Cargills (Ceylon)

CARG – Rs.193.0 Disclaimer: CT CLSA Securities (Pvt) Ltd is an associate of PLC, the parent of CARG

Chayanika Ranasinghe Key Highlights

Email : [email protected] Phone : +94 77 2379731 3Q18 Results Update

. 3Q18 recurring net profit of Rs.636mn (largely unchanged YoY), broadly in line with our expectations. Earnings are adjusted for CARG‟s proportion of the Rs.481mn capital gain received by associate from disposal of subsidiary Trust Finance (CALF) . CARG group net profit forecasts broadly maintained at Rs.2,535mn for FY18E (+20% YoY) and Rs.3,055mn for FY19E (+21% YoY), particularly driven by the and Restaurants sectors. Retail sector to marginally overtake FMCG earnings contribution in FY19E given the significant expansion plans in the pipeline - targeting to double its retail network in the medium term . On 01 Feb 2018, CARG announced a capitalisation of reserves amounting to Rs.6.4bn (out of reserves of Rs.9.4bn as at 30 Sep 2017), via the issuance of 32mn shares in the proportion of 01:07 at a consideration of Rs.200.0 per share; XC : 20 Mar 2018 . The CARG share has outperformed the market rising +13% both during the past 3 months and 12 months (vs. the ASI‟s gains of +1% and +2% respectively during the same period) ASI . CARG is trading at PER multiples of 19.5X FY18E and 16.2X FY19E whilst offering ROEs of 17- CARG

130 1,200 19% (up from low single digits in FY15) Share Volume ('000) - RHS 10 April 2018 1,000 Our estimated Sum-of-the-parts (SOTP) valuation suggests that CARG is currently trading at a 120 . 800 -19% discount to our estimated breakup NAV of Rs.238 per share 110 600 Thousands Beverage Food & Tobacco . CARG has demonstrated much greater resilience to its peers in the recent quarters. CARG‟s 400 closest listed competitor, Ceylon Cold Stores (CCS) has been negatively impacted from the 100 introduction of the “sugar tax”, given its exposure to carbonated soft drinks. The relative 200 attractive multiples vs. other listed peers, coupled with the double digit growth expectations and 90 0 the recent measure to improve share liquidity will likely find favour amongst investors, 14-Feb-17 14-Aug-17 14-Feb-18 particularly given that the relatively illiquid nature of the share may be a deterrent. Moreover, medium to long term investors favouring the consumer driven story of Sri Lanka may find favour in the share, on the back of CARG‟s strong market positioning and brand equity

Key Trading Information Relative Share Price Movement (%)

Shares in Issue (mn) 256.0 115 Market Cap (US$ mn) 318.1 CARG 110 Estimated Free Float (%) 18.7 3M Avg Daily Volume 38,024 105

3M Avg Daily Turnover (US$) 45,882 100 ASPI 12M High / Low (Rs) 200.2 / 157.5 95 3M / 12M Price Change (%) 10.9 / 22.5 07-Apr-17 09-Oct-17 10-Apr-18

CARG: Valuation Ratios FY15 FY16 FY17 FY18E FY19E Net Revenue (Rs mn) 61,631 71,017 84,191 89,916 103,750 Net Profit (Rs mn) 158 1,571 2,106 2,535 3,055 Earnings per Share (Rs) 0.6 6.1 8.2 9.9 11.9 Earnings per Share Growth (%) -79.7 >+100.0 34.0 20.4 20.5 Price / Earnings Ratio (X) 193.9 21.4 15.2 19.5 16.2 Price / Earnings Growth (X) -2.4 0.0 0.6 1.0 0.8 Gross Dividends per Share (Rs) 1.8 3.1 4.9 3.8 4.5 Gross Dividend Yield (%) 1.5 2.3 3.0 2.0 2.3 Net Book Value per Share (Rs) 49.0 55.2 54.5 60.7 68.1 Price / Book Value (X) 2.4 2.4 3.0 3.2 2.8 Return on Equity (%) 1.3 11.8 15.0 17.2 18.5 Market Price per Share (Rs) 119.9 131.3 164.5 192.6 193.0

Note: Valuations are based on recurring EPS, Adj. for Capital Issues (if any); Historic Ratios are based on Y/E MPS Source: CARG, CT CLSA Adjusted for the 01:07 Capitalisation of Reserves – XC : 20 Mar 2018

CT CLSA SECURITIES (PVT) LIMITED | A Member of the Colombo Stock Exchange 1 CARGILLS CARG (CEYLON) PLC Cargills (Ceylon) Investment Cargills Foods Cargills Restaurants s Company (Pvt) Quality Cargills Quality Cargills Food Co. Ltd (92%) Foods Foods Limited Restaurants Investments (Pvt) Ltd (92%)* (100%) ‘Food City’ Limited Banking

Cargills Quality Dairies Property Cargills Quality Cargills Bank Cargills Agrifoods The Business Dairies (20%) 8% stake Cargills Ceylon (CARG), a 70% owned subsidiary of listed conglomerate, C T Holdings held by IFC Cargills Agrifoods (Kist) Leading player in local (CTHR), is one of the leading retail and food & beverage companies in Sri Lanka. The group food and beverage space primarily operates in three sectors – Retail, Fast Moving Consumer Goods (FMCG) and Restaurants, Cargills Quality Cargills Food CT Properties with exposure to banking through 40% associate, Cargills Bank, and property development through Confectionaries Processors (KFC) (25%) 22% associate, C T Properties.

The group was listed on the Colombo Stock Exchange (CSE) in 1946 and the Page family currently Cargills Quality Confectionaries(Kist) controls ~81% of the company.

CPC Lanka Operates Sri Lanka’s CARG has evolved to become Sri Lanka‟s largest private retail chain with 351 outlets spread across largest private retail the country. CARG owns and operates leading processed food brands under its FMCG umbrella, with chain its key product categories comprising dairy (ice cream, yoghurt, liquid milk forms, cheese), processed meat, agrifoods (fruit juices and nectars, jams, sauces, cordial, water and spices) and Cargills Food Processors (Pvt) Ltd - KFC confectionery (biscuits). The group has operated the KFC franchise in Sri Lanka since 1996, which * 8% stake held by IFC Source: Company Filings currently comprises 31 outlets, and a TGI Fridays‟ outlet under franchise operations since 2013.

Recent Financial Performance C P C Lanka (Kist, My Choice)

CARG posted a 3Q18 recurring net profit of Rs.636mn (largely unchanged YoY), broadly in line with our expectations. Quarterly earnings are adjusted for CARG‟s proportion of the Rs.481mn capital gain received by associate Cargills Bank from disposal of subsidiary Colombo Trust Finance (CALF). Consequently, 1-3Q18 recurring net profit amounted to Rs.1,912mn (-1% YoY)

Key Figures & Ratios (Rs mn) 3Q17 3Q18 % YoY 1-3Q17 1-3Q18 % YoY Net Revenue (Rs mn) 22,226 23,164 4.2 64,095 68,671 7.1

Gross Profit (Rs mn) 2,646 2,705 2.2 7,801 8,206 5.2 Other Operating Income (Rs mn) 424 487 15.0 1,252 1,482 18.4 Composition (%) Total Opex (Rs mn) -1,663 -1,810 8.8 -3,088 -3,362 8.9 Sectoral Information (Rs mn) 2Q14 2Q15 % YoY EBIT (Rs mn) 1,407 1,383 -1.7 4,269 4,474 4.8 2Q14 2Q15 CARGILLS Net Revenue 20,879.6 22,164.9 6.2 100 100 Net Finance Cost (Rs mn) 312 268 -14.2 802 1,020 27.2 (CEYLON) PLC Transportation 4,135.8 3,230.8 -21.9 19.8 14.6 Share of Associates (Rs mn) -7 -9 20.9 -30 8 -125.4 Net Profit (Rs mn) 637 636 -0.1 1,936 1,912 -1.2 Leisure 5,268.2 5,480.8 4.0 25.2 24.7 Property 547.9 1,099.5 >+100.0 2.6 5.0 EPS (Rs mn) 2.8 2.8 -0.1 8.6 8.5 -1.2 Consumer Foods & Retail 5,946.4 7,040.1 18.4 28.5 31.8 Gross Profit Margin (%) 11.9 11.7 -0.2 12.2 11.9 -0.2 Cargills Quality Cargills Food Co. Foods Limited Investments Financial Services 2,336.5 2,606.8 11.6 11.2 11.8 EBIT Margin (%) 6.3 6.0 -0.4 6.7 6.5 -0.1 (Pvt) Ltd (92%)* (100%) Information Technology 1,751.5 1,750.8 0.0 8.4 7.9 Effective Tax Rate (%) 26.3 39.7 13.4 36.6 41.5 4.9 Others 893.3 956.0 7.0 4.3 4.3 Net Debt (Rs mn) 10,501 9,247 -11.9 10,501 9,247 -11.9

Net Debt : Equity (%) 66.6 54.3 -12.3 66.6 54.3 -12.3 Cargills Quality Profit After Tax 2,302.4 2,976.9 29.3 100.0 100.0 Kotmale Holdings Cargills Bank Capex (Rs mn) 1,408.1 1,361.6 -3.3 2,938.3 3,502.1 19.2 Dairies (20%) Transportation 696.1 552.8 -20.6 30.2 18.6 Note : Earnings and valuations on a recurring basis Source : CARG & CT CLSA Leisure 1,031.7 1,022.1 -0.9 44.8 34.3 3 Q18 earnings adjusted for a Rs.481mn capital gain (Rs.191mn for CARG’s effective~40% holding) received by Cargills Bank from divesture of its subsidiary Colombo Trust Finance (CALF) ; 2Q18 earnings excluding Rs.1,010mn capital gain from disposal of investment properties Property 8.4 322.5 >+100.0 0.4 10.8 Cargills Quality Cargills Agrifoods Consumer Foods & Retail 175.7 364.4 >+100.0 7.6 12.2 Confectionaries CT Properties Sectoral Analysis Financial Services 216.2 318.3 47.2 9.4 10.7 (25%) Composition % Information Technology 31.2 91.0 >+100.0 1.4 3.1 (Rs mn) 3Q17 3Q18 % YoY 1-3Q17 1-3Q18 % YoY 3Q17 3Q18 DIST’s quarterly interims only report the cumulative sectoral earnings, thus quarterly sectoral earnings are derived and may be subject to Others 143.1 305.8 >+100.0 6.2 10.3 change subsequent to restatements of accounts Cargills Food Millers Ltd. Group Net Revenue 22,226 23,164 4.2 64,095 68,671 7.1 100.0 100.0 Processors (KFC) Retail 17,726 18,399 3.8 50,803 54,277 6.8 79.8 79.4 FMCG 3,643 3,790 4.0 10,833 11,583 6.9 16.4 16.4 Restaurants 858 976 13.8 2,459 2,811 14.3 3.9 4.2 CPC Lanka Group EBIT 1,407 1,383 -1.7 4,269 4,473 4.8 100.0 100.0 Retail 738 665 -9.9 2,323 2,328 0.3 52.5 48.1 FMCG 576 584 1.4 1,713 1,782 4.0 40.9 42.2 Restaurants 86 131 53.1 209 350 67.7 6.1 9.5 * 8% stake held by International Finance Corporation (IFC) Source: Company Filings Others* 8 3 -64.4 24.4 13.0 -46.6 0.5 0.2

*1-3Q18 earnings adjusted for Rs.1.0bn capital gain from disposal of investment properties in 2Q18. Sector earnings assumed to primarily comprise rental income – previously accounted for under Retail sector Source : CARG & CT CLSA Note: Earnings from banking & property development accounted for under Associates A CT HOLDINGSEQUITY GROUP REPORT AND TITLE CLSA |GROUP Date COMPANY 2 Cargills (Ceylon)

Retail Sector

3Q18 EBIT of Rs.665mn (-10% YoY, 48% of group EBIT), below our expectations, amid erosion in margins due to increased promotional activities in the tight consumer environment. 1-3Q18 EBIT of Rs.2,328mn (up marginally YoY)

380 338 315 Key Listed Players : No. of . Retail sector earnings comprise those from the retail businesses and the holding company, 330 297 Supermarkets which also includes contribution from Associates 269 280 243 CARG CCS RICH . Since opening its first „Food City‟ supermarket in 1983 in Colombo, CARG has evolved to 211 400 230 194 338 become Sri Lanka‟s largest modern retailer (in terms of market share), with a wide retail 297 315 network of 351 outlets across the country. CARG positions itself via its offering of “higher 180 300 256 value for the lowest price” and holds an estimated modern retail market share of ~40%. 130 Most fresh food sold at CARG outlets are directly sourced from farmers through its collection

200 centres across Sri Lanka and has gained international recognition

FY13 FY14 FY15 FY16 FY17 FY12 . 3Q18 sectoral revenue, accounting for 79% of group revenue, rose +4% YoY, attributable to a 100 64 72 combination of same store sales growth and added contribution from newly opened stores. 31-Dec-17 45 61 66 59 50 59 CARG has added 36 new outlets since 31 Mar 2017, increasing the total number of outlets to the current 351 (338 as at 31 Dec 2018). 13 more outlets were opened post-quarter end 0 FY15 FY16 FY17 1-3Q18 . Sectoral EBIT margin eroded to 3.6% in 3Q18 (vs. 4.2% in 3Q17 and 4.4% in 2Q18), likely due to increased promotional activities in the tight consumer environment, particularly amid the CCS : Ceylon Cold Stores, RICH : Richard Pieris & Co. relatively high inflationary pressures. Further, margins may have been partly impacted by Source: CARG, CCS, RICH increased expansion driven expenses. CARG indicated that the group continued to drive measures to control overall operating costs Per Capita GDP (US $) 2014 Per Capita GDP – Provincial (Rs’000) . Retail sector net profit forecasts revised down by -9% to Rs.1,110mn for FY18E Western Retail : Net Profit (Rs mn) and as a % (+15% YoY on a recurring basis, 44% of group net profit) and by -7% to Rs.1,385mn 4,200 Central of Group NP for FY19E (+25% YoY, 45% of group net profit), due to the downgrade in EBIT margin Southern NP (Rs mn) forecasts for the aforementioned factors and lower than anticipated new store openings for Northern FY18E. Meanwhile, YoY growth driven by same store sales coupled with added contribution 3,700 % of Group NP - RHS from newly opened stores. Despite weak domestic consumerism amid tightening fiscal policy, Eastern 1,800 60 CARG has demonstrated greater resilience given its operating model of offering relatively more North Western 1,400 competitive prices versus other retailers and the traditional stores North Central 40 3,200 o Based on discussions with CARG management, the company is expected to open 60-70 Uva 1,000 20 new outlets per year in the near term, with a medium to longer term target to double Sabara-Gamuwa 600 its retail network to around 600 outlets. We forecast sector capex at Rs.2.7bn for FY18E 2,700 0 (vs. Rs.1.7bn in FY17) and Rs.4.7bn for FY19E 300 400 500 600 700 800 200 Retail Sector Profitability of Key Listed Players: CARG vs. CCS (Rs mn) 2011 2012 2013 2014 2015 2016E2017E o According to Nielsen, modern retail penetration in Sri Lanka is only ~18-20%, with Source: Ministry of Finance, Central Bank of Sri Lanka, CT CLSA Note: 2002 base taken due to Source: Central Bank of Sri Lanka -200 -20 the relatively low penetration largely attributable to the majority of the supermarkets being CARG CCS unavailability of data FY15 FY17 FY19E situated within the Western Province. Just two of the larger players, namely „Food City‟ and FY13 FY14 FY15 FY16 FY13 FY14 FY15 FY16 state-owned Lak Sathosa have a noticeable presence outside of the Western province Source: CARG, CT CLSA Revenue 44,258 49,204 49,610 56,119 13,721 15,049 18,248 22,146 o Competition among retailers, particularly in Greater Colombo, is stiffening with the main players, particularly John Keells Holdings‟ (JKH) listed subsidiary Ceylon Cold Stores (CCS), EBIT 1,689 1,927 934 1,681 -190 239 573 1,237 expanding aggressively - 72 outlets as at 31 Dec 2017. In early-Apr 2018, international Finance Costs -1,099 -1,102 -703 -401 -51 -58 -23 41 International retail retail chain SPAR opened its first outlet in Sri Lanka through a JV with local player, PBT 1,699 1,078 290 1,296 -249 33 549 1,278 EBIT Margins (%) of Select Retailers Ceylon Biscuits Ltd (CBL), and announced plans to open 20 outlets within a five year chains entering Sri Net Profit * 354 523 -29 663 -209 -55 380 905 Lanka period. Further, press articles reported that UK retailer, Sainsbury’s is also believed be exploring to enter Sri Lanka partnering with a local conglomerate Deemed VAT N/A 83 862 ND^ N/A 61 339 286 Food City Arpico Keells o Sector EBIT margin forecasts revised down by 20bps to 4.1% for FY18E (vs. 4.3% in FY17) Capex 2,848 2,438 1,319 1,725 445 493 467 832 8 and 4.0% for FY19E. The erosion in margins in FY19E is on the back of higher Net Debt/(Cash) 11,933 13,047 6,358 5,817 789 901 217 -465 operational costs from the new outlets under the group’s aggressive expansion 6 Rev. Growth YoY (%) 12.9 2.4 9.0 13.2 15.1 9.7 21.3 21.4 plans, particularly outside of the Western Province. Nevertheless, the overall impact from NP (Rs mn) EBIT Margin (%) 3.8 3.9 1.9 3.0 -1.4 1.6 3.1 5.6 4 the rise in costs is anticipated to be better absorbed given that the group benefits from % of Group NP - RHS greater economies of scale 1,800 60 2 o The International Finance Corporation (IFC) acquired an 8% stake in CARG‟s retail business 1,400 0 40 in 4Q15 at a total consideration of Rs.2.6bn, valuing the retail business at ~Rs.32.5bn. The investment has an embedded put option, exercisable between 2020 and Feb 2021 1,000 Retail Sector : NP & Contribution to Group Retail Sector : Revenue and Capex (Rs bn) -2 20 600 Key Listed Players : FY13 FY14 FY15 FY16 Key Listed Players : Key Listed Players : NP (Rs mn) % of Group NP - RHS Revenue Capex - RHS 0 Retail Sector Revenue (Rs bn) Retail Sector EBIT Margin (%) 200 Retail Sector Capex (Rs bn) 1,400 80 75 3.0 1,200 70

CARG CCS RICH -200 -20 2.5 80 60 CARG CCS RICH CARG CCS RICH 8.0 1,000 FY15 FY17 FY19E 65 2.5 2.0 60 6.0 800 40 60 1.5 600

Thousands 55 2.0 40 4.0 20 1.0 400 50 200 0.5 20 2.0 0 45 1.5 0 40 0.0 0 0.0 -200 -20 35 1.0 FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17 1-3Q18 FY14 FY15 FY16 FY17 1-3Q18 FY13 FY14 FY15 FY16 FY17EFY18E Source: Respective Company Interims FY13 FY14 FY15 FY16 FY17E FY18E CT CLSA SECURITIES (PVT)EQUITY LIMITED REPORT | A MemberTITLE | of Date the Colombo Stock Exchange 3 Source: CARG Annual Reports, CT CLSA

* Recurring Net Profit excluding fair value gains ^ Not disclosed Source: Company Filing Cargills (Ceylon)

FMCG Sector

FMCG 3Q18 sectoral EBIT up +1% YoY to Rs.584mn (42% of group EBIT), broadly in line with our expectations, driven by topline growth though partly negated by the YoY erosion in profit margins. 1-3Q18 EBIT of Rs.1,782mn (+4% YoY) Import Dairy (Magic, Processed Meat Confectionary Agrifoods (Kist ) Distribution . Sector comprises Dairy (ice cream, yoghurt products, cheese, ultra-high temperature (UHT) Kotmale ) (Goldi, Sams) (Kist) Sri Lanka Food & Bev Growth (%) and pasteurised milk under „Kotmale‟ and „Magic‟ brand names), Agrifood (juices, nectars, (Millers) jams, sauces and cordials under „Kist‟ brand), Processed Meats, Confectionary (biscuits) and Import Distribution (under Millers). Dairy and Agrifoods are assumed to contribute over Volume Change 70% of sector earnings Price Change Overall growth . As per CARG, it is the market leader in ice cream with a market share of ~40-45%. „Magic‟ is believed to be the market leader in the impulse ice cream category whilst „Kotmale‟ 11.0 12 and „Magic‟ collectively command a leading presence in the take home category. The other 6.3 6.8 8.6 8.0 significant player in ice cream manufacturing is CCS 8 . Kotmale has a growing presence in liquid milk offerings under pasteurised milk, UHT, Ready to 1.3 2.6 4 Drink (RTD) forms, and in yoghurt and cheese. CARG group‟s full dairy requirements are 1.4 fulfilled locally and CARG is amongst the largest private collectors of fresh milk 0 . 3Q18 revenue grew +4% YoY, attributable to higher volumes and value contribution across all -4 -3.0 key segments, with the dairy segment in particular having performed well. CARG implemented price increases for select products, partly to pass on the VAT hike and higher input costs

. FMCG product portfolio has been expanded, with the launches of Drinking Yoghurt, three

1Q2016 2Q2016 3Q2016 4Q2016 1Q2017 2Q2017 3Q2017 4Q2017 4Q2015 variants of Stirred Yoghurt, three new ice creams under the impulse category and two new Source : Nielsen Sri Lanka juices. Furthermore, CARG stated that the FMCG business continued to gain market share through these initiatives. Meanwhile, competition continued to stiffen with several players, including dairy giant, Fonterra too entering the drinking yoghurt segment FMCG : Net Profit (Rs mn) and as a % . Quarterly EBIT margin meanwhile eased to 15.4% (vs. 15.8% in 3Q17 though up from 14.5% of Group NP in 2Q18), particularly due to the increase in prices of key raw materials NP (Rs mn) . FMCG sector NP forecasts maintained at Rs.1,158mn for FY18E (+16% YoY, 46% of % of Group NP - RHS group NP) and Rs.1,361mn for FY19E (+18% YoY, 45% of group NP) 1,600 200 o Whilst local consumer spending is anticipated to remain subdued in the near term, the 1,200 150 impact on players such as CARG is expected to be limited given that most of the segments in which CARG operates are considered to be relatively underpenetrated. Demand for food items is expected to be on the rise in the medium to 800 100 longer term driven by the overall growth in disposable income levels. Management indicated that it is eyeing to differentiate products whilst innovating and expanding its 400 50 portfolio to keep current with the changing consumption patterns and demand

0 0 o EBIT margins forecast at 15.0% for FY18E (vs. 14.6% in FY17) and 15.4% for FY19E. FY15 FY17 FY19E Sector margin improvement aided by the growth in revenue coupled with cost rationalisation efforts, with the group embarking on several cost saving measures at the back end of operations. Furthermore, the biscuits segment has turned profitable subsequent to its acquisition in 2010 FMCG : EBIT Margin (%) o Prices of fresh milk sourced locally remain politically sensitive, given its impact on farmer disposable incomed. Farmgate prices for local liquid milk were last revised up by +17% per 16 litre in Jul 2015 and by +20% in Oct 2014. The industry as a whole is expected to pass on any significant cost hikes to consumers by way of price increases to cushion margins 14 o We forecast sector capex at Rs.1.2bn for FY18E-19E (vs. Rs.1.5bn in FY17), mainly for the 12 expansion of the cheese manufacturing facilities, which are currently operating at full capacity and given the potential growth upside for lower priced locally manufactured cheese 10 products. FY17 capex was primarily attributable to the expansion of the ice cream manufacturing facilities and the setting up of an operation for the production of milk 8 powder for internal requirements and to stabilise raw material inputs. The new Kotmale Integrated Dairy Plant was opened in Apr 2017 at a total investment of Rs.3bn 6 o In anticipation of the significant opportunities in the local F&B sector going forward, several FY15 FY16 FY17 FY18E FY19E players have entered the dairy segment particularly and expanded their product portfolios. Direct competitor, CCS announced new investments for its ice cream plant of ~Rs.3.8bn with operations expected to start from mid-2018

National Budget 2018 Proposals and Potential Impact . To grant tax concessions on imported capital goods during the construction period for large scale investments in the dairy industry, which may benefit CARG . Introduce an Excise duty of Rs. 12/ltr or Rs.0.50/gram of sugar contained in beverages - water based non alcoholic drinks excluding fruit or vegetable juices w.e.f 10 Nov 2017 o The FMCG portfolio of CARG does not feature soft drinks though we cannot rule out the possibility that the sugar tax (for added sugar content) may be extended to encompass fruit or dairy beverages. Meanwhile, we expect CARG to continue exploring new product development with healthier options A CT HOLDINGSEQUITY GROUP REPORT AND TITLE CLSA |GROUP Date COMPANY 4 Cargills (Ceylon)

Restaurants

3Q18 sectoral EBIT of Rs.131mn (+53% YoY; 9% of group EBIT), above our expectations, amid continued strong contribution from the KFC franchise. 1-3Q18 EBIT of Rs.350mn (+68% YoY)

Restaurants : Net Profit (Rs mn) and . Restaurants sector includes franchise operations for KFC, launched in 1996 and currently as a % of Group NP comprising 31 outlets – with the addition of another outlet in 3Q18, and TGI Fridays – one outlet, opened in 2013. NP (Rs mn) . The international franchise chains compete closely, with most having evolved their respective % of Group NP - RHS 350 20 menus to include customised offerings catering to the local palate. KFC stands apart from the competition, with its specialty in chicken, which is more widely consumed in Sri Lanka 250 0 Major Franchise Operators in Sri Lanka . Given the continued strong performance in 3Q18, sectoral Net Profit forecasts revised 150 -20 up by +18% to Rs.267mn in FY18E (+65% YoY, 11% of group net profit) and by Commencement in Sri +21% Rs.309mn in FY19E (+16% YoY, 10% of group net profit) Restaurant Franchisee Outlets 50 -40 Lanka . Overall sector growth in the medium term to be mainly driven by expansion plans coupled with -50 -60 Pizza Hut Gamma Pizzakraft Overseas (Pvt) Ltd 1993 37 the anticipated rise in disposable income levels. CARG management indicated that there is -150 -80 potential for adding KFC outlets, especially in areas outside of the Western province, which are KFC CARG 1995 27 FY15 FY17 FY19E underpenetrated by eating-out options McDonald’s Abans 1998 8

Dominos Jubilant FoodWorks Lanka Ltd (JFLL) 2011^ 15 Others Burger King Softlogic Holdings PLC 2013 9

^ Re-entered Source: CT CLSA 3Q18 sectoral EBIT of Rs.3mn (-64% YoY) resulting in 1-3Q18 sectoral recurring EBIT of Rs.13mn (-47% YoY). Earnings anticipated to comprise rental income earned by the parent company, previously accounted for under the Retail sector . 1-3Q18 earnings adjusted for the Rs.1,012mn capital gain in 2Q18 from the disposal of CARG‟s two investment properties at Dawson Street and Vauxhall Street, with a total land extent of ~334 perches on 29 Sep 2017 for a total consideration of Rs.4.2bn. Given the lack of details available, we have continued to maintain the rental income earned under the Retail sector

Associates

Recurring loss on share of associates of -Rs.9mn in 3Q18 (vs. –Rs.7mn in 3Q17) below our expectations, likely attributable to higher collective impairment charges from Cargills Bank Ltd (~40% stake). Earnings also comprise contribution from C T Properties Ltd (~22% stake) which is incurring losses as it currently does not have any ongoing property development projects

. Quarterly earnings are adjusted for a Rs.481mn capital gain (Rs.191mn for CARG‟s effective ~40% holding) received by Cargills Bank from divesture of its 80.3% stake in Colombo Trust Finance (CALF) to Dialog Axiata (DIAL) for a consideration of Rs.1,072mn. Proceeds from the Restaurant Sector : NP & Contribution to Group Restaurant Sector Revenue and Capex (Rs mn) divesture would likely be utilised to support growth and strengthen the balance sheet . CARG invested a total estimated Rs.3.9bn Cargills Bank in 2016 (total investment at Rs.5.2bn), NP (Rs mn) % of Group NP - RHS Revenue Capex - RHS Divestment of finance primarily via a rights issue to be in line with the Central Bank‟s minimum capital requirement of company 200 40 4,000 500 Rs.10bn (stated capital of Rs.4.7bn as at 31 Mar 2016). Consequently, promoters CARG and 150 CTHR increased the combined stake to 65% 20 400 . Latest Central Bank directive requires LCBs to increase the minimum capital requirements from 100 0 3,000 the current Rs.10bn to Rs.20bn by end-2020. Potential listing of the bank is in the 50 300 pipeline though no exact details and timelines have yet been disclosed -20 Cargills Bank Key Metrics & Ratios : 0 200 As at 30 Sep 2018 . Cargills Bank, currently with 17 branches, of which seven are “instore” branches, is expected to -50 -40 2,000 face stiff competition as the newest addition to an already crowded sector. Funding costs are -100 -60 100 Recurring PAT 1-3Q18 Rs.46mn expected to be on the high side for the bank, while providing amongst the highest rates among LCBs to grow its funding base -150 -80 1,000 0 Total Assets Rs.32bn . The bank is expected to utilise CARG’s retail network to drive low cost expansion FY13 FY14 FY15 FY16 FY17E FY18E FY13 FY14 FY15 FY16E FY17E FY18E Total Loans Rs.18bn beyond traditional branch banking. In Aug 2017, the bank introduced Sri Lanka‟a first ever chip, pin and contactless debit card with MasterCard and launched its own credit card in Mar Source: CARG Annual Reports, CT CLSA Total Deposits Rs.20bn 2018 offering more competitive rates than its competitors Total Capital Rs.10bn . On 01 Jan 2018, Mr. Rajendra Theagarajah was appointed as the bank‟s CEO, who had served Gross NPA 2.7% as its Non-Executive Joint Deputy Chairman since Dec 2016. Mr. Theagarajah is a veteran Net Interest Margin banker and prior to joining Cargills Bank, he functioned as the CEO of National Development 6.6% Bank (NDB) from 2013 – 2016 and of Hatton National Bank (HNB) from 2004 – 2013. Return on Assets 0.8% . Recurring profits on share of associates forecasts revised down to Rs.40mn for FY18E vs. Return on Equity 0.8% Rs.75mn previously (Rs.22mn in FY17) and Rs.50mn for FY19E vs. Rs.85mn previously (+25% Source : Cargills Bank YoY) primarily comprising contributions from the bank

A CT HOLDINGSEQUITY GROUP REPORT AND TITLE CLSA |GROUP Date COMPANY 5 Cargills (Ceylon)

Group Financial Review

CARG: Net Debt (Rs bn) & Net Debt . Group net debt fell -12% YoY (whilst +5% QoQ) to Rs.9,247mn, resulting in a net debt : equity of 54.3%. YoY decline attributable to the receipt of Rs.4.2bn proceeds from the divestment of to Equity (%) investment properties on 29 Sep 2017

Net Debt . Consequently, net finance costs decreased -14% YoY and -30% QoQ to Rs.268mn in 3Q18 – its Net Debt : Equity - RHS lowest level since 1Q17. The Group’s debt profile comprises entirely of short term 14 110 maturities

12 . Quarterly capex amounted to Rs.1,362mn (-3% YoY) and 1-3Q18 capex of Rs.3,502mn (+19% 90 YoY), primarily for expansion in the retail network and some building capacity in FMCG. FY17 10 capex amounted to Rs.4,507mn

70 8 Capitalisation of Reserves 6 50

. On 01 Feb 2018, CARG announced a capitalisation of reserves amounting to Rs.6.4bn (out of

3Q15 3Q16 1Q17 3Q17 1Q18 3Q18 1Q16 reserves of Rs.9.4bn as at 30 Sep 2017), via the issuance of 32mn shares in the proportion of 01:07 shares at a consideration of Rs.200.0 per share; XC : 20 Mar 2018. Consequently, CARG‟s total number of shares increased from 224.0mn to 256.0mn, with the new shares being listed on 28 Mar 2018

Sectoral Revenue Composition (%) Sectoral Net Profit Composition (%)

FY19E FY19E 4% 10% 16% 4% Retail Retail 18% 4% Total Capex (Rs mn) and Capex Growth (%) Sectoral Capex Composition (%) FMCG FY16 FMCG 42% 45% FY16 54% Capex YoY Growth - RHS FY19E Restaurants 5,500 60 78% Restaurants 45% 5% 11% Retail 80% 40 4,500 8% 20 21% FMCG FY15 Note: Retail net profit also comprises earnings from Associates 3,500 0 71% Restaurants -20 2,500 CARG: Sectoral Net Profit Forecasts (Rs mn) -40 84%

FY16 FY17 FY18E % YoY FY19E % YoY 1,500 -60 Retail 663 966 1,110 14.9 1,385 24.8 FY15 FY16 FY17 FY18E FY19E Source: CARG Annual Reports, CT CLSA Share of Associates -26 22 40 83.7 50 25.0 FMCG 858 995 1,158 16.4 1,361 17.5 Restaurants 62 162 267 64.5 309 16.0 Group Net Profit 1,571 2,106 2,535 20.4 3,055 20.5 Source : CT CLSA

A CT HOLDINGSEQUITY GROUP REPORT AND TITLE CLSA |GROUP Date COMPANY 6

22 18 14 10 6 2 Cargills (Ceylon)

Outlook and Valuations

Retail sector to overtake . CARG group net profit forecasts broadly maintained at Rs.2,535mn for FY18E (+20% FMCG earnings YoY) and Rs.3,055mn for FY19E (+21% YoY), driven across all key sectors. Retail sector to contribution marginally overtake FMCG earnings contribution in FY19E given the significant expansion plans in the pipeline - targeting to double its retail network in the medium to longer term

. On 02 Aug 2017, CARG announced that it has entered into an agreement with the Bank of China Limited to promote cooperation and strengthen business ties between the two entities. The most likely area of cooperation within the two entities would be in the banking space, involving Cargills Bank. Bank of China commenced operations as a commercial bank in Sri Lanka on 28 Mar 2018, likely primarily to fund large infrastructure development projects such as the Colombo Port City

Share outperformed the . The CARG share has outperformed the market rising +13% both during the past 3 months market and 12 months (vs. the ASI‟s gains of +1% and +2% respectively during the same period)

. The CARG share is trading at PER multiples of 19.5X FY18E and 16.2X FY19E whilst offering ROEs of 17-19% (up from low single digits in FY15). The current multiples to near term earnings are lower than the regional valuations and to listed peer, CCS, which trades at multiples of 28.9X FY19E though whilst offering ROEs of 22%. CCS has been negatively impacted from the introduction of the “sugar tax”, given its exposure to carbonated soft drinks

. Our estimated Sum-of-the-parts (SOTP) valuation suggests that CARG is currently trading at a -19% discount to our estimated breakup NAV of Rs.238 per share

. CARG has demonstrated much greater resilience to its peers in the recent quarters. The relatively attractive multiples vs. other listed peers, coupled with the double digit growth Well positioned to expectations and the recent measure to improve share liquidity will likely find favour amongst capitalise on the growth investors, particularly given that the relatively illiquid nature of the share may be a deterrent. potential in the local F&B space Moreover, medium to long term investors favouring the consumer driven story of Sri Lanka may find favour in the share, on the back of CARG‟s strong market positioning and brand equity.

CARG: Sum-of-the-parts (SOTP) Valuation Sector Fair Value (Rs mn) Main Valuation Basis Retail 22,505 18X FY19E Net Profit (excl. Share of Associates) FMCG 23,138 17X FY19E Net Profit Restaurants 4,018 13X FY19E Net Profit CARG : NP Breakdown (Rs mn) CARG : Revenue and NP (Rs bn) CARG : Net Debt (Rs bn) and Net Debt to(Rs mn) Other 11,170 Investment Property & Investments in Associates Total Value 60,831 FY16 FY17E FY18E Revenue Recurring Net Profit - RHS Net Debt Finance cost - RHS 90 3 16.0 1,340 Number of shares (mn) 256 Value per share (Rs) 238 Retail 663 1,155 1,417 80 14.0 1,140 Source : CT CLSA 2 70 12.0 FMCG 858 1,140 1,371 940 Local Peer Analysis – FY19E Relative Valuations Regional Peer Valuations – FY19E Relative Valuations 60 10.0 1 CARG CCS NEST 6808 HK AMRT IJ VNM VN Restaurant 62 150 174 740 50 8.0 MPS (Rs) 193.0 930.0 1,730.0 Market Cap (US$ mn) 11,098 1,765 12,713 Earnings per Share (Rs) 11.9 32.8 79.8 Total 1,583 2,444 2,962 40 0 6.0 540 EPS Growth (%) 5.0 57.7 17.9 EPS Growth (%) FY13 FY14 FY15 FY16 FY17E FY18E FY13 FY14 FY15 FY16 FY17EFY18E 20.5 17.0 17.9 Price / Earnings Ratio (X) 23.3 39.5 26.6 Note: Retail sector includes Associate contribution Source: CARG Annual Reports, CT CLSA Price / Earnings Ratio (X) 16.2 28.3 21.7 Price / Earnings Growth (X) Price / Earnings Growth (X) 0.8 1.7 1.2 4.7 0.7 1.5 Return on Equity (%) 18.5 22.3 76.4 Return on Equity (%)^ 12.7^ 5.9 40.5

CCS: Ceylon Cold Stores, NEST: Nestle Lanka ^2017 Source : CT CLSA 6808HK: SunArt Retail Hong Kong, AMRT IJ: Sumber Alfaria, VNM Source : Bloomberg VN: Vietnam Dairy

A CT HOLDINGSEQUITY GROUP REPORT AND TITLE CLSA |GROUP Date COMPANY 7 Cargills (Ceylon)

Major Shareholder Movements

Major Shareholder Movements as at 31 December 2017

Change Name No. of Shares % Comment (Shares)*

1. C T Holdings PLC 157,249,240 70.20 -

2. Mr. V R Page 15,000,093 6.70 - Director

3. Employees’ Provident Fund 7,356,416 3.28 - GoSL Related Party

4. Odeon Holdings (Ceylon) (Pvt) Ltd 4,822,920 2.15 - Director / Related Party

5. Ms M M Page 4,386,203 1.96 +64,400 Related Party

Ceylon Guardian Investment Trust PLC 6. 4,175,700 1.86 - - A/C No.1

7. CF Ruffer Pacific Fund 3,474,555 1.55 -

Stewart Investors Indian Subcontinent 8. 2,664,100 1.19 -1,263,500 Fund

9. Butterfield Trust (Bermuda) Ltd 1,357,500 0.61 -18,000

10. Florida Retirement System 1,301,800 0.58 -

11. - A/C No. 1 1,298,613 0.58 - GoSL Related Party

12. JB Vantage Value Equity Fund 902,770 0.40 -

13. GF Capital Global Limited 889,000 0.40 -

14. Tundra Frontier Opportunities Fund 864,500 0.39 - New Entrant to Top 20

15. Associated Newspapers of Ceylon Ltd 799,840 0.36 -

16. J.B. Cocoshell (Pvt) Ltd 654,414 0.29 +205,652

17. The Ceylon Investment - A/C No.2 630,439 0.28 - New Entrant to Top 20

18. Sir Chittampalam A Gardiner Trust 563,040 0.25 -

Lloyd George Indian Ocean Master 19. 516,740 0.23 -167,000 Fund

The Ceylon Guardian Investment Trust 20. 456,550 0.20 - PLC - A/C No.2

Total 209,364,433 93.47

*Change since 30 September 2017 Exited Top 20 : Gesellschaft MBH for APT-Univers : 531,200 shares and Mr. J C Page : 455,000 shares

CT CLSA SECURITIES (PVT)EQUITY LIMITED REPORT | A MemberTITLE | of Date the Colombo Stock Exchange 8 Research Trading & Sales Consultant / Sales

Sanjeewa Fernando Lasantha Iddamalgoda Rohan Fernando [email protected] [email protected] [email protected] +94 77 742 7439 +94 11 255 2295 +94 11 255 2297 +94 77 778 2103 +94 76 778 2101 Chayanika Ranasinghe [email protected] Dyan Morris +94 77 237 9731 [email protected] +94 11 255 2320 Yasas Wijethunga +94 77 722 4951 [email protected] +94 77 053 2059 Manura Hemachandra [email protected] Rasika Nanayakkara +94 77 261 4797 [email protected] +94 11 255 2290 Rosco Todd [email protected] Shahan de Silva +94 77 262 7233 [email protected] +94 11 255 2290 Dhammika de Silva [email protected] Subecca Sothylingam +94 77 356 2699 [email protected] +94 11 255 2290 Arusha Michael [email protected] Shahana Kanagaratnam +94 77 395 6765 [email protected] +94 11 255 2290 Nuwan Madusanka [email protected] +94 76 858 9722

Disclaimer : This document has been prepared and issued by CT CLSA Securities (Pvt) Ltd. on the basis of publicly available information, internally developed data and other sources, believed to be reliable. Whilst all reasonable care has been taken to ensure that the facts stated are accurate and the opinions given are fair and reasonable, neither CT CLSA Securities (Pvt) Ltd. nor any director, officer or employee, shall in any way be responsible for the contents. CT CLSA Securities (Pvt) Ltd. may act as a Broker in the investments which are the subject of this document or in related investments and may have acted upon or used the information contained in this document, or the research or analysis on which it is based, before its publication. CT CLSA Securities (Pvt) Ltd., its directors, officers or employees may also have a position or be otherwise interested in the investments referred to in this document. This is not an offer to buy or sell the investments referred to in this document. It is not intended to provide professional, investment or any other type of advice or recommendation and does not take into account the particular investment objectives, financial situation or needs of individual recipients. Before acting on any information in this publication/communication, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek your own professional advice, including tax advice.

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