Osem (TASE: OSEM) Ronit Goodman Research Analyst Food Processing & Distribution Neutral ℡ 972-3-753 2057 [email protected] Initiation Of Coverage 31 JULY 2003

Stock Data Impressive Management, Nestle’s Support & Price (NIS) 33.2 Expected Continuous Growth Already Factored Into Shares O/S (m) 96,644 Price. Initiating Coverage With A Neutral Rating. Market Cap (Nis,m) 3,198 • We are initiating coverage on Osem with a neutral rating. As one of Free Float (%) 18.2% Israel’s leading food manufacturers and distributors, Osem’s sales 12 Mo. Range (NIS) 20.08-37.6 growth has been 3.3 times higher vs. overall food sector growth 12 Mo. Average Volume (Nis,m) 2.8 since 1991. Moreover, although Israel is in its third year of recession, operating profits have increased by 3.5 times in the last Estimates FY02a FY03e FY04e five years and 1Q03 was the 16th consecutive quarter in which Net Income (NIS,m) 126.9 139.6 143.8 operating profits increased.

EPS 1.31 1.45 1.49 • Nestle (NSRGF), with 50.1% stake, will remain key in Osem’s EPS growth (YoY) (6.4)% 10.7% 2.7% success. Serving as Nestle’s subsidiary in Israel, Osem has exclusive PER 25.2x 22.9x 22.2x rights to manufacture and distribute Nestle products as well as to Revenues (NIS,m) 2,287 2,335 2,405 utilize their technological and marketing know how.

Rev. Growth (YoY) (2.7)% 2.1% 2.9% • Osem’s impressive management and its clear long-term growth EV/EBITDA 9.8 9.4 8.7 strategy that includes a thorough approach to marketing, cost Dividend Yield 4.6% 4.6% 4.6% cutting, M&A and expansion into new product categories, should ROE 13.4% 12.9% 11.7% continue to support the Company’s growth and leading position.

PEG 12.6 11.5 11.1 • In recent years, Osem’s dividend payout has exceeded its 50% of net income policy. In 2002, Osem distributed 100% of earnings, in 2001 Changes 119% and in 2002, 124%. While this may appear generous short Previous Current term, the policy could prove detrimental to growth long term.

Rating Neutral • So far, Osem has withstood the challenges presented by the difficult Price Tag (NIS) macro climate, particularly vs. their peers. Excluding extraordinary FY03E EPS (NIS) 1.45 income, FY02 earnings increased 7.7% YoY and operating income FY04E EPS (NIS) 1.49 increased 17.5% YoY. Despite an expected decrease in food FY03E Rev (NIS,m) 2,335 consumption, we project FY03 sales will reach NIS 2,335 million, 2.1% YoY increase, mainly due to new product launches, recent FY04E Rev (NIS,m) 2,405 price increases and a halt in inflation. FY03 earnings should increase CAGR (%) 2% 10% to reach NIS 139.6 million.

OSEM Versus Ta100 Relative Strength • In our view, the recent merger between Strauss and Elite, making Elite Israel’s second largest food company, will not significantly

120% impact Osem or increase competition. As Strauss owned 50.1% in Elite prior to the merger, the companies already enjoyed a mutually 105% beneficial working relationship. Strauss and Elite operate in different 90% food categories, with separate distribution and marketing channels

75% and therefore the merger is unlikely to improve synergies that could

60% pose a threat to Osem.

Aug- Oct- Dec- Feb- Apr- Jun- 02 02 02 03 03 03 Investment Recommendation:

TA 100 Osem With solid management and Nestle backup, Osem should continue to perform well and grow consistently in upcoming quarters. Utilizing 7.5% discount rate and an estimated 2% infinity growth rate on our estimated FCF, Osem’s fair value stands at NIS 3,581 million, representing NIS 37.0/S, 12% higher than today’s current share price. Due to the limited upside, we are initiating our coverage with a Neutral rating.

1 Osem Nessuah Zannex Equity Research

Company History. Founded in 1942, Osem is one of Israel’s leading food product manufacturers and distributors in terms of profitability and market capitalization. With 10 factories and approx. 4,500 employees, Osem product basket comprises over 1,000 different products within Israel.

Osem began by focusing on first line of business was the dry food segment (pastas, pastry etc.), becoming a market leader with 75% market share in the pasta market, which is worth NIS 190 million. In recent years, Osem’s product range has expanded to include chilled and frozen products, ice creams, meat substitutes and so on. In 1996, Nestle began purchasing Osem shares (currently owns 50.1%) providing the platform for Osem to expand its product basket to include products in which Nestle holds global market leadership such as cereals, coffee, confectionary and recently, pet foods.

Osem’s Product Distribution Other 11% Baked & Snacks 26% Chilled Products

9%

Frozen Products

16% Ice Creams 8% Instant Coffee 5% Ambient Products 25% Source: Company Data

Osem’s main focus is on the Israeli market. Israel is in its third year of recession. Domestic Slowdown To According to the Central Bureau of Statistics, salaries were eroded by 5.6% and Limit Top Line Growth. unemployment reached over 10% in 2002. Moreover, food consumption decreased by 6.8% in 2002 and by 8.2% in 1Q03. In FY03, we believe unemployment will continue to increase to reach over 11% and that food consumption will continue to be depressed and decrease by approx. 3%-4% YoY.

Osem’s sales to the main retail chains comprise approx. 40% of total sales, while the

remaining 60% is distributed to the private market including kiosks, small

supermarkets, hotels, hospitals and restaurants.

The retail sector is a conspicuous victim of the current recession and competition from discount stores has intensified. These trends battered Israel’s two leading retail chains – Blue Square (BLSQ) and Supersol (SAE). Blue Square FY02 sales decreased by 4.9% YoY in 2002, while same store sales (SSS) decreased by 11.2% YoY; Supersol FY02 sales decreased by 1.2% YoY, while SSS decreased by 7.5% YoY. We note that some of the aforementioned decreases were the result of erosion due to high increase in inflation vs. lower increase in food index.

With no meaningful improvement projected in the economic outlook near term and

increasing competition, the retail sector is set continue suffering. Product prices are

likely to be pressed down while customers search for bargain prices at discounted

formats stores, negatively impacting retail chains’ revenues growth.

We note that Osem’s margins at discount stores are not necessarily lower, as these stores are usually more efficient than the big chain stores and with lower fixed costs.

2 Osem Nessuah Zannex Equity Research

So far, Osem appears to have proved itself relatively resilient to the challenges presented by the economic climate. Osem’s FY02 sales decreased by 2.7% YoY. However, Elite (one of Osem’s main competitors) appears to be harder hit by the recession as sales from its operations in Israel dropped 6.7% YoY last year.

We note that as 40% of Osem’s products are sold via retail chains, the recession will

gradually take a larger toll on the Company, limiting top line growth. We estimate

that FY03 sales will increase only by 2.1% YoY to reach NIS 2,335 million. Osem’s Focus on Particularly in the current climate, retail stores will continue to aggressively press Improving Operating & manufacturers and suppliers prices threatening Osem’s margins. Gross Margins Should Maintain Performance Despite expected low sales growth in upcoming quarters, Osem is expected to In Slowdown. continue focusing on improving gross and operating margins by merging factories, distribution lines and other synergetic activity. FY03 gross margins are set to decrease from 43.19% in 2002 to reach 42.63%. Inner efficiency steps should support increasing operating margins from 9.02% in 2002 to reach 9.85% this year.

Domestic Market Players:

Aside from Osem, the following players dominate the Israeli food market: Elite, Strauss, Telma and Tnuva.

Elite (ELEI), one of Osem’s main competitors, focuses on coffee, chocolate,

confectionary and salty snacks. Elite is a market leader in the chocolate and Elite: Osem’s Main confectionary market as well as in powdered coffee. Although it co/owns the Competitor. Leads in confectionary company with PepsiCo (50% Elite and 50% Pepsi Co.), Osem retains Chocolate and in its leading position in this segment. FY02 sales reached NIS 2,120 million. Powdered Coffee. While Osem focuses efforts on expanding food products in Israel, Elite focuses on maintaining its leadership in the above mentioned segments while aiming to expand overseas mainly through the coffee segments, which is classified as a growth driver.

Strauss: Osem’s Strauss dominates the ice cream segment, with 55% market share. Osem acquired Purchase of Noga Could 51% of Tnuva’s share in Noga Ice creams in late 1996 as a means to establish Nestle Challenge Strauss’s Ice Cream in Israel and recently agreed to acquire the remaining 49% stake. Osem Leading Position. currently has 35% market share in that segment. Strauss also competes head to head with Osem on dairy products and chilled salads product lines.

Strauss currently holds 50.9% in Elite (61.3% voting rights). Both companies announced their intention to merge recently, via the acquisition of Strauss’s dairies Strauss & Elite Merger (80% held by Strauss and 20% held by Danone). The merger will position Elite as Will Not Significantly the second largest Israeli food company (after Tnuva) and should increase its Impact Osem. efficiency and cooperation with Strauss.

We believe the merger will enable Strauss to leverage itself as a shareholder. As Strauss is a private family business, the merger will enable it to augment some of its holdings in Elite.

We do not believe that this merger will impact Osem significantly. Elite may be slightly strengthened as efficiencies are increased, mainly via a reduction in the number of management employees. However, both companies have already enjoyed been reaping the benefits of a united company, for example, when negotiating prices and shelf positioning with retail chain stores.

Moreover, we do not believe the deal will increase the synergy between the two companies as the companies operate in different food segments that utilize separate manufacturing, distribution and marketing channels. Strauss dominates the ice cream segment, and operates in frozen and chilled food segments while Elite’s main areas of business focus on dry foods - coffee and confectionary. Hence, we do not believe that this merger threatens to intensify competition in segments in which Osem operates.

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Telma has not amended its strategy significantly since Unilever took control in Telma: A Leader in 2000. The Company dominates the soup, sauces and cereal market, while Osem is Soups and Cereal; Osem ranked second in these segments. Telma is one of Osem’s main competitors in the Ranked #2. salty snacks market.

Tnuva is the one of the major food players in Israel. However, it is not considered a Tnuva: A Commodity direct competitor to Osem, as it is more a commodity player and not a value added Player and Therefore product player like Osem. Tnuva focuses on dairy products, frozen non- processed Not A Direct meat, fruits and vegetables. Recently, Tnuva entered the frozen/chilled meats Competitor.. markets, which is one of Osem’s operational areas via competes Of Tov and Hod Lavan.

Retail Sales Growth in 2002

Company Harsher Impact of Slowdown on Food Osem -2.7% Retailers vs. Osem. Elite Israel -6.7% Supersol (SSS) -7.5% Blue Square (SSS) -11.2% Food Consumption -6.8%

Source: Company Financial Statements

Clear Long Term Osem’s management pursues a clearly defined and carefully thought out long term Strategy Supports strategy. This approach supports Osem’s position as one of the leading players in the Osem’s Leading Israeli food industry. Indeed, in line with its strategy, Osem holds a top three ranking Position in Food in each of its market segments. Osem will not enter a specific segment if the Industry. Company assesses that such rankings are unobtainable. Osem’s strategy includes the following criteria:

• Expansion Into New Food Product Segments: We believe that Osem’s thorough approach to expansion is one of the Company’s major plus points. Once potential new areas of expansion have been identified and researched, via flavor tests and other measurements, Osem ensures that the penetration process is gradual and carefully monitored. Every two to three years, Osem expands into new value added food categories – processed foods – that carry higher profit margins, mainly to those markets where Nestle operates to facilitate penetration and consolidation.

• Independent Production and Distribution: This approach carries two clear advantages; Osem enjoys overall profits as manufacturer and distributor while relationships with the Company’s customers are strengthened. Moreover, the combined role is not more costly due to the critical mass. At its central distribution areas across Israel, Osem utilizes a cross docking method; orders are processed and products are directly delivered according to demand thereby keeping inventory accumulation to a minimum.

• Efficiency Measures: Part of the ongoing drive to improve efficiency and operating margins involves merging factories and distribution channels. Osem’s operating profit has increased by 3.5 times in the last 5 years. In 2002, operating income increased by 17.5% YoY while margins rose from 7.5% to 9%.

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Two Main Growth Mergers & Acquisitions: Starting in the mid 90s, Osem’s mergers and acquisitions Drivers: M&A And strategy supported expansion into new food segments and has been crucial in cutting Nestle’s R&D and costs via merging factories and distribution lines. Marketing Support. We believe that Osem will continue to acquire companies that are synergetic to its core strategy and that add value.

The table below lists some of Osem’s main acquisitions.

Date Company 1994 Acquired “Mili” - a ready to eat schnitzels, onion rings etc. 1995 Acquired 50% of “Tivall” meat substitutes Established “Frostiv” - a frozen food distribution company 1996 Acquired 51% in Tnuva’s Ice creams. 1997 Merged “Of Tov” frozen Schnitzels Company into existing frozen food activity. Entered chilled salads segment by acquiring 51% of “Sabra Salads”. Established “Ostiv” – a chilled food distribution company. 1998 Acquired “Hod Lavan”’s chilled meats for $6 million. Merged “Asis” with “Beit Hashita” (vegetable can companies). 1999 Acquired 1% of Tivall in order to reach a controlling stake. Acquired Pri & Yerek for NIS 15 million. Merged “Frostiv” and “Ostiv” the chilled and the frozen distribution companies into one distribution channel. 2000 Acquired remaining 49% of “Sabra Salads” for $6.3 million. 2002 Acquired Uniliever pet food activity, mainly the brand name, for NIS 5.5 million. 2003 Acquiring the remaining 49% of Tnuva’s Ice creams for NIS 37.5 million. Source: Company Data

Osem entered the ice cream sector by merging with Tnuva’s two existing ice cream factories. Osem held 51% in Noga Ice creams, and recently reached an agreement to purchase the outstanding 49% from Tnuva. Completed a few days ago, the deal enables Osem to save further costs by merging managerial and computer systems, distribution lines, accounting procedures and so on.

The Company is currently working on merging the ambient products distribution system into the merged chilled-frozen distribution system. This is expected to be completed and fully operational in 2004.

Nestle’s Ownership Key In 1996, Nestle exercised an option to purchase 10% of Osem and purchased a To Osem’s Future further 5% in the open market. At a later stage, Nestle purchased a further 25% of Success. Osem shares from Claridge’s to reach 40% stake. In 2000, Nestle stake totaled 50.1% following the purchase of another 7% from the founding family and the open market.

Via Nestle’s ownership, Osem obtained an exclusive right to manufacture and distribute Nestle products in Israel and an exclusive right to use their technological and marketing know how. Osem effectively acts as Nestle’s subsidiary in Israel. With such heavyweight support we believe that Nestle is a key factor in Osem’s future growth and success.

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Osem’s Exclusive Rights The decision of whether to produce locally is based on economic justifications. To Manufacture & Before the manufacturing process starts, Osem imports the intended product and Distribute Nestle verifies customers’ tastes to ensure the penetration success of the product. Products In Israel Coffee, for example, is not economical to manufacture in Israel and is therefore Provides Competitive imported. On the other hand, frozen foods’ transportation costs and Kosher related Edge & Exposure To costs and other tariffs (custom), especially on ice creams, are very costly. Therefore Leading Food these are manufactured domestically. Categories

Osem launches a new product category every 2-3 years, in line with its strategy of continual evaluation and its aim to attain a top three rating in each market segment. We are impressed that not all Nestle products were introduced in one swift go as it ties in with Osem’s careful assessment policy.

Other food lines in which Nestle holds a leading global market position that Osem

has yet to penetrate, and that could provide good growth drivers, include

mineral/sparkling water, dairy products, milk substitutes and baby foods such as

Materna, Remedia. The Israeli baby food market is worth NIS 220 million.

In 1996, Osem successfully launched Nestle’s coffee brands including “Tasters’ Osem Wins Over 40% Choice” and “NesCafé Classic” that was later re-branded as “Red Mug”. The total Market Share In Instant Israeli coffee market, excluding black coffee, is worth NIS 300 million. Osem Coffee & 60% In currently comprises approx. 40% and approx. 60% of total instant coffee segment Granulated Coffee and granulated coffee market respectively. Today, the granulated and freeze-dried Segments In Less Than coffee comprises approx. 75% of the total coffee market. Elite currently controls the 10 Years. powdered and the black coffee market in which Osem is not a player.

We expect demand for granulated coffee to grow at the expense of powdered coffee.

Nestle’s position as the world market leader in the coffee segment (over 50% global

market share) will continue to hold benefits for Osem. Nestle invests approx. $700

million a year in research and development related to the coffee market.

In 1997, Osem entered the breakfast cereal segment, which is worth NIS 400 million, where Telma is a market leader with 70% market share. Osem is ranked 2nd with 24% market share.

In 1999, Osem expanded its product basket to include chocolates. Elite currently

dominates the Israeli chocolate market, worth NIS 700 million, with 70% market

share. This area is more difficult to conquer in Israel due to Kosher dietary

requirements and the need for specially supervised milk. Osem has introduced

chocolate that is recognized as Kosher in other countries.

In the same year, Osem expanded into the pet food category where Telma was one of the leaders with a 20% market share. In 2001-2002, Osem comprised approx. 8% of Aggressive M&A the pet food market segment. Nestle, which is a world leader in this segment, strategy Pushes Osem recently purchased Purina, which is the largest US pet food company, making Osem To Leading Position in the distributor of the brand in Israel, adding 7% more to Osem’s market share. Pet Foods. We project Moreover, Osem recently purchased Telma’s pet food activity, pushing Osem to hold Sales In This Segment a leading position in this market. These acquisitions are expected to add NIS 25 To Reach NIS 40 million million to sales from this segment to reach NIS 40 million. in FY03. We believe that there is considerable potential for growth in this particular market as

the choice of pet food types is continually expanding. Osem’s size is expected to

prove advantageous, as it will enable costs to be lowered through improved distribution and storage.

Nestle Know-How Saves Nestle’s technical and marketing know how is very beneficial to Osem. It saves costs Osem Costs via product lines, production phases, recipes, engineering, marketing resources, advertising and by being a part of Nestle’s supply chain management and so on.

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Tivall Answers Although Osem focuses mainly on the Israeli market, their soy based meat substitute, Convenience & Health Tivall, has achieved significant success in Europe. Osem holds 51% in Tivall - 49% Food Trends Ensuring is held by the original founders (Kibutz Lochamei Hagetaot). Overseas Success Story. Tivall answers two major recent trends in food consumption: convenience and health We Project That foods. It requires minimal preparation time and contains many essential nutrients as Overseas Sales Will it is a soy based product. The outbreak of foot and mouth disease and mad cow Increase By Approx. 7% disease in Europe pushed this product to the forefront of people’s awareness and in FY03. sales climbed dramatically, by approx. 30%, as the diseases made front page headlines.

Today, over 50% of Tivall products are earmarked for export. We note that food exports in Israel total around 5%-10% of total sales. Osem’s export (mainly Tivall and at a much lesser extent, Sabra chilled salads, cakes and soups) increased by 11% YoY in 2002. We project that overseas sales will increase by approx. 7% in FY03.

We believe that management may form strategic alliances to expand Tivall’s penetration overseas.

Company Rankings & Market Share Within Food Segments

Product #1 #2 #3 Pasta Osem 75% Others Snacks Osem 50% Elite 30% Telma 10% Soups & Sauces Telma 50% Osem 40% Others Baked Goods Osem 40% Elite & Others Chilled Salads Strauss 40% Osem 30%-40% Chilled Meats Osem 30%-40% Zoglobec 30% Tirat Zvi 30% Meat Substitutes Osem 40% Ice Cream Strauss 55% Osem 35% Coffee Osem 60% Elite (Granulated) Chocolates Elite 70% Cereals Telma 70% Osem 24% Pet Food 35% Maabarot 30%

Source: Company Data

Strengths & Weaknesses:

Strengths:

Nestle: We believe the strong connection has been and will continue to be a key Osem’s Thorough factor in Osem’s success, pushing the Company forward. As we mentioned Management Team & previously, Nestle provides Osem with the technical and marketing know how and Nestle’s Support Should inclusion in the supply chain management of world Nestle, which is a major cost Maintain Strong saving advantage vs. other domestic companies. The fact that Nestle is a strong Performance market leader in different market niches should benefit Osem as they expand into new food categories.

Management Quality: We are very impressed with Osem’s management. Their clear long-term growth strategy has already yielded results as performance demonstrates. There has been double-digit real growth in the past ten years while operating profit has tripled in the last five years, despite harsh macro conditions. Launches and expansion into new food segments is gradual and continually evaluated. The Company continues to acquire new businesses and to cut costs by improving manufacturing and distribution channels.

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Expected Continuous Growth: Osem managed to expand at a double digit pace in recent years by concentrating mainly on the domestic market, despite its small size. We believe that management’s strategy and the relationship with Nestle will continue to support growth of current products and penetration of new categories.

Strong Brand: The Company’s brand is very strong and easily identifiable in Israel.

Strong Vs. Other Food Companies in the Peer Group: Osem has a proven track record, even in the current domestic climate that negatively impacted other companies in this segment. Moreover, as displayed in the following table, Osem’s financial strength is significantly higher than the average food companies.

Osem’s Balance Sheet Strengths vs. Peers

Food Companies’ Osem’s FY02 Average Acid Ratio 1.16 2.09 Quick Ratio 0.82 1.74 Shareholders Equity/Balance Sheet 38% 56% Long Term Loans/Balance Sheet 9.7% 2.3%

Source: NZS Research

Weaknesses & Risks:

Fierce Competition: The possible entrance of global players into the domestic Fierce Competition and market place, such as Unilever via their ownership of Telma, would add to already Weakening Negotiation intense competition. Position With Retail Chains Retail Chains: As the retail food chains strengthen at the expense of smaller retail outlets, their negotiation power with food manufacturers and suppliers increases making Osem increasingly subject to pricing pressures.

Macro Environment: While Osem has so far relatively weathered the storm, the risk that the recession presents to sales and overall performance can not be discounted.

Dividend Policy: In recent years, Osem’s dividend payout has exceeded its 50% of net income policy. In 2002, Osem distributed 100% of earnings, in 2001 119% and in 2002, 124%. While this may appear generous short term, the policy could prove detrimental to growth long term.

Financial Data Decrease In Food FY02 sales revenues decreased by 2.7% YoY to reach NIS 2,287 million. However, Consumption To Keep sales quantity actually increased by 5.1% YoY, despite Israel’s 3% decrease in GDP Sales Growth Moderate. per capita and 6.8% decrease in food consumption. The erosion from a 6.5% CPI

increase during 2002 and only 4.9% increase in the food index negatively impacted

sales.

Since 1991, Osem’s average sales growth increase is 3.3 times the average of the Israeli food retail sales growth. This growth is a result of an ongoing drive to launch new products, to enter new product categories and a gradual increase in exported products, mainly Tivall.

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1Q03 sales increased by 7.4% YoY to reach NIS 587 million. Sales to the Israeli We Expect Sales To market increased by 6.7% YoY reaching NIS 498 million. This was mainly a result Grow By 2.1% In 2003. of the Passover holiday that was celebrated during the first quarter in 2002, negatively impacting sales, as some of its products do not fulfill dietary (Kosher) requirements for the Holiday. This year, Passover was celebrated on the second quarter. Therefore, YoY and QoQ sales are expected to be lower in 2Q03 totaling NIS 565 million. We note that the Company states that even when neutralizing the Passover effect, sales in 1Q03 increased, despite 5% decrease in food consumption during the quarter.

Moreover, if we compare 2H03 to 2H02, thereby including the Passover holiday in both years, we project sales in 2H03 will be moderately higher, by 2.7% YoY.

1Q03 overseas sales increased by 11% YoY, with Tivall as the main driver. We estimate that sales to overseas will continue to rise by approx. 7% this year.

We believe that the halt in the inflation and the increase in product prices that began in 4Q02, accompanied by continued aggressive launches of new products will positively impact FY03 sales revenues that are expected to increase by 2.1% YoY to reach NIS 2,335 million.

As demonstrated in the table below, Osem sales growth was less impacted by the domestic slowdown vs. other food retailers.

2002 Sales of Israeli Food Public Companies In NIS m

2,500 2,000

NIS m 1,500

1,000

500

- Osem Elite Tempo Shemen Gan Mei Eden Dov ek Vita (Pri Nev iot Sanf rost Shmuel Hagalil)

Source: Company Data

As the slowdown is limiting Osem’s growth through sales revenues, the Company Osem’s Operating Profit continually focuses on improving profit margins by decreasing costs and improving Increased 3.5 Times In efficiency, for example, by merging acquired companies. The Last Five Years. Osem’s operating profit increased 3.5 times in the last 5 years. 1Q03 was the 16th consecutive quarter whereby operating profit increased.

In 2002, operating profit increased by approx. 17.5% YoY to reach NIS 204 million, while margins increased from 7.5% to 9%. Most of the increase was a result of a learning curve in the merged ice cream factories, chicken factories and in the vegetable cans factories, increasing synergy and cost saving by merging different product divisions. Merging between factories also freed real estate for sale, lowered maintenance costs, city taxes and depreciation. Implementation of the Nestle’ supply chain management model saves Osem middle-men costs and improves logistics.

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. Osem’s Operating Profit Increased 3.5 Times In The Last 5 Years

250 10% 9% 200 8% 7% 150 6% 5% 100 4% 3% 50 2%

1% 0 0% 1997 1998 1999 2000 2001 2002 Operating Profit Source: Company Data Operating Margins

Efficiency steps and growth drivers to be implemented in upcoming quarters.

During 2002, Osem gradually merged and transferred the Bnei Brak soup and snacks

factory distribution lines into its factory in Shderot. The merger was recently

completed and all production lines are working. This is expected to save approx. NIS Planned Efficiency Steps 5 million – NIS 8 million in expenses in FY03 and to free 14 acres of the Bnei Brak Expected To Contain factory for sale. Push Up Operating Margins Osem has commenced adding the ambient distribution channels to the already merged chilled and frozen systems. The process should be completed by the start of 2004. The merger should cut costs and improve logistics and efficiency, saving NIS 5 million - NIS 8 million.

There are also plans to expand activity in the pet food and the ice cream segments. This process has already begun via recent acquisitions of Telma’s share in pet food segment while the deal to acquire the outstanding 49% of Tnuva’s share in Noga Ice creams in order to hold a full 100% in Noga is in the final stages. The full merger is expected to enable Osem to unite all the managerial and computer systems, transportation, accounting procedures and so on, saving further costs.

Osem is expected to reap the benefits of Nestle’s latest global efficiency plan. Nestle standardized its supply chain management systems to reduce costs. All Nestle’s subsidiaries around the world will now be using the same SAP computerized systems, which will lead to a reduction of maintenance costs and make product pricing easier.

FY04 plans include potential entry into the frozen patisserie segment and the expansion of Sabra chilled salad factories and home cakes, as well as the baked cakes factory. Osem also intends to transfer most factories to “preferred areas” in order to receive tax benefits and subsidies.

Moreover, the Company plans to build a logistics center with an estimated investment of $50 million, mainly for distribution to relatively distant areas.

The above implementation of steps is expected to increase FY03 operating margins from 9.02% in 2002 to 9.85% and to increase operating profit by 11.5% YoY to total NIS 230.1 million.

FY03 Earnings Set To FY02 earnings decreased by 0.3% YoY and totaled NIS 125.9 million. Disregarding Rise By 10% To Reach extraordinary income gained in 2001 (from selling land), earnings actually increased NIS 139.6 million. by 7.7% YoY. 1Q03 earnings increased 7.2% YoY reaching NIS 31.7 million. This was achieved due to the significant increase in operating profit that quarter and despite the increase in tax rates as a result of the end of tax benefits to some of the companies’ factories. Osem plans to expand and operate more factories with tax benefits in 2003. FY03 earnings are set to increase by 10% to reach NIS 139.6 million.

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Valuation: Market 2002 PER E2003 PER Cap Israeli Companies $US Millions Osem 749 25.3 23.6 Elite 418 NMF 22.2* Mei Eden 201 NMF Na Gan Shmuel 41.5 9.6 Na Sanfrost 40.6 8.9 Na Tempo 36.5 NMF Na Shemen 20.6 8.3 Na Foreign Companies US$ Millions Nash Finch 205 8.35 7.0 Horizon Organic 261 67.8 55.1 Wild Oats Market 288 35.6 17.8 International Multi foods 437 Na 12.8 Hain Celestial Group 544 71.6 17.0 United Natural 562 30.4 20.8 American Italian 824 20.3 16.9 Average 39.0 21.0 * Market consensus

Source: NZS Research

Utilizing 7.5% discount rate on the company’s estimated FCF, Osem’s value stands Current Share Price at NIS 3,581 million, 12% higher than today’s market value, representing a price Leaves Limited Room target of NIS 37.0/S. As demonstrated in the table above, Osem’s FY03 PER is For Upside. relatively higher vs. its peers. This supports our view that upside is limited at the current price. Moreover, the domestic macro environment increases risk for Osem. We initiate our coverage on Osem with a neutral rating.

We are very impressed with Osem’s management and emphasize that its relationship with Nestle is key. We believe that Osem will continue to outperform its domestic peer group, mainly through increased efficiencies.

Company Description.

With 10 factories and approx. 4,500 employees, Osem manufacturers and distributes over 1,000 different products within Israel. Nestle owns 50.1% and by Dan Proper (the founder and CEO) and family members own 11.82%.

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Osem Q1/02 Q2/02 Q3/02 EQ4/02 E2002 Q1/03 EQ2/03 EQ3/03 EQ4/03 E2003 E2004 Sales 546,213 584,100 594,201 563,158 2,287,672 586,724 565,506 607,535 575,796 2,335,561 2,405,628 Cost of Goods Sold 315,086 320,595 341,743 322,106 1,299,530 338,373 324,318 347,814 329,355 1,339,860 1,376,019 Gross Profit 231,127 263,505 252,458 241,052 988,142 248,351 241,188 259,721 246,441 995,701 1,029,609 Sales, marketing 139,227 157,404 150,318 136,403 583,352 141,750 136,287 146,477 138,767 563,280 579,756 General, management 47,893 50,577 46,458 53,468 198,396 54,034 49,312 50,182 48,747 202,275 209,290 Operating Profit 44,008 55,524 55,682 51,181 206,394 52,567 55,589 63,062 58,927 230,145 240,563 Interest income 1,641 1,457 4,125 6,152 13,375 1,242 1,204 1,200 1,200 4,846 1,264 Other income -158 361 1,439 82 1,723 2,188 200 200 200 2,788 - Earnings before Tax 45,491 57,341 61,246 57,414 221,492 55,997 56,993 64,462 60,327 237,779 241,827 Taxes 13,573 22,711 23,420 21,835 81,538 20,077 21,087 23,851 22,321 87,336 89,008 Eaquity based companies Earn 2,349 6,958 1,749 1,994 13,050 4,187 2,312 1,765 1,765 10,029 9,850 Net Earnings 29,569 27,672 36,077 33,585 126,903 31,733 33,594 38,846 36,241 140,414 142,968

Shares Outstanding 96,644 96,644 96,644 96,644 96,644 96,644 96,644 96,644 96,644 96,644 96,644 EPS 0.31 0.29 0.37 0.35 1.31 0.33 0.35 0.40 0.37 1.45 1.48

Margins & YoY Growth Gross Profit Ratio 42.3% 45.1% 42.5% 42.8% 43.2% 42.3% 42.7% 42.8% 42.8% 42.6% 42.8% Operating Profit/Sales 8.06% 9.51% 9.37% 9.09% 9.02% 8.96% 9.83% 10.38% 10.23% 9.85% 10.00% Net Earnings Margins 5.41% 4.74% 6.07% 5.96% 5.55% 5.41% 5.94% 6.39% 6.29% 6.01% 5.94% Sales Growth YoY -5.86% -1.65% -5.24% 2.54% -99.90% 7.42% -3.18% 2.24% 2.24% 2.09% 325.39% Gross Income Growth -4.06% 5.06% -4.53% 5.23% -99.90% 7.45% -8.47% 2.88% 2.24% 0.76% 326.89% Operating Income Growth 21.64% 28.48% 7.06% 15.73% -99.88% 19.45% 0.12% 13.25% 15.14% 11.51% 332.75% Net Earnings Growth 5.76% 6.69% 6.14% -54.21% -99.92% 7.32% 21.40% 7.68% 7.91% 10.65% 325.58% Tax Rate 29.84% 39.61% 38.24% 38.03% 36.81% 35.85% 37.00% 37.00% 37.00% 36.73% 36.81%

Precentage of Sales Analysis Revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Cost of sales 57.69% 54.89% 57.51% 57.20% 56.81% 57.67% 57.35% 57.25% 57.20% 57.37% 57.20% Gross Profit 42.31% 45.11% 42.49% 42.80% 43.19% 42.33% 42.65% 42.75% 42.80% 42.63% 42.80% Sales&Marketing Expenses 25.49% 26.95% 25.30% 24.22% 25.50% 24.16% 24.10% 24.11% 24.10% 24.12% 24.10% Sales&Management Expense 8.77% 8.66% 7.82% 9.49% 8.67% 9.21% 8.72% 8.26% 8.47% 8.66% 8.70% Operating Profit 8.06% 9.51% 9.37% 9.09% 9.02% 8.96% 9.83% 10.38% 10.23% 9.85% 10.00% Investment Income 0.30% 0.25% 0.69% 1.09% 0.58% 0.21% 0.21% 0.20% 0.21% 0.21% 0.05% Other Income -0.03% 0.06% 0.24% 0.01% 0.08% 0.37% 0.04% 0.03% 0.03% 0.12% 0.00% Profit before taxes 8.33% 9.82% 10.31% 10.20% 9.68% 9.54% 10.08% 10.61% 10.48% 10.18% 10.05% Taxes 2.48% 3.89% 3.94% 3.88% 3.56% 3.42% 3.73% 3.93% 3.88% 3.74% 3.70% Equity Based Companies 0.43% 1.19% 0.29% 0.35% 0.57% 0.71% 0.41% 0.29% 0.31% 0.43% 0.41% Profit 5.41% 4.74% 6.07% 5.96% 5.55% 5.41% 5.94% 6.39% 6.29% 6.01% 5.94%

Key Parameters EBITDA 66,977 78,493 78,651 74,150 298,272 72,608 75,378 82,851 78,716 339,878 335,055 Enterprise Value 2,926,559 2,925,721 2,926,721 2,928,559 2,928,559 2,891,455 3,197,965 3,197,965 3,197,965 2,917,611 3,145,794 ROE (%) 3.54% 3.18% 3.97% 3.56% 13.45% 3.12% 3.18% 3.56% 3.34% 12.95% 11.65% ROCE (%) 3.54% 3.18% 3.97% 3.56% 13.69% 3.36% 3.31% 3.68% 3.32% 13.53% 10.17% Earnings Yield (%) 0.92% 0.87% 1.13% 1.05% 3.97% 0.99% 1.05% 1.21% 1.13% 4.39% 4.47% CFPS 0.00% 0.00% 0.00% 0.00% 158.84% 0.00% 0.00% 0.00% 0.00% 156.76% 153.40% PER (x) 108.1525 115.5664 88.6433 95.2186 25.2000 100.7773 95.1953 82.3238 88.2417 22.7753 22.3683 EV/Sales (x) 5.3579 5.0089 4.9255 5.2002 1.2801 4.9281 5.6551 5.2638 5.5540 1.2492 1.3077 EV/EBITDA (x) 43.6950 37.2739 37.2116 39.4953 9.8184 39.8228 42.4256 38.5989 40.6266 8.5843 9.3889

12 Osem Nessuah Zannex Equity Research

Ratings Key 1. Strong Buy: Expected to significantly outperform the relevant broader market index over the next 6-12 months. An identifiable catalyst is present to drive appreciation. 2. Buy: Expected to outperform the relevant broader market index over the next 12-18 months. 3. Neutral: Expected to perform in-line with the relevant broader market index over the next 6-12 months. 4. Sell: Expected to underperform the relevant broader market index over the next 6-12 months.

This document has been prepared by Nessuah Zannex Securities Limited (Nessuah Zannex) an institutional share broker. It has been prepared on the basis of publicly available information, data developed internally and other sources believed to be reliable. Whilst we have taken all reasonable care to ensure the facts stated are accurate and opinions given are fair and reasonable at the time of publication, neither the Directors, Officers and Employees shall in any way be responsible for contents. This document is not an invitation to buy or to sell securities.This report is provided solely for the information of professional and experienced investors who are expected to make their own independent investment decision without undue reliance on this or other related documentation. Nessuah Zannex, its Directors, Officers and Employees accept no liability and no part for any direct or consequential loss arising from utilization of this or other related documents. This document is the property and copyright of Nessuah Zannex Securities Limited and no part of this document may be reproduced or distributed in any manner without the prior, express written permission of Nessuah Zannex Securities Limited. From time to time Nessuah Zannex Securities, its parent affiliated companies, Directors or Officers may, to the extent permitted by the law, have a position, or be interested in transacting, in securities or commodities either directly or indirectly related to the subject of this and other reports. Nessuah Zannex, its parent and/or affiliated companies, may also solicit or perform Investment Banking and Advisory Services from any company mentioned in this report or other related documentation. Nessuah Zannex is regulated by the Israeli Securities Authority and the Tel Aviv Stock Exchange. Securities products and services offered through Nessuah Zannex. Services Offered Through Nessuah Zannex Securities Limited

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13 Osem Nessuah Zannex Equity Research

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14 Osem Nessuah Zannex Equity Research