CFA Institute Research Challenge Hosted by CFA Society India Indian Institute of Management Kozhikode The CFA Institute Research Challenge is a global competition that tests the equity research and valuation, investment report writing, and presentation skills of university students. The following report was submitted by a team of university students as part of this annual educational initiative and should not be considered a professional report. Disclosures: Ownership and material conflicts of interest The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation Compensation of the author(s) of this report is not based on investment banking revenue. Position as an officer or a director The author(s), or a member of their household, does not serve as an officer, director, or advisory board member of the subject company. Market making The author(s) does not act as a market maker in the subject company’s securities. Disclaimer The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society India, CFA Institute, or the CFA Institute Research Challenge with regard to this company’s stock.
Transcript
CFA Institute Research Challenge
Hosted by
CFA Society India Indian Institute of Management Kozhikode
The CFA Institute Research Challenge is a global competition that tests the equity research and valuation, investment report writing, and presentation skills of university students. The following report was submitted by a team of university students as part of this annual educational initiative and should not be considered a professional report. Disclosures: Ownership and material conflicts of interest The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation Compensation of the author(s) of this report is not based on investment banking revenue. Position as an officer or a director The author(s), or a member of their household, does not serve as an officer, director, or advisory board member of the subject company. Market making The author(s) does not act as a market maker in the subject company’s securities. Disclaimer The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society India, CFA Institute, or the CFA Institute Research Challenge with regard to this company’s stock.
Recommendation:
Buy
INVESTMENT SUMMARY We issue a BUY recommendation on Britannia (BRIT) with a one-year target price of INR 6369 per share, representing an 11.6% upside from cthe losing price of INR 5708 per share as on October 10th, 2018. Our target price is based on a mix of the Free Cash Flow to Equity Model and P/E multiple, attributing 70% and 30% weighting respectively to each methodology. The key drivers for our recommendation are:
Key Figures Market Cap (INR Bn) 662.27
No. of shares outstanding (Mn) 120
52w High 6,934.35
52w Low 4,302.30
Avg. daily volume (30 days) 3,19,083
TTM P/E ratio 61.71
EV/EBITDA 39.19
TTM EPS 89.34
Beta 0.56
Valuation
DCF Target Price (70%) 5,988
P/E Multiple Target Price (30%) 7,257
Target Price (12 months) 6,369
Major Stakeholders
Associated Biscuits Int. Ltd. (Promoter) 44.90%
LIC 4.00%
Arisaig Partners 1.76%
Figure 1: Market Segmentation
Rural expansion: Rising rural disposable incomes due to Direct Benefit Transfer Scheme, has incentivized BRIT’s rural distribution expansion (55000 to 144000 dealers in 4 years) and helped it double its rural sales to INR 15.56 Billion. They expect rural revenues to grow at 30% CAGR and contribute 30-35% to their mix (from ~20% now) over the next 2-3 years. BRIT is currently servicing 45,000 villages, which is around 6% of India’s 700 thousand. (Census, 2011). Distribution expansion: BRIT’s direct reach has grown 2x over the past three years to 1.8 million outlets (as of 2QFY18), with an increase in 13% in H1-FY2018, and is second only to HUL(Hindustan Unilever). They currently reach 180 million Indian Households (73% of total) through 5.2 million outlets, with a target to reach 90%. There is up to a 20-share point increase potential when they go direct vs when they go through wholesalers. Making premium offerings affordable in Hindi Belt: Gujarat, Rajasthan, MP and UP are key states in central India, which contribute 40% of Industry sales, but only around 18-20% for BRIT. Currently 60% of biscuit consumption in India is in INR 5/10 packs, so their strategy to democratize premium offerings by launching smaller size SKU’s in this price range will help them gain in- roads in these states. Expand dairy portfolio to high-value added and long shelf life products: BRIT will focus its dairy product launches on Ready to Drink beverage and Dairy whitener, where there is less competition. It has begun procuring milk directly from farmers (~25,000) and will over the next 2 years begin in-house manufacturing of VAP (cheese) vs. outsourcing in order to stay competitive. BRIT’s stated goal is to grow this segment from INR 4 to 15 billion in 5 years, at a CAGR of 30%. Innovative product launches: BRIT plans 65 product launches by March 2020 (including 55 in 2019) to expand their product portfolio from 85 to 150. Each launch is expected to add INR 2.5 billion or more incrementally in the next 3 years (20% of sales by FY22) and would help accelerate the growth of the company in the next 18-24 months from current levels of 12% p.a. to at least 15%. Growing Capex: BRIT will invest INR 5 billion by 2019 for a new plant to scale up capacity in value added milk products and quadruple dairy revenues. With this plant, BRIT shall backward integrate in dairy (earlier via contract packers) & flour. They also have a 60% stake in a JV with Chipita as part of their foray into the Macro Snacking category (croissants), which they plan to grow to an INR 2.5 billion segment in 2 years, and they will bear the initial costs of manufacturing facilities at INR 1.5 Bn CURRENT HIGHLIGHTS
BRIT made its largest investment till date of INR 10 Bn in setting up Ranjangaon manufacturing facility. A fully smart factory, it will ensure efficiency in production, delivery of goods and resource utilisation.
The plant will focus on Cakes, Biscuits, Dairy and Croissant. Share price and Volume chart:
Figure 2: Revenue Split by Category
Source: Company Filings
Figure 3: Revenue Split by Geography
Source: Company Filings
Edible Oils,
31.0%
Dairy, 27.7%
Rice, Pasta and Noodles,
8.7%
Savoury Snacks,
6.8%
Biscuits, Snack-
bars & Fruit-snacks,
6.6%
Baked Goods, 3.4%
Other, 15.8%
Source: Euromonitor
75%
5% 5%
15%
Biscuits DairyInternational Rusk, Cake, Bread
94%
6% India
OutsideIndia
Company Name: Britannia Industries Ltd., Ticker: BRIT, Exchanges: NSE,BSE Industry: Packaged Food Share Price (10
th Oct 18): INR 5,708,
One-Year TP: INR 6,369 (11.6% increase)
BUSINESS DESCRIPTION Britannia Industries is one of India’s leading food companies with presence in 79 countries across the globe. They have local manufacturing facilities in the UAE and Oman and serve North America, Europe, Africa and South East Asia market through exports. It is investing in a state-of-the-art facility in Mundra SEZ (INR 1.55 Bn, 28,000 tones), Gujarat, to service the exports market. Its product portfolio includes Biscuits, Bread, Cakes, Rusk, and Dairy products including Cheese, Beverages, Milk and Yoghurt. As of 31 March 2018, Britannia had 3,794 employees on its rolls. Business and geographic segments: The company majorly serves in bakery and dairy products business. Bakery products contribute around 90% of total revenue with Biscuits (75%) contributing the largest. Dairy on the other hand contributes around 5% and remaining 5% is from international operations (Fig. 2). India is the largest geographic market of BRIT contributing 94% of total revenue while remaining 6% is coming from outside India with major contribution from the Gulf countries (Fig. 3). Major subsidiaries of the company include Sunrise Biscuit Company Private Limited, Ganges Vally Foods Private Limited, Boribunder Finance and Investments Private Limited, Daily Bread Gourmet Foods (India) Private Limited (Daily Bread), Britannia and Associates (Mauritius) Private Limited (BAMPL), and Britannia and Associates (Dubai) Private Company Limited (BADCO) among others. BRIT product portfolio: One of the reasons for their steady growth is its continuous product innovation and large product portfolio across categories. The brands under biscuits category include Good Day, Tiger, NutriChoice, Crackers, Marie Gold, Milk Bikis, Jim Jam, Treat, Bourbon, Little Hearts, Pure Magic and Nice Time. Its products under breads include Whole Wheat Breads, White Sandwich Breads and Bread Assortment. Its products under dairy category include Cheese, Fresh Dairy and Accompaniments. Its products under cakes category include Bar Cakes, Veg Cakes, Chunk Cake, Nut & Raisin Romance, and Mufills. Its product under rusk category includes Premium Bake. Britannia is now entering into macro snacking category by partnering with Greek croissant maker Chipita (EUR 800mn in revenues) Goal & Strategy: The ultimate goal of BRIT is to become Total Foods Company. BRIT’s theme in coming years is very clear and it is to reduce the distance to market. At the end of fiscal year 2018 the company directly reached to 1.8 Mn retail stores up from 0.7 Mn in fiscal year 2014 representing an increase of 152% (Fig. 5). BRIT is also planning to double the share of International Business from current 5% to 10% by 2023. Company is going for vertical integration in Dairy business and wants to control the entire value chain and setup fully integrated operation as they consume around INR 3.5 Bn of Dairy every year and they don’t want to outsource it to third party. Focus is also on innovations to strengthen position in bakery by plugging gaps and white spaces in existing portfolio that could be high value yielders and truly path breaking, new-to-market, disruptive product formats. As part of their dairy expansion, Britannia has spent INR 10 Bn in setting up a 150-acre integrated food park at Ranjangaon Maharashtra, which is expected to commercialise by December 2019. This plant would be spread across and would have integrated dairy processing units in addition to units catering to the Chipita JV and other manufacturing units for biscuits, rusks, etc. Britannia has already started milk procurement in Maharashtra on a pilot basis and expects to go full scale once the Ranjangaon plant is fully operational. It aims at sourcing milk from ~25,000 farmers. Competitive Advantage: Britannia caters to 180 Mn (70% of overall) households in India, with 80% households covered in urban India and 90% in metros through its total reach of 5.2 Mn outlets (1.8 Mn direct). Their focus on premiumization through smaller lot sizes and incremental price changes is helping them rapidly expand their user base, while their scale has helped them absorb input cost increases more efficiently than competitors. They have consistently delivered a lower freight cost increase (adjusted for volumes) than diesel price changes, and new facilities will help them lower manufacturing costs by up to 25%. They have an impressive cost saving record (INR 2.3 Bn in 2018 which is 4.5x 2014 savings), driven by lower Freight costs (distance travelled by biscuit reduced to 375 Km vs 650 Km in 2010 and target of 250 Km to bring in line with efficiency of local players). New plants in Maharashtra and Bengal offer 25-30% savings on manufacturing cost (labor, fuel, power etc). The packaged food industry is growing at an explosive rate of 19.21% CAGR from 2011-17 with a growth of 19% in 2017 alone, resulting a total market size of INR 4300 Bn (Source: Euromonitor). It is expected to grow at 13.6% CAGR from 2017-22 to reach market size of INR 8200 Bn. The underlying drivers for this industry are (1) shift towards packaged food from unpackaged unbranded products, (2)
Figure 4: Strategy
Source: Team Analysis
Figure 5: Direct Distribution
Source: Company Filings
Figure 6: Rural Distribution Increase
Source: Company Filings
Figure 7: Growth in Hindi States
Source: Company Filings
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
FY14 FY15 FY16 FY17 FY18
No
. of
ou
tle
ts in
mill
ion
s
2.5x
0
2000
4000
6000
8000
10000
12000
14000
16000
FY14 FY15 FY16 FY17 FY18
No
. of
RP
Ds
(Ru
ral P
refe
rre
d
De
ale
rs)
0%
5%
10%
15%
20%
25%
30%
Utt
ar P
rad
esh
Mad
hya
Pra
des
h
Gu
jara
t
Raj
asth
an
Ne
t S
ale
s V
alu
e G
row
th %
FY15
FY16
FY17
FY18
Reduce distance to market
Democratize premium offering for
Hindi belt
Backward integration in dairy
category
Capital investments to improve operating
efficiency
premiumisation trend, (3) competition among bigger brands and (4) performance of smaller categories. Edible oils and dairy, the biggest categories in packaged food (Fig. 1), which also attracted strong investment from both international and domestic players during 2017 leading to investments initiatives from existing players to venture in to these categories. Biscuits and Baked goods(in which BRIT is the market leader) forms around 10% of the entire packaged goods market. Biscuits, Snack Bars and Fruit Snacks: The biscuit industry in India is 3
rd largest in the
world after USA and China. The entire market for biscuits, snack bars and fruit snacks in India is around INR 288 billion (Source: Euromonitor). BRIT tops this category with market share of 25%. We believe that BRIT has tremendous scope of increasing its market share by taking the place of many small players which consist of almost 30% of the entire biscuit market (Fig. 10). In terms of volume, biscuit production by the organised segment is estimated to be 3 million tonnes. We believe BRIT has significant opportunity to improve its volume as the per capita consumption of biscuits in India is significantly low at 2.3kg compared to 19kg in Iran, 10kg in USA & UK, and over 4.5kg in Southeast Asian countries (Hong Kong, Singapore, Thailand etc.) (Source: Elara Capital). Providing 75% of BRIT’s revenues, the biscuits category is primarily driven by (1) premiumisation, and (2) healthy living trend. Consumers are opting for premium biscuits that include high quality ingredients, exotic flavours, new products and innovative packaging. Middle class consumers are willing to pay extra for the right value products and are consuming more filled biscuits and cookies, slowly shifting from plain biscuits. BRIT entered this segment by introducing new brand called Pure Magic Deuce. Lower income groups on the other hand are shifting to filled biscuits and cookies as many companies are offering such biscuits at affordable prices compared to some of the premium brands. Strong demand is expected from the lower middle-class population for premium biscuits as disposable income of this segment is estimated to rise in the coming years. Along with this the lifestyle and eating habit of Indian consumers is changing and they are demanding healthier snacks. Baked products: Baked goods revenues grew by 11% CAGR from 2011-17 with a, resulting a market size of INR 146.8 billion, while volume sales rose by 3% to three million tonnes (Source: Euromonitor). Baked goods is expected to grow at CAGR of 8% from 2017-22 to reach market size of INR 219 Mn. Major factors affecting the slower growth rate are increasing competition from other packaged food categories such as sweet biscuits and savoury snacks & rising commodity prices. Artisanal producers (unorganised segment) accounted for 47% of the total market, however their share has been decreasing consistently from 51% in 2012 on account of changing consumer preferences towards the longevity of the packaged baked goods. BRIT has grown and gained significant market in the organised segment of baked goods, it leads the market with 12.3% market share (Fig. 11). We believe there is a huge potential for BRIT to increase its market share in these segments on account of good brand recall and their continuous effort in providing the quality products. BRIT has taken steps to upgrade its manufacturing capabilities, product quality, and also range of offerings beyond sliced bread. It has also grown its whole wheat and brown bread range well.
INDUSTRY OVERVIEW & COMPETITIVE POSITIONING As per our analysis the HHI index of packaged food industry in India is 1448.3 (Fig. 12) which is quite low and it indicates that the concentration in the industry is low which leads to high competitiveness among the market players. Around 23% share of the unorganised sector is adding to the intense competition in the market. However, existence of brand loyalty in certain product towards existing firm such as Amul in case of butter limits the competition for these products. The threat of substitutes is moderate as biscuits can sometimes be substituted by other snacking products such as wafers, chocolate bars, cakes and pastries. The raw materials used in making bakery product majorly come from unorganised sector which leads to low bargaining power of the supplier. Consumers tastes and preferences change which leads to low brand loyalty in these product types. The low switching cost also increases the bargaining power of the consumer (Appx. 6). BRIT is well positioned in the packaged goods industry with market leader in Biscuits and Baked goods category. Three out of five forces are weak which provides a conducive environment for BRIT to grow and strengthen its position in the market. The only concern we have here is the intense competition among the peers and the large dependence on the unorganised sector. But we believe that BRIT having a good brand image coupled with its continuous
Figure 8: Cost savings YoY
Source: Company Filings
Figure 9: Industry CAGR
Source: Team Analysis, Euromonitor
Figure 10: Market Share in Biscuit Category
Source: Euromonitor
Figure 11: Market Share in Baked Goods
Source: Company Filings
0
500
1000
1500
2000
2500
FY14 FY15 FY16 FY17 FY18
Incr
em
en
tal C
ost
Sav
ings
Eac
h
Ye
ar (
INR
'Mn
)
~ INR 650 Mn of costs taken out in 2018
25.0%
24.8%
13.5%
4.6%
2.2%
29.9%
BritanniaIndustries Ltd
Parle ProductsPvt Ltd
ITC Ltd
Anmol Biscuits (P)Ltd
Surya Food &Agro Pvt Ltd
other
Artisanal, 47.4%
Other, 32.9%
Britannia Industrie
s Ltd, 12.3%
Modern Food
Enterprises Pvt
Ltd, 3.8%
Monginis Foods
Ltd, 3.6%
Biscuits 14.6%
Packaged Food 13.6%
Dairy 20.6%
Baked Goods 9.0%
effort in product innovation and quality improvements would keep on gaining the market share in the future. The results are already visible with BRIT overtaking Parle to set on the growing trajectory (Fig. 14). FINANCIAL ANALYSIS Historical revenue growth and key drivers: Britannia has attained a compounded annual growth of 10% in the last four years and we expect the revenues to grow at CAGR of 16% from 2018-2023. The company currently has five major product categories: Biscuits (73% of net sales in FY18), Dairy (4%), Bread (5%), Cakes (5%) and Rusks (8%). Apart from these product categories, Britannia achieved 5% revenue from international markets, especially from Gulf countries. From the above revenue split, it is evident that biscuits business is the key contributor for Britannia for its revenue. We have projected sales for the next five years based on the company’s prospects and market expectations (Appx. 14). Now the company is planning to transform itself from being a packaged foods company to being a global total foods company by venturing into new product categories and launching numerous products. Britannia has ambitiously planned to launch 65 new products in the next 18 months, and most of these products will be non-biscuits products as the company wants to transform itself into a total foods company. We agree with CEO Varun Berry’s statement that the dairy business will grow from INR 4 Bn to INR 15 Bn and assumed a growth rate of 30.38% for next five years considering the fact that company will build two dairy plants, one in Maharashtra and another one in West Bengal. We have assumed an aggressive growth rate for bread (10%), cakes (19.84%) and rusk (15%) segment as the company is trying to grow its non-biscuits categories significantly. Britannia’s international business which currently contributes to around 5% of total sales would grow aggressively as the company is planning to go global on a large scale because of which we assumed an accelerated growth of 33% for the next five years as they will be expanding into international markets. We captured all these growth assumptions and forecasted the revenue for five years which resulted in a 16% YoY growth with net revenue of INR 223 Bn for the financial year 2023. Estimation of COGS and operating expenses: Cost of goods sold is the major cost accounting for 62% of its total sales in FY 2018. COGS majorly constitute the cost of materials consumed (49.9% of sales) and purchase of stock-in-trade (12.2% of sales). We forecast that the COGS will come down to 56% of sales by 2021 as the food manufacturing unit in Ranjangaon and dairy facility in West Bengal will become functional by 2021 that will lead to the backward integration of raw materials, ultimately reducing the cost of goods sold. We estimated depreciation and amortization at constant rate till 2021 and forecasted a steep rise of 56% in depreciation expense for FY 2022 as we are expecting Maharashtra dairy plant to get capitalized in the financial year 2021. We gradually increased the freight and distribution expenses as the company is trying to increase its direct shipping outlets. We increased the freight expenses as a function of sales to provide a cushion to capture crude oil price volatility. As the company will be launching around 50 products in the next 12 months, the marketing expenses are expected to surge heavily. With its new brand logo and to position itself as a global total foods company, Britannia will have to spend massively on marketing and promotions. We raised the advertising expense by 50% for the next two years and gradually reduced it over the next three years. Profitability ratios and multiples: The Company has promised cost savings of INR 2.5 Bn every year. The cost savings come from product recipe, wastages, supply chain and backward integration of raw materials. By cost-saving measures, we estimated the profitability of the company to grow up. We estimated that PAT margins will grow gradually till FY 2020 and will rise substantially from 11.8% (FY 2020) to 15.3% as the result of cost reduction arises from Ranjangaon plant as it will start its functions by 2021. We are predicting that the P/E multiple will go down to around 55 by the financial year 2023 as earnings per share YoY growth will be more than Britannia’s stock price growth. Net working capital and liquidity: FMCG companies generally tend to have their cash conversion cycle as low as possible. Britannia, being a packaged foods company, has a cash conversion cycle of -4 and is targeting to reduce it significantly in the next five years. We calculated the days payable, days relievable and days of inventory individually for different categories based on its business requirements and estimated the cash conversion cycle of Britannia. The reduction will make the company more liquid and reduce the pressure of working capital requirements in their operations
Figure 12: HHI Index calculation Company % Share
Britannia Industries Ltd 25.0%
Parle Products Pvt Ltd 24.8%
ITC Ltd 13.5%
Anmol Biscuits (P) Ltd 4.6%
Surya Food & Agro Pvt Ltd 2.2%
Others 29.9%
HHI Index= ∑(Market share^2) 1448.3
Source: Team Analysis
Figure 13: Porter’s 5 Forces
Source: Team Analysis
Figure 14: Britannia vs Parle
Source: Company Filings
Figure 15: Revenue Growth
Source: Company Filings, Team Analysis
Rivarlywithin theIndustry
SupplierPower
BuyerPower
Threat ofNew
Entrants
Threat ofSubstitute
s
FY13 FY14 FY15 FY16 FY17 FY18 FYE19
Bis
cuit
s M
arke
t Sh
are
Britannia Parle
6%
Gap
3%
Gap
-
50
100
150
200
250
FY1
6
FY1
7
FY1
8
FYE1
9
FYE2
0
FYE2
1
FYE2
2
FYE2
3
INR
Bn
which will have a positive effect on the free cash flow of the company. As the cash balance is maintained predominantly for the precautionary purpose, we have not considered cash and cash equivalents in our working capital calculation.
VALUATION We issue a BUY recommendation on Britannia Industries (BRIT) with a target price of INR 6369, implying a 11.6% upside from the closing price of INR 5708 per share on October 10th, 2018. Our target price calculation is based on the Free Cash Flow to Equity (FCFE) model with a target price of INR 5988 (Appx. 13) and P/E multiple with a target price of INR 7257 (Appx. 15). We respectively attributed weights of 70% and 30% to each methodology. The choice of attributing less weight to multiples methodology is driven by the lack of pure comparable companies to Britannia. From Net Income to FCFE estimations: FCFE largely depends on how working capital requirement and capital expenditure will play out in the forecasts. There is an increased capex in first 3 years with facility in Nepal, Bengal, Andhra Pradesh and Rajnandgaon being the committed facilities and we’ve also forecasted a perpetual capex of Rs. 3.5 Bn which is 20% higher than its depreciation which signifies that company will perpetually invest in growth over and above replacement capital expenditure. As management has suggested that their focus is on drastically reducing working capital requirements as a percentage of revenue, we’ve forecasted that NWC (excluding cash balance which is not for transaction purpose) will come down significantly from 14.7% in 2018 to -2.4% in 2023. This release in working capital will create a significant value for equity shareholders. Estimating the risk-adjusted discount rate: We used CAPM (Capital Asset Pricing Model) to estimate the cost of equity. To arrive at the risk-free rate of 6.06%, we reduced country risk (1.95%) from 10-year Indian government bond (8.02%) to eliminate sovereign risk attached in the 10-year Indian government bond. Country risk was arrived based on Moody’s country credit rating relative to US credit rating which was 1.95%. Equity risk premium of 7.27% was arrived at from NYU’s country equity risk premium table calculated by Aswath Damodaran. We regressed Britannia monthly stock price with NSE market index for last three years and calculated beta value as 0.56. By capturing all the above estimation and assumptions in the CAPM, we estimated the cost of equity as 10.12%. Optimistic views on terminal growth: For terminal growth, we’ve assumed that industry will grow at GDP growth rate perpetually and Britannia will be able to maintain its market share. According to Aswath Damodaran, risk-free rate is a very good proxy for perpetual GDP growth rate and hence perpetual growth rate has been assumed to be 6%. In the DCF valuation, 87% value is derived from terminal value and hence we can see that target price is highly sensitive to perpetual growth rate. (Fig. 20) FCFE Model – FCFE model was primarily used because company has no significant long-term debt. DCF analysis reveals an undervalued valued share price: To assess the robustness of our DCF valuation, we evaluated the sensitivity of our result for the most influential inputs, namely Ke and the terminal growth rate. The most conservative scenario marks a downside of -10.3%. A very optimistic combination of 9.0% discount rate and a terminal growth rate of 7% results in an upside of 86%. These results reinforce our positive view of industry growth rates and the belief that BRIT’s market leadership position is going to benefit the company greatly in commanding margins and trading terms. We expect the free cash flow to grow from INR 4.41 Bn in 2018 to INR 35.57 Bn in 2023 which implies 52% CAGR and which we believe is achievable considering aggressive initiatives from the management. This FCF growth is due to a combination of revenue growth, EBITDA margin expansion and release of working capital. Multiple analysis: If we analyze P/E multiple, we see that Britannia has historically traded at premium to the industry P/E because of its market leadership position. Currently, it is trading at a P/E multiple of 68x vis-à-vis industry median of 61x which implies 10% premium. Going forward, we expect FY2023 forward P/E multiple to be 55x on the backing of strong EPS CAGR of 28%. CORPORATE GOVERNANCE Group Structure: BRIT, with its headquarters based in Kolkata, India has 23 subsidiaries out of which 16 are domestic and 7 are located abroad. BRIT’s subsidiaries include 19 production and distribution companies (in India, Dubai, Oman, Nepal & Mauritius), 2 holding and 2 financing subsidiaries. (Appx 3) Executive Committee & Board of Directors: Key management personnel in BRIT’s
Figure 16: Cost Bridge
Source: Company Filings
Figure 17: EBIDTA Margin
Source: Company Filings
Figure 18: Cash to Cash Conversion
Source: Company Filings
Figure 19: Assumptions
Revenue
16.6% CAGR 2018-23 supported by New Product Launches in High Growth Categories (Non-Biscuit) and International Market Expansion
COGS Reduction in COGS by 700 basis points on the backing of vertical integration and focus on margin accretive business
Cost of Equity
10.12% (as shown in Fig. 20)
Terminal Growth
6.00% (Assumed perpetual GDP growth rate of 6.00%)
Source: Team Analysis
69.5%
4.1% 4.0% 5.2%
1.4% 15.8%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Re
ven
ues
FY
20
18
Co
st o
f Sa
les
Ad
vert
Exp
Em
p B
en
efi
t Ex
p
Oth
er
Exp
De
prn
& A
mo
rt
EB
IT F
Y2
01
8
0.0%
5.0%
10.0%
15.0%
-
500.00
1,000.00
1,500.00
FY13 FY14 FY15 FY16 FY17 FY18
Operating Profit % to Net Sales
(50)
(30)
(10)
10
30
50
70
90
FY16 FY17 FY18 FYE19 FYE20
Days in Inventory Days in Acs Recvs
Days in Payables Op Cash Cycle
current executive committee are MD Varun Berry, who joined over from HUL in 2013, & CFO N Venkataraman. BRIT’s board has an optimum mix of Executive, Non-Executive and Independent Directors and is headed by a Non-Executive Chairman, Mr. Nusli N Wadia. BRIT currently has 14 Directors out of which 4 (29%) are Non-Executive-Non-Independent Directors and 9 (64%) Independent Directors (including one women director). The current board composition is in line with most of the Uday Kotak committee recommendations such as separation of the roles of Non-Executive Chairperson and Managing Director, at least half of directors should be independent directors and one women director. 50% of the members of BoD have education and proficiency in finance while the other half is composed of members with engineering and management competencies. The First concern we have is the number of company’s directorship held by board members. Almost half of the board members have directorship in more than 5 other companies which make us question whether the members devote sufficient time for supervision of BRIT’s management. Second concern is the remuneration of MD and Directors has increased significantly (17%) whereas the median remuneration of permanent employees was 12.4% lower compared to last year. Environmental sustainability & social responsibility: Environment, Health and Safety are at core of BRIT’s values. To promote a Zero Accident culture, BRIT has strengthened its work place systems and practices through several accident prevention programs. BRIT endeavours to reduce the distance travelled overall by its products, thereby reducing emissions on account of transportation. Shareholder Base: The company has 120 Mn shares outstanding. During the 12 months ending June 2018, BRIT paid dividends totalling INR 25 per share. Currently the biggest shareholder of BRIT is Associated Biscuits International Limited, holding a stake of 44.90%. The promoters and directors hold approximately 51% of the companies stake. Life Insurance Corporation of India is the largest public institution with 4% stake in the company. (Fig. 2)
INVESTMENT RISKS The company is exposed to a variety of risks for which the board has set up a risk management committee to monitor, review and mitigate the risk exposure of the business. Credit Risk: Britannia faces 2 kinds of credit risks, from distributors (as receivables) or bond issuers. Default risk of distributors: The Company mitigates the risk of default from its distributors by maintaining minimum day’s receivables of -4 days and having a fragmented network of distributors across the country. It also determined to increase the direct shipping distribution which will reduce the distributors involved in the supply chain which in turn reduces the risk of default from distributors. Default risk of borrowers: The Company manages its surplus cash balance by actively buying bonds from various established firms that sum to a total value of INR 9.60 Bn earning a non-operating income of INR 1.04 Bn as interest income. Britannia reduces the risk of default from the bond issuers by maintaining a diversified portfolio and also by meticulously picking the issuers having a favourable credit rating. Liquidity risk: Corporate treasury department: Liquidity risk is the risk that the firm will not be able to meet its financial obligations as they become due. The firm’s corporate treasury department under the guidance of senior management is responsible for liquidity, funding and settlement management. Working capital: Britannia maintains a high level of cash and cash equivalents to meet its short-term financial obligations. The idea is to maintain more cash balance than the expected cash outflows on trade payables and other financial liabilities. It is also estimated that the firm will substantially increase its cash and cash equivalents as a result of reduced cash conversion cycle to reduce the working capital requirements which will make the firm more liquid. Beside this, Britannia has lines of credit and overdraft facility with various banks to manage the liquidity risk exposure of the company. Inflation risk: Cost of material consumed: For any packaged foods company, inflation is one of the biggest risks that will have a serious effect on the financial performance of the business. As most of the revenue is from the biscuit segment, the price of sugar, wheat, and milk powder plays a vital role in determining the margins of the products produced by the company. As wheat constitutes 32% value in a typical glucose biscuit, the price of wheat is one of the key determinants on the financial
Figure 20: Computation of Cost of Equity
10y Indian Government Bond 8.02%
Country Risk Premium 1.95%
Risk-free rate 6.07%
Market Risk Premium 7.27%
Beta 0.56
Market Capitalization (Bn) 662.27
Enterprise Value 653.29
Cost of Equity 10.12%
Source: Team Analysis
Figure 20: Sensitivity Analysis
Ke
Perpetual Growth Rate
5.0% 5.5% 6.0% 6.5% 7.0%
9.0% 15.8% 25.8% 39.2% 57.9% 86.0%
9.5% 7.1% 14.8% 24.7% 37.9% 56.3%
10.1% -1.3% 4.4% 11.6% 20.7% 36.6%
10.5% -5.5% -0.7% 5.3% 12.8% 22.4%
11.0% -10.3% -6.3% -1.4% 4.5% 11.9% Source: Team Analysis
Figure 21: Shareholding Pattern
Source: Company Filings
Figure 22: Top 10 Public Shareholders
Source: Company Filings
Figure 23: List of Board of Directors
Nusli N Wadia Keki Dadiseth
A K Hirjee Ajari Puri
Jeh N Wadia Naseer Munjee
Ness N Wadia Ranjana Kumar
Avijit Deb Ajay Shah
S S Kelkar Y.S.P. Thorat
Nimesh N Kampani Keki Elavia
Source: Company Filings
Promoter, 50.7%
Free Float, 49.3%
35.8%
15.7% 9.1% 7.6%
5.9%
5.8%
5.7%
5.0%
4.8% 4.5% Life Insurance Corporationof IndiaArisaig Partners (Asia) PteLtdGeneral InsuranceCorporation of IndiaNomura India InvestmentFundBaron Emerging MarketsFundLife Insurance Corporationof India P&GS FundMotilalOswal Most FocusedMulticap 35 FundICICI Prudential FocusedBluechip Equity FundMorgan Stanley MauritiusCompany LimitedKotak Select Focus Fund
performance of the biscuit business. Inability to pass on the pricing pressure to consumers due to higher competition can result in further pressure. Commodity Price risk: Crude oil price: Britannia with its wide supply chain network having around five million distribution outlets, transportation is a significant element of the supply chain. Transportation cost is heavily dependent on the crude oil price which is relatively volatile and not as stable as other costs. In last one-year, crude oil price is gone up from $55 per barrel to $74, a 34% price increase in one year. Britannia will be able to handle this risk by increasing the direct shipping outlets and warehouses which will invariably reduce the transportation cost as it will ultimately reduce the distance covered. Strategic Risk: Market saturation: Biscuit is highly penetrated category across all segments and markets. It will be difficult for the company to achieve accelerated growth in biscuits, may experience slowdown instead. With increased competition and emergence of new players, it can be difficult for Britannia to maintain its market share. Success rate: Britannia has planned to launch 50 products within next one year. It is going to enter new product categories and also plans to solidify its hold in the cake, rusk, dairy and cake markets. It is also planning to expand vastly in international market targeting 50% revenue outside the country. However, failure of new launches and disappointing entry in new markets cannot be ruled out completely. Technological Risk: New technologies may make the competitors more efficient, in turn, may adversely affect the competitive positioning of Britannia in the industry. Risk of increasing competition: As biscuits market is highly established and saturated, it is tough to handle competition in terms of maintaining market share and competitive positioning for a long-term.
Source: Team Analysis
Figure 24: List of Executive officers
Varun Berry MD
N. Venkatraman CFO
Jayant Karpe Head-BCR
Venkat Shankar Head-Dairy
Ali Harris Shere Head-Marketing
Sudhir Nema Head-R&D
Gunjan Shah Head-Sales
Manjunath Desai Head-Consumer Insights
Ritesh Rana Head-HR
Vinay Singh Kushwaha
Head-Supply Chain
Manoj Balgi Head-Procurement
Anindya Dutta Head-International Business
Source: Company Filings
Figure 25: Tornado Analysis
Source: Team Analysis
Appendix 1: Commodity and currency risks Factor Explanation Forecast Crude Oil Impacts freight costs, which average around 5%
of sales for Britannia. Crude oil is expected to trade at 66.19 USD/BBL by the end of this quarter, according to Trading Economics global macro models and analysts’ expectations. Looking forward, we estimate it to trade between 50 and 60 in a year’s time.
Wheat Impacts input costs. Makes up ~ 40% of COGS for Biscuits. Along with sugar, this is one of the few commodities that is policy dependent
Expected to trade between 12 and 16.6 over the next year.
Sugar Impacts input costs. Makes up ~ 24% of COGS for Biscuits. Along with sugar, this is one of the few commodities that is policy dependent
Sugar will be range bound between 35.4 and 27.8/Kg over next few months
Exchange rate (USD/INR) Indian Rupee is one of the biggest losers among emerging markets after Turkey. Severely impacts consumer purchasing power.
USD/INR exchange rate will be range bound between 67 and 78 over the next year
APPENDIX 2: Product types
APPENDIX 3: Subsidiaries Country Company Function Currency Capital (Millions) India Sunrise Biscuit Company Pvt Ltd. Manufacture of other food products
INR
292 Ganges Valley Foods Pvt Ltd., Kolkata Manufacture of other food products 16 International Bakery Products Limited, Balam
Manufacture of other food products 29.5
Boribunder Finance and Investments Pvt Ltd.
Other financial intermediaries 56.7
Britannia Dairy Pvt Ltd., Bangalore Manufacture of dairy product 177.8 J B Mangharam Foods Private Limited, Gwalior
Production, processing and preservation of meat, fish, fruit vegetables, oils and fats.
9.5
Manna Foods Private Limited, Bangalore Manufacture of other food products 0.6 Daily Bread Gourmet Foods Pvt Ltd, Bangalore
Hunting, trapping and game propagation including related service activities
637
Mauritius BRIT and Associates Pvt Ltd. Manufacture of other food products Mauritian rupee
-
Dubai BRIT and Associates Pvt Ltd. Company Manufacture of other food products Dirham - Strategic Brands Holding Company Limited Manufacture of other food products -
Oman Al Sallan Food Industries Co. SAOC Production of cookies, biscuits, candy & confections.
Omani Rial -
Appendix 4: Corporate Governance Assessment
Methodology of Corporate Governance Scoring Sections Max Points P E The goal of the Scorecard: to provide an extensive and comprehensive picture of the governance quality of listed companies. The Scorecard has two main features: - P-questions that can be dealt with by publicly available external sources (i.e. the company's publications and its website) and - E-questions that need evaluation, individual appraisal and judgment that should also be a result of discussions with the company. With this approach, a broad picture of the strengths and weaknesses of the individual company governance performance can be gained. The total score is the aggregate of the individual section scores.
I. Shareholders and General Meeting
7.00 4.5 2.5
II. Board of Management
14.00 5.5 8.5
III. Supervisory Board
28.00 14 14
IV. Transparency and Governance
10.50
5 5.5
V. Reporting and Audit
10.50
5.5 5
Total Score for BRIT Points Max. Points % Shareholders and General Meeting 4.0 7.00 57 Management Board 12.0 14.00 86 Supervisory Board 23.0 28.00 82 Transparency & Governance 9.0 10.50 85 Reporting & Audit 9.3 10.50 88 Total 57.3 70.00 82
Members of BOD: 80% of BOD members are non-executive(11/14), while 57% are independent
Number of mandates held by BOD: most Members hold 5 or more mandates outside Britannia
Independence of BOD members: Chairman of the Board and CEO separate
Board Composition: Board has 1 female director(7.15% of Board)
Rating System
100%-90% Excellent
90%-80% Very Good
80%-70% Good
70%-60% Satisfactory
Appendix 5: SWOT Analysis
Strengths Weaknesses - Market leader in Biscuit market with 33% share, 1.1 times its nearest rival Parle - Rapidly expanding direct reach with existing Distribution Channel. - Well positioned to benefit from premiumisation of biscuits and increasing rural preferred Dealer expansion - 100-year-old legacy and Presence in 73% of India’s households - R&D to sales ratio Above Industry Median
- Earnings too dependent on Biscuit Market (73%). - Weak Hindi Belt presence (only 18% sales vs 40% for industry) - Marginal Players in High growth Dairy Business - High conversion costs as 65% of production is outsourced.
Opportunities Threats - New product launches to expand portfolio by 76% by Mar’20 -Can quadruple dairy revenue share in 5 years if ramp up successful - Value added dairy can be a hit as competition is very less here.
- Rising crude prices can inflate freight costs, - Falling Rupee and inflationary pressures may dampen consumption - Dairy Facility Capex is Return Dilutive for at least 2 years pending ramp up
Appendix 6: Porter’s 5 Forces
5 Forces Subcategories Assessment
Buyer power
Use of multiple sources Many alternatives available in commoditized biscuit Market. However Macro snacking and Value-added dairy are relatively less crowded and a focus area for Britannia
Product differentiation Very low in Glucose Biscuits. However, Value added dairy and macro snacking have higher differentiation
Backward integration Britannia's backward integration will enable them to produce 65% of their output vs 46% currently.
Threat of substitutes
Number of substitutes For standardized products it is High, in fact, BRIT, is expected to lose market share in Biscuits and Baked goods segment market due to their focus on Value Added dairy
Relative price BRIT is democratizing premium biscuit offerings through smaller pack sizes for cost sensitive consumers to stave off this challenge from substitutes
Relative quality BRIT's expertise and high-quality products are one of their key advantages.
Rivalry within the industry
Concentration 3 players (including BRIT) control 80% of the Biscuit market, with HHI of 1450 --> Highly concentrated. Baked Goods market is dominated by Artisanal Players (47% market share) and is fragmented.
Size of Competitors BRIT and its 2 rivals are evenly matched in terms of market share in the biscuit market, while BRIT is dwarfed in Value added dairy
Fixed Costs BRIT currently outsources its production up to 45%, which they plan to bring down to 46%. Thus, their planned Dairy ramp up will increase fixed costs to around 54% of total
Diversity of Competitors Competitors are mainly domestic, except Nestle. Parle G is the only competitor with a pure-play business model (Biscuit), the other competitors have a broader product mix.
Strategic Stakes BRIT has currently medium excess capacity with their expansion strategy. It is expected to increase Overall capacity by 14% by 2021 when its Integrated production facility in Western India is fully operative.
Excess Capacity BRITs Mundra(Western India) expansion for International Business along with planned dairy production ramp up (from 20000 to 300000 Litres per day) increases chances of excess capacity being unutilized
Exit Barriers Highest for rivals like Parle who have a pure play business model. BRIT and other competitors have lower risk due to their diversified product mix
Threat of new entrants
Scale Economies Less for niche market like value added dairy and macro snacking. High for biscuits. Product Differentiation increasing trends of disruptive product launches, eg. BRIT's Pure Magic. BRIT's product
mix is 80:20 in favour of Premium products, which is indicative of high differentiation.
Switching Costs Switching costs for customers are quite low
Rivarlywithin theIndustry
SupplierPower
BuyerPower
Threat ofNew
Entrants
Threat ofSubstitutes
Porter's 5 Forces
0
2
4
6
8
Concentration
Size ofCompetitors
IndustryGrowth
Fixed Costs
ProductDifferentiat…
Diversity ofCompetitors
StrategicStakes
ExcessCapacity
Exit Barriers
Rivarly within the Industry
0
1
2
3
SupplierConcentratio
n
ProductDifferentiati
on
Suppliers'input tobuyer
Dependenceon the
industry
ForwardIntegration
Supplier Power
012345
BuyerConcentratio
n
Use ofMultiplesources
BackwardIntegration
Importanceof the
product to…
Buyers'volume
Buyer Power
0
2
4
6
8
Economiesof Scale
ProductDifferentia…
SwitchingCosts
CapitalRequireme…
ExpertiseRequirement
DistributionChannels
CostAdvantage
Legal ndRegulatory…
Threat of New Entrants
0
1
2
3
4
No. ofsubstitute
s
RelativePrice
RelativeQuality
Incentiveto
Substitute
Threat of Substitutes
Capital requirements Capital requirements for Biscuit Manufacturers are significant both in terms of manufacturing equipment and R&D spending for new entrants, whereas BRIT has 100 years of experience in this segment.
Expertise requirement Low barrier to entry as Biscuit production technology is standardized. For new segments of macro snacking and Value-added dairy however barriers are higher
Distribution channels BRIT's Biscuits are available in 65% of India's retail outlets, while they have ramped up their rural preferred dealers by 4X over 4 years
Cost advantage BRIT has ramped up cost saving by 4.5X in 4 years and currently save 230 Crores (~2.5% of revenues). They also have the lowest freight cost increases adjusted for crude oil inflation.
Legal and regulatory barriers FSSAI handles this. Generally, less stringent than for other Chemical industries Defense of market share BRIT has 33% Biscuit and 12.3% Baked Goods market share but is weak in dairy
(0.72%)
Supplier power
Supplier concentration Quite diffuse, especially for dairy Product differentiation Low for INR 5/10 SKU biscuit and medium/high for Value Added dairy and macro
snacking Suppliers' Input to buyer BRIT aims at sourcing milk from ~25,000 farmers.
Dependence on the industry
The raw materials used in making bakery product majorly come from unorganised sector which leads to low bargaining power of the supplier.
Forward integration In the Dairy and Biscuit Industry, suppliers do not have the means to integrate forward.
Appendix 7: Altman Z Score
Particulars 2014 2016 2017 2018 The Altman Z-Score Analysis is used to verify company's financial health and the probability of filing for bankruptcy. If the Z-score is below 1.81 - a firm has a high probability of bankruptcy, while a score of 2.99 indicates a financially sound firm that is far from filing for bankruptcy. The formula is (1.2*Z1) + (1.4*Z2) + (3.3*Z3) + (0.6*Z4) + (1.0*Z5).
Working Capital INR Mil -5361 -771 6405 2301
Asset Turnover (Average) 0.7 1.0 0.9 1.0
Revenue INR Mil 113342 208708 224947 290552
Average total assets* 153165 217404 247195 299538
Total liabilities* 116972 169510 186039 231543
Net Sales* 1136 2087 2249 2906
Shares outstanding Mil 2661 2846 2886 2935
Likelihood of bankruptcy is high if Z-score is below 1.8. BRIT has Z score above 3 and hence is highly unlikely to face bankruptcy.
Avg of max and min share price 731 2733 3052 4176
Market Cap* 1944659 7776837 8809154 12255680
Operating Income INR Mil (EBIT) -1079 25883 29131 41351
Net Income INR Mil -1641 6819 15894 17604
Dividends INR per share 0.6 0.45 0.95 1.56
Retained earnings -3237.6 5538.3 13152.3 13025.4
Working Capital/avg total assets -0.04 0.00 0.03 0.01
Retained earnings/avg total assets -0.02 0.03 0.05 0.04
