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Buy Britannia Industries Ltd For Target Rs.4,120

Widening moats strengthen right-to-win; upgrade to Buy

Structural opportunity attractive; track record best among peers

* Widening moats: The management’s efforts in the last few years on a) expanding distribution, especially direct reach which is now at 2.3m outlets (next only to HUVR) while its total reach is now the best for any listed Food company and is nearing Parle among unlisted ones; b) boosting R&D capabilities, after setting up a new R&D center five years ago; c) successful implementation of its low unit packs strategy, leading to consistently strong growth in the hinterland; d) consistent cost rationalization, which is essential in a low gross margin category like Foods; e) continued investments in boosting overall and regional manufacturing capabilities (including the ongoing INR15b on its mega facility in Ranjangaon); and f) its new regional strategy (similar to HUVR’s highly successful WIMI strategy) is resulting in consistently widening moats over peers in Biscuits (market leadership has extended for 37 quarters now) and in the broader USD40b Food category where BRIT made an impressive initial foray in FY20.

* Exciting long-term opportunity: With the widening of its moats, BRIT has strengthened its right to win and is poised to gain further market share (currently only in the mid-30s despite widening of moats) in the Biscuits category, which contributes ~80% of sales, and in the overall USD40b Packaged Food industry, where it has made a strong foray in recent years.

* Remarkable track record: BRIT’s track record over the last 10 years ending FY20 is extremely strong, with topline and earnings ahead of peers. This is remarkable given that most FMCG peers have struggled to post double-digit CAGR over the last three-to-five years.

Valuation and view

* Inexpensive valuations: The extraordinary strong base in FY21E (40% EPS growth forecasted), led by high in-home consumption and low material and A&P costs, does put some pressure on the next few quarters particularly in 1QFY22 where the base has shown 105.4% EPS growth. However, beyond that it will become less challenging in subsequent quarters. On the other hand, the stock is now attractive at 36.5x FY23E EPS, a discount to its 3/5 year average P/E multiple of 48x/46x and also on a relative basis as compared to its peers.

* Recent underperformance leads to a favorable risk-reward ratio: Since our downgrade in Nov’19 on challenging valuations and rising raw material costs (not a concern now), the stock has underperformed peers (4% return v/s double-digit average returns by its peers). While we remain cautious due to challenges to FY22 earnings growth and thus our buy call may be slightly advanced, we believe downside is limited as the narrative is likely to move to FY23 and beyond in the next few months.

* Upgrade to Buy: Immense structural opportunity, remarkable track record, RoEs of over 40% superior to most consumer peers, and an attractive riskreward ratio on FY23E earnings, after its recent underperformance, leads us to upgrade BRIT to a Buy. Our TP of INR4,120 (based on 45x FY23E EPS) implies an upside of 24% from its CMP.

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