AKD Securities Limited – EFOODS: Improved volumes unleash top gear growth

Karachi, April 23, 2015 (PPI-OT): Earmarking the highest ever quarterly profits in 1QCY15 (NPAT: PkR1.1bn, EPS: PkR1.39), Engro Foods (EFOODS) is well on the road to make a new mark. While the sequential jump in profitability is attributable to a host of peripheral factors (seasonal weakness in raw milk prices along with internationally lower powder milk prices), volumetric recovery (+22% YoY), jump in GMs (+700bpsYoY) and in-control operating expenses are all fundamental key positives indicative of a promising future outlook.

In this regard, AKD Securities Limited have updates AKD Securities Limited’s investment case for EFOODS, upward revising AKD Securities Limited’s earnings projection by 60%-70% in CY15F-CY18F primarily on account of improvement in market share and GMs. Consequently, AKD Securities Limited’s revised TP has gone up by 50% to PkR181/sh (upside 22%). The stock has provided 37%CYTD return where AKD Securities Limited feels there is room for further appreciation considering strong recovery in core fundamentals (5yr earnings CAGR of 45%). While a forward P/E of 39x seems demanding, the PEG multiple, more appreciative of the long-term potential, stands at an appetizing 0.86 (vs. 2.01 for peers). BUY!

Is volumetric recovery sustainable? 1QCY15 turned out to be an exceptional quarter for EFOODS in terms of volumetric growth. EFOODS’ effective competitive pricing (Olpers offered at 5% discount to competition) worked wonders for the Dairy volumes that suffered heavily on the back of distribution issues and intense competition, growing by 22%YoY, taking company’s market share to 56% in Mar’15 (as per management).

In this regard, AKD Securities Limited believes the trend is likely to sustain and thus have increased AKD Securities Limited’s market share assumption by 200bps to 56% in CY15F to fully reflect the growth in volumes. Consequently, the revenues go up by 11% YoY to PkR48.9bn in CY15F with Olpers and Tarang expected to contribute 35% and 58% respectively to revenues. That said, recent move by competition to cut down prices in order to narrow down/equalize the price differential can hamper volumetric growth and remains a key downside risk.

GMs on the mend: Despite company’s intended focus on volumes, GMs for 1QCY15 went up by a good 770bps/700bps QoQ/YoY to 27.3% with a host of peripheral factors like 1) seasonal weakness in milk procurement prices along with the slump in int’l powdered milk prices (+4% contribution to GMs) and 2) lower energy and variable costs (+3% contribution to GMs) turning positive for the company.

However, sustainability of GMs at these levels does not seem likely particularly during the lean season when milk supply is at its lowest levels, assuming no price increments. That said AKD Securities Limited expects GMs entrenched in the range of 24%-25% in CY15F-CY18F with room to grow should the company decide to increase product prices/ focus on high margin products (e.g. cream, ghee).

Ice-cream neither here nor there: EFOODS continued with its innovative strategy in 1QCY15 with a variety of new launches in this particular segment, despite energy shortage continuing to restrict the segment’s growth potential. While the segment failed to come into profits on account of winters, the company’s market share in this segment improved by 1ppt to 29% in 1QCY15 against 28% in Dec’14. While AKD Securities Limited’s estimated revenue contribution from this segment stands at 6% in CY15F, AKD Securities Limited rules out an aggressive stance in this segment until a sustainable improvement in the energy situation.

Investment Perspective: Following elimination of loss making foreign operations and resolution to domestic distribution issues, EFOODS seems all fit to get back on its growth trajectory (5yr earnings CAGR of 45%+) where positive surprises can come in the form of: 1) new product extensions, 2) commercial launch of powder milk and 3) likely restart of Omung sales in Punjab. Although EFOODS trade at a demanding forward P/E of 39x, its 5yr PEG of 0.86 (vs. 2.06 for peers) is more appetizing. Our revised TP of PkR181/sh implies a BUY stance with an upside potential of 22%.

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