Britannia has ~32% market share in biscuits, which we expect to gradually move up by ~100 basis points every year over the next 3-4 years driven by: increasing share in the ‘Hindi Belt’ led by distribution expansion, launch of premium products and gradual shrinking of the unorganised sector after GST. We expect volume led 13% revenue CAGR over FY18-20. Gross margins declined y-o-y in FY17 and H1 FY18 due to significant inflation in inputs like wheat flour, edible oil and sugar. Britannia hiked prices with a lag which caused margin compression. However, this is reversing as prices of wheat, sugar and milk are declining. Britannia’s RM index was up over 10% y-o-y in FY17, and has come down to just 1% in Q3 FY18. We expect this to go into deflation over the next 3-4 quarters if current spot prices hold. We expect agri inflation to remain structurally soft over 2-3 years. Britannia continues to drive supply chain efficiencies, which will further aid the recovery in margins.
We believe Britannia as a brand has the ‘right to win’ in many food categories outside of biscuits. There is potential to leverage the brand and distribution in many new categories which management is in the process of identifying. One of the initiatives was to enter into a JV with Chipita, a Greek company, for long shelf-life filled croissants. We are only wary of the dairy segment, which is a very tough category to make money in. We value Britannia at 45x Mar-2020 earnings, in-line with our target multiple for HUL and Nestlé and at a 10-15% premium to other larger Indian domestic FMCG companies like GCPL, Dabur and Marico.
We initiate with ‘Outperform’ and a target price of Rs 5,500. Key risks include: Rise in competitive intensity from Parle or ITC and a sharp spike in input costs such as sugar, milk, palm oil and flour. Britannia is the market leader in biscuits, the largest packed foods category in India. We see the company consistently gaining market share over the next 3-4 years and moving towards category domination from just leadership.
We also see potential for Britannia to become a broader foods play as the brand has right to win in many other segments and management is seriously evaluating options. We expect margin expansion to restart after 4-5 tough quarters of steep input cost inflation, as the input cost cycle has reversed and cost savings programmes gather momentum. We expect an 18% earnings CAGR over FY17-20.