IMS Coverage Initiation - Engro Foods- 18-09-2017 final...

InterMarket Perspective

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Research Entity Number – REP-085

ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 17 & 18

18 September 2017

Yusra Beg

[email protected]

+92-21-111-467-000 Ext: 305

• We initiate coverage on Engro Foods (EFOODS) with a Sell stance and a Dec’18 TP of PRs81/sh. EFOODS has achieved significant milestones in just over 10yrs of existence and it will continue to be a major player in Pakistan’s dairy sector, but an interim period of consolidation will keep profitability and thus share price in check, in our view.

• A temporary lull in the loose-to-packaged milk conversion cycle should not detract from exceptional LT prospects in a 200mn+ population, even as competition is now much tougher. An increasing pie size should dovetail with likely entry into powder e.g. GUMP under new sponsor Friesland Campina. Again, however, these are medium-term themes and ongoing challenges need attention before the company becomes aggressive again.

• We expect EFOODS to post EPS of PRs0.42 in CY17F, its worst performance since CY13. Coming from a low base, EFOODS is then projected to post 5yr Sales/Profit CAGRs of 19%/71%. On CY18F estimates, the stock trades at an acceptable P/S of 1.6x but very expensive P/E of 74.5x. The discrepancy between the two metrics is due to royalty & technical assistance fee being paid directly out of sales to the Sponsors.

Initiate with a Sell We initiate coverage on Engro Foods Ltd (EFOODS) with a Sell stance and Dec’18 TP of PRs81/sh. While long-term growth prospects in the backdrop of Pakistan’s 200mn+ population are immense, near-term outlook is beset by market share attrition, weaker margins and assorted challenges being faced by the industry. Royalty & technical fee arrangements do not help the bottom-line. EFOODS will eventually make a comeback, but it may not happen over the next 1-2 years.

Loose-to-packaged conversion has stalled for now Processed milk’s market share grew from an estimated 3% in 2001 to over 9% in CY12. However, the conversion cycle has since stalled and market share is c. 8.5% in 2016. This is a result of (i) removal of zero rating status for dairy sector, (ii) negative media portrayal amidst a tougher stance on quality & food labelling by regulators especially in Punjab, and (iii) a wider price gap versus loose milk. We do not see this derailing the long-term prospects for conversion (processed share projected to increase by c. 50bps pa over the next 10yrs); near-term, however, this lull adds to pressure on incumbents now facing heightened competition.

Peak market share may be gone for good EFOODS’ UHT market share is estimated to have fallen to less than 40% this year, sharply down from an estimated 49% in CY16, and the company’s sales are on track to decline for a 2nd year in a row. Major pressure was witnessed by both Tarang (tea whitener) and Olpers (UHT milk) with strategic missteps also adding to tougher operating conditions. We think EFOODS will now be able to maintain market share in existing products but peak market share of c. 50% appears to be gone for good, in our view.

Powder entry will come, but not immediately EFOODS is on the defensive, with focus on consolidating performance of the existing product suite. Until this is achieved, and it may take at least a year, the company is likely to keep ambitions of entering the powder segment on the backburner, in our view. Similar to ICI’s Morinaga, we build a powder trading business in our EFOODS’ model; GUMP from CY19 onwards and infant formula from CY21. Despite being a trading business, marketing costs associated with initial launch may delay breakeven on new products by 1-2years.

Valuations can only stretch so much 5yr sales / profit CAGRs are projected at 19% / 71% but valuations are still stretched. EFOODS trades at a CY18F P/E of 74.5x and even on CY19F this looks expensive at 49.5x (due to royalty & technical assistance fee, we think the P/S metric now has limited relevance for EFOODS). Our TP of PRs81/sh takes into account likely entry into the powder segment from CY19; without new additions to the product suite, our TP would be about PRs70.5/sh. Upside risk to our thesis can arise from introduction of minimum pasteurization law and stronger than expected performance of any new products.

Valuations can stretch up to a point; Initiate with a Sell

Engro Foods – Initiating Coverage

Engro Foods Limited

Price (PRs/sh) 99.6

TP (PRs/sh) 81.0

Stance Sell

Upside/downside -18.7%

Bloomberg / Reuters EFOODS PA / ENFL.KA

Mkt Cap (US$mn) 724.2

52wk Hi-Low (PRs/sh) 207.82/83.07

3m Avg. Daily Vol ('000 shrs) 524

3m Avg. Traded Val (US$mn) 0.57

EFOODS - Valuation Snapshot

Key Ratios CY16 CY17F CY18F CY19F

EPS (PkR) 3.11 0.42 1.34 2.01

EPS Growth (%) -25% -87% 220% 51%

PER (x) 31.98 n.m 74.52 49.47

P/S (x) 1.72 2.01 1.64 1.39

PBV (x) 4.45 4.39 4.12 3.79

Debt to Equity (%) 44.1% 123.6% 129.9% 110.9%

Source: IMS Research

EFOODS - Price Performance

1M 6M 12M FYTD CYTD

Absolute % (6.4) (42.5) (30.1) (18.0) (48.1)

Rel. Index % (3.9) (31.1) (36.5) (9.9) (37.6)

Abs. (PRs) (6.8) (73.7) (43.0) (21.9) (92.4)

Index Abs. (%) (2.5) (11.4) 6.4 (8.1) (10.5)


2 | P a g e

Perspective

CY15/CY16 NPAT levels may take up to 5yrs time in re-emerging

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

CY1

2

CY1

3

CY1

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CY1

5

CY1

6

CY1

7F

CY1

8F

CY1

9F

CY2

0F

CY2

1F

CY2

2F

PRsmn


UHT Market share will take time to recover

0%

10%

20%

30%

40%

50%

60%

1Q

CY1

2

2Q

CY1

2

3Q

CY1

2

4Q

CY1

2

1Q

CY1

3

2Q

CY1

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3Q

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CY1

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CY1

5

4Q

CY1

5

1Q

CY1

6

2Q

CY1

6

3Q

CY1

6

4Q

CY1

6

Source: Company Accounts & IMS Research

Sales should trough in CY17F

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40,000

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80,000

100,000

120,000

140,000

CY1

3

CY1

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8F

CY1

9F

CY2

0F

CY2

1F

CY2

2F

CY2

3F

CY2

4F

CY2

5F

CY2

6F

Existing brands (PRs mn) New Brands (PRs mn)

10yr Sales CAGR CAGR 16% (From CY16)


Gross margins vs. Net margins trend

0%

5%

10%

15%

20%

25%

30%

0%

1%

2%

3%

4%

5%

6%

7%

8%

CY1

1

CY1

2

CY1

3

CY1

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CY1

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CY1

6

CY1

7E

CY

18

F

CY

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F

CY

20

F

CY

21

F

CY

22

F

CY

23

F

CY

24

F

CY

25

F

CY

26

F

Net Margins (Lhs) Gross Margins

Source: Company accounts & IMS Research

Loose-to-packaged conversion trend

64%

34%

2%

CY0554%

42%

4%

Milk lost Traded Milk Processed Milk

CY16


Valuation on P/S looks reasonable but inflated on P/E

1.00

1.25

1.50

1.75

2.00

2.25

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100

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300

CY17F CY18F CY19F CY20F

P/S (x) Rhs P/E (x)


3 | P a g e

Perspective

Regional Valuation Comparison

Sym Company Name Orign

Market Cap

(USD) PER (x) ROE (%) P/S (x)

5YRs. Revenue CAGR

(%)*

ENFL.KA ENGRO Foods Limited Pakistan 724 74.52 5.5% 1.64 4.2%

600887.SS Inner Mongolia Yili Industrial Group Co Ltd China 22,490 20.15 24.5% 2.43 10.1%

2319.HK China Mengniu Dairy Co Ltd China 10,402 20.67 -3.6% 1.27 7.0%

VNM.HM Vietnam Dairy Products Jsc Vietnam 9,454 20.04 41.2% 3.56 16.7%

0151.HK Want Want China Holdings Ltd China 8,601 17.44 28.7% 2.85 0.1%

NESM.KL Nestle Malaysia Bhd Malaysia 4,741 21.71 98.4% 3.52 3.6%

600597.SS Bright Dairy And Food Co Ltd China 2,462 23.24 11.3% 0.80 11.4%

600429.SS Beijing Sanyuan Foods Co Ltd China 1,563 -- 2.2% 1.75 13.8%

HAPL.NS Hatsun Agro Product Ltd India 1,503 45.28 38.6% 2.29 21.2%

600300.SS V V Food & Beverage Co Ltd China 1,375 -- 2.6% 2.02 -3.6%

002329.SZ Royal Group Co Ltd china 1,190 13.88 10.6% 3.18 33.0%

1432.HK China Shengmu Organic Milk Ltd China 1,082 12.34 12.7% 2.04 54.8%

002770.SZ Henan Kedi Dairy Co Ltd china 942 37.84 5.8% 7.66 6.0%

1230.HK Yashili International Holdings Ltd China 935 126.69 -5.6% 2.78 -5.7%

DBMS.KL Dutch Lady Milk Industries Bhd Malaysia 898 24.65 90.1% 3.32 5.3%

600419.SS Xinjiang Tianrun Dairy Co Ltd China 779 31.54 10.6% 5.82 16.8%

002732.SZ Guangdong Yantang Dairy Co Ltd china 725 32.64 12.4% 4.31 10.5%

6863.HK China Huishan Dairy Holdings Company Ltd China 724 3.68 5.3% 1.05 64.7%

1717.HK Ausnutria Dairy Corp Ltd China 643 9.82 14.5% 1.53 15.2%

HEFI.NS Heritage Foods Ltd India 530 28.27 22.2% 1.79 6.3%

002719.SZ Maiquer Group Co Ltd china 517 36.39 2.5% 6.04 10.0%

KDAI.NS Kwality Ltd India 448 10.65 17.4% 0.42 23.3%

PAMF.NS Parag Milk Foods Ltd India 328 28.00 2.6% 1.22 14.0%

PRDA.NS Prabhat Dairy Ltd India 203 18.70 6.8% 0.92 23.9%

CNON.KL Can-One Bhd Malaysia 140 7.51 11.5% 2.26 8.0%

FAUJ.KA Fauji Foods Ltd Pakistan 129 -- -43.1% 5.86 -2.7%

CDC.AX China Dairy Corp Ltd Hong Kong 52 -- 22.2% 3.37 32.1%

LAMB.CM Kotmale Holdings Plc Sri Lanka 43 -- 21.6% 3.09 -4.8%

LMF.CM Lanka Milk Foods (Cwe) Plc Sri Lanka 37 -- 4.6% 1.07 -4.3%

UMDA.NS Umang Dairies Ltd India 24 -- 4.8% 0.74 6.9%

MLKF.BO Milk Food Ltd India 17 -- 5.0% 0.29 5.0%

RAFL.CM Renuka Agri Foods Plc Sri Lanka 10 -- 11.3% 0.62 -0.3%

MDRD.BO Modern Dairies Ltd India 4 -- 18.7% 0.06 -7.9%

*Last 5yrs reported Revenue CAGR. (For regional companies), EFOODs CAGR is from CY13 to CY18F

Source: Reuters, IMS Research

4 | P a g e

Perspective

Friesland Campina Based in the Netherlands, Friesland Campina is the sixth largest milk producer globally,

with over 11bn euros in revenues. The company produces and sells consumer products

such as dairy-based beverages, infant nutrition, cheese and desserts in Europe, Asia and

in Africa via its own subsidiaries. The Company is fully owned by Zuivelcoöperatie

FrieslandCampina U.A., which is a cooperative with +19,000 member dairy farmers in the

Netherlands, Germany and Belgium.

Acquisition of Engro Foods

Friesland Campina acquired 51% equity stake in EFOODS in Aug'16 at an inital price of

PRs120/sh ( Dec’16 Tender at a price of PR151.8/sh) i.e. ~US$450mn, together with a

recurring annual royalty/technical fee arising from EFOODS’ future sales. Specifically, FC

and ENGRO will also be entitled to technical assistance fee of 2.0% and 0.5% based on

EFOODS’ future net sales (net of taxes). FC will also receive a royalty fee of 2.0% (net of

taxes) of the future net sales of any products produced by EFOODS or FC and sold under

trademarks that are owned by FC. FC is expected to broaden the product portfolio in

segments like infant milk, growing up milk, etc.). Moreover, FC could also assist in

reviving EFOODS’ segments like juices and ice-cream in the long run.

Engro Foods Limited Headquartered in Karachi - Pakistan, Engro Foods was established in CY06 and has since

penetrated Pakistan’s UHT milk segment, including the specialized- Tea Creaming

segment (market share in UHT segment is ~40% and 28% in Ice Cream). EFOODS has a

network of 1,635 milk collection centres, which collect milk from about 150,000 farmers

on a daily basis. The milk, about 400mn litres (capacity 748mn litres), is processed in

plants located in Sahiwal and Sukkur. The company also runs its own dairy farm in Nara

that produces over 35,000 litres per day with a total herd size of 5,251 animals (2016).

Production & Capacity – Segment wise

CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14 CY15 CY16

Dairy & Beverages

Capacity (mn litres) 127 321 376 447 446 601 657 730 748 748

Production (mn litres) 107 177 247 315 388 477 423 473 553 483

Utilization 85% 55% 66% 70% 87% 79% 64% 65% 74% 65%

Ice cream

Capacity (mn litres) - 10 10 19 36 36 39 39 39 39

Production(mn litres) - N/A 7 13 18 17 15 17 19 20

Utilization - 0% 67% 67% 50% 47% 37% 43% 50% 50%


TIMELINE

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r-1

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Jun

-17

Dairy Omung is

launched

Omore icecream gains

25% market share

Tarang

becomes UHT

market leader

First packaged

lassi launched

in Pakistan

Ecolean packaging

introduced for Olper’s Milk.

Olper’s becomes market leader

with 44% share in Premium UHT

milk category

Engro Foods powder production

facility in Sahiwal commences

operations

Omore achieves highest volume

of 19mn liters with 28% market

share.

Al Safa PRs881mn

loss writeoff drops

CY13 NPAT

EFOODS exits Al Safa, loss of

PRs600mn in CY14

SMP Prices collapse to

US$2000/MT

Friesland Campina

acquires Engro Foods

Buy back rumors

pull the stock price

UHT market share

drops to 49%, posts

Loss after tax in

4QCY16

Market share drops as

competition rises

Acquisition of

Al-Safa Halal

foods in Canada


Subsidiary

Engro Foods currently

has two major segments

1) Dairy & Beverages

and 2) Ice-creams.

Tarang, Olpers and

Omung are major brands

in the dairy UHT

segment with Omore in

ice-creams.

Parent Company

Friesland Campina, a dairy

giant in Netherlands,

acquired 51% stake in Engro

Foods Pakistan, effectively

reducing ENGRO’s stake to

36%.

5 | P a g e

Perspective

Loose-to-packaged conversion has stalled for now Processed milk’s market share grew from an estimated 3% in 2001 to 9%+ in 2012.

However, the conversion cycle has since stalled and market share is c. 8.5% in 2016. This

is a result of (i) removal of zero rating status for dairy sector, (ii) negative media portrayal

amidst a tougher stance on quality & food labeling by regulators especially in Punjab, and

(iii) a wider price gap versus loose milk. We do not see this derailing the long-term

prospects for conversion (processed share projected to increase by c. 50bps pa over the

next 10yrs); in the near-term however, this lull adds to pressure on incumbents already

facing heightened competition.

Strong conversion rate until 2012 Pakistan’s processed milk industry witnessed strong growth in the mid-2000s, riding on

the coat-tails of higher rural incomes amidst heavy promotional activities by new players

in a market traditionally dominated by just Nestle’s Milk Pak. Processed segment’s

market share grew from an estimated 3% in 2001 to 9%+ in CY12 as income levels rose

and as awareness campaigns regarding adulterated milk - targeted towards the middle

income segment (~40% of population) - caused a shift towards healthier options. As a

result, EFOODS was able to commence business as late as 2005 and drive sales to

PRs49.8bn (US$475mn) by 2015, an exceptional 10yrs of growth that saw it overtake

NESTLE in the UHT segment which is a phenomenal achievement. This strong track

record together with appealing conversion prospects over the longer-term, also enabled

previous sponsors ENGRO to attract foreign companies looking to enter the Pakistan

market, which culminated in Friesland Campina acquiring a controlling stake in EFOODS

in late-CY16.

Last few years have been tough After peaking in CY12, the processed milk segment’s market share has steadily fallen to

an estimated c.8.5% in CY16 and we expect it to converge to 8% this year before

beginning to rise again. This subdued period is a function of multiple reasons such as:

• Removal of zero rating status for dairy sector: Up till FY16, Pakistan’s dairy sector

remained under the protection of zero rating regime with allowable tax refunds.

However, GoP recently not only discontinued this regime but imposed 25%

regulatory duty on skimmed milk powder where 20% customs duty was already in

place. GoP imposed 10% sales tax on concentrated powder milk, cream, yogurt,

cheese, butter, whey whilst UHT and Fat Filled milk remained exempt. In a tough

environment to pass on costs, this has led to reducing margins.

• Tougher stance on quality & food labeling by regulators: In late 2016, Sindh High

Court ordered an inquiry into adulteration of milk for several UHT milk producers.

Olpers was declared fit for consumption in Jan’17 however, this managed to damage

image of packaged UHT milk during that time. Moreover, rules on labelling of

packaged milk were tightened in Punjab whereby Punjab Food Authority declared

labelling of EFOODS’ dairy drink as misleading. The brand had to undergo rebranding

before continuing sales.

Pakistan- Milk Production and Dairy Sector Profile

Key variables FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

CAGR

2001-

16

Pakistan GDP (PRs tn) 4.5 4.8 5.3 6.1 7.0 8.2 9.2 10.6 13.2 14.9 18.3 20.0 22.5 25.4 27.7 29.6

GDP Growth (YoY) N/A N/A 4.7% 7.5% 9.0% 5.8% 5.5% 5.0% 0.4% 2.6% 3.6% 3.8% 3.7% 4.1% 4.1% 4.5%

Population (mn) 140.4 143.2 146.8 149.7 152.5 155.4 158.2 161.0 163.8 173.5 177.1 180.7 184.4 188.0 191.1 195.4 2.2%

World milk consumption (mn tonnes)* 589.1 604.7 615.9 629.5 648.7 667.5 685.8 699.2 708.3 723.1 742.2 762.3 765.1 789.1 802.8 816.0 2.2%

Pakistan milk consumption (mn tonnes)* 26.3 27.0 27.8 28.6 29.5 32.0 33.0 34.0 35.2 36.3 37.5 38.6 39.9 41.1 42.5 43.8 3.5%

Pakistan Buffalo herd (mn) 23.3 24.0 24.8 25.5 26.3 27.3 28.2 29.0 29.9 30.8 31.7 32.7 33.7 34.6 35.6 36.6 3.1%

FAO Dairy Price Index (2002-2004=100) 105.5 80.9 95.6 123.5 135.2 129.7 219.1 223.1 148.6 206.6 229.5 193.6 242.7 224.1 160.3 153.8 2.5%

Pakistan fresh milk prices (PRs/ltr) 18.2 17.9 18.4 19.2 21.3 23.9 26.7 30.5 36.6 42.3 50.1 58.2 65.2 69.9 76.2 78.2 10.2%

Int'l SMP prices (US$/MT)

N/A 3,176 2,951 3,534 4,230 2,498 1,887

*ECM- Energy corrected milk

Source: FAO STAT, Pakistan Economic Survey, SBP & IMS Research Source: FAO STAT, Pakistan Economic Survey, SBP & IMS Research

Processed milk is c. 8.5% of Pakistan’s

market vs. peak of 9.6% in CY12.

We expect processed milk share to

trough at about 8% in CY17F and

cross the 10% mark in CY22F

Pakistan’s annual milk production of

43.8mn ton (growing at 2%pa) is the

4th

largest in the world. Milk accounts

for 6% of Pakistan’s GDP

6 | P a g e

Perspective

• Wider price gap versus loose milk: With packaged UHT milk prices retailing at about

PRs.120-125/ltr the premium to loose milk (~PRs80/ltr) has widened to 56%, the

highest in 5yrs. This has stalled conversions from loose milk to packaged and has

built added pressure on volumetric growth for incumbent packaged market.

Conversion will keep happening over medium to longer run While some aforementioned factors have seen improvement, some issues remain

outstanding and may curb the loose-to-packaged conversion pace for now. Over the

longer run however, we believe continued conversion is inevitable due to factors such as

(i) rising GDP growth, (ii) higher per capita incomes – last reported at US$1,629 but

estimated at US$2,500 after informal economy is taken into account, (iii) rising

awareness of healthier options, (iv) gradual rise in urbanization and (v) greater scale

which may allow packaged milk prices to close the gap with loose milk prices. We

estimate that processed market share will grow by c. 50bps pa to cross 10% by CY22F

and reach 12%+ by CY26F.

Implementation of minimum pasteurization laws pitched to GoP Compared to several regional economies, Pakistan’s processed milk market share is

significantly low. This can potentially experience a growth spurt if Pakistan introduces a

minimum pasteurization la w. In this regard, we understand that EFOODS is also in talks

with the Government to introduce a minimum quality standard, which may immensely

help in clamping down on unadulterated milk and thereby prove to be a boon for the

packaged milk industry. This will face challenges however, and implementation is in no

way certain even over the medium-term. That said, it will have immense benefits for

companies like EFOODS.

The price differential vs. loose milk is quite high

0%

10%

20%

30%

40%

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60%

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Jul-

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Jul-

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PRS/Litre

Fresh Milk Prices - Lhs Discount to Olpers

Source: Economic Survey & IMS Research

Conversion going through a rough patch

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

CY

01

CY

02

CY

03

CY

04

CY

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CY

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CY

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CY

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Pasteurization is intended to make

milk safer through a heating process,

albeit at a lower temperature than

for the UHT process

Processed milk has grown at a 15yr CAGR of 13% since FY01

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

CY0

1

CY0

2

CY0

3

CY0

4

CY0

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CY0

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CY0

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CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

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5

CY1

6

mn litres

Milk Consumption Tradeable Milk Processed Milk

Source: Economic Survey & IMS Research

7 | P a g e

Perspective

Peak market share may be gone for good

EFOODS’ UHT market share is estimated to have fallen to less than 40% this year, sharply

down from an estimated 49% in CY16, and the company’s sales are on track to decline for

a 2nd

year in a row. Major pressure was witnessed by both Tarang (tea whitener) and

Olpers (UHT milk) with company missteps also adding to tougher operating conditions.

We think EFOODS will now be able to maintain market share in existing products but

peak market share of c. 50% appears to be gone for good, in our view.

Sharp market share loss in UHT segment In the UHT segment, EFOODS quickly filled out its market share to c. 50% as early as

2012, just within 7yrs of commencing operations. Considering the market was dominated

by Nestle’s Milk Pak brand, this is a significant achievement that cannot be taken lightly.

The two main products that enabled such rapid market share accretion for EFOODS are

Olpers (UHT milk) and Tarang (tea whitener) where we understand that these two brands

together contribute more than 85% of the company’s topline. For a number of reasons

however, EFOODS has been unable to maintain its market share which is estimated to

settle at less than 40% in CY17F, down from an average of 51% in the last 5yrs. These

reasons can be summarized as follows:

• Emergence of new competition: The untapped potential of Pakistan’s milk market

(43.8bn liters) has new players such as Fauji Foods (FFL) and Dalda (Cupshup).

Mapped onto our projections for sector demand, FFL management has implicitly

projected to gain approximately 15% UHT market share by CY22. This would require

other players (Olpers, MilkPak etc.) to potentially readjust their market shares or for

smaller players to become increasingly sidelined.

• High discounting from competitors: SMP is a key input used in the production of

tea whiteners. Therefore, recent drop in international skimmed milk powder prices

(down 49% since CY13), proved beneficial for local players, allowing room for price

discounts. Resultantly, heavy discounting from competitors weighed down on

Tarang in particular, resulting in loss of market share.

• Change in recipe mix: Channel checks suggest Tarang in particular faced consumer

backlash due to an ill-judged change in recipe to maximize profitability (not

confirmed by EFOODS management). While the issue has been resolved,

competitors took advantage of this gap where we understand peers such as Qudrat

and Haleeb have overtaken Tarang in Khyber Pakhtunkhwa.

• Improved quality of loose milk: Given rise in SMP imports by local industry players

(amid soft SMP prices), quantum of loose milk procurement by tea creamer

producers declined. This caused a drop in adulteration of loose milk due to higher

availability and resulted in improved quality for a certain period. This built pressure

on EFOODS’ UHT milk brand Olpers in the form of substitution.

Dairy competition products timeline

EFOODS UHT Market share trend

0%

10%

20%

30%

40%

50%

60%

CY1

1

CY1

2

CY1

3

CY1

4

CY1

5

CY1

6

Source: Company Accounts

CY81 CY87 CY90 CY99 CY03 CY06 CY12 CY15 CY16

Nestle MilkPak Haleeb Milk Nestle Everyday Candia Milk Tea MaxShakarganj-

Good Milk Day Fresh Dalda -Cupshup FFL- Nurpur Milk

SMP prices have bottomed out at c.US$2,000/MT

-

1,000

2,000

3,000

4,000

5,000

Jun

-10

Jun

-11

Jun

-12

Jun

-13

Jun

-14

Jun

-15

Jun

-16

Jun

-17

US$/mt

Source: Company Accounts

8 | P a g e

Perspective

In our view, some of EFOODS’ market share in the UHT segment is now gone for good.

Put differently, although some market share recovery may happen over the next few

years, achieving levels of c. 50% in UHT segment again now appears extremely difficult,

especially with the advent of new, aggressive competition. As such, we keep market

share of existing products at an average of 40% in our financial projections.

Tarang: On the comeback trail Pakistan’s consumption of tea whitener and creamers takes up approximately 32% of the

processed milk consumption (as per Tetra Pak in CY15) and is the fastest growing

category in Pakistan. As per channel checks, Pakistan consumes 72bn cups of tea

annually where tea whiteners, containing lesser quantity of milk solids, are a less costly

option as compared to all-purpose packaged milk.

Within this category, EFOODS’ tea whitener brand Tarang was the market leader during

CY14-15 (52% share as per Nielsen Retail Audit Report 2015). Tarang’s brand resonates

with Pakistan’s rural population and, out of EFOODS’ top 3 brands, Tarang is the main

revenue driver, contributing an estimated ~40% to the topline in CY16.

We understand that Tarang lost traction with consumers in 2HCY16 owing to variation in

recipe mix (as per channel checks) and swift entry of competition (e.g. Shakarganj Food’s

Qudrat brand) within that period, leading to loss in market share in rural segments

(especially Khyber Pakhtunkwa). EFOODS’ dairy market share thus dropped from 56% in

CY15 to 49% in CY16 and is projected to drop sharply to c. 40% in CY17F.

Recent drop in international skimmed milk powder (SMP) prices, a key ingredient in tea

whitener, also gave opportunity to discounters to eat into Tarang’s market. Tarang has

responded with price cuts as well (PRs5/ltr cut to PRs75/ltr); however growth within this

segment going forward would likely be more moderate in our view, compared with the

initial swift growth trajectory. Within tea creamers, Tarang competes with Haleeb’s Tea

Max with 25% market share (Dec’15) while remaining is taken up by Chaika, EveryDay,

Qudrat, Dostea and Cupshup in that order. That said, recent price competition

(aggressive discounting) may have moved certain players up the scale.

Olpers to maintain sales momentum…

Olpers falls under EFOODS’ UHT milk umbrella competing with both UHT and pasteurized

players alike. This category has historically been priced at a premium to fresh milk with

the premium last shrinking to just 24% in Sep’13. This was due to sudden shift in demand

for loose milk vs. UHT which forced UHT milk producers to reduce their prices. However,

the gap has widened significantly ever since to 56% - an all-time high.

Although Olpers has maintained its brand presence even while competition has risen, we

believe a tougher operating environment lies ahead as Fauji Foods expands its UHT milk

business under legacy brand Nurpur. Going forward, we believe shift in consumer

preference towards packaged milk should be gradual. We anticipate Pakistan’s processed

milk market to grow at a 10yr CAGR of 8.4% as awareness for packaged milk increases.

Price discount - fresh milk vs. Tarang (250ml)

-10%

0%

10%

20%

50

60

70

80

90

Jan

-12

Sep

-12

May

-13

Jan

-14

Oct

-14

Jun

-15

Feb

-16

Oct

-16

Jul-

17

Price/ Litre

Tarang prices - LhsDisc. To Fresh Milk Prices

Source: PBS, Economic Survey & IMS Research

Product Summary Tarang Olpers Omung

Dairy Market share: ~40% combined Market share in CY17

Category: Tea creamer All purpose UHT

milk Dairy drink

Target market: Lower middle class Upper middle class Lower middle class

Competition: Tea max, Chaika, Everyday, Qudrat,

Cupshup, Dostea

Milk Pak, Nurpur,

Day Fresh, Haleeb Loose milk

Region sold: Punjab, KPK, Sindh Punjab & Sindh Punjab

Highest by SKU: 200ML, 125ML, 250ML, 500ML 250ML, 1LTR,

1.5LTR 250ML, 1LTR

MRP per 250ML PRs.25 PRs.35 PRs.20

Contribution to sales (in volumes) 47% 38% 10%


9 | P a g e

Perspective

Sales contribution from Omung to rise gradually

Omung, envisaged as the direct competitor to loose milk (priced at a 5% dscount to loose

milk), remains in a sticky position even now as the company was recently fined of

PRs62mn through the Competition Commission of Pakistan for incorrect advertising of

Omung as alternate to loose milk, while it is infact merely a dairy drink. The company has

taken a court stay order in this regard.

Recall that Omung sales were initially barred in Punjab after the provincial food authority

stated that the product did not meet the classifications of the Punjab Pure Food Rules

2011. Specifically, in order to be categorized as milk, milk solids need to be in excess of

13.5%, while only 10% milk solids go into the production of Omung. Approval has now

been received from the Punjab Food Authority but Omung sales were affected in the

intervening period and will take time to regain traction particularly as price discount to

loose milk is now limited to about 5%.

Ice-cream segment to gain traction in the long run Pakistan’s Ice Cream consumption stands at approximately 90mn litres out of which

~80% is branded while remaining 20% is unbranded. Wall’s (Unilever) is the market

leader (60% market share in CY16) with Omore (EFOODS) the second largest player (30%

market share in CY16). The remaining 10% is catered by Gourmet, Igloo and Hico. Omore

sales have grown at a 7-yr CAGR of 16% across CY09-16, recovering after a period of

deceleration during CY13 owing to severe power crisis in the country. Although we

expect power shutdowns to drop significantly as fresh energy supply enters the grid in

2018, it would be hard to replicate the initial high growth witnessed from CY09 onwards.

Given recent drop in EFOODS’ dairy volumes, ice-cream dropped in tandem where

market share dropped to approximately ~28%. Going forward, we anticipate healthy

growth in volumes and recovery in market share, where we model in 7% (10-yr CAGR) for

the ice-cream market for the next ten years. Omore still has room to expand and gain

shelf space in smaller cities compared to Walls, which cements our view of some market

share expansion. The company continues to invest in its cold chain infrastructure, where

we have modeled in 35% market share for Omore by CY26.

Segment wise mkt share - D&B & Ice-cream

40%

44%

48%

52%

56%

60%

20%

23%

25%

28%

30%

1Q

CY1

2

2Q

CY1

2

3Q

CY1

2

4Q

CY1

2

1Q

CY1

3

2Q

CY1

3

3Q

CY1

3

4Q

CY1

3

1Q

CY1

4

2Q

CY1

4

3Q

CY1

4

4Q

CY1

4

1Q

CY1

5

2Q

CY1

5

3Q

CY1

5

4Q

CY1

5

1Q

CY1

6

2Q

CY1

6

3Q

CY1

6

4Q

CY1

6

Ice Cream and Frozen Desserts Dairy & Beverages - Rhs


Price discount - fresh milk vs. Olpers (1000ml)

0%

20%

40%

60%

0

20

40

60

80

100

Jan

-12

Jul-

12

De

c-1

2

Jun

-13

No

v-1

3

May

-14

Oc

t-1

4

Mar

-15

Sep

-15

Feb

-16

Au

g-1

6

Jan

-17

Jul-

17

PRS/Litre

Fresh Milk Prices - LhsDiscount to Olpers


10 | P a g e

Perspective

Powder entry will come, but not immediately EFOODS is on the defensive, with focus on consolidating performance of the existing product suite. Until this is achieved, and it may take at least a year, the company is likely to keep ambitions of entering the powder segment on the backburner. Similar to ICI’s Morinaga, we build a powder trading business in our EFOODS’ model; GUMP from CY19 onwards and infant formula from CY21. Despite being a trading business, marketing costs associated with initial launch may delay breakeven on new products by 1-2years.

Pakistan’s milk powder industry Since incorporation in 2006, the EFOODS has harbored plans to enter into Pakistan’s Growing-up-milk (GUMP) and infant milk powder market, and it may finally be in a position to do so under Friesland Campina. Pakistan’s milk powder industry stands at approximately 66,000MT (i.e. ~600mn litres) - a major chunk of which is imported - growing at a 5yr CAGR of 5%. Within this market, GUMP takes up a fair share, targeting toddlers and infants from stage-3 and onwards (12months-3yrs), where Nestle Pakistan leads with ~60%+ market share through legacy brand Nido. Infant formula, on the other hand, is a niche market catering to infants from birth to 12months (i.e. stages 1-3). Within this space, Nestle Pakistan again leads with ~30%+ market share followed by Meiji and Morinaga (ICI), making about 75% of the total market.

Brands similar to Friso & Dutch Lady may be introduced… Our talks with management suggest that Engro Foods may launch Growing-up-milk as its

first product in the milk powder category, followed by infant formula within

approximately 2yrs of the first launch. With change of hands in sponsor, EFOODS will

benefit from Friesland Campina’s vast experience in dairy, particularly GUMP and infant

powder through existing flagship brands: i) Friso (infant formula), ii) Dutch Lady

(Growing-up-milk); both in Malaysia, and iii) Peak in Nigeria (Growing-up-milk). FC’s dairy

brands in Malaysia hold a +60% market share which leads us to believe that similar

products would likely be introduced in Pakistan, but not immediately.

…but immediate focus lies on reviving existing business As per management guidance, EFOODS is expected to prioritize its existing products to

arrest decline in volumes – due to recent loss in UHT market share – and revive its Dairy

& Beverages segment. Therefore, we anticipate introduction of GUMP brands not earlier

than CY19, followed by infant formula in CY21, both via trading operations rather than

manufacturing inside Pakistan. Taking cues from Morinaga (ICI) – which has a similar

business model – we anticipate the company to enter initially into trading business for

these brands. We expect this initial plug-and-play to continue for a few years, where

EFOODS may potentially consider setting up manufacturing plant after the new brands

formally kick-off.

What is GUMP?

Growing-up milk is marketed as being

suitable for toddlers aged between one year

old and three years old. Growing-up milk has

vitamins, minerals and prebiotics added to

it. It also contains higher levels of iron than

other formula milks.

What is infant formula?

Infant formula is a manufactured food

designed and marketed for feeding to

babies and infants under 12 months of age,

usually prepared for bottle-feeding or cup-

feeding from powder or liquid.

Powdered Milk Categories Age Groups

Infant Formula 0-6months

Follow-up-formula 6-12months

Growing-up-milk 1-6yrs

Full-cream-milk 4-12yrs


Friso is a Singaporean brand for infant milk powder under FC


Dutch Lady is a Malaysian brand under FC umbrella


11 | P a g e

Perspective

Go big or go home: EFOODS likely to aim for a large piece of the pie

Historically, EFOODS has tended to invest significantly on brand promotion for new

products in order to penetrate the market. Given that Pakistan’s milk powder industry is

about half that of ambient UHT – including higher number of participants, making it

harder to penetrate – we anticipate higher allocation of funds for initial promotional

campaigns. This would be in contrast to lack of major promotions for ICI’s Morinaga for

instance, where the latter is already an established brand in the Pakistani market.

As per management guidance, we expect EFOODS to incur one time marketing expense

close to PRs500mn per product launch, followed by sustained higher recurring

promotions. EFOODS has achieved high market shares in the past and in our view it will

likely be confident in achieving the same in the powder market as well. We build in up to

20% market share in both categories (GUMP & Infant Formula) by 2026.

Lucrative on margins but translation to the bottom-line may take time While UHT milk business has margins of approximately 20%, Pakistan’s milk powder

industry has far more to offer, in our view. Margins in the growing-up-milk category

average north of 30%, while infant formula trading business margins range between 55-

60%. That said, FrieslandCampina is entitled to Technical Assistance Fee of 2.0% on

EFOODS’ future net sales (net of GST) in addition to Royalty Fee of 2.0% on net sales (net

of sales taxes) of any new products produced by EFOODS, sold under trademarks that are

owned by FC.

Therefore, although we anticipate swift rise in market share to reflect directly in sales,

higher marketing & distribution expenses, coupled with payments to FC, will prohibit full

translation to the bottom-line.

We expect both products (GUMP an d infant formula) to post a loss of PRs0.41/sh and

PRs0.46/sh respectively in their first year (CY19 and CY21), and breakeven onwards as

market share gains momentum and marketing expense normalizes. By 2026, we expect

new products to contribute 21% to EFOODS’ overall topline and 11% to profitability.

EFOODS likely to compete against big players in the long run

Currently, Nestle remains the brand leader in the domestically produced infant formula

market through its products Nan and Lactogen, while Mead Johnson’s Meiji and ICI’s

brand Morinaga dominate the imported infant powder market. Nestle is also brand

leader in growing-up-milk formula market through Nido, which competes in both stage-3

infant formula market (vs. Meiji) and also the 1-3yrs growing-up-milk market. Given

EFOODS’ history of competing against Nestle in the dairy segment, the former may feel

confident in entering the powder segment opposite Nestle, particularly that it now has

FC backing, in our view. Although we anticipate the industry volumes to grow at a 9%

10yr CAGR, we expect shuffling in market shares to take place. Nutrico’s intention to set

up a manufacturing facility (commercial operations by FY18) cements the underlying

potential in the infant powder market.

Market share- Infant formula

Nestle Nido

FC EFOODS

Cow & Gate

BioMil

Meiji

Morinaga

Apatamil/ EnfaGrow

Progress Gold

CY16

CY26


Market share- Growing-up-milk

Nestle

FC EFOODS

Meiji

Morinaga

Mead Johnson

Abbott

Cow & Gate

Nuzzer Pharma

Others

CY16

CY26


Payments to sponsors

-

1,000

2,000

3,000

4,000

-

75

150

225

300

375

CY1

7F

CY1

8F

CY1

9F

CY2

0F

CY2

1F

CY2

2F

CY2

3F

CY2

4F

CY2

5F

CY2

6F

PRsmn(PRsmn)

Royalty Fee - Lhs Technical Fee

Source: Company Announcements and IMS Research

We expect EFOODS to enter the GUMP

market in 2019 and infant formula in 2021,

via a trading business

We build in c. 20% market share for both

product categories after 10yrs, after which

these new products will contribute 11% and

21% to EFOODS’ sales and profits,

respectively by CY26.

12 | P a g e

Perspective

Valuations can only stretch so much; Initiate with Sell

5yr sales / profit CAGRs are projected at 19%/71% but valuations are still stretched.

EFOODS trades at a CY18F P/E of 74.5x and even on CY19F this is an expensive 49.5x

(due to royalty & technical assistance fee, we think the P/S metric now has limited

relevance for EFOODS). Our TP of PRs81/sh takes into account likely entry into the

powder segment from CY19; without new additions to the product suite, our TP would

be about PRs70.5/sh. We thus initiate with a Sell stance. Risks emanate from a

continued tougher operating environment amidst aggressive competition. Upside risk

can arise from introduction of minimum pasteurization law and stronger than expected

performance of any new products.

Weak 1HCY17 sets the tone for full year results EFOODS reported 2QCY17 loss of PRs149mn (LPS: PRs0.19), bringing 1HCY17 profit to

PRs182mn (EPS: PRs0.24), down 91%YoY. Revenues lifted slightly from the 1QCY17

trough, but GMs dropped sharply to 15.6% (-4ppt QoQ; -11ppt YoY) owing to price

discounts offered to regain market share. Additional factors that contributed to 1HCY17

earnings drop were (i) continued decline in UHT market share (CY16: 49% vs. CY15: 56%)

with tepid growth in ice-cream segment volumes, and (ii) booking of 2.0% technical fee

expense to Friesland Campina. We expect 2HCY17 to depict an improvement compare to

2QCY17 but not by much.

EFOODS – 1HCY17 Result Review

(PRsmn) 1HCY17 1HCY16 YoY 2QCY17 2QCY16 YoY 1QCY17 QoQ

Sales 18,005 23,100 -22% 9,328 11,464 -19% 8,677 7%

COGS 14,879 16,723 -11% 7,876 8,395 -6% 7,003 12%

Gross Profit 3,125 6,377 -51% 1,452 3,069 -53% 1,674 -13%

Gross Margin 17.4% 27.6% 15.6% 26.8%

19.3%

Distribution expense 2,251 2,541 -11% 1,267 1,144 11% 984 29%

Admin Expense 408 423 -4% 177 232 -24% 231 -23%

Other opex 31 273 -89% 2 153 -99% 29 -94%

Other income 148 56 163% 100 0

48 111%

Operating Profit 583 3,197 -82% 109 1,540 -93% 474 -77%

Finance cost 222 214 4% 166 111 49% 56 194%

PBT 361 2,983 -88% (56) 1,429 -104% 418 -113%

Taxation 176 1,022 -83% 89 576 -85% 87 3%

PAT 186 1,961 -91% (145) 853 N/A 331 -144%

EPS (PRs) 0.24 2.56

(0.19) 1.11

0.43

Source: Company Announcement

Sales to resume growth but margin uplift to take time From its CY17F trough, we expect EFOODS to post a sales CAGR of 19% across the next

5yrs. Market share on existing product suite should rise, but only modestly given

competition in the UHT space has increased significantly. Margins are also likely to

recover from the 2QCY17 trough but only gradually. On existing products, we expect GMs

to average 19% over CY18F-20F vs. an average of 21% over CY14-16. However, after

incorporating likely entry into the higher margin powder segment over the medium-term,

our GMs for EFOODS are expected to consistently expand and reach 24% by CY26F.

Royalties and technical fee take away a significant chunk from EFOODS’ topline. Based on

our projections, EFOODS will end up paying as much as PRs21.8bn in these payments

across the next 10yrs. Were there no such paying arrangements, our EPS estimates for

EFOODS across the longer run would be 56% higher than current estimates. In such a

scenario, our TP for EFOODS would stand at PRs102/sh.

Quarterly revenue trend paints a weak picture

-1,500

-1,000

-500

0

500

1,000

1,500

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1Q

CY1

0

3Q

CY1

0

1Q

CY1

1

3Q

CY1

1

1Q

CY1

2

3Q

CY1

2

1Q

CY1

3

3Q

CY1

3

1Q

CY1

4

3Q

CY1

4

1Q

CY1

5

3Q

CY1

5

1Q

CY1

6

3Q

CY1

6

1Q

CY1

7

PRsmn PRsmn

Net Sales PAT


Had there been no royalty & technical fees,

our EPS estimates over the longer run would

be 56% higher than current estimates and

our TP would then stand at PRs102/sh

13 | P a g e

Perspective

Valuations may take time in catching up We intiate coverage on FrieslandCampina Engro Foods (EFOODS) with a Sell stance and

CY18F Target Price of PRs81/ share. We have valued the stock using a Discounted

Cashflow Valuation Model.

Valuation Methodology

We have valued EFOODS using Discounted Cashflow Methodology as we believe both

Price-to-Sales and PEG valuations would not correctly reflect the underlying risks of the

stock:

• Reasons for not using PEG/PE valuation: Taking CY17F as the base, PEG for the next

5yrs works out to 1.05x. Valuing EFOODS at PEG of 1 results in a TP of PRs94.3/sh for

EFOODS. However, we refrain from adopting the P/E valuation methodology due to

its arbitrary nature. Peer-based valuation is also difficult in this case given EFOODS’

unique dynamics and very low earnings base for CY17/18F.

• Reasons for not using Price to Sales valuation: Although we project 10yr sales CAGR

of 11% till CY26, translation to the bottomline would be gradual. This is due to the

impact of (i) hefty technical fee to FrieslandCampina & Engro Corporation, (ii)

payment of royalty to Friesland Campina amid weak fundamentals and (iii) initial-

launch marketing expense on new powder products. This makes P/S a less relevant

metric for valuing EFOODS, in our view, (valuing EFOODS at NESTLE’s CY18F P/S

multiple of 4.1x would result in a TP of PRs249.1/sh for EFOODS which does not

appear justified to us).

As such, we give preference to DCF where we have extended explicit forecasts to CY26 to

account for (i) potential consolidation of existing brands in the medium term and (ii)

formal take-off of new brands in the longer run. Therefore, NPAT is set to increase at a 3-

year CAGR of 101%% during CY17-19 and 9-year CAGR (CY17-26) of 39% respectively.

EFOODS- Valuation Snapshot

W/o new brands CY15 CY16 CY17F CY18F CY19F CY20F CY26F

EPS (PRs) 4.13 3.11 0.42 1.34 2.40 3.27 ………………….. 9.36

PER(x) 24.14 31.98 238.48 74.52 41.52 30.46 ………………….. 10.64

PS(x) 1.53 1.72 2.01 1.64 1.40 1.21 ………………….. 0.66

EBITDA Margin 14.4% 13.5% 7.2% 7.7% 8.7% 8.7% ………………….. 10.4%

Gross Margin 23.1% 22.6% 16.3% 17.7% 19.2% 19.7% ………………….. 22.4%

Net Margins 6.3% 5.4% 0.8% 2.2% 3.4% 4.0% ………………….. 6.2%

Incl. new brands

EPS (PRs) 4.13 3.11 0.42 1.34 2.01 3.38 ………………….. 11.52

PE(x) 24.14 31.98 238.48 74.52 49.47 29.44 ………………….. 8.65

PS(x) 1.53 1.72 2.01 1.64 1.39 1.18 ………………….. 0.59

EBITDA Margin 14.4% 13.5% 7.2% 7.7% 7.8% 8.7% ………………….. 11.3%

Gross Margin 23.1% 22.6% 16.3% 17.7% 19.4% 20.0% ………………….. 24.3%

Net Margins 6.3% 5.4% 0.8% 2.2% 2.8% 4.0% ………………….. 6.8%


Risk Free Rate 6.0%

Beta 1.10

Terminal growth 5.0%

Risk Premium 8.0%

Cost of Equity 14.6%

Food Sector- Sector chart

-100%

0%

100%

200%

300%

400%

Au

g-1

1

Jan

-12

Jun

-12

No

v-1

2

Ap

r-1

3

Sep

-13

Feb

-14

Jul-

14

De

c-1

4

May

-15

Oct

-15

Mar

-16

Au

g-1

6

Jan

-17

Jun

-17

KSE100 Index IMS Food Universe Source: IMS Research

Scenario Based DCF Valuation Market Share Scenarios by CY26

Bull Case TP PRs90 *Existing Brands: 50%

EFOODS regains lost market share and significantly strengthens existing dairy

segment brand equity. New products gain swift success and customer acceptability

eating into Nestle and Nutrico market share by CY26. *New Products: 30%

Base Case TP PRs81

Existing Brands: 41% EFOODS increases promotional activity on Tarang, regains portion of lost dairy market

and maintains 41% share till CY26, while new brands penetrate with significant

advertising amid rising competition. New Products: 20%

Bear Case TP PRs66

Existing Brands: 30% EFOODS continues to lose market share as cannibalization by competitors increases

and loose milk conversions drop. New brands fail to gain significant traction despite

heavy marketing leading to 10% market share by CY26. New Products: 10%

*Existing brands: Tarang, Olpers, Omung; New brands: GUMP & infant formula Source: IMS Research

14 | P a g e

Perspective Key Risks Upside Risks

Upside risk factors include (i) Rise in processed milk market, (ii) Regaining market

share in existing products, (iii) Earlier than expected launch and success of powder

products and, (iv) any rumors of shares buyback by Sponsor FrieslandCampina.

Rise in processed milk market

Currently Pakistan’s processed milk market stands at approximately 8% of traded milk,

where we anticipate it to grow to 12.2% by CY26. Any increase in conversions over our

estimates remains key upside risk.

Regaining market share in existing products

EFOODS lost significant market share in CY16 (49%) where we anticipate market to pick

pace in the medium term and stabilize at 41% by CY26. Any increase in market share

through higher promotional activity would cause our TP to lift.

Earlier than expected launch and success of powder products

We anticipate EFOODS to enter the powder market through GUMP by CY19 and infant

formula by CY21. However, earlier than anticipated launch coupled with higher than

anticipated earnings in the respective brands remains upside risk.

Potential buyback by sponsor FC

Although the sponsor; Friesland Campina is not looking to delist Engro Foods at this

time (as per management rhetoric) however, any potential change in delisting plans

could increase stock price. The parent company and most of it subsidiaries worldwide

are not listed.

Downside Risks

Downside risk factors include (i) swift rise in skimmed milk powder prices (SMP), (ii)

swift rise in skimmed milk powder prices (SMP), (iii) rise in exchange rate and, (iv)

failure to enter the powder market in a timely manner

Significant dilution of market share through new entrants

EFOODS’ recent loss of market share opens up avenues for other players to cater the

remaining demand where we further share dilution becomes key downside risk. New

entrants such as Fauji Foods pose a major risk which is spending aggressively on milk

collection network and brand building.

Swift rise in skimmed milk powder prices (SMP)

Any increase in SMP prices would have a negative impact on gross margins where it

becomes non-viable for the company to rely heavily on imported SMP above

US$3200/MT, hence switching to locally procured liquid milk. That said SMP prices are

still at multi-year lows where chances of swift increase in prices amid international

oversupply seems slim.

Rise in exchange rate

Any upward fluctuation in the exchange rate poses downside risk as input costs would

rise and consequently dilute margins (if not passed through to the consumer). We cater

in 4% rupee depreciation in our model where any additional decline in value is a risk.

Failure to enter powder market in a timely manner

Any failure to enter the powder market in time would result in a drop in valuation given

lower discounting in the later years on our valuation.

15 | P a g e

Perspective EFOODS Company Graphs

SMP prices vs. Gross margins

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

0%

5%

10%

15%

20%

25%

30%

CY1

2

CY1

3

CY1

4

CY1

5

CY1

6

CY1

7F

CY1

8F

CY1

9F

CY2

0F

SMP Prices (US$/MT) GMs (Lhs)


Revenue vs. NPAT (PRsmn)

-

500

1,000

1,500

2,000

2,500

3,000

3,500

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

CY1

2

CY1

3

CY1

4

CY1

5

CY1

6

CY1

7F

CY1

8F

CY1

9F

CY2

0F

Revenue NPAT - Rhs

Source: PAMA, Company Accounts & IMS Research

Segment-wise revenue breakup (PRsmn)

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

(500)

500

1,500

2,500

3,500

4,500

CY1

2

CY1

3

CY1

4

CY1

5

CY1

6

CY1

7F

CY1

8F

CY1

9F

CY2

0F

Dairy Farm (Lhs) Trading sales (Lhs)

Ice cream Dairy & Beverages


GUMP & Infant formula sales trend

-

2,000

4,000

6,000

8,000

10,000

12,000

CY1

9F

CY2

0F

CY2

1F

CY2

2F

CY2

3F

CY2

4F

CY2

5F

CY2

6F

(PRsmn)

Growing up milk Infant formula


EFOODS UHT market share

0%

10%

20%

30%

40%

50%

60%

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

3

CY1

4

CY1

5

CY1

6

CY1

7F

CY1

8F

CY1

9F

CY2

0F

CY2

1F

CY2

2F

CY2

3F

CY2

4F

CY2

5F

CY2

6F

EFOODS UHT Market Share


Working capital trend (PRsmn)

(20,000)

(15,000)

(10,000)

(5,000)

-

5,000

10,000

CY1

2

CY1

3

CY1

4

CY1

5

CY1

6

CY1

7F

CY1

8F

CY1

9F

CY2

0F

Short-term borrowings Payables Receivables Inventory

Source: Bloomberg & IMS Research

16 | P a g e

Perspective

EFOODS - Valuation Summary

Profit & Loss Account

(PRsmn) CY15 CY16 CY17F CY18F CY19F CY20F

Net Revenue 49,834 44,346 38,053 46,646 55,037 64,948

Cost of sales 38,303 34,307 31,858 38,403 44,384 51,932

Gross profit 11,531 10,039 6,196 8,244 10,654 13,016

Admin & Selling Exp. 6,338 5,989 5,259 6,323 7,919 8,769

EBITDA 7,171 5,979 2,721 3,573 4,266 5,666

Dep & Amortization 1,977 1,930 1,785 1,652 1,531 1,419

EBIT 5,194 4,050 936 1,921 2,735 4,247

Financial Charges 856 348 583 605 614 500

Other income 326 149 295 301 307 313

Other charges 369 332 92 154 224 356

Profit before Tax 4,294 3,518 556 1,463 2,204 3,704

Taxation 1,132 1,131 236 439 661 1,111

Net Profit after Tax. 3,162 2,387 320 1,024 1,543 2,593

Balance Sheet

(PRsmn) CY15 CY16 CY17E CY18F CY19F CY20F

Non-Current Assets 15,230 14,246 13,255 12,480 11,786 11,177

Total Current Assets 11,055 10,467 25,651 30,075 30,674 31,882

Total Assets 26,285 24,714 38,906 42,555 42,460 43,058

Share capital 7,666 7,666 7,666 7,666 7,666 7,666

Reserves - - - - - -

Surplus on revaluation - - - - - -

Total Equity 14,913 17,151 17,404 18,512 20,137 22,827

Long Term Debt 2,196 500 1,833 5,333 4,000 3,333

Total Non current Liabilities 4,013 2,106 3,211 7,022 5,993 5,685

Short term Debt 7,360 5,457 18,291 17,021 16,330 14,546

Total Current Liabilities 7,360 5,457 18,291 17,021 16,330 14,546

Total Liabilities 11,373 7,563 21,503 24,043 22,323 20,231

Cash Flow Statement

(PRsmn) CY15E CY16 CY17E CY18F CY19F CY20F

CF from Operating Activities 4,768 5,126 6,568 2,215 4,951 3,111

CF from investing Actitivities (956) (1,097) (821) (839) (801) (766)

CF from Financing Activities (3,764) (3,591) 6,630 2,789 (2,556) (1,333)

Change in cash 48 438 12,377 4,164 1,594 1,011

cash at beginning 197 289 703 13,029 17,256 18,911

Cash at end of year 289 703 13,029 17,256 18,911 19,995


Key Ratios CY15 CY16 CY17F CY18F CY19F CY20F

EPS (PkR) 4.13 3.11 0.42 1.34 2.01 3.38

EPS Growth (%) 256% -25% -87% 220% 51% 68%

PER (x) 24.14 31.98 n.m 74.52 49.47 29.44

P/S (x) 1.53 1.72 2.01 1.64 1.39 1.18

BVPS (PRs) 19.45 22.37 22.70 24.15 26.27 29.78

PBV (x) 5.12 4.45 4.39 4.12 3.79 3.34

DPS (PRs) - 10.00 - - - -

DY (%) 0.0% 10.0% 0.0% - - -

ROE (%) 21.2% 13.9% 1.8% 5.5% 7.7% 11.4%

ROA (%) 12.2% 9.4% 1.0% 2.5% 3.6% 6.1%

D/E (%) 76.3% 44.1% 123.6% 129.9% 110.9% 88.6%

EBITDA Margin 14.4% 13.5% 7.2% 7.7% 7.8% 8.7%

Gross Margin 23.1% 22.6% 16.3% 17.7% 19.4% 20.0%

Net Margins 6.3% 5.4% 0.8% 2.2% 2.8% 4.0%

EFOODs - PER (x) CY18F

-

100

200

300

400

500

Jan-12 Dec-12 Nov-13 Nov-14 Oct-15 Sep-16 Sep-17

(x)

PER (x)


EFOODs - P/Sales (x) CY18F

-

1.0

2.0

3.0

4.0

5.0

Jan-12 Dec-12 Nov-13 Nov-14 Oct-15 Sep-16 Sep-17

(x)

P/Sales (x)


17 | P a g e

Perspective

I, Yusra Beg, certify that the views expressed in the report reflect my personal views about the subject securities. I also certify

that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations made in this

report. I further certify that I do not have any beneficial holding of the specific securities that I have recommendations on in this

report.

Ratings Guide* Upside

Buy More than 15%

Neutral Between 0% - 15%

Sell Below 0%

*Based on 12 month horizon unless stated otherwise in the report. Upside is the percentage difference between the Target Price

and Market Price.

Valuation Methodology: We use Discounted Cash Flow (DCF) to value EFOODS as P/S and PEG would be misleading under current

company dynamics.

Risks: Please refer to page 14.

Disclaimer: Intermarket Securities Limited has produced this report for private circulation only. The information, opinions and

estimates herein are not direct at, or intended for distribution to or use by, any person or entity in any jurisdiction where doing so

would be contrary to law or regulation or which would subject Intermarket Securities Limited to any additional registration or

licensing requirement within such jurisdiction. The information and statistical data herein have been obtained from sources we

believe to be reliable where such information has not been independently verified and we make no representation or warranty as to

its accuracy, completeness and correctness. This report makes use of forward looking statements that are based on assumptions

made and information currently available to us and those are subject to certain risks and uncertainties that could cause the actual

results to differ materially. No part of the compensation of the author(s) of this report is related to the specific recommendations or

views contained in this report.

This report is not a solicitation or any offer to buy or sell any of the securities mentioned herein. It is meant for information

purposes only and does not take into account the particular investment objectives, financial situation or needs of individual

recipients. Before acting on any information in this report, you should consider whether it is suitable for your particular

circumstances and, if appropriate, seek professional advice. Neither Intermarket Securities Limited nor any of its affiliates or any

other person associated with the company directly or indirectly accepts any liability whatsoever for any direct or consequential loss

arising from any use of this report or the information contained herein.

Subject to any applicable law and regulations, Intermarket Securities Limited, its affiliates or group companies or individuals

connected with Intermarket Securities Limited directly or indirectly may have used the information contained herein before

publication and may have positions in, or may from time to time purchase or sell or have a material interest in any of the securities

mentioned or may currently or in future have or have had a relationship with, or may provide investment banking, capital markets

and/or other services to, the entities mentioned herein, their advisors and/or any other connected parties.

18 | P a g e

Perspective

NOTICE TO US INVESTORS

This report was prepared, approved, published and distributed by Intermarket Securities Limited (IMS) located outside of the

United States (a “non-US Group Company”). This report is distributed in the U.S. by LXM LLP USA, a U.S. registered broker

dealer, on behalf of IMS only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securities Exchange

Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. customer in

the securities described in this report must be effected through LXM LLP USA.

Neither the report nor any analyst who prepared or approved the report is subject to U.S. legal requirements or the Financial

Industry Regulatory Authority, Inc. (“FINRA”) or other regulatory requirements pertaining to research reports or research

analysts. No non-US Group Company is registered as a broker-dealer under the Exchange Act or is a member of the Financial

Industry Regulatory Authority, Inc. or any other U.S. self-regulatory organization.

Analyst Certification. Each of the analysts identified in this report certifies, with respect to the companies or securities that

the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject

companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the

specific recommendations or views expressed in this report. Please bear in mind that (i) IMS is the employer of the research

analyst(s) responsible for the content of this report and (ii) research analysts preparing this report are resident outside the

United States and are not associated persons of any US regulated broker-dealer and that therefore the analyst(s) is/are not

subject to supervision by a US broker-dealer, and are not required to satisfy the regulatory licensing requirements of FINRA

or required to otherwise comply with US rules or regulations regarding, among other things, communications with a subject

company, public appearances and trading securities held by a research analyst account.

Important US Regulatory Disclosures on Subject Companies. This material was produced by Analysis of IMS solely for

information purposes and for the use of the recipient. It is not to be reproduced under any circumstances and is not to be

copied or made available to any person other than the recipient. It is distributed in the United States of America by LXM LLP

USA and elsewhere in the world by IMS or an authorized affiliate of IMS. This document does not constitute an offer of, or

an invitation by or on behalf of IMS or its affiliates or any other company to any person, to buy or sell any security. The

information contained herein has been obtained from published information and other sources, which IMS or its Affiliates

consider to be reliable. None of IMS accepts any liability or responsibility whatsoever for the accuracy or completeness of any

such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the

date of this document. Emerging securities markets may be subject to risks significantly higher than more established

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subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information

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are not any other actual, material conflicts of interest of LXM LLP USA at the time of the publication of this research report.

As of the publication of this report LXM LLP USA, does not make a market in the subject securities.

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