Sri Lanka | Beverage, Food & Tobacco EQUITY RESEARCH Initiation of coverage 19 December 2013 Cargills (Ceylon) PLC (CARG.N0000) A consumption play Cargills (Ceylon) PLC (CARG) is the largest organized food retailer by market Key statistics capitalization listed on the Colombo Stock Exchange (CSE), and also CSE/Bloomberg tickers CARG.N0000/CARG SL manufactures a range of fast-moving consumer goods (FMCG) and operates a Share price (18 Dec 2013) LKR149 fast-food chain. The company is majority owned by its parent company CT No. of issued shares (m) 224 Holdings PLC (CTHR), itself one of the largest traded conglomerates on the Market cap (USDm) 258 CSE. We expect the typical signs of consumption growth, such as rising GDP Enterprise value (USDm) 363 and private consumption expenditure, to support CARG’s revenue growth, at Free float (%) 20.5% an 11.3% CAGR over FY14E-FY16E. We also forecast CARG’s EBIT margin to 52-week range (H/L) LKR184/143 expand to 4.3% in FY16E from 4.1% in FY13. Margin development across all Avg. daily vol. (shares,1yr) 43,098 segments is likely to be tempered by persisting high operating costs, Avg. daily turnover (USD 55 particularly electricity and fuel expenses, as well as currently underwhelming ‘000) results from the brewery and biscuits businesses. CARG’s debt and gearing Source: CSE, Bloomberg levels in the past three years have risen due to a string of acquisitions and Note: USD/LKR=129.1 (average for the one year ended 18 investments to expand capacity of several product lines. Our SOTP and P/E December 2013) analyses yield a valuation range of LKR110-149, compared with the share price of LKR149 as of 18 December 2013. Share price movement We forecast revenue to post an 11.3% CAGR over FY14E-FY16E as 130% consumption levels are set to improve. CARG’s revenue is likely to be driven by its retail segment, which we forecast to also grow at an 11.2% CAGR to FY16E, 120% spurred by improving macroeconomic indicators, such as increasing GDP per capita and consumption expenditure. We also expect CARG’s supermarket count to grow 110% 38% to 292 stores in FY16E from 211 as at the end of FY13, compared with an almost 50% increase over FY10-FY13. The aforementioned factors should also 100% support the growth of the FMCG segment, at a forecast CAGR of 11.2%, as 90% increasing purchases of processed and convenience goods combine with enhanced Dec-12 Feb-13 May-13 Jul-13 Oct-13 Dec-13 capacity of several product lines to boost CARG’s revenue inflows. CARG ASPI S&P SL 20 CARG’s EBIT margin to expand only slightly by 18bps through FY16E, Source: CSE, Bloomberg restrained by cost pressures. We forecast an EBIT margin of 4.3% in FY16E, relatively flat compared with its FY13 figure of 4.1%. We estimate the retail Share price performance segment’s margin to widen 17bps to 4.0% in FY16E, while economies of scale from the recent capacity expansions in the FMCG segment should improve the margin 3m 6m 12m 14bps to 4.3% in FY16E. CARG’s overall margin growth will feel the pinch from CARG -4% -12% -4% increasing operating costs, particularly higher electricity and fuel expenses, in addition to the currently loss-making brewery and biscuits operations. S&P SL 20 -1% -9% 6% All Share Price Index 0% -6% 5% CARG’s relatively high net debt and gearing levels may limit investments in the short-term. Over the past three years, CARG has undertaken several Source: CSE, Bloomberg acquisitions and capacity expansion activities, mostly funded by debt, which climbed Summary financials to LKR14.4bn in 2QFY14 – up almost fivefold from FY10. Due to this rise in debt, CARG’s gearing levels have increased to 55% in 2QFY14 from 33% in FY10 and LKRm (year end 31 should result in a high interest expense over FY14E-FY16E; the company’s interest March) 2013 2014E 2015E cover ratio has fallen to 1.8x in FY13 from 3.3x in FY10 as a result. Consistent Revenue 55,379 61,373 69,802 negative free cash flow (FCF) generation may also make large investments unlikely EBITDA 3,604 4,191 4,815 in the near term. EBIT 2,262 2,431 2,950 We establish a share price range of LKR110-149, compared with the current Net profit 1,630 774 1,168 share price of LKR149. We used the SOTP valuation technique to arrive at a valuation range of LKR110-149, inclusive of bull- and bear-case scenarios. Our P/E Recurrent EPS 7.3 3.5 5.2 analysis suggests that CARG currently trades at a 2014E P/E of 42.8x – a 7% ROE (%) 13.7 6.3 8.6 premium to our normalized P/E of 40.0x – and yields a valuation range of P/E (x) 20.9 42.8 28.3 LKR131-145 by factoring in a 5% premium and a 5% discount to this normalized P/E Source: CARG, Amba estimates to account for potential positive and negative considerations, respectively. 1 A capital market development initiative by the Colombo Stock Exchange in association with Amba Research Cargills (Ceylon) PLC Table of Contents CARG to post a revenue CAGR of 11.3% over FY14E-FY16E on the back of improving consumption trends .................. 3 CARG is positioning itself to capture the anticipated enhanced demand for organized food retail ....................................................... 3 Current low penetration of modern food retail highlights growth potential ............................................................................................ 5 FMCG revenue to grow at an 11.2% CAGR through FY16E ................................................................................................................ 6 Restaurant revenue to rise at a CAGR of 14.4% through FY16E ......................................................................................................... 7 Potential risks to the food retail sector .................................................................................................................................................. 8 EBIT margin to modestly widen 18bps to 4.3% in FY16E as cost pressures persist .......................................................... 9 Retail EBIT margin to expand 17bps supported by retail volume growth ................................................................................................... 9 FMCG margin to widen 14bps, driven by recent investments in capacity expansion and new products .............................................. 9 Restaurant margin to expand 10bps, fueled by more consumers dining out in the local restaurant sector ........................................ 10 Downside risks to margins .................................................................................................................................................................. 11 High debt level and negative FCF generation could restrict investment opportunities in the near term ........................... 12 We arrive at a valuation range of LKR110-149 for CARG shares ..................................................................................... 14 Our SOTP analysis yields a valuation range of LKR110-149 per share ............................................................................................. 14 P/E analysis yields a fair value range of LKR131-145 per share ........................................................................................................ 16 Other sources of potential upside/downside ....................................................................................................................................... 16 Relative valuation data used as a measure of comparison ................................................................................................................ 17 Share price performance .................................................................................................................................................... 18 Earnings release focus areas ............................................................................................................................................. 19 Appendix 1: Company overview......................................................................................................................................... 20 CARG’s business segments ............................................................................................................................................................... 21 Management strategy, transparency and governance ........................................................................................................................ 22 Shareholding structure ....................................................................................................................................................................... 22 Board of directors ............................................................................................................................................................................... 23 Appendix 2: Key financial data ........................................................................................................................................... 25 Summary group financials (LKRm) ..................................................................................................................................................... 25 Key ratios............................................................................................................................................................................................ 26 Segmental summary ..........................................................................................................................................................................