Oct 2016 Interims

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RESEARCH NOTE: Oct 2016 Interims

INTRODUCTION: Tepid results but the future looks bright… Trading & Liquidity

Sefalana posted a tepid set of interim results with revenue growing by a Market Cap BWP2.7bn modest 9% to P2.0bn (H15: P1.8bn). Of concern is the decline in Market Cap US$247mn revenue from the main revenue line - the ‘Trading consumer goods’ Shares in Issue 250,726,709 which came in at P1.211bn (H15: P1.22bn). This business segment is the core revenue driver for the group contributing 60% and 48% of Year End April towards revenue and PBT. GP margins from this segment went down to Free Float 100%

5.2% from 5.8%, while GP margins for the group fell to 7.6% from 7.9%. 12 month high P13.80 The decline in margins doesn’t surprise us given the intense competition 12 month low P10.75 in the FMCG sector dominated by Choppies in Botswana. EBITA increased marginally by 4%, while PAT decreased by 1.2% to P57.9mn Target Price P13.42 (H15: P58.6mn). Basic Earnings Per Share softened to 24.96 thebe from PE 16.0x 25.39 thebe, while an interim dividend of 5 thebe was declared, giving a P/B 2.6 52 week rolling dividend yield of 2.1%. Reuters Code SEFA.BT

Bloomberg SFLN.BG KEY INVESTMENT THEMES Code  Strong performance from Namibia operations. ISIN No. BW 000 000 0157  Potential for growth in Lesotho and South Africa. BSE Code SEFALANA  Diversified business model RECOMMENDATION: BUY  Very profitable business segments with high margins.

 Entrepreneurial management team, and strong brand.

 Presence in strategic locations and within certain major cities.

Sefalana PE ratio of 16x is now below the market average PE of 17.2x.

Our forward PE ratio is favourable as we expect the group to enter into another growth phase after the acquisition of the biggest wholesaler in

Lesotho and the entrance into South Africa through the acquisition of a

25% stake in a yet to be named but existing group. The Lesotho Assign a BUY acquisition is expected to increase Group turnover by P150 million in the recommendation first 6 months of trading and contribute approximately P7 million to profit by the year end. With general elections expected in 2019

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017) we expect the government to increase its expenditure especially towards social welfare programs and Sefalana will likely benefit from these tenders. Already government has awarded Foods Botswana a provisional tender to supply 3,000 tonnes of Tsabana and Malutu per month for the next three months and these tenders are likely to be renewed. The Delta Dairy plant has been revamped and the plant has More business for been a beneficiary over the years of the children’s milk feeding scheme Foods Botswana and Management is highly optimistic that they will be awarded the lucrative tender going forward.

VALUATION AND RECOMMENDATION

We derive a value of P13.42 using relevant valuation methods and the stock is trading at a 24% discount to the current price of P10.75. The stock is still in a growth phase with Namibia operations exceeding operations. We see more growth potential in Lesotho and the entrance into the more lucrative but competitive South African market is exciting.

Against this background, we assign a BUY recommendation on the stock.

OVERVIEW OF OPERATIONS

Trading Consumer Goods – steady growth amidst toughening environment Trading consumer goods segment is the core of Sefalana Holdings as it contributed 60% and 48% of Sefalana revenue and PBT. This is down Decline in performance from from the 66% and 57% contribution towards revenue and PBT during the the Trading Consumer Segment same period in 2015. This decline signify the intensity of the level of competition in this segment. Sefalana Cash & Carry contributed 60% to revenue whilst Metro (Sefalana) Namibia contributed 32% to revenue.

There were no new store openings during the period under review.

Overall profitability for this segment fell 16%.

Namibia business doing well…

The Namibia business continues to do well, contributing 32% and 22% of the Group’s revenue and PBT. Turnover rose by 24% with PBT Strong performance from Namibia growing strongly by 34%. We remain bullish over Namibia’s operations and we expect the increase in activity to continue going forward.

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017)

Key Ratios H 2016 H 2015

GP Margin 7.6% 7.9%

ROE 13.9% 14.3%

ROA 9.3% 6.4%

Current Ratio 1.8 1.7 EBITDA Margin 3.9% 4.1%

NAV 5.3% 4.8%

Source: Motswedi Calculations

Trading - Others

The ‘Trading – others business’ which is comprised of Commercial

Motors (Pty) Limited and Mechanized Farming (Pty) Limited had a tough year and contributed only 3% to the group turnover and PBT. Its performance is strongly linked to government tenders and we expect this Performance linked to Government Tenders segment to turn a corner in the coming months ahead of the 2019

General elections. More exciting times are also coming as an agreement was entered last year with Botswana Railways to supply 8 locomotives at an undisclosed amount. This is exciting to us, but we are cautious as it is a long term project that will only generate profits for the company in the forthcoming years. The successful fulfilling of this agreement will certainly increase the groups revenue and profitability.

Segmental results – Profit Before Tax (P’000)

H 2016 H 2015 Change

Trading consumer goods - Botswana 38,782 46,281 -16.2%

Trading consumer goods - Namibia 17,825 13,292 34.1%

Trading – others 2,681 4,762 -43.7% Manufacturing 4,313 980 340.1%

Property 9,405 7,757 21.2%

Property – Zambia 5,212 3,284 58.7% Total 81,092 80,432 0.8% Source: Sefalana Financials

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017)

Manufacturing The manufacturing business is comprised of Foods (Botswana) and the recently acquired Delta Dairies. Its contribution to the group is slowly growing as it contributed 7% and 5% towards the group’s revenue and

PBT. This is double from last period performance largely due to the short The future looks bright for Foods Botswana term orders placed by the government for the various feeding programmes. Some of these tenders had previously been awarded to other companies previously by the government but because of non- deliverance they were taken away and given back to Foods (Botswana). Expectations are high that this time around Foods Botswana will be awarded the tenders as they have a good and strong track record of delivery.

Delta Dairies plant has been restored and is fully operational. Manufacture of milk commenced in December 2015 with the supply of Delta Diaries on board the A Star brand of milk to the Sefalana stores. The plant has been a beneficiary over the years of the children’s milk feeding scheme and Management is highly optimistic that they will be awarded the lucrative tender going forward.

KEY TAKE AWAYS FROM THE RESULTS

Under penetration of retail markets offers opportunities

Although the retail market in Botswana is dominated mainly by Choppies and few other players such as Spar and Shoprite, the wholesale market remains very active with a market share between 30% - 40%. In a matured economy, the share of wholesale should be below 20%, hence there is still a gap in the market which Sefalana through their retail business can exploit. The transformation of the economy, coupled with the prevalence of modern shopping malls have afforded consumers access to new shopping experiences, new products and new retail outlets to buy from.

Regional Expansion drive

Sefalana expansion drive outside Botswana into Namibia is bearing fruits as the Metro Namibia contributed 29% and 10% of the Groups revenue Regional expansion drive gathering momentum and PBT. On the 1st November 2016 Sefalana entered the Lesotho market through the takeover of the country’s largest cash and carry 4

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017) outlet, TFS wholesalers which is located in Maseru. This acquisition is expected to increase Group turnover by P150 million in the first 6 months of trading and contribute approximately P7 million to profit by the year end. Sefalana is also at an advanced level to expand into South Africa through the acquisition of a 25% stake in an already existing business. The effective date of entry into the South African market is 1 May 2017, subject to due diligence review. We give management a thumbs up on this strategy to take a stake in an existing business which already have a track record, a stable clientele base and is more familiar with the South African terrain very well.

Strong operational team

Sefalana have a strong management team with diverse experience in the retail sector, manufacturing sector and property sectors. Sefalana also has a strong board which adheres to good corporate governance. The majority of the Board members are non-executive Directors (5/8) and the Strong team majority of the non-executive Directors are independent. This ensures that no one individual or block of individuals dominate the Boards decision making and this promotes objectivity. Non – executive Directors bring objective judgement and experience to the deliberations of the

Board.

Retail stores gaining momentum

The ‘Retail’ business continue to grow from strength to strength contributing positively towards the top line, despite intense competition from other established retail brands such as other major retail chain stores from South Africa such as Shoprite, Spar and Pick n Pay. It should be noted however, that some of the chain stores have a completely different business model to Sefalana retail business. Pick n’ Pay focus on value and on the middle to top end market, while Sefalana and

Choppies focuses on volume and lower to middle income segment. Pick

‘n Pay has 9 stores in Botswana, while Spar has 26 stores located mainly in the major towns across the country. Its target market is the middle to top end segment. Shoprite has five stores and five USave stores in

Botswana and its target market is the lower to middle income earners, the same target group with Sefalana retail business and Choppies.

Although the retail business is still expanding, we are positive about its 5

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017) growth and has the potential to contribute significantly towards the Group’s earnings going forward. We are mindful of the potential effect of market saturation due to the presence of other competitors such as Choppies which is now in almost every corner especially in cities and towns and also to some extent Shoprite. It is our view however, that there is still some space for other players in the retail space and Shoppers success will largely depend on its ability to aggressively market its brand, finding good location for the stores and proper prizing for their products.

Diversified business model

Sefalana have a diversified business model which helps to diversify income streams. The group has exposure in retail, manufacturing, agric equipment supply, dairy and properties. The group is at an advanced Diversified business model

stage of launching a new range of animal feed products in early 2017 using bran from sorghum and maize. This will give the group another source of income.

THREATS / WEAKENESS

Weaker disposable Incomes Profitability for the business is directly influenced by the increase in volumes and is positively correlated to consumers’ pockets. Botswana economic growth has been under pressure over the past years with the decline in consumer disposable incomes. Company closures particularly the mines has further thrown more people onto the streets further eroding disposable incomes. The impending liquidation of BCL and its affiliates mines ie Tati Nickel Mines has further compounded the situation and Decline in economic activity increased anxiety in the economy. The government being the major single employer in the country has not been meaningfully increasing civil servants salaries over the past 8 years and the private sector has in turn taken a cue by doing the same.

Although headline inflation is currently contained in Botswana, the actual food inflation is rising and eroding consumers disposable incomes and further reducing the average basket size. The excessive rains in most parts of Southern Africa might reduce yields and push food prices higher once again.

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017)

Competition in Botswana has reached a peak especially from Choppies which is almost suffocating the whole Botswana’s retail sector with 78 stores dotted across the country (and still counting). In most cases, most Competition intensifying lucrative and busy retail sites have either been taken up or earmarked for other uses.

Foreign Exchange exposure. While expanding into other markets outside Botswana is positive in terms of income diversification, this also exposes the group to other currencies that are volatile ie the rand.

The rapid expansion especially in Botswana, a small country with a population of around 2mn people and in a market which is almost saturated might result in cannibalism among Shoppers stores and this might lead to a reduction in margins. Already, the group had to make a bold decision to close one of the Shoppers store within the ‘Station area’ and surprisingly the site was quickly taken over by Choppies.

VALUATION & RECOMMENDATION

We derive a value of P13.42 using relevant valuation methods and the BUY up to P13.42 stock is trading at a 24% discount at the current price of P10.75. The stock is still in a growth phase with Namibia operations exceeding Trading at a 24% discount operations. We see more growth potential in Lesotho and the entrance into the more lucrative but competitive South African market is exciting. Against this background, we assign a BUY recommendation on the stock.

RECOMMENDATION SCALE Buy Hold Reduce Sell Sustainable Trading at a Weak Balanced Premium Fundamentals Fundamentals Strong Growth in the

Potential long term Threatened Opportunities and Growth Outlook Growth

Overvalued at Undervalued Par Valued current levels Over Valued

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017)

Research Motswedi Securities (PTY) LTD Plot 113, Unit 30, Kgale Mews, Gaborone P/Bag 00223,Gaborone, Botswana Tel: +267 318 8627 Fax: +267 318 8629 Email: [email protected] [email protected]

Disclaimer: The views expressed in this research note reflect the views of Motswedi Securities (Proprietary) Limited based on the information available at its disposal at the time of writing and may change without notice, and is provided for information purposes only. While Motswedi Securities (Proprietary) Limited has taken all reasonable steps in carefully preparing the document, it does not take any responsibility for any action that may be taken on the basis of the information contained herein. Each recipient of it is advised to undertake its own analysis and evaluation of the terms and contents hereof, and obtain independent advice as appropriate, before acting in any way upon the information contained herein. Accordingly, this document is not intended, and no part of this document should be read, as constituting, in any way, an offer or other solicitation for the purpose of the purchase or sale of any of the securities referred to herein. This document may not be reproduced, distributed or published by any recipient for any purposes without the authorization of Motswedi Securities (Proprietary) Limited.

Sefalana Interim Results Analysis **October 30 2016** Prepared by Motswedi Securities (Pty) Ltd (Posted on 22 Feb 2017)