Karachi: EFOODS is one of the few companies at the KSE offering investors organic growth and a direct exposure to the Pakistani consumer play, where consumption growth is expected to be fuelled by stable population growth, rising urbanization, and improving literacy ratio which in general helps in the proliferation of branded products. AKD Securities has revised AKD Securities’ Target Price for EFOODS to PkR52/share and upgraded EFOODS to ‘Buy’ after accounting for i) higher sales growth and margin outlook, ii) exit from the loss making rice business (sale of EFOODS stake in Engro Foods Supply Chain to Eximp), iii) revision in peer multiples and iv) rolling forward AKD Securities’ target price onto end – Dec’12. EFOODS is a true growth story where AKD Securities forecasts earnings to grow at a 5-yr CAGR of 54%, the highest in the AKD Universe.
Dairy segment literally the EFOODS cash cow: Dairy segment has set the foundation for EFOODS growth where in CY11, the segment’s net sales were recorded at PkR27.3bn (+41%YoY), accounting for 91% of EFOODS topline while segment profits doubled (+104%YoY) to PkR14bn, with profitability growth driven by higher sales and improving margins. Going forward, AKD Securities expects the Dairy segment to continue to grow where AKD Securities expects the segment’s revenues to rise at a 5-yr CAGR of 31% and reach PkRlO6bn by 2016. The `Ice cream’ segment’s loss during CY11 expanded by 6%YoY to PkR4O5mn as the segment is still in its growth stages (revenues up 61%YoY to PkR2.6bn) and will take a couple of years, in AKD Securities’ view, to come in the green. Operating conditions for Ice Cream manufacturers have generally been tough due to the high costs incurred in the supply chain network, mostly due to the high energy costs. By way of comparison, the margins of Ice cream segment are the lowest of all the ULEVER segments. Encouragingly though, the branded Ice Cream category continues to grow as even ULEVERs segment sales were up by 11%YoY in CY11 to PkR6.1bn.
What could go wrong? The key risk factors for EFOODS in AKD Securities’ view would be i) sales growth, ii) margin slippage, particularly of the ice cream segment and iii) interest rates where financing of EFOODS aggressive capex plan would be heavily tilted towards debt. Nestle could be a game changer for the dairy industry as it plans huge investment of ~US$400mn in Pakistan over the next 3 years. AKD Securities has provided EPS impact based on a 1% change in the variable mentioned above where clearly, earnings are most sensitive to AKD Securities’ margin assumptions. Key upside could come in the form of a JV with a foreign brand, particularly in the child nutrition segment, which should lead to significant margin improvement for EFOODS.
FMCG sector trades at significant premiums: Given the sector’s high inflation pass-through ability and exposure to the growing Pakistani consumer market, earnings of the listed FMCG sector (ex-EFOODS) has grown at a 5-yr CAGR of 23%. While the sector’s earnings growth has been impressive, the most significant factor is that earnings growth has been consistently positive reflecting the relative insularity of the sector to economic conditions. Similarly, FMCG sector has traded at premium multiples where the average PIE for the last five years has stood at 19.5x while the P/S multiple has averaged at 1.5x.
Valuation methodology: AKD Securities has valued EFOODS using a blend of relative valuation (P/E and P/S) and discounted cash flows (DCF). For P/E and P/S, AKD Securities has used the FMOG sector 5-yr average multiples for which AKD Securities arrives at respective target prices of PkR37 (CY12F EPS of PkR1.92 and target P/E of 19.5x) and PkR83 (CY12 sales/sb. of PkR55 and target P/S of 1.5x), while AKD Securities’ DOF target for EFOODS is PkR44. AKD Securities’ blended average TP for EFOODS is PkR52/share where AKD Securities has applied 25% weight each to P/E and P/S and 50% weight to AKD Securities’ DOE value.
Recommendation: Despite the apparent demanding multiples, AKD Securities still remains Overweight on EFOODS given its superior growth profile. Accounting for growth, EFOODS is still very cheap on PEG basis compared to peers ULEVER and NESTLE, where AKD Securities has arrived at AKD Securities’ PEG ratios using the CY12 PE and 5-yr earnings OAGR as AKD Securities’ denominator. EFOODS provides attractive upside of 25% to AKD Securities’ Dec-end IP of PkR52. Buy!