By: Foundation Securities Limited
Engro Foods Limited could benefit in future from easing commodity prices and robust volumetric growth. We are confident the energy crisis will be resolved and it would help to smooth the supply chain of its high margin ice cream segment. We raise our TP to Rs169.7 based on the above and roll forward our valuation, and upgrade the stock to Outperform from Neutral.
Margin expansion: EFOODS GPM expanded by 5.8ppt to 26.2% during 1HCY15, thanks to easing raw material prices as well as higher volumetric sales. Thus profitability improved 6x compared to the same period last year.
Robust volumetric growth: Management’s strategy to regain market share through price reduction has started yielding results. During 1HCY15, the company posted strong volumetric growth of 25%/11% in dairy & beverages/ice cream & frozen goods. Subsequently, its market share in Pakistan rose to 55% and 29% respectively. We foresee this growth trajectory to continue given our confidence in its strong brand equity and higher GDP growth expectation (76% of GDP constitutes household consumption).
Lower raw material cost: EFOODS is ideally placed to benefit from lean commodity prices as we expect selling prices to remain stable given strong consumer demand. As there is global oversupply of milk, skimmed powdered milk prices (SMP) are trading at their lowest levels (down 17% since Jan 2015) and palm oil prices (one of the main ingredient of Tarang) are also on a downward trajectory (down by 29% since Jan 2015).
Despite dairy farms earnings not covering costs (US$2900/MT), we expect 1) extension of the Russian ban on imports from EU to June 2016, 2) removal of EU production quotas, and 3) ongoing flush season in Australia and NZ to keep prices at these levels till the end of this year. Subsequently, we lower our SMP assumption by 29% and 36% for CY15 and CY16 respectively.