March 2014 KESTREL CAPITAL Member of the Securities Exchange

Company update

Uchumi Supermarkets Ltd Bloomberg Ticker : UCSP.KN Recommendation: LIGHTEN Reuters Ticker: UCHM.NR

We issue a LIGHTEN recommendation on Limited (Uchumi) based Share Statistics on a fair value of KES 10.50 implying a 29.3% downside from current market price. We are Fair Value (KES) 10.50 of the opinion that increased competition in the region has in the past year put pressure on Price (KES) 14.85 the company’s sales growth which we expect to remain subdued in the medium term (2 year Issued shares (m) 265.4 forward CAGR of 5.2% to KES 15.9bn in FY15F). Rising costs (2 year forward CAGR of Market cap (KES bn) 4.1 5.4%) as the company continues to expand both locally and regionally will continue to im- Market cap (USD m) 47.4 Year end June - pact bottom line performance, with the EPS estimated to record a 2 year forward CAGR of Free float (% ) 86.6 62.0% ( -85.1% y/y in FY14F and -3.1% y/y in FY15F). Uchumi is trading at forward P/E Av daily trading vol (USD) 38,422 and P/B multiples of 74.0x and 1.3x compared to its Africa and Middle East peer compara- ble medians of 21.2x and 4.7x respectively. Its forward ROE, at 1.8%, is also significantly Price Return lower than the peer comparable median of 23.8%. We therefore feel that the counter is over- Absolute Excess valued based on the above multiples and that its medium term prospects may not justify the 3m -22.8% -24.2% current high valuation. 6m -21.4% -26.3% • Rising competition to suppress revenue growth - 2 year forward CAGR of 5.2% com- 12m -28.1% -32.3%

pared to 3 year historical CAGR of 14.4% Price Trend • Gross margin improvement as cost of sales rise slower than revenues - +40 bps over Source: NSE the next three years to 19.7% in FY16F Research Analyst • Rise in specialty income to support bottom line growth -Speciality income to increase 7.8% y/y and 10.3% y/y FY14F and FY15F respectively • Expansion drive to spur growth in operating expenses - EBITDA margin to ease 290bps y/y to 2.5% in FY14F and shed 10bps y/y to 2.4% in FY15F • Higher debt levels to drive finance costs upwards – Finance cost to rise 18.8% y/y to KES 19.1m in FY14F. • Rights Issue to be conducted in 2H14 - 100.0m shares to be offered possibly in 2H14 • Fair value gains on investment – we have not included any forward fair value gains on the 20 acre land that Uchumi owns which is revalued annually. • Lower earnings to suppress ROaA and ROaE - ROaA to ease 550bps y/y to 0.9% and ROaE to shed 1100bps y/y to 1.8% in FY14F • Inability to pay dividends in the medium term - Due to suppressed earnings growth, capex requirements and negative free cash flow position • Industry analysis -A look at the four major supermarkets in

Joy D’Souza Key Statistics FY11 FY12 FY13 FY14F FY15F

EPS(KES) 1.47 1.03 1.35 0.20 0.19 [email protected] Growth (%) -54.9 -29.8 30.3 -85.1 -3.1 +254 20 2251 758 DPS (KES) - - 0.30 - -

P/E x 10.1 14.4 11.0 74.0 76.4 P/B x 1.7 1.5 1.3 1.3 1.3 Div yield (%) 0.0 0.0 2.0 0.0 0.0 ROaA 10.9 6.1 6.8 0.9 0.9 ROaE 20.5 11.1 12.8 1.8 1.7 Source: Company, Kestrel estimates Uchumi Supermarkets Limited KESTREL CAPITAL

• Rising competition to suppress revenue growth – Rising competition has seen Uchumi lose its revenue market share (amongst the four major supermarkets) from 3rd position to 4th in the last two years, with the percentage easing 170bps to 12.5% in 2013. We expect the growth in revenue to be slower compared to the past in light of increasing competition in the region. The four major supermarkets in Kenya have been on an aggressive expansion plan with , , Uchumi and Naivas increasing their stores regionally from 37, 37, 21 and 19 in March 2012 to 45, 46, 34 and 29 respectively currently. There’s also been in- creased interest by South African retailers who are said to be looking to enter the Kenyan market through buying local supermarkets. We estimate that sales will rise at a 2 year for- ward CAGR of 5.2% (compared to 3 year historical CAGR of 14.4%) driven by increased sales from new branches put up between last year (6 branches) and this year (4 branches already launched) and a rise in disposable incomes driven by economic advancement. Our forecasts suggest a 3.5% y/y rise in sales in FY14E ( -4.0% y/y in 1H14) and a subsequent 6.9% y/y rise in FY15F.

FY11 FY12 FY13 FY14F FY15F Revenue (KES m) 10,841 13,919 14,369 14,872 15,898 % y/y ch 12.8 28.4 3.2 3.5 6.9 Number of stores 18 25 31 40 42 Average revenue per store (KES m) 602 557 464 372 379 Customer numbers (m) 20 22 24 28 Source: Company, Kestrel estimates

• Gross margin improvement as cost of sales rise slower than revenues -Better supplier terms coupled with an improvement in the macroeconomic environment will drive gross margin improvement with cost of sales expected to grow at a 2 year forward CAGR of 5.0% compared to the 2 year forward CAGR of 5.2% in revenue. Our estimates are underpinned on stable inflation as well as better supplier terms coupled with economies of scale realised as the company continues to grow. We note that Uchumi has managed to surpass the 18.0% gross margin target set by management in 2011 when the company was re -listed on the NSE, achieving 19.3% in FY13 and 19.9% in 1H14. We expect gross profit margin improvement to support bottom line growth, especially, in light of growing costs attributable to upgrading of facilities and expansion. We highlight the historical gross margin performance and our estimates going forward below:

FY11 FY12 FY13 FY14F FY15F Revenue (KES m) 10,841 13,919 14,369 14,872 15,898 % y/y ch 12.8% 28.4% 3.2% 3.5% 6.9% Cost of Sales (KES m) (8,944) (11,407) (11,600) (11,972) (12,782) % y/y ch 13.0% 27.5% 1.7% 3.2% 6.8% Gross margin 17.5% 18.0% 19.3% 19.5% 19.6% y/y bps ch -20 50 130 20 10 Source: Company, Kestrel estimates Uchumi Supermarkets Limited KESTREL CAPITAL

• Notably, Uchumi introduced an electronic demand based system in 2012 with the aim of managing its inventory and reducing non movers. However, we are yet to see the benefits come through given that if anything, the inventory turnover has slightly deteriorated with the inventory days increasing from 34 days to 37 days. The company’s cash conversion cy- cle has however improved over the years from –0.02 in FY11 to –9.72 in FY13, mainly driv- en by an improvement in supplier credit terms which is currently at an average of 58 days (from 45 days in FY11) with management working towards growing the same to an average of 60days. Receivables turnover has remained stable with receivable days at 11 days. Uchumi, like its counterparts (Nakumatt, Tusky’s and Naivas) has introduced online shop- ping which is yet to catch up in the region.

FY08 FY09 FY10 FY11 FY12 FY13 DSO (Receivables) 6.80 11.89 9.84 11.08 10.19 11.07 DSI (Inventory) 40.92 32.87 32.72 34.24 34.17 37.29 DPO (Payables) 56.93 61.93 50.30 45.34 52.20 58.08 Cash conversion cycle (9.21) (17.17) (7.73) (0.02) (7.84) (9.72) Source: Company, Kestrel estimates

• Rise in specialty income to support bottom line growth - In line with the expected growth

in the number of outlets, we estimate specialty income to grow 7.8% y/y and 10.3% y/y in FY14F and FY15F respectively. Our estimates are derived from the assumption that special- ty income will stand at 3.1% of total revenue in the next three years from 3.0% in FY13 and 2.7% in FY12. This will be driven by a rise in income collected from the sublet space in the new outlets (Uchumi sublets space to various outfits including jewellery stores, cosmetics stores, gift shops and mobile phone stores) as well as a rise in commissions generated from money transfer services including MPESA (Uchumi is the largest MPESA agent), transactions on other utility payment services including electricity, water and cable TV (DSTV) as well as till branding. • Expansion drive to spur growth in operating expenses – Uchumi has this year put up 4

Source: Company, Kestrel estimates new branches and plans to put up 5 more before the end of the year to support revenue growth in the face of growing competition. Additionally, Uchumi has embarked on an exer- Tanzania accounted for 4.4% of cise to upgrade its older establishments. Approximately KES 300m will be spent in FY14F total revenue in FY13 from 2.6% under the expansion plan. The company has been on a cautious expansion plan since 2011, in FY12 after an additional store with 3, 7, and 5 branches opened in 2011, 2012 and 2013 respectively. Out of the branches was put up. Kenya and Uganda’s earmarked for 2014, 3 have so far been opened in Kenya with 3 more to go and 1 has been contribution declined from 85.9% opened in Dar es Salaam Tanzania, with 2 more to go. The company also intends to venture and 11.5% to 85.5% and 10.1% into Rwanda by opening two stores in 2015. We therefore expect operating expenses to con- respectively. Revenue from Tan- tinue rising and consequently weigh down on the EBITDA margin which we estimate to zania grew75.0% y/y in FY13. We decline 290 bps y/y to 2.5% in FY14F and -10bps y/y in FY15F to 2.4%. may see the two new stores ex- (KES m) FY11 FY12 FY13 FY14F FY15F pected to be put up in Tanzania EBITDA 612 625 783 372 382 support revenue growth. %y/y ch 1.0% 2.1% 25.2% -52.5% 2.6% EBITDA margin 5.6% 4.5% 5.4% 2.5% 2.4% Number of stores 18 25 31 40 42 y/y ch 3 7 6 9 2 Source: Company, Kestrel estimates Uchumi Supermarkets Limited KESTREL CAPITAL

• Tanzania may have a stronger contribution to revenue in the medium term -Tanzania accounted for 4.4% of total revenue in FY13 from 2.6% in FY12 with only one store at the time. Kenya and Uganda’s contribution declined from 85.9% and 11.5% to 85.5% and 10.1% respectively. Revenue from Tanzania grew 75.0% y/y in FY13 while Kenya grew 2.9% y/y and Uganda declined 9.4% y/y. We may see the new store put up early this year and the other two new stores expected to be put up in Tanzania support revenue growth go- ing forward. However, its important to note the difficult operating environment in Tanzania (both regulatory and the locals apprehensiveness towards foreign companies operating in the country) which has seen some companies shut down, including Deacons Kenya and there- fore poses a risk to the company.

Source: Company

• Higher debt levels to drive finance costs upwards – Uchumi had sufficient internally ICDC is a Development Finance generated cash in FY11 and FY12 to support working capital requirements as well as expan- Institution (DFI) in Kenya and sion activities. However, in FY13 and 1H14, slow revenue growth and high operating costs owns a 1.6% stake in Uchumi amidst the ongoing expansion resulted in cashflow constraints forcing the company to take Supermarkets. up additional debt and overdraft facilities to finance its operations. In June 2013, Uchumi took up a KES 300.0m loan from ICDC at 16.0% payable in three years. Its overdraft rose 98.9% h/h to KES 781.8m. The company’s debt to equity ratio increased 300bps y/y to 26.4% in FY13 and we estimate it to rise further by 330bps y/y to 29.7%. We estimate fi- nance costs to grow 18.8% y/y to KES 19.1m in FY14F.

• Rights Issue to be conducted in 2H14 – Uchumi plans to conduct a Rights Issue in 2H14 to support its expansion plans and working capital. Management has indicated that the com- pany will be floating 100.0m shares to add on to the existing 265.4m ordinary shares, which implies a 27.4% dilution to existing shareholders. Given the company’s aggressive expan- sion plan, Uchumi pegs its funding estimates on the successful issuance of the Rights failure of which the company will have to take up additional debt financing to counter its cash flow constraints.

Uchumi Supermarkets Limited KESTREL CAPITAL

• - Investment (KESm)FY10FY11 FY12 FY13 Fair value gains owing to the 20 acre land under subsidiary Kasarani Mall Limited We Balance b/f 450 580 750 1,000 note that Kasarani Mall Limited which is Uchumi’s 100% owned subsidiary owns two piec- fair value gains 130 161 250 480 es of land under long -term lease arrangements. The land is revalued annually and has grown Additions - 9 - - from a fair value of KES 450.0m in 2009 to KES 1.5bn in FY13. In our three year forward Closing bal 580 750 1,000 1,480 Source: Company estimates, we have taken a conservative approach and have not factored in any further gains from revaluation of the land despite the fact that management indicates that they shall con- tinue to revalue the land annually. We therefore believe that, factoring in any subsequent gains, earnings performance may significantly surpass our estimates.

FY10 FY11 FY12 FY13 FY14F FY15F Including historical fair value gains Operating income 2,134 2,349 3,131 3,676 3,361 3,625 % y/y ch 22.0 10.1 33.3 17.4 -8.6 7.8 Operating margin 5.6 4.8 3.0 3.5 0.6 0.6 PBT 433 515 403 486 76 74 % y/y ch 154.9 18.8 -21.7 20.5 -84.3 -3.1 PBT margin 4.5 4.7 2.9 3.4 0.5 0.5 Excluding historical fair value gains Operating income 2,004 2,188 2,881 3,196 3,361 3,625 % y/y ch 14.5 9.2 31.7 10.9 5.2 7.8 Operating margin 4.2 3.3 1.2 0.1 0.6% 0.6 PBT 303 354 153 6 76 74 % y/y ch 78.4 16.8 -56.7 -96.2 1189.3 -3.1 PBT margin 3.2 3.3 1.1 0.0 0.5 0.5 Source: Company, Kestrel estimates • Lower earnings to suppress ROaA and ROaE – We forecast ROaA and RoAE to come under pressure on account of lower earnings growth, with the ROaA easing 550bps y/y to 0.9% and the ROaE shedding 1100bps y/y to 1.8% in FY14F. This is quite an underperfor- mance compared to Uchumi’s peer comparable medians of 5.8% and 23.8%. • Inability to pay dividends in the medium term – Due to suppressed earnings growth, negative free cash flow position ( -KES 290.0 and -KES 31.0 in FY14F and FY15F respec- tively) and considering the capex requirements in place, we feel that Uchumi may not be in a position to pay dividends in medium term.

Shareholding

Shareholding % Local Individuals 35.7 Foreign Companies 33.7 Local Companies 15.7 Government of Kenya 13.4 Foreign Individuals 13 Source: Company filings

Uchumi Supermarkets Limited KESTREL CAPITAL

Industry Analysis Competitive environment While we appreciate that most of the East African region remains grossly underserved, we think that low income levels in the underdeveloped areas coupled with poor infrastructure will contin- ue to be a hindrance for supermarkets to grow their footprints in such areas in the medium term. The informal market has not changed much over the years and accounts for approximately 70% - 75% of the retail market. As such, these supermarkets will continue targeting the major devel- oped towns in their expansion plans resulting in a further rise in competition.

In Kenya, the major supermarkets have quite a number of outlets in the city center and upcoming towns. The CBD, for example, hosts 5 Nakumatt’s stores, 9 Tuskys stores, 2 Uchumi stores, 2 Naivas store and 6 Ukwala stores. Tuskys is currently in the process of acquiring Ukwala’s 6 Nairobi outlets (subject to approval), which will place it ahead of the rest with regards to total stores in Nairobi. Westlands, which is approximately 10 minutes from the CBD was previously home to 2 Uchumi stores (Sarit Center Mall and Westlands Arcade) and 2 Nakumatt stores (UK Center and Westgate which is no more). In March 2013, Naivas stepped out of its old strategy where it previously concentrated on residential areas and the densely populated parts of the city center by opening a new store in Westlands and Ngong Road, adding to the competition in those areas. Upgrading of Thika superhighway has seen lots of developments crop up around Kasarani and Ruaraka which are approximately 15 and 20 minutes from the CBD. Uchumi remained dom- inant in the area for a while with its Jipange branch in Ruaraka before new malls cropped up and attracted other supermarkets. The new Thika Road Mall (TRM) houses Nakumatt while Naivas has put up a store in the new Mountain Mall which is approximately 5 minutes away from The market share figures only include Na- Uchumi. Naivas has an additional two stores on the superhighway, Naivas Ruaraka and Naivas kumatt, Tuskys, Uchumi & Naivas Kasarani. Nakumatt plans on opening another store in the upcoming Garden City mall located Source: Company, Kestrel estimates opposite the Mountain Mall and developed by Actis. Garden City Mall is expected to be the larg- est mall in East Africa. All the four major supermarkets have footprints in other major towns including Mombasa, Nakuru, , Thika and Eldoret.

All the major supermarkets are The stiff competition in Kenya has seen these supermarkets venture into other East African coun- focused on the CBD and its envi- tries including Uganda, Tanzania and Rwanda. Nakumatt (currently with 7 stores) and Uchumi rons as well as the new Thika (currently with 6 stores) were the first to open outlets in Uganda over four years ago with Tuskys Superhighway which has seen (currently with 6 stores) following suit shortly after. Other major supermarkets in Uganda in- several developments come up. clude South African Shoprite with two stores and locally owned Quality Supermarket.

Out of the four major supermarkets in Kenya, only Nakumatt and Uchumi have presence in Tan- zania. Uchumi has two outlets in Dar es Salaam while Nakumatt has one store in Arusha. Nakumatt, Tuskys and Uchumi Uchumi plans to put up 3 more stores in Tanzania in the next two years while Nakumatt is in ahave been expanding in Ugan- talks with Shoprite to acquire its three stores in the country. Naivas, currently with 29 stores in da while Nakumatt and Uchumi Kenya plans to double this number in the next two years. We think that Naivas may be consider- are aslo expanding in Tanzania. ing venturing into other East African countries like its counterparts.

Uchumi Supermarkets Limited KESTREL CAPITAL

Industry Analysis (cont’d)

Number of stores (2012) Kenya Uganda Tanzania Rwanda Total Nakumatt 30 4 1 2 37 Tuskys 32 5 - - 37 Uchumi 18 2 1 - 21 Naivas 19 - - - 19 Total 99 11 2 2 114 Source: Company; Kestrel estimates

Number of stores (2014) Kenya Uganda Tanzania Rwanda Total Nakumatt 34 7 1 3 45 Tuskys 40 6 - - 46 Uchumi 26 6 2 - 34 Naivas 20 - - - 29 Total 129 19 3 3 154 Source: Company; Kestrel estimates

Operating performance

The retail business is a high volume low margin business and as such, a company’s ability to grow its earnings significantly and remain profitable depends on its ability to grow its revenues and manage it costs. Previously Nakumatt and Uchumi targeted the high –upper middle class segments as evidenced by the location of their stores while Tusky’s and Naivas targeted the mid- dle -lower income segments. However, in the last two years, we have seen a shift in these strate- gies with supermarkets now expanding to areas they feel have strong potential for growth. Na- kumatt recently put a store in Eastlands which is considered a middle -low class area while, as The market share figures only include Na- kumatt, Tuskys, Uchumi & Naivas mentioned previously, Naivas put up an outlet in the upmarket Westlands area. Uchumi, also, has Source: Company, Kestrel estimates stores spread out in both low and high end areas. It therefore appears that these major supermar- kets no longer focus on niche markets but on customer numbers. Expansion is therefore the key growth strategy for supermarkets in Kenya. However, expansion is capital intensive and if not adopted carefully, can hurt operating and net profit margins. Based on our research findings, between 2011 and 2013, Nakumatt’s operating margin has improved to 4.4% from 2.6%, Naivas has gone up to 1.3% from 1.1% while Uchumi’s has declined to 3.5% from 4.8%.

Based on our research findings, between 2011 and 2013, Na- kumatt’s operating margin has improved to 4.4% from 2.6%, Naivas has gone up to 1.3% from 1.1% while Uchumi’s has de- clined to 3.5% from 4.8%. Uchumi Supermarkets Limited KESTREL CAPITAL

Valuation

Relative valuation EV/EBITDA Peer median EV/EBITDA 11.10 Forward EBITDA/share 1.44 Per share value 15.96

P/E Peer median PE 21.20 Forward EPS 0.19 Per share value 4.12

Net Assets valuation Net Assets 3,030,272 Number of shares 265,400 NAV per share 11.42

Valuation (KES 000) Value Weights Weighted value Relative Earnings multiple (EV/EBITDA) 4,235,143 33% 1,411,714 Relative Earnings multiple (P/E) 1,093,789 33% 364,596 Net assets 3,030,272 33% 1,010,091 Total Derived Value 2,786,401 Per share value 10.50 Source: Kestrel estimates Uchumi Supermarkets Limited KESTREL CAPITAL

1H12 Earnings Analysis

Income statement (KES m) 1H12 1H13 1H14 %y/ych Net sales 7,504 7,589 7,286 -4.0% Cost of sales (6,123) (6,113) (5,835) -4.5% Gross profit 1,381 1,476 1,451 -1.7% Other income 147 213 294 37.7% Operating income 1,528 1,689 1,745 3.3% Operating expenses (1,310) (1,547) (1,612) 4.2% Net operating income 218 142 133 -6.3% Finance costs (14) (10) (26) 158.1% Profit before tax 204 132 107 -19.0% Tax (61) (40) (32) -19.0% Profit after tax 143 92 75 -19.0%

EPS* 1.08 0.70 0.56 -19.0% No of shares 265 265 265

Key ratios 1H12 1H13 1H14 %y/ych Gross margin 18.4% 19.5% 19.9% 0.5% Operating margin 2.9% 1.9% 1.8% 0.0% Net profit margin 1.9% 1.2% 1.0% -0.2% ROaA 7.1% 3.7% 2.6% -1.2% ROaE 12.5% 6.9% 5.0% -1.9% *Assuming a 30% tax rate ** Normalized Source: Company, Kestrel estimates

Uchumi Supermakets announced 1H14 earnings results which were significantly below our ex- pectations, posting a 19.0% y/y decline in profit before tax to KES 106.9m. The dismal perfor- mance was driven by a 4.0% y/y decline in sales to KES 7.3bn, a 4.2% y/y rise in operating ex- penses to KES 1.6bn and a 158.1% y/y growth in finance costs to KES 26.2m. We highlight the key earnings drivers below:

• Revenue declines 4.0% y/y to KES 4.3bn - Management attributed the decline in reve- nue to reduced government spending which adversely impacted private sector spending. We also feel that increased competition from key players including Nakumatt, Tuskys and Naivas who have also been on an expansion trail may have resulted to lower volumes. In 2013, Nakumatt, which has a total of 45 stores, took over four outlets from Woolmart super- markets in Nairobi Kenya, put up three stores in Uganda and is in the process of acquiring three Shoprite outlets in Tanzania, while Naivas (third largest supermarket in Kenya by rev- enue), currently with a total of 30 branches, opened 3 stores in Kenya. Tuskys (the second largest supermarket in Kenya after Nakumatt), is in the process of acquiring all the 6 Nairobi stores of which is the fourth largest supermarket in Kenya. • Gross profit margin improves on lower costs -Despite gross profit recording a 1.7% y/y decline to KES 1.5bn, gross margin improved 50bps y/y driven by a 450 bps y/y decline in cost of sales to KES 5.8bn which made up for the 400bps y/y decline in sales. This was at- tributable to the lower cost environment as highlighted by y/y inflation which declined to 7.15%in December 2013 from a high of 8.29% in September 2013, albeit coming from a low of 6.02% in July 2013.

Uchumi Supermarkets Limited KESTREL CAPITAL

• Expansion drive results in a 4.2% y/y growth in operating expenses to KES 1.6bn - Uchumi Supermarkets opened 5 branches in 2013 (4 in Kenya and 2 in Uganda) which we believe contributed to the rise in operating expenses, driven by higher administration and establishment expenses. The company is also in the process of upgrading the look of its old- er stores which is expected to continue driving an increase in operating expenses going for- ward. • Higher debt position drives finance costs up -In 2013, Uchumi undertook a KES 300.0m loan from ICDC which will be repaid on a quarterly basis over a period of three years at a rate of 16.0%. Additionally, the company’s bank overdraft increased 98.9% h/h to KES 781.8m. As such, net finance costs 158.1% y/y to KES 26.2m which resulted in a 20bps y/y decline in the Net profit margin to 1.0%. • Cash position worsens on the back of negative operating, investing and financing cash flows -Due to the poor operating performance, net cash flow from operating activities de- clined to -KES 4.7bn while net investment cash flow declined from -KES 224.4m to –KES 226.5m on account of the new stores that were put up. Financing cash flows declined from – KES 512m to –KES 96.9m. Consequently, cash and cash equivalents reduced to –KES 621.6m from –KES 327.2m. • Outlook and valuation: ◊ Uchumi plans to open an additional 9 branches this year (5 in Kenya and 4 in Tanzania) and an additional 2 branches in Rwanda in the medium term, which will bring its total branch network to 42. To aid the expansion plan and support working capital requirements, the company plans to conduct a Rights Issue in 2H14 subject to CMA approval. A total of 100,000,000 shares will be offered to add on to the existing 265,424,636 ordinary shares. ◊ Opportunities for retail companies in the East African region remain high given the fact that, save for the major cities, most of the region remains underserved with shoppers mainly car- rying out their shopping in informal outlets. However, poor infrastructure in upcountry areas coupled with low income levels continue to be a hindrance to growth of retail stores in such areas. As such, competition has been quite strong with the major players targeting developed towns including Nairobi, Nakuru, Mombasa, Kisumu and Eldoret in Kenya, Kampala in Uganda and Dar es Salaam in Tanzania. We see rising competition continuing to significant- ly affect Uchumi’s earnings growth in the medium term. ◊ Uchumi is currently trading at a P/E of 32.1x compared to its African and Middle East peer comparables average of 22.8x and median of 20.1x. Its ROE at 5.0% is significantly lower than the 21.9% African and Middle East peer comparable average and median of 22.4%. We feel that the company is quite expensive at the current multiples and therefore issue a LIGHTEN recommendation on the counter. Uchumi Supermarkets Limited KESTREL CAPITAL

Industry Comparable

Name Country P/E P/B EV/EBITDA ROA(%) ROE(%) UCHUMI SUPERMARKET LTD Kenya 74.0 1.3 12.8 0.9 1.8 SHOPRITE HOLDINGS LTD South Africa 21.3 4.7 11.1 10.0 25.4 CHOPPIES ENTERPRISES LTD Botswana 30.6 6.4 20.5 12.8 22.4 PICK N PAY STORES LTD South Africa 39.8 9.6 12.2 4.4 25.5 SHUFERSAL LTD Israel 13.4 2.4 7.6 3.1 17.2 RAMI LEVI CHAIN STORES Israel 25.6 8.9 15.6 12.7 43.2 TIV TAAM HOLDINGS LTD Israel 18.0 2.5 9.1 2.9 14.8 MASSMART South Africa 20.9 5.4 9.7 5.7 26.9 ABDULLAH AL OTHAIM Saudi 20.5 4.9 18.3 10.2 25.9 OK ZIMBABWE Zimbabwe 14.2 3.1 8.6 11.7 23.8 MEIKLES LTD Zimbabwe 21.2 0.3 10.3 1.2 2.3

Mean 27.2 4.5 12.3 6.9 20.8 Median 21.2 4.7 11.1 5.7 23.8 Source: Bloomberg, Kestrel estimates

Uchumi Supermarkets Limited KESTREL CAPITAL

Financial Summary

y/y 2yr Income statement (KES m) FY11 FY12 FY13 FY14F FY15F ch% CAGR% Sales 10,841 13,919 14,369 14,872 15,898 3.5% 5.2% Gross profit 1,897 2,511 2,768 2,900 3,116 4.7% 6.1% Operating profit 2,349 3,131 3,676 3,361 3,625 -8.6% -0.7% Finance cost/income (4) (17) (13) (19) (21) 46.7% 26.2% Profit before tax 515 403 486 76 74 -84.3% -61.1% Taxation (124) (129) (129) (23) (22) -82.3% -58.6% Profit after tax 390 274 357 53 52 -85.1% -62.0% Attributable income 390 274 357 53 52 -85.1% -62.0%

No of shares 265 265 265 265 265 0.0% 0.0% EPS 1.47 1.03 1.35 0.20 0.19 -85.1% -62.0% DPS - - 0.30 - -

Balance sheet (KES m) Fixed assets 1,439 2,115 2,255 2,555 2,655 13.3% 8.5% Other non-current assets 1,168 1,233 1,593 1,583 1,576 -0.6% -0.5% Current assets 1,398 1,594 1,725 1,801 1,923 4.4% 5.6% Total assets 4,005 4,942 5,574 5,940 6,155 6.6% 5.1% Shareholder equity 2,279 2,658 2,925 2,979 3,030 1.8% 1.8% Non –current liabilities 183 80 200 100 - -50.0% -100.0% Current liabilities 1,542 2,204 2,448 2,861 3,125 16.9% 13.0% Total equity and liabilities 4,005 4,942 5,574 5,940 6,155 6.6% 5.1%

Cash flow statement (KES m) Cash generated by operations 445 348 286 353 361 23.5% 12.4% Working capital (Increase)/Decrease 203 48 (58) 11 16 -118.4% Operating cash flow 262 552 334 295 371 -11.7% 5.5% Cash taxes (11) (15) (5) (23) (22) 377.2% 115.0% Net cash flow before investing 251 546 332 272 349 -18.1% 2.6% Net cash invested (316) (726) (440) (568) (380) 29.1% -7.1% Free cash flow (65) (180) (108) (296) (31) 174.7% -46.6% Net financing cash flow (132) (135) 195 (160) (120) -182.0% Net cash flow for the year (197) (316) 87 (456) (151) -622.7% Opening cash balance 475 (6) (305) (209) (665) -31.5% 47.7% Closing cash balance 262 (305) (209) (665) (816) 218.4% 97.7% Source: Company. Kestrel estimates Uchumi Supermarkets Limited KESTREL CAPITAL

Recommendation guide

STRONG BUY: Highly undervalued/ strong fundamentals BUY: Good value/ strong fundamentals ACCUMULATE : Buy on price dips HOLD : Correctly valued with little pricing upside or downside LIGHTEN : Overvalued by the market/ Reduce exposure/Declining fundamentals/ industry concerns SELL: Weak fundamentals and challenging operating environment/Highly overpriced

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The opinions and information portrayed in this report may change without prior notice to investors. This publication may not be distrib- uted to the public media or quoted or used by the public media without prior and express written consent of Kestrel Capital (EA) Ltd.

Directors, staff of Kestrel Capital (EA) Ltd and their family members, may from time to time hold shares in the company it recommends to either buy or sell and as such the investor should determine for themselves the applicability of this recommendation.

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