East African Breweries Limited Watch Your Limit March 2016

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EAST AFRICAN BREWERIES LIMITED WATCH YOUR LIMIT MARCH 2016

Analyst: Stephanie Kimani [email protected] Direct Line: +254711047125 AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 1 contents

3 Valuation Highlights

4 Global and African Alcohol Industry Trends

7 Company Description

8 Financial Review

12 Investment Case

13 Valuation and Forecasts

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 2 Valuation Highlights

Bloomberg Code EABL KN EQUITY We initiate our coverage on EABL with a SELL recom- Price (05th February 2016) Ksh 268 mendation on a target price of Ksh 214.34 (being an Target Price Ksh 214.34 average of the DCF valuation price Ksh 198.56 and Potential Downside 20.02% the EV/EBITDA valuation price of Ksh 230.12). This target price reflects a 20.02% downside from its cur- 52 week range (Ksh) 355.00 - 245.00 rent price of Ksh 268 (05th February 2016). Market Cap 74,600,000 Shares outstanding (“mns”) 790.774 Financial Year End 30th June

Our recommendation is based on: Focus powered by strategy: EABLs primary focus is in the East African markets where it continues to grow and relentlessly gain market share. With an aver- Continued growth in the Kenyan market: age gross profit margin of 48.69%, a shift in consumer tastes Kenya is EABLs largest market currently contributing 67% to total towards the more profitable spirits portfolio as seen by the fi- sales revenue. With the boost in its lower end beer portfolio from nancial results for the first half of 2016 that saw its reserve and the rise in Senator Keg sales following the removal of excise mainstream segments grow at impressive double digits and a tax, increased demand for more premium beers and the shift in rise in aspirational drinking – EABL has an opportunity to ex- consumer sophistication towards the spirits portfolio – we expect ploit these dynamic developments and boost sales revenue. We that sales revenue growth in Kenyan will average at 14% with estimate future sales revenue CAGR to stand at 7.72% up from the market increasing its contribution to total sales revenue to the past 7.49% for a 5 year period. The driver of this growth 69%. The Kenyan economy is expected to grow between 5.8% will be based on shifts in the product mix from the beer to spirits and 6% in 2016 while in 2015 it attained lower middle class portfolio. We expect that the spirits portfolio will sustain revenue income status following an expansion of its GDP by 25%. We growth and therefore maintain a stable sales revenue growth expect that these factors will be paramount in retaining Kenya’s going forward. market leader status in EABL. Over and above this, EABL has continued to aggressively market its products and seek market share as it meets consumer demand Disruptions in key markets: and expands its portfolio to meet the ever changing needs of South Sudan has always presented a great growth potential for the consumer. EABL, but with the political unrest that has faced the country for the past 3 years, EABL has found it difficult to operate due to the Continued growth in global alcohol markets fueled by lack of hard US dollar currency which remains the main trade emerging markets: currency for the company. Due to this, its most popular brand With a 1 billion liter increase in the amount of alcohol consumed Tusker Lager has experienced a continued decline in sales vol- in 2014 (The Economist, June 2015), there is no wonder why the umes as it continues to be the most popular beer brand in South alcoholic industry is a $1.2 billion global industry (P&S Market Sudan. Research, 2015). Even with an average decline in alcohol consumption in developed countries, the industry reigns supreme Uganda and Tanzania continue to face economic slowdowns that with massive opportunities in emerging markets such as Af- have affected consumer purchasing power. The Ugandan market rica. On the back of emerging markets as a final frontier, the is experiencing polarization while the Tanzanian market contin- global alcohol industry is expected to grow at a CAGR of ues to be a difficult market for EABL to work in due to restrictions 3.2% between 2015 and 2020 to a whopping $1.451 bil- from the Fair Competition Commission (FCC) on the purchase of lion industry (P&S Market Research, 2015). This is mainly Serengeti Breweries Limited (SBL). attributed to a relentless and inevitable growing young population, increasing urbanization, positive demo- graphic developments and higher disposable incomes that are set to improve the market potential.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 3 Global Alcohol Industry Trends

Global alcohol consumption volumes buoyed by growth in emerging markets: There has been a change in the tastes of consumers as they choose In 2014, approximately 249 billion liters of alcohol (The Econo- to consume flavored alcoholic drinks as opposed to bitter and mist, 2015) was consumed globally which translates to a 1 bil- strong alcoholic drinks. This has further promoted growth in the lion increase from the year 2013. However, it can be noted industry through the rise of flavored alcoholic drinks especially that global alcohol consumption per head has actually declined in the Vodka brand RTD segments. Notably in the beer portfolio, from 56.6 liters in 2012 to 55.4 liters in 2014 duly caused by consumers are moving towards more innovatively brewed beers less alcohol drinking in developed markets but this has been increasing the popularity of craft beers that tend to have a bet- buoyed by increased drinking in emerging markets. One such ter taste and have undergone better brewing techniques emerging market is that of Africa which has increasingly become an attractive final frontier for the global alcohol industry. This is mainly attributed to a relentless and inevitable growing Millennials to drive alcohol demand: young population, increasing urbanization, positive demograph- Millennial consumers are estimated (UN 2014) to account for ic developments and higher disposable incomes that are set to 1.8 billion out of the 7 billion of the global population. Close to improve the market potential. This does not beg to question one-third of the millennials live in emerging markets reaffirming the race these alcohol producing companies are in to get into the position of these consumers as the most influential consumers emerging markets. who will drive the consumer goods market.

These consumers can be viewed as alpha influencers who are particularly capricious and fickle on product choice and demand more in terms of quality especially from premium brands. This can be seen by the influence that the craft boom has had on mainstream beers and spirits. These consumers are moving towards more innovatively produced alcoholic drinks and want to be part of the ‘story’ behind the brands they consume. This has caused alcohol producers to focus their marketing strategies in favor of ‘telling stories’ and having activations that bring the brand closer to the consumer.

Source: The Economist

Convergence in alcohol consumption trend: Taking a look at the OECD member countries, which currently account for 63% of global GDP and 18% of global population, there appears to be a convergence in the consumption of alcohol coming down from very high averages in the 1960s. This is directly related to the ‘drink less, drink better’ initiative that was started by the OECD countries whose member alcohol producing companies adopted so as to encourage responsible drinking.

Focus on provenance and aspirational drinkers: Source: UN The global alcohol industry is expected to grow at a CAGR of 3.2% between 2015 and 2020 to a whopping $1,451 billion industry. This growth is favored by increased population growth together with a growth in middle class incomes. As consumers have a higher disposable income, they tend to have an increased sophistication in the alcoholic brands they choose this therefore leads to an increase in the sale of reserve and premium alcoholic brands. In the case of EABL, its premium and reserve segments have gained popularity in their markets and have continues to provide an average positive growth over the past 3 years.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 4 Change in consumer behavior: Even though premiumization is one of the key drivers influenc- ing the alcohol industry, there has been a great focus on how well alcoholic brands connect with an increasingly educated consumer class. Going forward, it has been increasingly important to manufacture more palatable alcoholic drinks and offer lower alcohol offerings that could represent a potentially significant up trade potential for younger adults especially in the promotion of moderation of alcohol consumption.

African Industry Analysis

Africa is the fastest growing consumer market: Large multinationals such as Diageo, Heineken, SABMiller and Alcohol per capita consumption on the rise: Castle have acquired significant stakes in African brewers and According to WHO latest information on alcohol prevalence, have assisted in facilitating operational efficiency and improved Kenya, Ethiopia and Eriteria fall below the average African alco- corporate governance. According the UN 2015 estimates hol prevalence rate while Uganda and Tanzania continue to sur- (World Population Prospects: The 2015 Revision, Key Findings pass the average. This continues to be a reason why EABL chooses and Advance Tables), Africa has the highest population growth to focus on gaining market share. A new World Bank report ex- rate, growing at a rate of 2.55% annually between 2010 – pects that with a slow decline in fertility in Africa would lead to 2015. Based on the 2.4 billion people projected to be added to a growing young population with the region being a much larger the global population between 2015 and 2030, 1.3 billion will part of the world population. This is expected to cause a large in- be added in Africa. This growth is set to contribute to the grow- crease in alcohol per capita consumption. Countries like Uganda ing consumer base for alcoholic products and has such been the and Tanzania continue to be potential gold mines for EABL if and reason why emerging markets such as Africa have been viewed when economic conditions improve. as a final frontier for the global alcohol industry.

Alcohol per capita consumption on the rise: Based on the latest filings from WHO (2010) on alcohol per capita consumption in Africa, South Africa leads while Uganda, Tan- zania and Kenya follow respectively. It can be noted that there is opportunity in the East African market as alcohol consumption is relatively high but is yet to be fully exploited. This is due to the dominance of illicit or traditional brews that continue to be a favorite amongst the vast drinking majority who are in the lower income bracket. With continued effort from respective govern- ments to formalize alcohol drinking, there is an improved chance for the formal alcohol industry to gain from a shift in consumption.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 5 Local Brewers performance attracting foreign presence: With the promise of better revenue generation and attractive return on investment as seen below, the African continent has attracted many foreign companies who want a share of this increasing profitable pie. Companies like SAB Miller cover 17 countries and a further 21 countries through associate interest in Castel group while Diageo covers 14 countries with its largest market being in Nigeria. The benefit that Diageo has over SAB Miller is that it aggressively targets to gain market share in populous countries thus enabling it to benefit from the ripe alcohol market. There are currently 15 listed alcohol brewers in Africa. EABL compares well with industry average with a strong P/B ratio and return on invested capital (ROIC) that continues to make its mark as a darling investment at the Nairobi Securities Exchange. Source: Bloomberg, AIB Capital Estimates

Country Name EV/EBITDA T12M P/S P/B P/E Beta:M-1 ROIC LF Botswana Sechaba Breweries Ltd 18.76 18.56 9.55 20.37 0.88 n/a Cameroon Soc De Eaux Minerales Du Cam n/a n/a n/a n/a n/a n/a Cameroon Soc Brasseries Du Cameroun n/a n/a n/a n/a 0.21 n/a Ghana Guinness Ghana Breweries 10.44 0.83 5.54 n/a 0.91 1.39 Kenya East African Breweries Ltd 11.68 3.39 15.94 24.49 0.32 22.38 Mauritius Phoenix Beverages Ltd n/a 1.14 1.74 17.15 0.75 n/a Morocco Oulmes Etat n/a n/a 4.72 n/a 0.54 n/a Mozambique Cervejas De Mozambique 5.08 1.37 2.58 9.42 n/a 24.38 Namibia Namibia Breweries Ltd 7.24 1.93 4.49 18.09 n/a 25.53 Nigeria Guinness Nigeria Plc n/a 1.50 3.67 260.07 0.73 4.09 Nigeria Nigerian Breweries Plc n/a 2.70 4.59 20.82 0.95 19.24 Nigeria Golden Guinea Breweries Plc n/a n/a n/a n/a 0.37 n/a Nigeria Champion Breweries Plc 23.52 2.43 3.16 n/a 0.55 n/a Nigeria International Breweries n/a 3.12 5.17 30.83 0.12 15.12 Nigeria Premier Breweries Plc n/a n/a n/a n/a 0.37 n/a Nigeria Jos Intl Breweries Plc n/a 0.84 n/a n/a 0.37 n/a Rwanda Bralirwa Sa 7.63 2.26 4.40 13.52 n/a 24.86 South Africa Capevin Holdings Ltd n/a n/a 3.20 21.21 0.78 -0.04 South Africa Distell Group Ltd 15.12 1.70 3.25 22.13 0.69 11.21 Tanzania Tanzania Breweries Ltd 11.64 4.01 7.33 20.76 n/a 32.20 Tunisia Soc Frigorifique Et Brasseri 11.67 3.29 6.66 20.19 1.53 31.66 Zambia Zambian Breweries 10.94 2.51 3.36 25.73 0.68 10.59 Zambia National Breweries Plc 14.19 2.06 6.10 29.55 0.57 20.47 Zimbabwe Delta Corporation Ltd 4.49 1.17 1.41 7.73 n/a 13.20 Zimbabwe African Distillers Ltd 12.34 2.03 3.46 16.36 n/a 20.15 Average 11.77 2.99 5.02 34.02 0.63 17.28

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 6 2015 Highlights Company Description EABL is one of the largest companies in Kenya and has an exten- February: Announced its half year financial results for sive distribution network and product offering that cuts across all the half year ended December 2014. It posted an 11 classes. EABL is a Kenyan based holding company which manu- percent increase in net profit to Ksh 4.6 billion Ksh 4.1 factures branded alcoholic and non-alcoholic beverages. It was billion recorded in the same period in 2013. founded on 8th November 1922 by white settlers George and Charles Hurst. March: Announced that it is raising Ksh 11 billion debt through a corporate bond. Initially named Kenya Breweries limited (KBL) with its strategic expansion plan, KBL acquired Tanzanian based Tanganyika Brew- April: Announces that the first tranche of medium-term eries in 1935 and in 1936 these two companies were merged note it issued in March to raise Ksh 5 billion ($54 million) leading to the creation of EABL. The group’s headquarters are was oversubscribed, attracting Ksh 9.05 billion in bids. located in Nairobi, Kenya with subsidiaries in Kenya, Uganda, Tanzania and South Sudan. The group currently has distribution May: The President of Kenya signs the Alcoholic Drinks partners in Burundi, Democratic Republic of Congo and Rwanda. Control (Amendment) Act 2015 which removes excise EABL is East and Central Africa’s leading branded alcohol bev- duty levied at 90 per cent for beer made from sorghum, erage business. They have a wide and outstanding collection of millet and cassava was a good move towards reducing brands that range from beer, spirits and Adult Non-Alcoholic cost of beer targeting the low-end market. This is Act is Drinks (ANADs). EABL can be viewed as a Total Adult Beverage set to boost EABLs market share. (TAB) company.

EABL announces the sale of its subsidiary, Central Glass EABL operates through the following subsidiaries; KBL, Uganda Industries Limited (CGIL), to South Africa’s Consol Glass Breweries Limited, Serengeti Breweries Limited, United Distillers Proprietary. The sale is valued at Ksh 4.5 billion. Vintners, East African Malting’s Limited and East African Brewer- ies International which is the export arm of EABL currently cov- June: EABL financial year end (books close) ering South Sudan, Rwanda, Burundi, Eastern DRC, duty-free sales(International Travel) and other export markets. EABL pro- July: Crackdown on illicit brews begins. vides direct employment to over 1,500 people and indirect em- EABL on notice in Tanzania over Serengeti deal ployment to over 2 million people across East Africa.

August: EABL has reports a 40 per cent jump in full year net profits to Ksh 9.5 billion.

British-born EABL Group Finance Director Tracey Barnes resigns.

October: Concluded the sale of its subsidiary, Central Glass Industries, to South Africa’s Consol Glass Africa Proprietary.

December: Excise duty bill takes effect.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 7 Financial Review Sales revenue is generated from the segment sales from each of the markets EABL operates in. Kenya continues to be EABLs largest market with respect to sales revenue contribution while Uganda comes in second, Tanzania third and South Sudan fourth. In H1 2016, Kenya contributed 74% to sales revenue reaffirming its position as EABLs largest market while Uganda, Tanzania and EABLi accounted for 15%, 9% and 2% respectively.

In 2011, EABL made its move on the Tanzanian and Ugandan market with a primary focus on the Tanza- nian market. It sold 20% of its shareholding in Tanza- nia Breweries Limited (TBL) through a public offering in 2010; it then went ahead and acquired Serengeti Breweries Limited (SBL). EABL leveraged the purchase of SBL which drove its debt to equity ratio from 0% in 2010 to 19% (0.19 DE ratio) in 2011.

Thereafter, it acquired the 20% of SAB Miller’s stake in Kenya Breweries Limited (KBL) in 2011 which drove its debt to equity to 285% (2.85 DE ratio) in 2012. During the FY 2013, EABL invested Ksh 6 billion in net CapEx which put an upward pressure on its DE ratio to 294% (2.94 DE ratio).

In October 2013, the government introduced a 50% excise duty on Senator Keg beer which was a popular beer that targeted the lower end market. This slowed down overall demand causing EABL to shut down approximately 3,000 Senator Keg distribution outlets and reduce brewing operations in its Nairobi plant which led to an 85% decline in sales volumes of the Senator Keg due to an increase in price. In De- cember of the same year, South Sudan experienced political unrest which impacted its international operations and thus export volumes.

The FY 2014 was supported by a strong growth in the Kenyan market; However, in Uganda there was an economic slowdown which affected consumer purchasing power coupled with a 25% increase in excise tax which saw the alcohol industry contract. A scarcity of hard currency in South Sudan which impacted the consumer economy limiting purchase of EABL products. In Kenya the impact of the 50% excise duty tax on Senator Keg was cushioned by a stronger sales growth in premium and mainstream beers as well as spirits.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 8 The FY 2014 was supported by a strong growth in the Kenyan market; However, in Uganda there was an economic slowdown which affected consumer purchasing power coupled with a 25% increase in excise tax which saw the alcohol industry contract. A scarcity of hard currency in South Sudan which impacted the consumer economy limiting purchase of EABL products. In Kenya the impact of the 50% excise duty tax on Senator Keg was cushioned by a stronger sales growth in premium and mainstream beers as well as spirits.

Summary of Key Financials

Kshs (millions) 2014 2015 % Growth In 2015, net revenue grew by 6% owing to slower Net Revenue 60,748.89 64,420.46 6.04% growth in the Kenyan and Uganda markets and a decline in the Tanzanian market. Significant growth of Cost of Goods Sold 31,098.55 32,389.04 4.15% 53% was realized in the EABLi market which buoyed Gross Profit 29,650.34 32,031.42 8.03% sales. Operating Expenses 20,808.55 13,909.54 -33.15%

EBITDA 8,841.79 18,121.88 104.96% Cost of goods sold rose steadily as EABL set out to improve efficiency in its production line by sourcing EBIT 5,604.40 14,629.47 161.04% local raw and packaging material, reducing the us- PBT 9,863.33 14,151.24 43.47% age of utilities and also developing local spirits sup- PAT 6,315.32 9,535.22 50.99% pliers. This helped mitigate the impact of inflation on the cost of sales while improving its top line by an 8% growth. Operating expenses realized the largest decline largely due to a 16% decline in administrative expenses. This was attributed to a restructuring process that was aimed at making the management structure leaner. The restructuring process included Diageo’s efforts in 2014 to cut costs and improve efficiency by restructuring its marketing operations by increasing independence of its subsidiaries thereby enhancing efficiency since local teams would understand their markets better.

CAGR (2011-2015) Over the past 5 years, EABL has presented a Revenue 7% modest sales revenue CAGR of 7% reflecting its Operating expenses 21% expansion strategy and aggressive marketing EBITDA -2% campaigns that have boosted sales volumes and EBIT -4% PAT 1% as such revenues.

EBITDA has a negative CAGR reflecting increased operating expense due to its expansion and marketing campaigns over the period in review. PAT has taken quite a hit over the period in review with only a 1% CAGR largely attributed to the decline in sales revenue from its best-selling beer brand Senator Keg in 2013.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 9 Key Metrics

Year to 30th June 2009 2010 2011 2012 2013 2014 2015 DPS 8.05 8.75 8.75 8.75 5.5 5.5 7.5 Dividend Payout Ratio (%) 92.47% 96.38% 93.98% 65.01% 64.30% 66.92% 66.25% Retention Ratio (%) 7.53% 3.62% 6.02% 34.99% 35.70% 33.08% 33.75% Dividend Yield (%) 5.37% 4.83% 4.49% 3.80% 1.65% 1.94% 2.46% Price to Book (x) 5.28 6.01 5.76 20.87 31.22 24.68 18.06 Price to Earnings (x) 17.23 19.94 20.94 17.09 38.93 34.56 26.94 Price to sales (x) 0.004 0.005 0.004 0.004 0.006 0.005 0.005 EV/EBITDA 9.60 10.74 10.46 13.71 28.09 27.57 19.56 EV/EBIT 11.29 12.60 12.72 17.31 39.65 42.13 26.55 EV/Sales 3.41 3.67 3.51 3.71 4.85 4.25 4.15

Revenue Drivers

In 2015, EABL experienced a positive growth in all the four segments of its spirits brand portfolio with double digit growth of 71% increase in its reserve category segment followed by a 31% and 32% in its premium and emerging spirits segments. In H1 2016, two of its segments experienced growth as the premium and mainstream took lead with a growth of 45% and 14% respectively. This is in line with our expectation that the spirits brand portfolio will continue to boost EABLs top line as we expect an increased sophistication with an increase in the incomes of the middle class.

We expect to see a continued positive impact in the mainstream and emerging spirits segment translating to growth at a rate above 10% as we expect that EABL will benefit from increased lower end market sales primarily due to drinkers moving out of the illicit brew market following the Kenyan government crackdown against second generation brews mid-2015.

In 2015, the beer and RTDs brand portfolio realized positive growth in their premium and RTDs segments while the mainstream and emerging segments grew at negative levels. Tusker Lager brand has taken quite a hit from competing beer brands as sales volumes remained suppressed. The Guinness brand is quickly gaining popularity in Kenya and as such continues to help boost the premium segments.

We find that the growth in the premium beer portfolio, reserve beer portfolio and RTDs sales volumes have been directly attributed to EABLs aggressive marketing campaigns. During the FY2015, Guinness and Tusker Lite have had aggressive campaigns that have boosted sales volumes. Tusker Lite has had its “Lite the Way” campaign which was a five month campaign that started in February 2015. Guinness has also had an aggressive “Made of Black” campaign which is set to boost its popularity with beer consumers and as such boost sales.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 10 The mainstream beer segment: Going Forward: The mainstream beer segment has been on a free fall with a  Senator Keg will not have a huge impact on sales revenue 10% decline in H1 2016 primarily due to: however this all hangs in the balance as it is dependent on  Up trading in the consumers market from mainstream beer EABLs ability to service the excess demand for Kegs. Due to thus creating softness in the segment; the sale of CGI we expect that EABL will now have to  Suppressed performance of the Bell brand in Uganda due outsource a glass manufacturer. This we find was a cost to polarization as consumers with less disposable income effective move and we expect to see a reduction in its choose less expensive brands; expenses.  Tanzanian consumers shying away from premium and  Currently, beer and RTDs contribute about 70% while spirits mainstream beer brands and moving to the value end of contribute 30% to total sales revenue. Going forward we the beer portfolio which realized a 10.74% growth; expect that the spirits portfolio will surpass the beer and  Consumers have become more sophisticated in the type RTDs portfolio in contribution to total revenue to settle at of brands they consume thus creating a complexity in the an estimated 65% and 35% respectively. Going forward beer market. More and more consumers are migrating we expect continued growth in premium and reserve from the beer portfolio to the spirits segment and are segments with beer driven by Guiness and Tusker Lite while demanding more premium beer especially in the Kenyan spirits will be driven by Ciroc Vodka. market which boosted growth by 10%;  During H1 2016, value spirit experienced significant  The collapse of the South Sudanese market has contributed disruption by the withdrawal of the licence of one of its to the decline in the mainstream segment primarily due to key co-packers during the July alcohol crack down. EABL is the Tusker Lager brand which was and still is a key brand in the process of partnering with a new licensed co-packer in that market. The South Sudan market contributed 9% to and we also expect to see an increase in capacity of value total sales revenue in H1 2015 which has currently declined spirits as EABL seeks to make it a priority in H1 2016 so as to 2% in H1 2016. To note in 2015, 80% of the 9% to drive up sales volumes. contribution came from Tusker Lager sales.

2010 2011 2012 2013 2014 2015 Growth Analysis Revenue growth 12.41% 16.07% 23.67% 6.38% 2.86% 6.04% Gross Profit Growth 13.63% 15.28% 21.74% 2.36% 7.82% 8.03% EBITDA growth 7.96% 14.19% -0.42% -31.99% -13.38% 104.96% EBIT growth 8.27% 10.17% -4.18% -39.15% -22.49% 161.04% PBT growth 9.22% -2.53% 24.52% -27.13% -11.26% 43.47% Net Income growth 6.96% 2.00% 24.09% -41.69% -3.17% 50.99% COGS 11.25% 16.85% 25.53% 10.14% -1.47% 4.15% Margins Gross Profit Margin 49.49% 49.15% 48.39% 46.56% 48.81% 49.72% EBITDA Margin 34.12% 33.57% 27.03% 17.28% 14.55% 28.13% EBIT Margin 29.10% 27.62% 21.40% 12.24% 9.23% 22.71% Net Margin 22.85% 20.08% 20.15% 11.04% 10.40% 14.80% Effective tax rate -29.68% -26.41% -26.66% -41.32% -35.97% -32.62% PBT Margin 32.49% 27.28% 27.47% 18.82% 16.24% 21.97% Liquidity Ratios CapEx/Depreciation (x) 2.11 2.53 2.24 2.27 2.18 1.39 Current ratio (x) 1.49 1.05 0.80 0.70 0.72 1.02 Quick ratio (x) 0.81 1.01 0.81 0.88 0.75 1.08 Working capital/ Revenue -2.23% -4.71% 1.48% 3.88% 8.34% 8.76% Capital Management Ratios ROCE 42.76% 42.58% 45.04% 25.48% 25.08% 29.81% ROC 23.95% 18.83% 20.87% 11.41% 10.22% 14.91% ROA 23.12% 18.20% 20.49% 11.14% 10.05% 14.24%

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 11 Investment Case

Pros: A life line with the expected election period: in the FY 2018 is expected to boost sales revenue in H1 2018 as we expect increased alcohol consumption especially in the rural areas. During the election cycle, there is increased liquidity due to the political campaigns. This increases many of the populations ‘cash in hand’. Also, the election cycle creates temporary employment as campaign teams are formed and mass production of campaign material is required. The temporary employment creates a steady flow of income during that period and thus we expect to see an increase in discretionary spending. This is expected to boost sales revenue. In H2 2018 we expect a slowdown in sales revenue as liquidity declines in comparison to the election period stabilizing full year revenue growth.

Unexpected ‘boost’ in local beer market position: due to the Alcohol Drinks Control (Amendment) Act 2015 which removed excise duty levied at 90% from beer made from sorghum, millet and cassava which would reduce prices of beer targeting the lower end market. This is set to boost sales of its Senator Keg whose sales in H1 2016 as it had previously taken a hit from the tax placed on it in October 2013 which saw its sales drop by over 70% in the past 2 years. Evidence of this was presented during the H1 2016 results which revealed that within 2 months of the decline in excise tax, Senator Keg sales volumes sky rocketed to highs that have never been seen before at any point in time. Infact, Senator Keg sales

We however don’t expect the Senator Keg brand to be a significant revenue generator going forward beyond its current sales revenue contribution as it has continued to have a negative impact on Gross Profit Margin. The Act grants remission only if the licensed brewer manufacturers beer that has at least 75% content of sorghum, millet and cassava. This will see EABL gain a much more superior position in the lower end beer market boosting its market share in the Kenyan market. Currently, its competitors such as Keroche Breweries have been against the signing of the amendment to the Act as it leaves out other alcoholic products made from the above mentioned farm produce i.e. Viena Ice (ready to drink vodka) which targets lower end consumers.

The rise of aspirational drinking: is set to boost spirit sales revenue especially with the premium brands. Data from the Scotch Whisky Association (2014) showed that Kenyans consumed scotch worth Ksh 480 million in 2014 while Kenya is one of the top beer consuming countries in Africa after Nigeria and Uganda. We expect that as the economic growth continues to improve, consumption of spirits especially premium spirits, will increase as it becomes a matter of ‘class’. As middle class incomes improve, so will spirit sales growth. Euromonitor (2010) expects that Kenya’s social class is projected to grow to 28% from 2011 to 2020 which is one of the highest forecasts in the world! This means that there will be an increased demand for luxury brands that will appeal to the middle class as a matter of elegance and prestige.

Cons: Competition is on the rise: However, there are significant international new entrants in the alcohol market such as Pernord Ricard who carry the Jameson brand in their portfolio which is said to be the third largest premium brand spirit in Kenya. (Alexander Ricard, Chairman Pernord Ricard in an interview with Irish Times, September 2015.)This has brought about significant competition for its premium spirits segment which decline by 8% in H1 2016.

Currently, there are only 21 distillers that have been allowed to continue to manufacture alcoholic drinks in Kenya. Initially, there were about 200 registered alcohol manufactures. This comes after a government crackdown to on second generation (illicit) brews in July 2015. This is a decline in the number of local alcohol manufacturers in the market thus an opportunity for EABL to gain part of that market share in their effort to grow their lower end brand portfolio.

Collapse of the South Sudanese market: Due to the turmoil in South Sudan, EABL continues to find difficulty in selling its products and servicing the market demand. This is because of the lact of hard currency in South Sudan which can be used to convert South Sudanese pounds to US Dollars which is the main currency of trade for EABL in the country. This scarcity has caused EABL to accumulate 63 million South Sudanese pounds in the country which they expect to repatriate. However, EABL took huge hit when the South Sudanese central bank allowed its currency to float and as such brought about a major devaluation of the South Sudanese pound.

EABL has also declined to pull out of the South Sudanese market as they are hopeful that the turmoil would soon end thereby presenting a great market opportunity for them. We don’t expect the situation in South Sudan to improve any time soon as foreign reserves in the Central bank continue to rapidly diminish, inflation remains high at 110% (Decem- ber 2015)

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 12 Valuation:

We expect that sales revenue for the second half of 2016 will decline by 12% as the impact of Senator Keg’s bounce sales bounce back wears off as we don’t expect the brand to be a significant revenue generator going forward. This will bring sales revenue growth yoy to 10% on the back of the impressive contribution of Senator Keg to H1 2016 revenue. Thereafter we expect sales revenue to stabilize between the ranges of 10% - 12% as EABL shifts gears towards driving its value end portfolio while growing the spirits portfolio faster.

Gross profit margins (%) have been fairly stable at an average range of 48% - 49%. Gross profit margin (%) declined in the first half of 2016 due to the increase in sales volumes of Senator Keg as there was a significant increase in the cost of goods sold. We don’t expect Senator Keg to contribute to a higher Gross profit margin (%) going forward therefore GPM would increase. We therefore don’t expect to see a significant change in Gross profit margin (%).

EABL experienced an epic life line in the first half of 2016 due to the recovery of Senator Keg which recovered within 2 months of the decline in excise tax, sales volumes sky rocketed to numbers never seen before. According to the financial results for the first half of 2016, sales volumes grew by 21% which was boosted by the Kenyan market led by the Senator Keg brand. However, even with the positive boost that Senator Keg gave EABL volumes; the company is experiencing constraints in servicing the market demand as they have limited Kegs in stock. Man- agement has advised that they expect to invest in brewery infrastructure pertaining to Senator Keg production after the findings of an evaluation exercise that will determine whether the investment is necessary based on the economics of Senator.

Based on the economics of Senator Keg, we believe it highlights the fact that the brand isn’t profit motivated but more of a strategy for EABL to gain market share in the lower end market. This can be seen by the fact that a mug of Senator Keg costs Ksh 25 and we estimate that more than 50% of its retail selling price goes to costs such as VAT, excise duty, production costs, retail costs and distribution costs. Therefore, the absolute price would in normal occasions not justify continued investment in the business, However, based on the demand of the Keg we anticipate that EABL will have to seriously improve its efficiencies especially in its root to market to reduce on costs and at least make a pretty penny off the brand. In light of the above, our valuation accounted for less contribution of the Senator Keg to revenue focusing more on EABL profit motivated brands.

Valuation Assumptions  Risk free rate of 13.19% based on the 10 year average Treasury bond yield.  Beta of 0.82 based on 5 year computed beta.  After tax cost of debt of 8.46%.  Tax rate of 30%.  Equity risk premium of 5.0%  Terminal growth rate of FCF of 5% pegged on the long term economic growth rate of the country.  Cost of equity of 17.29%.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 13 Discounted Cash Flow Analysis

2015 2016F 2017F 2018F 2019F 2020F Net operating cash flows 14,526.84 20,628.37 18,777.64 20,430.26 22,243.79 24,233.90 Less: Capex (4,944.29) (7,736.48) (8,489.75) (9,316.37) (10,223.47) (11,218.89) Free Cash flows to Firm 9,582.56 12,891.89 10,287.89 11,113.89 12,020.32 13,015.00 223,586.91 TERMINAL VALUE 236,601.92

Period 0.59 1.59 2.59 3.59 Discount factor 0.94 0.85 0.76 0.69 Net Present Value Firm 12,114.84 8,700.94 8,459.50 8,234.43 Terminal Growth Rate 5% DCF Firm Value 183,382.54 Less net debt 26,362.73 DCF Equity Value 157,019.82 Number of shares 790.77 Per share value (KSH) 198.56

Relative Valuation

Average Breweries EV/EBITDA 12.29 EABL Bloomberg EV/EBITDA 11.06 Average EV/EBITDA 11.68 EBITDA TTM 18,220.21 Estimated EV 212,734.12 Less Net Debt 30,759.76 Derived Equity Value 181,974.36 Market Value of Equity (KSH) 230.12

Comparable Analysis

Gross Margin TTM Operating Margin Profit Margin TTM P/E ROE Global Industry Average 47.82784281 18.10057466 11.37965561 26.96 20.58 EABL 49.72242979 25.72705553 13.89675311 24.2236 78.84092

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 14 Income Statement

KSH (millions) FY2015 FY16E FY17E FY18E FY19E FY20E Revenue 64,420.46 70,692.85 77,575.95 85,129.24 93,417.97 102,513.74 COGS - excluding d&a 32,389.04 36,269.42 39,800.84 43,676.11 47,928.69 52,595.34 Write offs ------

Gross profit 32,031.42 34,423.43 37,775.11 41,453.14 45,489.28 49,918.41

Operating expenses 18,353.35 15,928.89 17,479.82 19,181.77 21,049.43 23,098.94

EBITDA 13,678.07 18,494.54 20,295.29 22,271.37 24,439.85 26,819.47

Depreciation 3,546.81 3,780.33 4,148.40 4,552.32 4,995.56 5,481.96 Amortization 54.40 113.19 124.21 136.30 149.58 164.14

EBIT 10,076.86 14,601.02 16,022.67 17,582.74 19,294.71 21,173.37

Reorganisation Costs ------Net Finance Income 4,074.38 3,412.72 3,647.66 3,905.48 4,188.40 4,498.87 Share of Associates PAT ------

PBT 14,151.24 18,013.75 19,670.34 21,488.22 23,483.11 25,672.24

Tax expense (4,616.03) (5,404.12) (5,901.10) (6,446.47) (7,044.93) (7,701.67)

PAT 9,535.22 12,609.62 13,769.24 15,041.76 16,438.18 17,970.57

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 15 Balance Sheet

FY2015 FY2016E FY2017E FY2018E FY2019E FY2020E Non-current assets Property, plant and equipment 35,580.38 39,770.05 44,713.00 50,482.56 57,159.23 64,831.32 Intangible asset - software 376.79 376.79 376.79 376.79 376.79 376.79 Intangible asset - Goodwill 3,577.19 3,577.19 3,577.19 3,577.19 3,577.19 3,577.19 Intangible asset - Brand 563.01 563.01 563.01 563.01 563.01 563.01 Prepaid operating lease rentals 10.54 10.54 10.54 10.54 10.54 10.54 Other investments 10.00 10.00 10.00 10.00 10.00 10.00 Deferred income tax assets 1,330.72 1,330.72 1,330.72 1,330.72 1,330.72 1,330.72

Total Non-current assets 41,448.62 45,638.30 50,581.24 56,350.81 63,027.47 70,699.56

Working Capital Total current assets 25,491.16 28,975.62 31,599.07 34,300.90 37,071.11 40,673.46 Total current liabilities 24,930.77 26,416.29 28,560.22 30,912.91 33,494.66 36,327.79 Net Working Capital 560.39 2,559.33 3,038.84 3,387.99 3,576.45 4,345.67

Net Assets 42,009.01 48,197.63 53,620.09 59,738.80 66,603.92 75,045.23

Shareholders’ Equity 13,353.18 18,000.16 21,924.67 26,180.10 31,000.53 37,198.06

Total Non-current Liabilities 28,655.83 30,197.47 31,695.42 33,558.69 35,603.39 37,847.17

Total Equity and Non-current Liabilities 42,009.01 48,197.63 53,620.09 59,738.80 66,603.92 75,045.23

Cash Flow Analysis

FY2015 FY2016F FY2017F FY2018F FY2019F FY2020F Net cash generated from operating activities 14,526.84 20,628.37 18,777.64 20,430.26 22,243.79 24,233.90 Net cash used in investing activities (4,683.70) (7,736.48) (8,489.75) (9,316.37) (10,223.47) (11,218.89) Net cash used in financing activities (10,578.02) (7,579.32) (9,618.25) (10,556.10) (11,602.91) (11,994.53) Increase/(decrease) in cash and cash equivalents (734.87) 5,312.57 669.64 557.79 417.41 1,020.47 At the start of the year (657.03) (1,391.90) 3,920.67 4,590.31 5,148.10 5,565.52 At the end of the year (1,391.90) 3,920.67 4,590.31 5,148.10 5,565.52 6,585.99

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 16 Recommendation guide AIB Capital recommendation system is based on the difference between the current share price, and the target price of the share. Rating categories are defined as follow:

BUY: Target Price more than 10% above the current price

HOLD: Target Price between +10% and -10% [(10%) ≤Upside/Downside≤+10%] of the current price

SELL: Downside potential is more than -10%

Disclaimer Though utmost care has been taken in the preparation of this report, we do not guarantee the accuracy or com- pleteness of the information contained herein nor will AIB Capital Ltd be held liable for the information contained herein.

The views expressed in this report are solely those of the Research Department and are subject to change without notice.

The information in this report is not an offer for the sale or purchase of any security. This document should only be considered a single factor used by investors in making their investment decisions.

This publication may not be distributed to the public media or quoted or used by the public media without prior and express written consent of AIB Capital Ltd.

Readers should be aware that AIB Capital Ltd seeks to do business with the company covered in this research report. Consequently, a conflict of interest may arise that could affect the objectivity of this report.

AIB CAPITAL – EAST AFRICAN BREWERIES LIMITED: Initiation Coverage Report 17 AIB CAPITAL LTD 9TH Floor, Finance House, Loita Street P.O.Box 11019 -00100, Nairobi.

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