Driven by lower costs, consolidated Ebitda margin expanded 343 basis points (bps) year-on-year and 250 bps sequentially to 19.7%. Ebitda is earnings before interest, taxes, depreciation, and amortization. Raw material costs were down by 5% compared to the year ago period. Staff costs fell by 1.7%. The strong margin show meant an Ebitda growth of nearly 23% in Q2 to 872 crore at a time when revenue rose by just about 1%.

 

(Graphics: Mint)
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(Graphics: Mint)

Should Britannia sacrifice a bit of its margin to fuel volume growth? “When the volume and demand is weak—what is the reason to sit at such a high margin?" asked an analyst in the company’s earnings call. To boost volume growth, should Britannia pass on some part of the margin to consumers and perhaps operate at a 17-18% margin rather than 19-20% margin?

In response, Britannia’s management said: “The agenda for us is to make sure that we grow our volumes much faster. But in times like this even throwing money is throwing money at the wall. We have to make sure that demand corrects before we start to do that." The company’s target would be to ensure that its revenue growth is faster than what it has seen in the September quarter.

To be fair, the base was high for Britannia as Q2FY23 revenue growth stood at 22%. Further, in general fast-moving consumer goods companies are bearing the brunt of weak demand and Britannia is not an exception. Easing commodity costs led to higher competition from local peers as they were able to return to the market. To remain competitive, Britannia lowered prices in some of its key brands and SKUs (stock keeping units). Overall, the company said its market share recovered last quarter. This is a positive. Thus, the market share gap between Britannia and the next largest competitor in the biscuits category is widening.

For Britannia, it helps that the urban markets are on a strong footing, but it is the rural that needs a push. Predominantly rural markets such as Madhya Pradesh and Uttar Pradesh have seen slower pace of sales growth. However, Britannia notes that it is growing faster than the overall market in these states.

To be sure, while the Q2 margin performance was aided by lower costs, there is a limit to which costs can be compressed. Given the ongoing conflict in the Middle East and Russia, Britannia is keeping a close watch on commodity price movements. Adding to the woes is the high margin base. Thus, it is likely that margin expansion may be curtailed ahead.

As such, Nomura Financial Advisory and Securities (India) expects Britannia’s Ebitda growth to be muted in the second half of FY24. “But this is largely understood by investors and built into the numbers, in our view," wrote Mihir Shah, an analyst at Nomura in a report on 2 November.

In this backdrop, a pick up in volume is the need of the hour for the Britannia stock, which is up by only 5% in 2023 so far. But valuations are not exactly mouth-watering. The stock trades at 44 times its FY25 estimated earnings, showed Bloomberg data. But scope for meaningful re-rating appears capped in the near term.

“Although we continue to like the company’s longer-term potential, near term triggers are missing given local competition and key raw materials prices such as wheat and sugar at multi-month highs," said analysts at Nuvama Research in a report on 2 November.

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