Engro Foods Not for the faint‐hearted! Wednesday November 6, 2013
Investment Thesis NEUTRAL Target Price Dec‐13: PKR 80 ƒ
Depressing 2013E earnings (down 51%YoY) has brought the company’s growth story to an abrupt halt. Distribution issues and the company’s inability to pass on cost pressures due to increased competition in the dairy segment has greatly undermined the company’s revenues (down 8%YoY) and has squeezed margins terribly to average at 21% for 2013E from 26% in 2012 ƒ
The dairy segment has been the company’s focal point and revenue driver, followed by the ice‐cream segment. We have taken Efoods share in the UHT segment at 51% in the model in 2014. However, given the company’s strong brand name, any improvement in the market share will be not very surprising and will resultantly lead to an upward revision in our estimates ƒ
We anticipate the market growth in the ice‐cream segment to remain subdued on account of the ongoing power crisis and lack of cold chain infrastructure. Thus, the company has shifted its focus towards taking away market shares form the existing industry by frequently introducing new products. Thus, we have modeled in 27% market share for Omore by CY15 ƒ
TP downgraded to PKR80/sh: We have used a blend of the following valuation techniques: DCF, regional PE/PS comparison to calculate our TP. For DCF based technique, we have used risk free rate of PKR 12.5% (latest 10 yr PIB auction rate), a terminal growth rate of 4% and beta of 1.28 Current Price: PKR 84 Bloomberg EFOODS.PA
Reuters ENFL.KA
MCAP (USD mn) 576
12M ADT ( USD mn.) 3.7
Shares Outstanding 766
Valuations 2012A 2013F 2014F EPS 3.4 1.7 2.9 DPS ‐ ‐ ‐ 0% CY13F Dividend Yield (%) Capital Gain (%) ‐5% Total Gain (%) ‐5% Efoods vs. KSE100 Relative Chart KSE100 Index
Financial Highlighs EFOODS
240
2012A 2013E 2014F 2015F 220
Sales 40,169 37,099 41,127 45,132 Gross Profit Operating Profit Finance Costs Profit Before Tax Tax Profit After Tax EPS 10,321 8,282 9,280 10,192 4,823 2,700 4,517 5,121 933 776 1,183 1,278 3,890 1,923 3,334 3,843 1,326 654 1,134 1,230 2,565 1,269 2,200 2,613 3.4 1.7 2.9 3.4 200
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Source: BMA Research EFOODS Profile: Engro Foods is a subsidiary of Engro Corporation, headquartered in Karachi. The company is engaged in manufacturing, processing and selling dairy products, ice cream, and frozen desserts. The company also owns and operates a dairy farm. Zoya Ahmed zoya.ahmed@bmacapital.com +92 111 262 111 Ext: 2053 BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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TP revised down to PKR80/sh; stance NEUTRAL We revise downwards our 2013E and 2014F earning projections for Efoods by 58% and 50% to PKR1.69/sh and PKR2.9/sh respectively. After adjusting for revenue slowdown and margin weakening, our margins now stand at 21% for 2013 and 22% in 2014. As a result, our TP goes down to PKR80/sh justifying a NEUTRAL stance. To arrive at our TP of PKR80/sh, we have used a blend of the following valuation techniques: DCF, regional PE/PS comparison. For DCF based technique, we have used risk free rate of PKR 12.5% (latest 10 yr PIB auction rate), a terminal growth rate of 4% and beta of 1.28. Although we have a NEUTRAL stance on the stock, we advise short‐term investors to remain watchful. To mention, the current PE stands at 47x on 2013E earnings of PKR1.69/sh (57% higher than last 2 years average P/E of 20x). Assuming 21% discount (based on last two years) to regional players, the company should trade at PE of 25x on 2013E earnings, the market can batter the stock down to PKR43/sh to reflect the downside in earnings presenting a wonderful opportunity to accumulate the stock. 2013 earnings to decline by 51%YoY The company has been reporting tremendous increase in earnings growing at a CAGR of 144% since the last two years. However, 2013 failed to keep up the growth pace where EPS is now expected to go down by a hefty 51% to PKR1.69/sh in 2013 versus PKR3.40/sh in 2012. What exactly went wrong? Disruption in supply chain network hurting sales One of the key reasons behind such dismal performance of the company was the disruption in the company’s distribution network where distributors handling almost 50% of the company’s sales decided to wind up operations in 1QCY13. Since then, things have not looked good as 9M2013 sales have slid by 5% to PKR28,023mn versus PKR29,395 in the corresponding period last year. As per Efoods management, the distribution issues have been taken care of but will take time to reflect on the bottom‐line. So, we expect revenues to pick up pace in 1H2014 onwards. New entrants increasing the bargaining power of buyers Secondly, the total milk market (loose and branded), at annual 38bn liters carries massive untapped potential for branded dairy players, who represent only 8% (5% UHT and 3% powdered) of total milk market. This mass untapped potential has attracted a lot of competition with many new product offerings coming into play, enhancing the bargaining power of buyers. This has hampered the industry’s pricing power as companies now seek to grow more volumetrically rather than focusing on margins (449bps drop in YoY margins). Efoods plans to do the same focusing on getting the volumes back through promotional offers by placing products at a discount. We believe this strategy will bode well for volumes however; margins will remain under pressure in the remaining 2013 as well as 1H2014. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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Efoods: Competition Profile Products Company Competition to Olpers MilkPak Nestle Haleeb Haleeb Foods Good milk Shakarganj foods Competition to Omung Dairy Rozana Nurpur Dairy Pure Shakarganj Foods GroAur Haleeb foods Competition to Tarang Everyday Nestle Chaika Shakarganj Tea Max Haleeb Chai Max Nurpur Millin Premier Source: BMA Research EFOODS: Product Profile and Positioning Since the beginning, Efoods story has been following a tremendous growth trajectory betting on country’s favorable demographics and socio‐indicators (rising consumerism, pacy urbanization and increasing middle income). EFOODs has set its presence in all of the three segments it operates in namely Dairy, Ice‐Cream and Juices and is not hesitating to explore other lucrative avenues (Al‐Safa, Powdered milk and Frozen foods). The dairy segment has been the company’s focal point and revenue driver, followed by the ice‐cream segment. We have taken Efoods share in the UHT segment at 51% in the model in 2014. However, given the company’s strong brand name, any improvement in the market share will be not very surprising and will resultantly lead to an upward revision in our estimates. Pakistan’s five main dairy product segments Others
5%
Tea creamer (22%) new
product segment for low end consumers
White milk (73%) , positioned either
as offering nutritional benefits for growing children or as an 'all purpose'
milk for families
Source: Tetra Pack Report 2010 BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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Olpers: positioned to snatch share from existing branded players The company initiated its journey in the Liquid Dairy Product (LDP) segment with UHT packaged milk, Olpers in 2007. The product came in to take away share from other established packaged players in the market and compete with offerings such as Milkpak, Haleeb etc. Olpers was able to successfully do that for Efoods at that time but now the market scenario and shopper dynamics have changed with consumers shifting their purchases towards more affordable alternatives. To mention, this segment trades at a price premium of ~20% to unprocessed milk and other dairy products and caters to socio‐
economic class A and B. Omung: the low priced alternative to loose milk Engro Foods launched Dairy Omung in August 2011 calling it a dairy liquid. The current strategy at Engro is to use Omung to take share from loose milk. Thus, the product is priced at 8‐10% discount to loose milk, thereby directly targeting consumers who still prefer loose milk. In addition to, Engro also launched lassi and cream products under the Omung banner, with the idea being to strengthen the equity of the master brand. Despite all these efforts, Omung has still not been able to make any significant mark uptil now. Having said, we anticipate Omung to drive momentum in revenues in years to come primarily due to its lower price as rising inflation trend will urge people to move towards such products. This will not only speed up conversion from unbranded loose milk, it will also help Efoods gain market share. Tarang: targeting a market of its own Tea whitener has become another area of innovation in the packaged milk sector targeted mainly at lower income segment. Tea creamers represent more than 25% of the total milk market. Affordability in conjunction with widespread tea drinking habits (32% of total milk consumption in Pakistan according to Tetra Pak) speaks volumes about the growth of the said segment. Effods has effectively used Tarang to build consumption through smaller SKU’s. The brand now makes up ~60% of the total tea whitener industry category and will continue to be the main revenue contributor for the company. Ice‐cream Segment: characterized by high margins and low volumes Pakistan’s Ice cream market is largely dominated by Unilever’s Walls with more than 50% of the market share. Efoods’ Omore has effectively captured 26% of the market in 2012 and has become the second largest player. We anticipate the market growth in the ice‐
cream segment to remain subdued on account of the ongoing power crisis and lack of cold chain infrastructure. Thus, the company has shifted its focus towards taking away market shares form the existing industry by frequently introducing new products. Thus, we have modeled in 27% market share for Omore by CY15. Against company’s target of achieving profitability in the said segment in CY13, the ice‐
cream revenues have slid by 7%YoY in 9M2013 to PKR2,266mn consequently bringing the bottom line for the segment in red by PKR136mn. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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Beyond CY14: The opportunity is still there ! Once the distribution issues settle in and the inflation shock tapers off, volumes should get back on track as the demand outlook for dairy products remain steady. The company’s strong brand name alongwith the favorable industry dynamics will help capitalize on the growth opporunities easily then. Undoubtedly, the potential is humungous. What needs to be followed now is the effectiveness of the potential and existing brands to tap this potential. Thus, we have not yet factored in these variables. The not‐rich, not‐poor consumers offer huge prospects on account of.. From a global perspective, emerging economies, primarily China, India, Brazil, Indonesia and Pakistan are now being termed as the biggest markets for Liquid Dairy Products (LDP) on account of a vast majority of economically empowered consumers. To mention, these countries alone account for 76% of the total LDP consumption in developing markets. Pakistan ranks second highest in terms of LDP consumption in developing countries where 64% of the population living on USD2‐USD8 per day accounts for 60% of all LDP consumption in the country, most of which is still consumed in unpackaged form, making these consumers an extremely important segment for milk processors. Furthermore, from 2006‐2009 consumption of packaged LDP in Pakistan increased steadily with a CAGR of 2.4% to 22 bn litres. . …Speedy Urbanization Urban centres drive economic growth as urbanization leads to greater brand awareness and higher disposable incomes. Today, 38% of Pakistan’s total population is urbanized growing up by 2.7%YoY. We expect the phenomenon to continue and give way to further growth in the dairy industry as people shift their spending towards branded and hygienic packaged milk. …An emerging middle class The growing middle class is another key growth driver of the dairy industry. This educated, aware and well‐informed section of the society (~42% of the population) is increasingly able to afford treated milk available at 10‐20% premium to its loose milk alternative. …Younger population presenting opportunity to create micro segments Pakistan’s age structure in itself presents a wonderful opportunity for micro segmentation to dairy players. Currently, 22% of the total population lies within the age bracket of 15‐25 years. Youth demands much more than just plain white milk creating room for dairy players to tap these opportunity sets through variants such as (flavored milk, flavored yoghurt). BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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Six developing countries represent 76% of LDP consumption in developing markets 72.5 Bio/litres
1%
100%
90%
80%
55.2 Bio/litres 3%
6%
Other Developing 24%
19%
Indonesia 70%
22%
60%
50%
40%
30%
Kenya
6 developing markets 76%
Brazil
China
Pakistan
50%
20%
India
10%
0%
2011 Total LDP Consumption
2011 LDP 6 developing markets Consumption
Source: Tetra Pack Report 2011 Expansion plans to determine the growth pace moving ahead Efoods has laid out an ambitious expansion plan and is not hesitating to enter into any and every segment that offers lucrative returns. From powdered milk plant (expected to achieve COD by CY13 end) to pasteurized milk shops (opening in early November 2013 as a pilot project) and meat business (anticipated to come online in 1H2014), the management is tapping onto every growth avenue in order to become a 100bn enterprise by 2020. Our model suggests that due to hefty loan repayments, the pre‐capex cash position of the company will be sufficient to finance approximately 30% ‐40% of the company’s future expansion plans in next two years. That said, we expect debt to equity to remain in the range of 70:30 in next two years. Since the company plans to utilize its cash to finance growth, we expect no dividend payouts by the company until 2015. Valuation To arrive at our TP of PK80/sh, we have used a blend of the following valuation techniques: DCF, regional PE comparison and regional PS comparison. For DCF based technique, we have used risk free rate of PKR 12.5% (latest 10 yr PIB auction rate) and beta of 1.28. Although we have a NEUTRAL stance on the stock, we advise short‐term investors to remain watchful. To mention, the current PE stands at 47x on 2013E earnings of PKR1.69/sh (57% higher than last 2 years average P/E of 20x). Assuming 21% discount (based on last two years) to regional players, the company should trade at PE of 25x on 2013E earnings, the market can batter the stock down to PKR43/sh to reflect the downside in earnings presenting a wonderful opportunity to accumulate the stock. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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