Cargills (Ceylon) PLC (CARG.N0000) · PDF fileCargills (Ceylon) PLC 2 A capital market...

Sri Lanka | Beverage, Food & Tobacco EQUITY RESEARCH

Initiation of coverage 19 December 2013

Cargills (Ceylon) PLC (CARG.N0000)

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A capital market development initiative by the Colombo Stock Exchange in association with Amba Research

A consumption play Cargills (Ceylon) PLC (CARG) is the largest organized food retailer by market capitalization listed on the Colombo Stock Exchange (CSE), and also manufactures a range of fast-moving consumer goods (FMCG) and operates a fast-food chain. The company is majority owned by its parent company CT Holdings PLC (CTHR), itself one of the largest traded conglomerates on the CSE. We expect the typical signs of consumption growth, such as rising GDP and private consumption expenditure, to support CARG’s revenue growth, at an 11.3% CAGR over FY14E-FY16E. We also forecast CARG’s EBIT margin to expand to 4.3% in FY16E from 4.1% in FY13. Margin development across all segments is likely to be tempered by persisting high operating costs, particularly electricity and fuel expenses, as well as currently underwhelming results from the brewery and biscuits businesses. CARG’s debt and gearing levels in the past three years have risen due to a string of acquisitions and investments to expand capacity of several product lines. Our SOTP and P/E analyses yield a valuation range of LKR110-149, compared with the share price of LKR149 as of 18 December 2013.

We forecast revenue to post an 11.3% CAGR over FY14E-FY16E as consumption levels are set to improve. CARG’s revenue is likely to be driven by

its retail segment, which we forecast to also grow at an 11.2% CAGR to FY16E, spurred by improving macroeconomic indicators, such as increasing GDP per capita and consumption expenditure. We also expect CARG’s supermarket count to grow 38% to 292 stores in FY16E from 211 as at the end of FY13, compared with an almost 50% increase over FY10-FY13. The aforementioned factors should also support the growth of the FMCG segment, at a forecast CAGR of 11.2%, as increasing purchases of processed and convenience goods combine with enhanced capacity of several product lines to boost CARG’s revenue inflows.

CARG’s EBIT margin to expand only slightly by 18bps through FY16E, restrained by cost pressures. We forecast an EBIT margin of 4.3% in FY16E,

relatively flat compared with its FY13 figure of 4.1%. We estimate the retail segment’s margin to widen 17bps to 4.0% in FY16E, while economies of scale from the recent capacity expansions in the FMCG segment should improve the margin 14bps to 4.3% in FY16E. CARG’s overall margin growth will feel the pinch from increasing operating costs, particularly higher electricity and fuel expenses, in addition to the currently loss-making brewery and biscuits operations.

CARG’s relatively high net debt and gearing levels may limit investments in the short-term. Over the past three years, CARG has undertaken several

acquisitions and capacity expansion activities, mostly funded by debt, which climbed to LKR14.4bn in 2QFY14 – up almost fivefold from FY10. Due to this rise in debt, CARG’s gearing levels have increased to 55% in 2QFY14 from 33% in FY10 and should result in a high interest expense over FY14E-FY16E; the company’s interest cover ratio has fallen to 1.8x in FY13 from 3.3x in FY10 as a result. Consistent negative free cash flow (FCF) generation may also make large investments unlikely in the near term.

We establish a share price range of LKR110-149, compared with the current share price of LKR149. We used the SOTP valuation technique to arrive at a

valuation range of LKR110-149, inclusive of bull- and bear-case scenarios. Our P/E analysis suggests that CARG currently trades at a 2014E P/E of 42.8x – a 7% premium to our normalized P/E of 40.0x – and yields a valuation range of LKR131-145 by factoring in a 5% premium and a 5% discount to this normalized P/E to account for potential positive and negative considerations, respectively.

Key statistics

CSE/Bloomberg tickers

Share price (18 Dec 2013)

No. of issued shares (m)

Market cap (USDm)

Enterprise value (USDm)

Free float (%)

52-week range (H/L)

Avg. daily vol. (shares,1yr)

Avg. daily turnover (USD

‘000)

CARG.N0000/CARG SL

LKR149

224

258

363

20.5%

LKR184/143

43,098

55

Source: CSE, Bloomberg Note: USD/LKR=129.1 (average for the one year ended 18 December 2013)

Share price movement

Source: CSE, Bloomberg

Share price performance

3m 6m 12m

CARG -4% -12% -4%

S&P SL 20 -1% -9% 6%

All Share Price Index 0% -6% 5%


Summary financials

LKRm (year end 31 March) 2013 2014E 2015E

Revenue 55,379 61,373 69,802

EBITDA 3,604 4,191 4,815

EBIT 2,262 2,431 2,950

Net profit 1,630 774 1,168

Recurrent EPS 7.3 3.5 5.2

ROE (%) 13.7 6.3 8.6

P/E (x) 20.9 42.8 28.3

Source: CARG, Amba estimates

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Dec-12 Feb-13 May-13 Jul-13 Oct-13 Dec-13

CARG ASPI S&P SL 20

Cargills (Ceylon) PLC

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Table of Contents

CARG to post a revenue CAGR of 11.3% over FY14E-FY16E on the back of improving consumption trends .................. 3

CARG is positioning itself to capture the anticipated enhanced demand for organized food retail ....................................................... 3 Current low penetration of modern food retail highlights growth potential ............................................................................................ 5 FMCG revenue to grow at an 11.2% CAGR through FY16E ................................................................................................................ 6 Restaurant revenue to rise at a CAGR of 14.4% through FY16E ......................................................................................................... 7 Potential risks to the food retail sector .................................................................................................................................................. 8

EBIT margin to modestly widen 18bps to 4.3% in FY16E as cost pressures persist .......................................................... 9

Retail EBIT margin to expand 17bps supported by retail volume growth ................................................................................................... 9 FMCG margin to widen 14bps, driven by recent investments in capacity expansion and new products .............................................. 9 Restaurant margin to expand 10bps, fueled by more consumers dining out in the local restaurant sector ........................................ 10 Downside risks to margins .................................................................................................................................................................. 11

High debt level and negative FCF generation could restrict investment opportunities in the near term ........................... 12

We arrive at a valuation range of LKR110-149 for CARG shares ..................................................................................... 14

Our SOTP analysis yields a valuation range of LKR110-149 per share ............................................................................................. 14 P/E analysis yields a fair value range of LKR131-145 per share ........................................................................................................ 16 Other sources of potential upside/downside ....................................................................................................................................... 16 Relative valuation data used as a measure of comparison ................................................................................................................ 17

Share price performance .................................................................................................................................................... 18

Earnings release focus areas ............................................................................................................................................. 19

Appendix 1: Company overview......................................................................................................................................... 20

CARG’s business segments ............................................................................................................................................................... 21 Management strategy, transparency and governance ........................................................................................................................ 22 Shareholding structure ....................................................................................................................................................................... 22 Board of directors ............................................................................................................................................................................... 23

Appendix 2: Key financial data ........................................................................................................................................... 25

Summary group financials (LKRm) ..................................................................................................................................................... 25 Key ratios............................................................................................................................................................................................ 26 Segmental summary ........................................................................................................................................................................... 27

Appendix 3: SWOT analysis .............................................................................................................................................. 28

Fact Sheet .......................................................................................................................................................................... 29

Sri Lanka investment environment overview ...................................................................................................................................... 29


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CARG to post a revenue CAGR of 11.3% over FY14E-FY16E

on the back of improving consumption trends

We believe CARG’s revenue growth will primarily be propelled by the company’s retail activities (accounted for 80% of CARG’s revenue – its largest segment), supported by favorable consumption patterns and its growing retail outlet footprint. The company’s revenue growth should be ably supported by its rapidly expanding FMCG segment, boosted by enhanced capacity of several existing product lines and the introduction of new products and variants, in addition to modest growth in the restaurants division.

Figure 1: We expect CARG’s revenue to post an 11.3% CAGR over FY14E-FY16E, driven by the retail and FMCG segments


CARG is positioning itself to capture the anticipated enhanced

demand for organized food retail

CARG’s island-wide chain of supermarkets currently enjoys a market share of 40-45% in the local organized food retail sector and slightly less than 7% of the estimated total groceries spend, according to management. The company has aggressively expanded its store network since FY10 in a bid to capture an anticipated rise in the volume of shopping at supermarkets, with the increasing presence of CARG’s own-brand goods in its outlets strengthening its revenue potential further.

CARG’s retail operations accounted for approximately 80% of its group revenue in FY13, and the company is the largest private supermarket retailer in Sri Lanka by both revenue and total store count, as shown in Figure 2. We forecast the retail segment to grow revenue at an 11.2% CAGR over FY14E-FY16E.

From a macroeconomic perspective, consumption and disposable income levels are steadily growing in Sri Lanka; however, this growth could be tempered by consumer spending cutbacks mainly due to previous and proposed price hikes on imported food items, and in fuel and electricity costs. Expenditure on food, beverages and tobacco recorded a 16.6% CAGR over 2007-2012 to LKR610.9bn, according to the Central Bank of Sri Lanka (CBSL), while overall private consumption grew 15.5% YoY in 2012, slowing from 25.1% in 2011; food, beverages and tobacco constitute the largest consumption expenditure. We believe that growth in the segment will be driven by the evolving needs and consumption patterns of middle- and upper-income consumers, who are progressively brand conscious, buy more convenience and processed foods, and continually demand better quality and levels of service.

Below, we examine three main factors that contribute to CARG’s competitive edge in the organized food retail space.

Expanding retail network. We believe that CARG’s retail strategy is to set up its supermarket

outlets across most regional cities in the country; in most instances, no other private supermarket

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FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E

YoY growth LKRm

Retail segment revenue (LHS) FMCG segment revenue (LHS)

YoY growth-Retail segment revenue (RHS) YoY growth-FMCG segment revenue (RHS)

Steadily improving macro trends should be a key revenue driver across all CARG’s segments

CARG’s retail segment to post a revenue CAGR of 11.2% through FY16E


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chain would have ventured into these cities. This is particularly crucial, as just over 50% of Sri Lanka’s total FMCG market is in rural areas, according to Nielsen, a global market research firm, and these regions are generally underserved by modern-format retailers.

In December 2009, CARG launched an ambitious expansion program to open 100 new outlets by FY14 – a 74% increase in its store count, which stood at 136 as of March 2009. The company remains on track to achieve this target, with net additions of 96 new supermarkets between March 2009 and September 2013, including 29 openings in FY13 alone. As of September 2013, the company had 232 stores in all 25 districts of Sri Lanka. CARG is far more aggressive in its expansion plans than its competitors Keells Super and Arpico, which had net openings of only four and minus one stores, respectively, in FY13, and seven and six over FY09-FY13. This allows CARG to enjoy a first-mover advantage in the new cities and regions it opens stores in and helps the company establish a strong local market position. Unlike CARG, Keells Super and Arpico focus more on opening larger stores in cities with higher levels of disposable income.

Figure 2: CARG leads Keells Super and Arpico in total store count

Source: CARG, Ceylon Cold Stores PLC, Richard Pieris and Company PLC

Efficient supply chain. CARG has built direct relationships with farmers from whom CARG buys

agricultural and dairy produce, which it then distributes to its retail outlets across the island. By directly sourcing from farmers in a typical produce supply chain, the company is usually, though not always, able to sell the products at highly competitive prices in its supermarkets – a key feature of its marketing strategy. Due to the relative efficiency of its supply chain and its efforts to minimize post-harvest wastage, CARG is typically able to price its products lower than modern trade competitors. This has made CARG popular with price-conscious customers.

Growth of private-label goods. We see that demand for private-label products is rising due to

improved quality and expanded product variety, and these products are popular with both retailers and customers who are looking to save money. A Nielsen report showed that sales of private-label goods, on average, grew 16% YoY in eight Asian countries in 2011. Customers benefit from the generally lower prices of these products, while retailers enjoy higher margins, often as much as 25% more than those on comparable branded goods. Since private-label goods often have lower marketing costs, supermarket retailers are able to offer such items at lower prices than similar branded products. Management stated that CARG typically prices its private-label products lower than the category leader. For CARG, private-label goods account for 3-4% of revenue, compared with 4% for Keells and 2% for Arpico.

A brief comparison of certain key ratios across the top three retailers is shown in Figures 3 and 4. CARG’s lower revenue per store can be attributed to the fact that most of its newer stores are being opened in less populated, lower-income towns, while Arpico and Keells continue to focus on higher-income areas. Furthermore, Keells and Arpico tend to have stores that are larger in size, contributing to higher revenue per store figures. Keells supermarkets are currently focusing on opening stores that have an average floor space of 7,000 sq. ft. while Arpico’s stores are 10,000-60,000 sq. ft. in size on average. CARG’s supermarkets, on the other hand, are in the 2,000-5,000 sq. ft. range, with

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Cargills Keells Super Arpico

CARG’s store expansion strategy is aggressive and allows the retailer to establish a first-mover advantage in several regional cities

CARG earns lower revenue per store compared to its local peers, as many of its new stores are located in less affluent towns


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expansion plans now focusing on the smaller-sized Cargills Express stores, particularly in suburban towns where revenue inflows are lower than in larger cities such as Colombo.

Figure 3: CARG’s FY13 revenue is 2.8x that of its closest local peer Arpico, but revenue per store is the lowest in the group

Revenue (LKRm) Revenue growth (YoY %) Revenue/store (LKRm)

Retailer FY11 FY12 FY13 FY11 FY12 FY13 FY11 FY12 FY13

Cargills 31,440 39,162 44,220 19.8 24.6 12.9 208 215 210

Arpico Supercentres 10,926 14,027 15,703 20.8 28.4 12.0 260 312 357

Keells Super 10,258 11,918 14,025 12.7 16.2 17.7 228 254 275


Figure 4: CARG’s margin is lower than Arpico’s; ROA is higher than that of Keells (%)

Operating margin ROA

Retailer FY11 FY12 FY13 FY11 FY12 FY13

Cargills 3.5 4.3 3.8 4.5 4.6 6.8

Arpico Supercentres 7.6 10.6 6.1 NA NA NA

Keells Super 0.2 0.7 -1.3 -2.5 0.4 -5.0


Current low penetration of modern food retail highlights growth

potential

An analysis of the sales contribution from modern store formats compared with total grocery sales across several regional peers reveals that penetration levels in a country generally go hand in hand with per capita GDP levels. This trend suggests that, as Sri Lanka’s GDP per capita rises, supermarket retailers have an opportunity to increase their presence and share of total food retail sales, although at probably a slow pace.

Figure 5: Regional comparison of modern food retail penetration levels and GDP per capita shows room for growth in the local market

Source: World Bank, JP Morgan, PricewaterhouseCoopers

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India Philippines Sri Lanka Indonesia Thailand Malaysia

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GDP per capita (LHS) Modern food retail penetration level (RHS)


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Overall food retail market growing, along with the preference for modern

food retail outlets

Traditional trade outlets, such as local grocers, outdoor markets and roadside stalls, continue to hold the largest share (85%) of the Sri Lankan food retail market, particularly in smaller cities and towns. We believe that such traditional retailers will continue to be influential, particularly in more rural towns, as customer loyalty is strong and personal relationships are likely to have already been established. However, CARG’s aggressive outlet expansion plan is targeting regional cities in an attempt to expose these areas to modern retail outlets. Organized retail (ie, supermarkets) is accreting market share, albeit slowly, by operating a low-margin, high-volume model, and entices customers with a larger range of products (some at prices lower than what traditional stores can offer) and a more comfortable shopping environment.

At a macro level, Sri Lanka’s modern food retailing sector is attractive, with only 15% of food sold through modern outlets in 2012 compared with 10% in 2004, according to data from Nielsen. The rest is bought through traditional grocery stores (which carry a limited range of staples and convenience goods) and outdoor markets (which offer fresh produce). The organized food retail segment should, therefore, benefit from the growing propensity for shopping at modern trade outlets. The trend in other emerging markets suggests that increasing disposable income is positively correlated with modern food retail market share, as consumers demand greater choice and look for a more convenient grocery shopping experience.

FMCG revenue to grow at an 11.2% CAGR through FY16E

The local food retail sector has seen a marked increase in lifestyle and impulse purchases over the recent past, spurred by a corresponding rise in disposable income. Through its FMCG segment, and its sizeable portfolio of nationally-distributed own brands of popular consumer goods, CARG is in a favorable position to take advantage of this trend.

We expect the following factors to further support CARG’s revenue growth in this segment.

New product launches. In FY13, CARG’s 91.7%-owned subsidiary Kotmale Holdings PLC (CSE

ticker: LAMB) expanded its line of cheese products by introducing cheese wedges, UHT milk cartons and, in 1QFY14, launched a new range of yogurt. CARG is also capitalizing on the growing demand for healthy and natural products, with a new line of natural juices. Furthermore, the company signed a deal with Carlton & United Brewers (CUB) to brew and distribute its Foster’s brand of beer in Sri Lanka – the brand is already available in the local market and bottling is scheduled to commence in 4QFY14E.

Capacity expansion. Over the past three and a half years, CARG has invested significantly in

expanding capacity in its FMCG segment, anticipating a rise in demand for these goods. The company bolstered one of its top-selling items by adding production and storage capacity to its dairy plant, which should be commissioned in 3QFY14E. Management expects sales of ice cream to improve as domestic consumers realize that locally produced ice cream variants are possibly on par with international equivalents.

In the brewery segment, CARG plans a substantial capacity increase to 600,000 hectoliters (htl) per annum from 50,000 htl at the time of the acquisition of the business in FY12; capacity is presently at 300,000 htl. Demand for alcohol is poised to benefit from growth in disposable income and the rise in tourist arrivals, evidenced by the 13.6% YoY growth in the malt liquor production industry in 2012, as per the Excise Department.

Geographical expansion. Processed meat revenue continued to increase in FY13, although the

product line experienced some margin pressure, and CARG is keen to explore additional markets for export, particularly the Indian market. Additionally, the company should also see further growth in this product category coming from the pickup in the local and Maldivian hospitality sectors, which CARG supplies to.

While traditional grocers are still the mainstay of the Sri Lankan organized food retail market, supermarkets are becoming more widespread and are now patronized by more consumers


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Restaurant revenue to rise at a CAGR of 14.4% through FY16E

We expect revenue in the restaurant segment, which accounted for 3% of CARG’s group revenue in FY13, to grow at a 14.4% CAGR over FY14E-FY16E, primarily due to more people eating out (the CBSL reported 50% YoY growth in private consumption expenditure (PCE) in the hotel, café and restaurant segment in 2012). In addition, CARG’s revenue in the segment has been recently boosted by higher price points at Kentucky Fried Chicken (KFC – which CARG operates through its wholly owned subsidiary Cargills Food Processors [Private] Limited) and the opening of the first TGI Friday’s restaurant. The local restaurant industry is likely to benefit from rising tourist arrivals, with the government forecasting a 28.0% CAGR in tourist arrivals over 2014E-2016E.

Figure 6: PCE on restaurant visits posted an 18.0% CAGR over 2009-2012

Source: CBSL

The company has already opened 25 KFC outlets, including 5 in FY13, mainly in Colombo and its suburbs. The recently launched outlets in regional cities have performed above the company’s expectations, with consumers in these areas showing a higher propensity to dine out than in the past. CARG has opened two new outlets in FY14E so far, with several more in the pipeline, according to the company.

KFC’s strength in the local quick-service sector is its ability to innovate and “localize” its food menus to make them more appealing to the local palette. The launch of KFC’s home delivery service in FY12 should also help boost revenue in the segment, as increasingly busy households opt to bring home the dining out experience.

CARG has also signed a deal to become the exclusive franchise in Sri Lanka for global restaurant chain TGI Friday’s. The first restaurant was opened in October 2013 in Colombo Fort, the heart of Sri Lanka’s business district, but no further expansion plans beyond the opening of the first restaurant are currently available; CARG does have the option to open up to five additional TGI Friday’s restaurants over the next five years. We forecast that CARG will open one new TGI Friday’s restaurant per year through FY16E.

KFC faces competition in the local market from other international fast-food chains – such as McDonald’s, Pizza Hut, Dominos and the soon-to-be-opened Burger King – as well as standalone restaurants and smaller, informal wayside food stalls. While it still enjoys a considerable level of popularity among diners, KFC’s high price point, relative to some of these smaller establishments, may negatively affect diner footfall. TGI Friday’s, on the other hand, is a higher-end, higher priced restaurant and competes with similar upscale restaurants, such as those found in upmarket cuisine-specific establishments.

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Spending on dining out is on the rise driven by higher disposable income and a growing middle class

CARG opened the first TGI Friday’s restaurant in its portfolio in October 2013, venturing into the high-end dining out market


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Potential risks to the food retail sector

While the local organized food retail industry is enjoying a period of stable revenue growth, the following factors highlight potential downside risks that may affect this momentum.

Regulatory changes could affect supermarket operators’ revenue and profitability levels. The 12% value-added tax (VAT) imposed in January 2013 on all retail and wholesale operators with quarterly revenues of more than LKR500m (this was later amended in the 2014 budget presented in November 2013 to lower the revenue treshold to LKR250m) is likely to moderate revenue, and consequently, margin growth, as not all of the extra costs can be passed on to consumers, who are sensitive to price hikes.

Several Sri Lankan industries, from tourism to plantations, are experiencing a severe dearth of qualified personnel, and the food retail sector is no exception. The lack of suitable personnel, especially managers and other higher-level executives, together with high employee turnover, makes managing and training human resources crucial for CARG’s expansion plans. Having well-trained personnel is becoming an increasingly important aspect for the success of supermarkets, as consumers have become more demanding in terms of the level and quality of customer service they expect when doing their shopping.


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EBIT margin to modestly widen 18bps to 4.3% in FY16E as

cost pressures persist

We forecast the EBIT margin to remain relatively flat over the explicit forecast period, expanding 18bps over FY14E-FY16E to 4.3%, as revenue growth struggles to offset persistent operating cost pressures.

CARG’s operating costs mainly consist of electricity and fuel expenses. Management stated that electricity costs account for 2-3% of CARG’s revenue; the company is a large consumer of electricity due to the demanding energy requirements of its supermarket chain and capital-intensive food processing plants.

Figure 7: EBIT margin expansion to be supported primarily by the retail segment, which accounts for 75% of EBIT


Retail EBIT margin to expand 17bps supported by retail volume growth

We believe CARG’s retail segment EBIT margin will expand 17bps in FY16E to 4.0% from 3.8% in FY13. This growth is likely to result from CARG’s aggressive outlet expansion strategy driving retail revenue growth. Although this margin expansion appears modest, we believe it is noteworthy, as margins in the food retail sector are typically low (refer to Figure 8 for a peer comparison of margins), with the focus being on selling high volumes. In addition, the segment contributed 75% to the group’s operating profit in FY13, and, as such, even a slight expansion in the segment’s margin would boost overall EBIT.

Two factors hindering the retail segment’s margin expansion are rising electricity and fuel costs and, to a lesser extent, the imposition of the VAT from January 2013. Although CARG does not disclose the exact breakdown between its fixed and variable operating costs, we believe the recent fuel and electricity price hikes have driven up the cost of logistics and the operating cost of supermarkets, especially larger outlets, thereby restricting significant margin growth in the upcoming quarters. We believe the introduction of the VAT will also negatively weigh on the segment’s profitability, although CARG states that the impact from the tax has been mitigated to some extent.

FMCG margin to widen 14bps, driven by recent investments in

capacity expansion and new products

We forecast an expansion in the FMCG segment’s EBIT margin to 4.3% in FY16E from 4.2% in FY13, as investments in the soft alcohol and the underperforming confectionary businesses weigh down on margin expansion in the short term. Since FY10, CARG has invested LKR1.5bn to expand capacity at its dairy plants and LKR2.0bn-2.5bn to increase the production capacity for its soft alcohol range. Although such significant capex may limit margin expansion in the short term (we believe CARG typically finances new investments through debt, resulting in a higher interest burden), we expect the dairy business to continue to drive profitability within the segment and brewery products to turn around from FY15E. The Kist biscuits line, launched in FY12 in an already competitive market, is still below the company’s expected level of performance and is currently a

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CARG Retail FMCG Restaurants

EBIT margin to grow as retail sales increase; however, higher electricity and fuel costs continue to pressure margin


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drag on margin. We expect this product line to also break even in FY15E, as improved distribution and marketing strategies raise the level of consumer awareness of the biscuit range.

Once again, the increase in electricity costs and VAT impact may temper margin growth in this capital-intensive segment, although CARG does not disclose to what extent. There could, however, be some scope for upside margin surprise from potential price increases, particularly for new flavor variants of ice creams, CARG’s best-selling product. The relatively low competition in the market – ice cream is a de facto oligopoly – means that CARG faces little resistance to increasing prices. If demand remains robust, CARG could push through greater price hikes to bolster margins. With regard to the soft alcohol business, further rises in excise duties on alcohol may pressure margins in the segment; excise duties were increased twice during FY13 and most recently in August 2013.

Restaurant margin to expand 10bps, fueled by more consumers

dining out in the local restaurant sector

We forecast the restaurant segment’s EBIT margin to expand to 9.8% in FY16E from 9.7% in FY13, driven by the increasing consumer expenditure on dining out in hotels, cafés and restaurants, as well as slightly increased prices at KFC and the recent addition of the higher margin TGI Friday’s restaurant. However, rising operating costs and input prices will continue to pressure margin in the segment. Relief in the form of increasing prices is also limited if these restaurants are to remain competitive, due to the already high price points charged.


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Downside risks to margins

Thin margins. Supermarket chain margins are typically thin, with their main focus being

on high sales volumes over high margins. There is, therefore, constant pressure to minimize operating costs, which is compounded by the recent hikes in fuel and electricity costs.

Figure 8 compares CARG’s operating and net margins with those of a sample of its global peers, and shows that while CARG’s operating margin has historically been in line with or slightly higher than the peer average, its net margin trails that of the peer group, possibly highlighting the negative net margin impact of its increased debt level.

Figure 8: Comparison of global peers highlights low margin levels in the food retail sector

Operating margin (%) Net margin (%)

Retailer Country 2011 2012 2013 2011 2012 2013

Cargills Sri Lanka 4.9 4.6 4.1 2.9 2.2 2.9

Tesco UK 5.8 5.9 3.9 4.4 4.4 0.2

Walmart USA 6.1 5.9 5.9 3.9 3.5 3.6

Carrefour France 2.9 2.8 3.0 0.5 1.6 1.3

Metro Germany 3.6 2.5 2.4 1.0 0.0 0.3

Aeon Co Japan 3.8 4.2 3.8 1.3 1.4 1.5

Al-Meera Consumer Goods Qatar 3.0 3.8 NA 6.6 7.0 NA

Dairy Farm Singapore 5.6 4.7 5.1 5.3 4.6 4.8

Sumber Alfaria Trijaya Indonesia 2.3 2.2 1.9 2.0 2.1 1.5

Midi Utama Indonesia Indonesia 2.9 2.6 NA 1.2 1.2 NA

Philippine Seven Corp. Philippines 5.1 5.3 NA 3.5 3.6 NA

Mean 4.1 4.0 3.7 3.0 2.9 1.9

Median 3.7 4.0 3.8 2.7 2.8 1.5

High 6.1 5.9 5.9 6.6 7.0 4.8

Low 2.3 2.2 1.9 0.5 0.0 0.2

Source: CARG, Bloomberg

Loss-making products. The FMCG segment may remain affected by the currently loss-making

brewery and biscuit businesses for longer than we expect, dragging down the overall segment and group margins.

Further hikes in electricity and fuel costs. Energy costs in Sri Lanka could rise further and

exert an even bigger strain on CARG’s current margin levels. All three of the company’s business segments have demanding energy requirements, and such increases would have a sizeable impact on profitability.


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High debt level and negative FCF generation could restrict

investment opportunities in the near term

Since FY10, following the end of the 30-year civil war in Sri Lanka, CARG has invested significantly in new business ventures, such as acquiring businesses and in capacity enhancement of existing product lines. The company reported it has made more than LKR12bn in post-war investments, about 7.4x its FY13 net profit. Most of these investments have been funded through debt and, as a result, CARG’s net debt increased to LKR13.5bn in 2QFY14 from LKR2.7bn in FY10 – an almost fivefold jump. The company’s gearing level came in at 55% as at 2QFY14, compared with 33% in FY10.

In addition, CARG’s free cash flow (FCF) generation has not been encouraging, with negative FCF reported every year since 2009, with the exception of 2010, resulting in an average group FCF yield of negative 4% for the past three years.

Figure 9: CARG’s net debt position is higher compared with peers’ Figure 10: CARG has generated negative FCF in the past three

years


Note: Data as of 2QFY14

Source: CARG

We believe this considerable level of debt may weigh on CARG’s ability to make further acquisitions or additional large investments until some part of the debt is paid down and the company’s liquidity position improves.

In FY10 and FY11, CARG was involved in several large acquisitions, mainly to expand its FMCG operations – Kotmale Holdings PLC and Diana Biscuits Manufacturers (Private) Limited in 2010, and McCallum Breweries (Ceylon) Limited, McCallum Brewing Company (Private) Limited and Three Coins Company (Private) Limited in 2011. Management noted that these transactions were carried out mainly to benefit from economies of scale and compete more closely with multinational food retailers, which account for around 70% of all branded food sales in supermarkets in Sri Lanka.

Figure 11: CARG’s net debt levels have risen over the past few years due to acquisitions and investments

Source: CARG

(15,000)

(10,000)

(5,000)

0

Cargills(Ceylon) PLC

Ceylon ColdStores PLC

Richard Pieris& Co. PLC

Nestle LankaPLC

LKRm

(4,000)

(3,000)

(2,000)

(1,000)

0

1,000


LKRm

0%

20%

40%

60%

(15,000)

(10,000)

(5,000)

0

FY09 FY10 FY11 FY12 FY13 2QFY14

LKRm

Net debt (LHS) Gearing (RHS)

CARG’s debt levels have risen due to recent acquisitions and investments in capacity enhancements


13


Banking venture stalled until final approval is awarded

CARG and its parent CTHR are the joint sponsors of Cargills Agriculture and Commercial Bank (CACB), which will have a capital base of LKR5bn and is awaiting final approval from the CBSL to commence operations. CACB will operate as a commercial bank and offer a full range of conventional banking services, such as corporate and project finance. We believe that the bank may have a particular focus on the microfinance space and cater to micro, small and medium enterprises (MSMEs), especially in the agricultural and agro-based sectors.

CACB was granted provisional approval by the CBSL in September 2011 and was originally scheduled to commence operations in July 2012, but this was pushed back several times due to delays in obtaining final approval.

CARG and CTHR each hold a 15% stake in CACB, each acquired for LKR660m, while two foreign investors – the International Finance Corporation (IFC) and DEG (a subsidiary of German state development bank KfW) – own 10% each. The IFC, the private sector investment arm of the World Bank, is expected to provide a senior loan worth USD7.0m to support CACB’s debt funding requirements, in addition to making a USD3.8m equity investment (equivalent to 44m shares of CACB’s initial share capital).

As more detailed and confirmed plans for the bank have not yet been formally announced, we have taken a conservative view and not factored this in our estimates. Furthermore, since CARG’s holding in CACB is only 15%, the bank would be accounted for only as an associate and, as such, its impact on CARG’s operations would be limited.

The launch of CACB is awaiting final regulatory approval; CARG holds a 15% stake in the venture


14


We arrive at a valuation range of LKR110-149 for CARG

shares

We establish a valuation range for CARG’s shares of LKR110-149, compared with the current share price of LKR149, based on our current earnings outlook. Our range is based on scenario analysis with the sum-of-the-parts (SOTP) and P/E-based relative valuation techniques. For comparison, we have also assessed CARG’s valuation levels relative to a group of local and international peers.

Figure 12: Valuation analysis provides a range of LKR110-149 per share (current share price: LKR149)

Source: CARG, Bloomberg, Amba estimates

Our SOTP analysis yields a valuation range of LKR110-149 per share

In valuing CARG shares, we applied an SOTP approach and made explicit EBIT forecasts for all three of CARG’s segments. Our base-case assumptions of a risk-free rate of 9.8% and a market risk premium of 5.0% yield a value per share of LKR125. We have also adjusted these assumptions to further consider for bull- and bear-case scenarios, yielding a valuation range of LKR110-149.

Other elements of our valuation approach include the following:

We conducted an SOTP analysis for all three of CARG’s business segments, with explicit forecasts over FY14E-FY16E, followed by a fade period up to FY23E.

CARG’s entire real estate portfolio consists of about 64 acres of land in and out of Colombo as of March 2013. We believe that some of these properties could be used for future development projects and be a sizeable source of further value and provide future upside to CARG’s valuation. We value CARG’s investment property portfolio based on this assumption. We have valued these properties based on average market land prices for the areas they are located in.

CARG’s current capital structure comprises 23% debt and 77% equity. We have assumed a 50% debt and 50% equity target capital structure, and a terminal growth rate of 3.0%.

Figure 13 sets out our SOTP assumptions in detail. We have estimated the following:

EBIT and FCF figures throughout the explicit and fade periods

Terminal value at FY23E, calculated by applying a terminal growth rate to unleveraged FCF as of FY23E

Finally, we arrived at our enterprise value (EV) by discounting the unleveraged FCF values over the explicit and fade periods at WACC.

131

110

140 184

145

149 149

100 125 150 175 200

52-week range

P/E analysis

SOTP

Our base-case assumptions include a risk-free rate of 9.8% and a market risk premium of 5.0%


15


Figure 13: Amba SOTP assumptions schedule

Retail

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 1,950

Cost of equity 13.8% FCF (528)

Cost of debt 13.0% Terminal value (undiscounted) 52,284

Terminal growth rate 3.0%

Effective tax rate 28.0% EV 27,450

WACC 11.6%

FMCG

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 318

Cost of equity 13.8% FCF (159)




WACC 11.6%

Restaurants

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 164

Cost of equity 15.1% FCF 22




WACC 14.0%

Source: Amba estimates, Bloomberg

We have also constructed bull- and bear-case scenarios to supplement our base-case SOTP valuation, mainly based on our projections for CARG’s store openings and performance, since the retail segment is CARG’s largest top-line contributor. The key distinguishing factors of these are as follows:

Bull-case: Here we assume that CARG will open 45, 28 and 22 stores respectively per

annum over FY14E-FY16E. This is in comparison to 41, 20 and 20 openings for the period in our base-case. In this scenario, we assume that the retail segment will perform above our expectations, supporting the accelerated pace of store openings. This scenario would yield a share price of LKR149.

Bear-case: Conversely, if the retail segment does not meet expectations due to sluggish

consumption levels, CARG may decide to slow down its store network expansion plans and open only 39, 16 and 19 stores annually over the explicit forecast period, resulting in a share price of LKR110.


16


P/E analysis yields a fair value range of LKR131-145 per share

CARG’s historical 12-month forward P/E has ranged between roughly 5.0x and 50.0x since FY10. We have used a normalized forward P/E of 40.0x based on the stock’s average multiple over the past three years. The stock currently trades at 42.8x its 12-month FY14E forward EPS (based on our forecasts) – a 7% premium to this normalized figure.

Figure 14: CARG has traded at a P/E of between 5.0x and 50.0x over the past three years


In determining a P/E valuation range, we consider two scenarios:

Optimistic scenario: In this scenario, we expect shares to trade at a 42.0x forward

multiple, based on our FY14E EPS estimate, implying a 5% premium to the share's normalized historical average. This valuation outlook may arise from several favorable factors, such as better-than-expected growth in CARG’s retail business driven by improving consumer demand and an increase in the proportion of shopping done at supermarkets. We applied the 42.0x forward P/E to our FY14E EPS estimate of LKR3.45 to arrive at a value of LKR145 per share.

Conservative scenario: Here, investors may apply a discount to CARG’s share due to

sluggish consumption levels affecting the performance of the retail and FMCG segments. By assigning a 5% discount to its normalized forward P/E, implying a 38.0x multiple applied to the FY14E EPS, we arrive at a share price of LKR131.

Other sources of potential upside/downside

In addition to the potential opportunities and risks outlined on pages 8 and 11 that may affect CARG’s business performance, the following factors could also impact our valuation and estimates.

Investments: CARG plans to launch Cargills Agriculture and Commercial Bank (CACB)

and is currently awaiting final approval from the CBSL. While details of the bank's start-up and operation plans are limited, CARG is likely to take advantage of its extensive store reach to expand the bank’s network by setting up bank branches inside each retail store at a low cost. This new venture could very well be a source of upside potential for CARG’s share price.

Restaurants: CARG has the option to open up to five more TGI Friday’s restuarants in

different parts of the island over the next five years. While the decision will presumably depend on how well the flagship outlet in Colombo performs, any additions to the restaurant count would have a positive effect on the company’s top and bottom lines.

Land bank: CARG holds a sizeable land bank, which includes several valuable properties

in Colombo. While we have factored in the potential value from the possible development of these properties, the actual returns from such investments may exceed our estimates and prove to be a greater source of potential share price upside.

-

50

100

150

200

250

300

Dec-10 May-11 Oct-11 Mar-12 Sep-12 Feb-13 Jul-13 Dec-13

LKR

5.0x 16.0x 27.0x 38.0x 50.0x MPS

Our scenario analysis applies a 5% premium and discount to account for better- and worse-than-expected growth in retail consumption levels


17


Relative valuation data used as a measure of comparison

Figure 15 presents CARG’s valuation metrics relative to a set of selected peers. The share is trading at an FY14E P/E of 42.8x, at a premium to its peer average of 21.1x.

Figure 15: CARG trades at an FY14E P/E of 42.8x, compared to the peer average of 21.1x

Company name

P/E (x) EPS CAGR (%) FCF yield (%)

2011 2012 2013 2014E 2015E FY14E-FY15E 2012 2013

Cargills (Ceylon) PLC 46.7 36.7 20.9 42.8 28.3 3.2 -0.2 -10.7

Domestic peers

Richard Pieris and Company PLC 15.4 5.6 6.7 8.0 6.4 -7.9 4.6 4.2

Ceylon Cold Stores PLC 81.2 3.8 6.7 21.5 17.2 NA 3.0 3.2

Nestlé Lanka PLC 17.9 28.8 34.3 29.9 NA NA 2.7 NA

International peers

Dairy Farm International Holdings 26.0 32.7 27.0 24.0 21.5 11.4 2.8 NA

Sumber Alfaria Trijaya 37.6 40.5 33.3 27.9 22.1 17.7 -0.2 NA

Aeon Company 12.8 23.3 20.9 19.3 17.1 14.7 4.4 NA

Wumart Stores Inc 28.6 28.6 18.9 17.2 14.4 12.0 4.7 NA

Mean 31.4 23.3 21.1 21.1 16.5 9.6 3.1 3.7

Median 26.0 28.6 20.9 21.5 17.2 12.0 3.0 3.7

High 81.2 40.5 34.3 29.9 22.1 17.7 4.7 4.2

Low 12.8 3.8 6.7 8.0 6.4 -7.9 -0.2 3.2

Source: CARG, Bloomberg, Amba estimates

Owing to CARG’s range of business activities, choosing an appropriate group of peers is challenging. Therefore, we have included a list of companies that, though imperfect, provides some measure of comparison for CARG with other regional food retailers.


18


Share price performance

CARG’s shares closed at LKR149 on 18 December 2013, LKR5 lower than 12 months earlier, a decrease of 4%, compared to a 6% increase in the S&P SL 20, a 5% increase in the All Share Price Index (ASPI) and a 12% increase in parent company CTHR over the period.

Figure 16: Over the past year, CARG has underperformed the main indices and its parent CTHR


As shown in Figure 17, over the past three years, CARG has underperformed its parent CTHR and the two main indices on the CSE. Its more recent performance (over the past six months) indicates the same pattern.

Figure 17: CARG vs. key indices

3m 6m 1 year 2 years 3 years

CARG -4% -12% -4% -24% -24%

CTHR 5% -4% 12% 26% -16%

S&P SL 20 -1% -9% 6% 6% -12%

ASPI 0% -6% 5% -1% -9%


60%

80%

100%

120%

140%

Dec-10 May-11 Sep-11 Feb-12 Jun-12 Oct-12 Mar-13 Jul-13 Dec-13

CARG CTHR ASPI S&P SL 20


19


Earnings release focus areas

Here is a checklist of items that investors should track in the next – and subsequent – quarterly earnings releases. We will closely track CARG’s performance across these key areas, and revise our forecasts and update our valuation range in the earnings update notes.

For the firm as a whole

1. How have debt levels changed in the period? Has there been an increase or has CARG paid down some of it?

2. Has there been any development on CACB? Has it commenced operations?

Retail

1. How many Cargills supermarkets were opened during the period?

2. Has the margin shown any further improvement? Are operating costs continuing to increase?

FMCG

1. Have there been any launches of new products or new variants of existing products?

2. Is there any indication of how dairy products have been selling, as this is the largest sub-segment within the division?

3. Have any capacity expansion plans been announced?

4. Have the brewery and/or biscuits businesses turned profitable yet? What are management’s expectations for when this will happen?

Restaurants

1. How many KFC outlets were opened in the period? What are CARG’s expansion plans for the chain?

2. How has the TGI Friday’s restaurant performed, with regard to revenue and profitability? Has the company decided on whether it will open any more restaurants in the country?


20


Appendix 1: Company overview

Cargills (Ceylon) PLC (CARG) is the holding company of the premier organized food retailer in Sri Lanka, with a comprehensive network of 232 Cargills supermarket outlets set up in all 25 of the country’s regional districts. The company’s subsidiaries also carry out food processing operations and run a chain of fast-food restaurants. CARG is the fourth-largest listed food and beverage company on the Colombo Stock Exchange (CSE) by market capitalization – with a value of LKR33.3bn as at 18 December 2013.

The company commenced operations in 1844 as a warehouse and import business, and was incorporated in 1946. CARG was acquired by its parent company CT Holdings (CTHR), which holds a 70.0% stake, in 1981, with the first Cargills supermarket established in 1983. The company has ventured into and invested in several business and product lines and currently operates in three primary business segments: retail, FMCG and restaurants (refer to page 21 for more details).

Figure 18: Retail segment accounted for 80% of revenue in FY13

Figure 19: Retail is also the largest EBIT contributor – 75% in FY13

Source: CARG Source: CARG

Note: Segmental EBIT figures were not available pre-FY11

CARG recorded revenue of LKR55.4bn in FY13, led by revenue growth of 12.9% YoY in the retail segment, representing a historic growth CAGR of 19.1% over FY09-FY13. The group posted an EBIT of LKR2.3bn, also at a 19.1% CAGR over the same period, to reach an EBIT margin of 4.1% in FY13.

-

20,000

40,000

60,000


LKRm

Retail FMCG Restaurants

-

500

1,000

1,500

2,000

2,500

FY11 FY12 FY13

LKRm

Retail FMCG Restaurants

Figure 20: CARG’s revenue posted a 19.1% CAGR over FY09-FY13

Figure 21: EBIT also rose at a CAGR of 19.1% over FY09-FY13, reaching a margin of 4.1%

Source: CARG Source: CARG

0%

10%

20%

30%

0

20,000

40,000

60,000


YoY growth LKRm

Revenue (LHS) YoY growth (RHS)

0%

10%

20%

30%

0

1,000

2,000

3,000


YoY growth LKRm

EBIT (LHS) YoY growth (RHS)


21


CARG’s business segments

Retail

The group’s retail operations (80% of revenue and 75% of EBIT in FY13) are carried out by Cargills Foods Company (Private) Limited, a fully owned subsidiary. CARG operates the largest private supermarket chain in Sri Lanka. As at end-September 2013, the company operated 232 stores across all 25 districts of the country, far ahead of its rivals Keells Super (51 outlets) and Arpico (44 outlets). In terms of retail revenue, its LKR44.2bn is 3.2x larger than Keells Super and 2.8x larger than Arpico. The company believes that it holds around 40-45% of the modern food trade market. The chain’s outlets have two formats: Cargills Food City supermarkets, which have a floor space of 3,000-5,000 sq. ft. on average, and therefore carry a wider range of stock keeping units (SKUs), and Cargills Food City Express outlets, which are convenience stores with an average floor space of 2,000 sq. ft.

FMCG

This is CARG’s food processing segment (17% of revenue and 17% of EBIT in FY13), and it manufactures a range of FMCG products under a number of popular household brand names. The segment’s product portfolio has expanded significantly in recent years and competes with international competitors such as Nestlé. The main brands under this segment are as follows:

Magic/Heavenly ice cream – Cargills states that it is the largest dairy ice cream player in the

country, and through its wholly-owned subsidiary Cargills Quality Dairies produces a range of ice creams, milk and milk shakes.

Kotmale – Kotmale Holdings PLC (CSE ticker: LAMB) is a local manufacturer and distributor of

dairy products. CARG holds a 91.7% stake in the company through Cargills Quality Foods Limited, a wholly-owned subsidiary. The brand has been in the market for about 30 years. It produces a variety of dairy products, including cheeses, ice creams, ultra-high temperature (UHT) milk, yogurt, fresh cream and ghee.

Kist – This brand’s product portfolio includes a range of jams, sauces, cordials, fruit-based nectars

and, more recently, juices.

Kist Biscuits – Following the acquisition of Diana Biscuits Manufacturers (Private) Limited in 2010,

Cargills Quality Confectioneries manufactures, distributes and markets biscuits and confectionaries. The segment has yet to perform up to management expectations amid a highly competitive local biscuit market.

Supremo/Finest/Goldi/Sams – CARG manufactures several types of processed meats under

these brand names, ranging from mass-market products to a premium deli range. The company also exports processed foods and meats to India, parts of the Middle East and the Maldives.

Three Coins/Sando/Irish Dark/Grand Blonde/Fosters – The acquisition of McCallum Brewery

Limited in 2011 signaled Cargills’ entry into the local beer market. The company’s brewery operations produce a range of premium and mass-market beers. Further to this, CARG signed an agreement with Australia’s Carlton United Breweries in March 2013 to brew and distribute the Foster’s brand of lager in Sri Lanka. The product is already available in the local market.

Restaurants

CARG’s restaurants segment (3% of revenue and 8% of EBIT in FY13) consists of the Kentucky Fried Chicken (KFC) chain of fast-food outlets and the recently opened (October 2013) TGI Friday’s restaurant.

KFC – Cargills holds the franchise for KFC, the largest international fast-food chain in Sri Lanka,

which currently runs 25 outlets, mostly in Colombo and its suburbs. The restaurant is one of the most popular chains in the country and the company plans to continue to open new outlets in regional cities in response to initial encouraging demand in these areas, as well as expanding in Colombo and its neighboring suburbs.

TGI Friday’s – The first local outlet of this international chain was opened in October 2013 in

Colombo and signaled CARG’s entry into a higher-end segment of the eating out market, with pricing on par with more fine dining restaurants. As part of its agreement with the owners of the chain, CARG has the option to open up to five further outlets in five years.


22


Management strategy, transparency and governance

CARG holds a leading position in Sri Lanka’s organized food retail sector, with a continually expanding store network, as well as manufacturing a growing range of processed foods and beverages. We believe the company is focused on establishing a first-mover advantage in regional cities through its outlet reach strategy and aims to become one of the premier food manufacturers in the country.

Compared with other local companies, we believe that CARG maintains a relatively commendable level of segmental disclosure in its annual financial reports. This should help both investors (particularly institutional investors) and analysts better understand the company and its operations.

However, we believe that the following areas could be improved:

There is very little, if any, performance-related information disclosed on a group or segmental basis. For example, the Cargills store count is not disclosed on a quarterly basis, while store sales space and performance data are not published at all. As a result, forecasting segmental and quarterly results is particularly challenging, and requires analysts to make a number of sweeping assumptions to do so.

A further breakup of the respective performance of different product lines within the FMCG segment would help highlight the leading and lagging products.

The management discussion section of the annual report does not list CARG’s specific financial and operational targets. Disclosing these details would allow investors and analysts to have a clearer idea regarding CARG’s future direction.

Shareholding structure

CARG’s holding company CT Holdings PLC (CTHR) holds the majority stake of 70.0%, while CARG’s directors have a 7.4% holding as at 30 September 2013. Institutional investors (both domestic and international) hold an 84.3% stake as of 30 March 2013, with the remaining 15.7% held by individual investors.

Figure 22: CARG’s domestic investors make up 95% of its shares

Figure 23: Institutional investors account for 84% of CARG’s shareholder base

Source: CARG, as of March 2013 Source: CARG, as of March 2013

The top five shareholders as of 30 September 2013 are presented below:

Name of shareholder Description Stake

CT Holdings PLC Domestic diversified holding company 70.0%

Mr. V R Page Deputy chairman and CEO of CARG 6.4%

Employees' Provident Fund Largest pension fund in Sri Lanka 3.3%

Odeon Holdings (Ceylon) (Private) Limited Investment company controlled by the Page family 2.1%

Ceylon Guardian Investment Trust PLC - A/C No.1 Investment arm of Carson Cumberbatch PLC, a large Sri Lankan conglomerate 2.0%

Source: CARG

CTHR 70%

Residents 25%

Non residents

5%

CTHR 70%

Institutions 14%

Individuals 16%


23


Board of directors

As of 31 March 2013, CARG’s board comprised 12 directors. Their details are provided below:

Name of Director Description

Mr. Louis Page Chairman. He is also the non-executive deputy chairman of CT Holdings PLC (CTHR) and has been

engaged in determining policy framework for CTHR in a non-executive capacity.

Mr. Ranjit Page Deputy chairman and CEO. He is also the managing director of CTHR. He has over 30 years of experience

in the food retailing, food service and manufacturing sectors.

Mr. Imtiaz Abdul Wahid Managing director and deputy CEO. He has held this position since May 2010 and has been involved in

CARG’s operations for over 26 years.

Mr. Sidath Kodikara Executive director. He is the COO for CARG’s retail operations and holds over 28 years of managerial

experience in the hospitality and retail sectors.

Mr. P. S. Mathavan Director. He has over 20 years of experience in the fields of finance, auditing, accounting and taxation.

Mr. Jayantha Dhanapala Independent non-executive director. He is a Sri Lankan diplomat and has served in several countries. He is

also a former United Nations under-secretary-general for disarmament affairs and a former ambassador of

Sri Lanka to the US and to the UN office in Geneva.

Mr. Priya Edirisinghe Independent non-executive director. He is the managing director of PE Management Consultants (Pvt) Ltd

and a consultant at HLB Edirisinghe & Co., Chartered Accountants. He is the chairman of CARG’s audit

committee and a member of the remuneration committee. He holds over 43 years of experience in both

public practice and in the private sector.

Mr. Sanjeev Gardiner Non-independent non-executive director. He is the chairman and CEO of the Gardiner Group, which

operates several large hotels in Sri Lanka, and holds over 25 years of management experience.

Mr. Sunil Mendis Independent non-executive director. He is a former governor of the CBSL and was previously the chairman

of Hayleys PLC, a large Sri Lankan conglomerate. He is the chairman of CARG’s remuneration committee

and a member of the audit committee.

Mr. Anthony A Page Non-independent non-executive director. He is also the chairman of CTHR and has previously served on the

board of the CSE and was a council member of the Employers Federation of Ceylon. He has 44 years of

management expertise in various businesses.

Mr. Joseph Page Non-independent non-executive director. He is also the deputy chairman and managing director at CT Land

Development PLC, a director at CT Properties Limited and managing director at Ceylon Theatres (Pvt.) Ltd.

Mr. Errol Perera Independent non-executive director. He is also an independent director at several other listed and non-listed

companies in Sri Lanka and has held senior management positions in varying types of businesses in

England, Malaysia and Sri Lanka.

Source: CARG


24


Figure 24: CARG’s corporate holding structure


Retail

FMCG

Cargills Quality Foods Limited (100.0%)

Millers Brewery Limited (100.0%) -Three Coins/Sando/Irish Dark/Grand Blonde beer

Cargills Foods Company (Private) Limited (100.0%) - Cargills Food City supemarkets

Kotmale Holdings PLC (85.3%)

Cargills Quality Confectioneries (Private) Limited (100.0%) - Kist Biscuits

Cargills Agrifoods Limited (100.0%)

Cargills Quality Dairies (Pvt) Limited (100.0%) - Magic/Heavenly ice cream

CPC Lanka Limited (100.0%)

Cargills Distributors (Private) Limited (100.0%)

Cargills Food Processors (Private) Limited (100.0%)

Millers Limited (100.0%)

Cargills Food Services (Private) Limited (100.0%) - KFC and TGI Friday's

Source: CARG


25


Appendix 2: Key financial data

Summary group financials (LKRm)

Income statement 2011 2012 2013 2014E 2015E 2016E

(for the year ended 31 march)

Revenue 37,129 48,256 55,379 61,373 69,802 76,410

EBITDA 2,685 3,415 3,604 4,191 4,815 5,199

EBIT 1,825 2,241 2,262 2,431 2,950 3,255

EBT 1,407 1,558 2,143 1,273 1,622 1,810

Net profit 1,094 1,064 1,630 774 1,168 1,303

Balance sheet 2011 2012 2013 2014E 2015E 2016E

(as at 31 march)

Current assets

Cash and cash equivalents 304 518 887 939 1,590 2,584

Short-term investments 76 141 362 425 425 425

Accounts receivable 1,589 2,895 2,540 2,964 3,921 4,292

Inventories 3,576 4,962 4,963 5,124 6,181 7,228

Total current assets 5,742 8,676 9,590 10,495 13,160 15,573

Non-current assets

Property, plant and equipment 11,105 14,230 20,638 21,802 22,729 23,842

Intangible assets 1,054 1,731 1,665 1,667 1,667 1,667

Total non-current assets 13,569 16,261 25,981 27,144 28,064 30,170

Total assets 19,311 24,937 35,571 37,640 41,225 45,743

Current liabilities

Short-term debt 6,234 7,369 12,276 13,385 13,941 14,459

Accounts payable 5,029 6,863 7,851 7,686 8,429 9,857

Income tax payable 278 379 285 449 449 449

Total current liabilities 11,561 16,451 20,460 21,834 23,133 25,079

Non-current liabilities

Long-term debt 384 243 1,850 2,027 3,145 4,414

Post retirement benefit obligation 193 250 285 349 349 349

Total non-current liabilities 908 1,017 3,071 3,394 4,513 5,782

Equity

Common share capital 131 131 131 131 131 131

Retained profit 2,583 3,226 4,389 4,810 5,978 7,281

Minority interest 90 86 107 58 58 58

Total equity 6,842 7,468 12,039 12,411 13,579 14,882

Total liabilities and equity 19,311 24,937 35,571 37,640 41,225 45,743


26


CASH FLOW STATEMENT 2011 2012 2013 2014E 2015E 2016E

(For the year ended 31st March)

Operating activities

Net cash flow from operating activities 2,088 3,446 821 2,109 3,061 4,695

Investing activities

Purchase of PPE and intangible assets (2,189) (3,537) (4,446) (2,917) (2,792) (3,056)

Net cash flow from investing activities (4,845) (3,848) (6,517) (3,083) (2,784) (3,049)

Financing activities

Debt issuance/(repayment) 1,777 (926) 6,365 2,546 1,674 1,787

Interest paid (364) (625) (1,285) (1,309) (1,300) (1,438)

Net cash flow from financing activities 1,489 (1,304) 5,916 1,949 374 (651)

Net increase/(decrease) in cash and cash equivalents (1,267) (1,706) 220 974 651 994

Key ratios

2011 2012 2013 2014E 2015E 2016E

Growth

Revenue growth (%) 20.3 30.0 14.8 10.8 13.7 9.5

EBIT growth (%) 27.7 22.8 0.9 7.5 21.4 10.3

EBT growth (%) 40.6 10.8 37.5 (40.6) 27.4 11.6

Net profit growth (%) 53.6 -2.8 53.2 (52.5) 50.9 11.6

Recurrent diluted EPS growth (%) 53.6 0.0 53.4 (53.0) 50.9 11.6

Margins

EBIT margin (%) 4.9 4.6 4.1 4.0 4.2 4.3

EBT margin (%) 3.8 3.2 3.9 2.1 2.3 2.4

Net profit margin (%) 2.9 2.2 2.9 1.3 1.7 1.7

ROE (%) 17.0 14.4 13.7 6.3 8.6 9.2

Liquidity and efficiency

Current ratio (x) 0.5 0.5 0.5 0.5 0.6 0.6

Total asset turnover (x) 1.9 1.9 1.6 1.6 1.7 1.7

Gearing and cash flow

Debt/Capital (%) 49.2 50.5 54.0 55.4 55.7 55.9

Interest cover 5.0 3.6 1.8 1.9 2.3 2.3

Free cash flow (FCF) yield (%) (0.2) (0.2) (10.7) (2.4) 0.8 4.9

Net debt/FCF (x) (62.0) (76.3) (3.6) (17.4) 56.0 9.7

Valuation

P/E (x) 46.7 36.7 20.9 42.8 28.4 25.4

P/BV (x) 7.6 5.3 2.8 2.7 2.5 2.2

EV/sales (x) 1.5 1.0 0.8 0.8 0.7 0.6

EV/EBITDA (x) 21.4 13.5 13.0 11.3 10.0 9.4

EV/EBIT (x) 31.5 20.5 20.8 19.4 16.3 15.1

Per share data 2011 2012 2013 2014E 2015E 2016E

Recurrent diluted EPS (LKR) 4.9 4.7 7.3 3.5 5.2 5.8

Book value per share (LKR) 30.1 32.9 53.3 3.5 5.2 5.8

Net operating cash flow per share 9.3 15.4 3.7 55.1 60.4 66.2

Net cash flow per share (5.7) (7.6) 1.0 9.4 13.7 21.0



27


Segmental summary

(For the year ended 31 March)

Retail 2011 2012 2013 2014E 2015E 2016E

Revenue 31,440 39,162 44,220 49,058 55,919 60,817

EBIT 1,111 1,702 1,689 1,950 2,228 2,423

YoY growth (%)

Revenue 19.8 24.6 12.9 10.9 14.0 8.8

EBIT NA 53.1 -0.7 15.4 14.3 8.8

Margin (%)

EBIT 3.5 4.3 3.8 4.0 4.0 4.0

FMCG 2011 2012 2013 2014E 2015E 2016E

Revenue 4,569 7,711 9,204 10,095 11,307 12,663

EBIT 553 342 383 318 475 544

YoY growth (%)

Revenue 23.3 68.8 19.4 9.7 12.0 12.0

EBIT NA -38.1 11.9 -17.0 49.4 14.7

Margin (%)

EBIT 12.1 4.4 4.2 3.1 4.2 4.3

Restaurants 2011 2012 2013 2014E 2015E 2016E

Revenue 1,119 1,383 1,955 2,219 2,576 2,930

EBIT 161 197 190 164 248 288

YoY growth (%)

Revenue 20.9 23.6 41.3 13.5 16.1 13.8

EBIT NA 22.3 -3.7 -13.9 51.5 16.1

Margin (%)

EBIT 14.4 14.3 9.7 7.4 9.6 9.8


FX rates (USD/LKR): Y/E 31 March 2013 = 129.59

Y/E 31 March 2012 = 112.64

Y/E 31 March 2011 = 112.12


28


Appendix 3: SWOT analysis

Strengths Weaknesses

Backing from parent company CTHR

Cargills is one of the most valuable and recognized brands in the country

First-mover advantage with most of its new outlet openings

Comprehensive distribution network – more extensive than competitors

High level of debt, which may temper further investments

over the short term

Has generated negative FCF annually since FY09, except in FY10

Opportunities Threats

Uptake in consumption appetite supported by rising disposable income in Sri Lanka

Further potential acquisitions to drive future growth

Any new taxes on supermarkets may further pressure

margin

Risk of further pressure on operating costs such as electricity and fuel expenses through price hikes


29


Fact Sheet

Sri Lanka investment environment overview

Sri Lanka’s economy has been on an upward trajectory since the end of the three-decade civil war in May 2009. Sri Lanka currently boasts South Asia’s highest GDP growth, conducive fiscal and monetary policy, and favorable socio-economic conditions, which together create an attractive investment destination.

Figure 25: Sri Lanka's GDP projected to increase at a 7% CAGR 2012-2016E

Figure 26: GDP per capita to increase 33% by 2016E

Source: Central Bank of Sri Lanka, Department of Census and Statistics Source: Central Bank of Economic and Social Statistics of Sri Lanka 2012, Road Map 2013 - Central Bank of Sri Lanka

Figure 27: Annual core inflation post-war has averaged 6.7%, government targeting mid-single digit levels in the medium term

Figure 28: CBSL expects the rupee to stabilize in the medium term despite recent volatility

Source: Department of Census and Statistics, Central Bank of Sri Lanka Source: Bloomberg

Figure 29: Fiscal deficit target of 5.2% of GDP for 2014E Figure 30: Debt-to-GDP to fall to 71% by 2015E

Source: Central Bank of Sri Lanka Source: Central Bank of Sri Lanka

6.8 6.0

3.5

8.0 8.2

6.4

7.5 8.0 8.3 8.5

0

1

2

3

4

5

6

7

8

9%

0500

1,0001,5002,0002,5003,0003,5004,0004,500

USD

8.5

7.7

13.6

7.0 7.0 6.9 5.8

0

2

4

6

8

10

12

14

16

2006 2007 2008 2009 2010 2011 2012

%

100

150

200

250

Jan-07 May-08 Oct-09 Mar-11 Jul-12 Dec-13

LKR/USD LKR/EUR LKR/GBP

0%

4%

8%

12%

0

200

400

600

LKRbn

Fiscal Deficit LKR bn As a % of GDP

102 102 91 88 85 81 86 82 79 79 78 75 71

0

20

40

60

80

100

120

%


30


The Sri Lankan equity market offers a rare and attractive alternative to investors in an investment era impacted by economic growth worries. Backed by the country’s robust economic growth, the Sri Lankan capital market is well set to offer attractive returns to investors who are keen to be a part of this emerging market success story. There are several strong incentives for entering the Sri Lankan capital market.

Figure 31: Post war, the ASPI has significantly outperformed global and developed market indices

Figure 32: Post war, the ASPI has also outperformed some of the best-performing regional indices

Source: Bloomberg *Note: All figures re-based to 1 July 2009

Source: Bloomberg *Note: All figures re-based to 1 July 2009

Figure 33: The CSE’s market capitalization has doubled since 2009

Figure 34: The government anticipates FDI inflows to reach USD2bn in 2013, a 19% CAGR 2009-2013E

Source: Bloomberg, Central Bank of Sri Lanka Source: Ministry of Finance and Planning, Board of Investment of Sri Lanka

Figure 35: Most sector P/Es are below market average and historical valuations

Figure 36: Trend is similar on a P/BV value

Source: Colombo Stock Exchange Source: Colombo Stock Exchange

0

80

160

240

320

400

Jul-09 May-10 Apr-11 Mar-12 Jan-13 Dec-13

ASPI Dow Jones FTSE 100

MSCI World DAX

0

100

200

300

400

Jul-09 May-10 Apr-11 Mar-12 Jan-13 Dec-13

ASPI Bombay (BSE 500)

Jakarta (JCI) Philippines (PASHR)

Thailand (SET) Hanoi (VNINDEX)

MSCI Emerging Market Index

1,092

2,211 2,214 2,168 2,418

0

1,000

2,000

3,000

2009 2010 2011 2012 2013(December)

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827 601 516

1,066

1,338

2,000

0

500

1,000

1,500

2,000

2,500

2008 2009 2010 2011 2012 2013E

USDm

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2011 2012 2013 Average market P/E 2010-2013

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2011 2012 2013 Average market P/BV 2010-2013


31


IMPORTANT DISCLAIMER

This document has been prepared on behalf of the Colombo Stock Exchange (“CSE”) by Amba Research Lanka Private Limited (“Amba”) and is sponsored by the CSE. The views expressed in this document are those of the authors based on available and accessible information from the public domain and do not represent those of the CSE. Please note, inter alia, that with the publication of this document on the CSE website, www.cse.lk, neither Amba , as author, nor CSE (as sponsor) intend to assume and are not assuming any responsibility or liability (including under contract, common law or tort) to any party arising out of or with respect to this document. This document is not intended to, and does not form part of any contract with anyone (including a contract between author and reader/recipient) and no one shall have any right (contractual or otherwise) to enforce any claim in relation to the document either directly or indirectly.

Except as otherwise indicated, you may only view and print one copy of the document for your own personal, non-commercial use. You may not copy, store [either in hardcopy or in an electronic retrieval system] transmit, transfer, broadcast, publish, reproduce, create a derivative work from, display, distribute, sell, license, rent, lease or otherwise transfer any of the contents to any third person (including, without limitation, to others in your company or organization) whether for direct or indirect commercial or monetary gain or otherwise without the prior written permission of Amba and CSE.

This document does not contain any investment advice nor does it constitute an offer to buy, sell or hold any of the investment product(s)/asset class (es) mentioned herein. Prospective investors are required to possess sufficient knowledge when evaluating the advantages and risks inherent to such investment product(s)/asset class(es) mentioned herein and to take into consideration their circumstances and financial position when assessing the suitability of such investments.. Prior to making an investment decision, prospective investors are strongly advised to obtain independent advice from competent legal, financial, tax, accounting and other professionals. Amba and CSE shall not be held liable in any manner for any direct, indirect or consequential loss that may arise as a result of investing in the investment product(s)/asset class (es) mentioned herein. Amba and CSE expressly disclaim any fiduciary responsibility or liability for any consequences, financial or otherwise from any reliance placed on the information in this document. The investment product(s)/asset class (es) described in this document may not be eligible for sale or subscription within a particular jurisdiction or to particular categories of investors. This document is not intended for distribution to a person or, within a jurisdiction where such distribution would be restricted or illegal. It is the responsibility of any person reading this document to observe all applicable laws and regulation of the relevant jurisdiction. Neither Amba, nor CSE, shall be responsible for any error which may have occurred at the time of printing of this document. The information set out in this document is subject to change without notice.

The information contained herein has been obtained from sources believed to be reliable and Amba and CSE make no warranty, expressed or implied, as to the accuracy, timeliness, completeness or correct sequencing of the information.

This document does not purport to list all of the terms and conditions, nor to identify or define all or any of the risks that would be associated with the purchase or sale of the investment product(s)/asset class (es) described herein. Please note that any price levels, rates, simulations, illustrations, terms or conditions contained herein are indicative only, and may vary in accordance with changes in market conditions. All the information included in this document is current at the time of preparing this document and subject to change at any time. Any forecast, projection or forward looking statement made in this document embodies assumptions and predictions about future events that by their nature cannot be verified as facts. They are not necessarily indicative of future or likely performance, of investment product(s)/asset class (es), countries, markets or companies. Any past market conditions or product performances may not be representative of future market conditions or product performances.

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