EFOODS: 1QCY17 EPS to clock in at PKR0.14, down 90% YoY
Wednesday, 12 April 2017
By: Taurus Securities Limited
Engro Foods Limited (EFOODS) is scheduled to announce its 1QCY17 results on 13th Apr ‘17, wherein we expect the company to post earnings of PKR108mn (EPS: PKR0.14), down 90% YoY from PKR1.07bn (EPS: PKR1.39) in SPLY. The drop in profitability is on account of declining market share and diminishing margins. We anticipate the top-line of the dairy producer to record a decline of 16% YoY on the back of stiff competition emanating from the emergence of new competitors and aggressive marketing campaigns carried out by some of the existing players. Gross margins are expected to depict a huge contraction of 15ppts, to settle at 13% for 1QCY17 against 28% in SPLY. We expect margins to decline in the wake of i) a 28% YoY surge in average SMP prices for the quarter (USD2,450/ton vs USD1,910/ton in SPLY), ii) 12% YoY increase in average HPO prices (USD680/ton vs USD608/ton in SPLY), iii) imposition of 25% Regulatory Duty (RD) on import of SMP, and iv) introduction of technical assistance fees to be paid to the parent company “RFC”.
Engro Foods Limited (EFOODS) posted earnings of Rs331mn (EPS Rs0.43) versus Rs1,100mn (EPS1.45) last year, down 70% YoY.
We attribute decline in sales to pressure from entrants in the dairy product segment.
The situation is further exacerbated by company’s attempts to pass on the impact of change in its taxation status from zero rated to exempt.
Besides, imposition of 25% regulatory duty (in addition to 20% import duty) on powdered milk caused the margins to shrink by 8pps to clock in at 20%.
Lower distribution & marketing (down 26% YoY) expense and taxation rate (down 9pps YoY) has provided some respite to the bottomline.
Rising competition from entrants as well as from existing players amid low disposable income and higher raw material prices would keep profitability in check, in our view. However, product diversification and technical assistance provided by acquirer would ease these concerns. Moreover, we believe resolution of electricity shortages along with infrastructure development should revitalize ice cream segment. However, we have an“Underperform” stance given exclusion of any potential benefits of acquisition as we await clarity on this front.
Engro Foods Limited (PSX: EFOODS) announced its 1QCY17 financial performance yesterday, and it hardly had any surprises; the food company continued with its dwindling profit perfomance amid heated competition. Earning for 1QFY17 are down by 70 percent year-on-year, and there was no dividend, announcement.
CY16 was a challenging year where the firm reported a decline in earnings. Revenues continued to fall and there was some volume and gross profit tightening as volumetric growth remained under pressure in the tea whitener segment due to changes in tax regime and increased competition. The changes in the tax regime came from budget 2016-17 that included a change in the GST regime from zero rating to exempt, which has resulted in an increase in the cost.
These constraints have continued their way in FY17 as well. And apart from the squeeze in the tea-whitener sales, the firm has also been facing pressure from higher international milk prices, which is likely to cap gross margins further with already limited pricing power of the industry.
EFOOD’s share price has also on a losing streak; the lacklustre perfomance of the stock on the stock exchcange is indicative of weak fundamentals and rising competitive forces keeping EFOODS down. Now that the Dutch firm, FrieslandCampina has taken over EFOODS, it will be interesting to watch how the firm gets out of the rut and turn things around. CY17 will be an important year if EFOODS wishes to turn the tables!
Having lost 41%CYTD, EFOODS dismal price performance is reflective of wary investor confidence. Fundamental weakness has gained prominence where apart from continuous volumetric regression; the recent recovery in international milk prices is an added pressure. In this regard, FAO dairy index is up 8.7%YoY since Jan'17 bringing CYTD average to 193.7 points (highest since 2015). This holds negative implication for the company's margin profile which is already under stress from the stiffening competition in the dairy space. Incorporating higher input costs, our EPS estimates for CY17F/CY18F now stand at PkR2.55/3.05 (revised down by 18%/17%), dragging our TP down to PkR138.7/sh (previously at PkR162.1/sh). Going forward, while expecting the new management to prioritize product enhancement, the period in transition is likely to witness slower earnings growth (5yr forward earnings CAGR of 9%) especially with pressure on volumes intact. That said, plans to diversify/extend current product lines are factors that can turn us bullish on the stock. .
FAO dairy index rebounds sharply: Averaging 193.7points CYTD, the FAO dairy index has been on a mend, pushing the index close to its three year high. In this regard, limited export availabilities in major milk producing countries amid firm domestic demand from Europe remained the key factors behind the price uptrend. Bearing negative implications for EFOODS, the recovery in prices is likely to limit cost savings from imported milk powder, leading us to revise down our Gross Margin (GM) assumption by 50bps/30bps in CY17F/CY18F.
CY17F- nothing exciting so far: CY17F is shaping up to be a slow year especially with the new management at the helm of affairs. Profits are likely to remain subdued where apart from volumetric regression, cost pressures from steady rise in international milk prices amid limited pricing power are expected to keep earnings under stress. That said, possible diversification into high margin milk derivatives like milk powder (commercial launch has been stalled for long) provides sizable growth potential (NESTLE is the only dominant player in the market) and revenue upside (potential revenue jump of 2.1% p.a assuming 3% market share).
Investment Perspective: While room for performance remains following such steep price correction, we remain skeptical on the company's growth potential until noticeable fundamental improvements particularly via product innovations and market recapturing. At our revised TP of PkR138.7/sh, we currently have an Accumulate stance on the stock.