DHOFAR CATTLEFEED (DCFI.MSM)

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1 INVESTMENT RESEARCH ANALYSTS COMPANY UPDATE September 9, 2009 Anil Kumar, CAIA Vice President - Research anilkumar@fincorpinv.org Tel: (+968) Joyce Monteiro Analyst joyce@fincorpinv.org Tel: (+968) Ext.340 DHOFAR CATTLEFEED (DCFI.MSM) Core operations see an improvement from lower raw material costs while fair value gains on its quoted AFS investments accrue to equity. Stock trades below its book value. RECOMMENDATION : BUY CMP : RO TARGET PRICE : RO VARIANCE : 23% INVESTMENT OPINION TABLE 1: FINANCIAL INDICATORS CMP (September 08, 2009) MCAP (RO Mn) EPS TTM (RO) (0.033) BV (RO) P/E TTM Dhofar Cattlefeed (DCFI) stands to gain from falling raw material costs (fodder, fruits) and price revision in its products in the current fiscal in its core business of dairy and beverages. Cost of raw materials is the largest overhead for the company and margins often tend to be volatile depending on these costs. Gross profit margin in H substantially improved to 28% from 18% in H The company reported its highest gross margin in recent times of 32% as it benefitted from lower input costs and a proactive pricing policy. We expect gross margin to expand further in Q owing to higher sales during Ramadan and stable raw material costs. Sales are expected to be weaker in Q4 and our estimate of turnover for the company in 2009 is RO 22.1 million, 3% higher YoY. Operating profit jumped 153% over Q to RO 730K in Q For H1 2009, the company reported an operating profit of RO 1 million as against a loss of RO 196K in H Net profit increased to RO 1 million in Q versus a loss of RO 255K in Q helped by higher other income. However, EPS fell 82% YoY to 11 baisas in H owing to sharply lower investment income. The recovery in MSM since April 2009 has improved significantly the net asset value of its quoted AFS portfolio which rose 49% sequentially in Q The MSM 30 index has risen around 12% in the first two months of Q and therefore further gains can be assumed. The management has appointed an independent auditor to determine the carrying value of their unquoted investments which will be reflected in Q We estimate the net asset value of its AFS portfolio and investment properties to be RO per share as on August 31, 2009 (see page 6). We value the fair value of its core business on a continuing basis at RO a share using DCF computation (see page 5). The fair value of the group using Sum of Parts approach is therefore RO 0.397, around 23% higher than its last traded price. The stock trades significantly below its book value and hence presents an attractive BUY opportunity. The main negatives for the company are its negative cash position (bank overdrafts) due to weak cash flows from operations, uncertainty regarding its unquoted investment portfolio and tough competition from stronger regional players like Almarai. Neg P/BV 0.61 NETWORTH (RO Mn) ROAE (TTM) 5.20% TOTAL ASSETS (RO Mn) ROAA (TTM) 3.55% DEBT/EQUITY 0.46

2 BUSINESS MODEL Dhofar Cattlefeed Company SAOG (DCFI) is a leading producer and distributor of dairy products, beverages and animal feed in Oman commanding an 85% market share in Salalah and a 15% market share in Muscat. The company s business segments comprise of Dairy & beverages Animal feed Agriculture & Farming Poultry breeding for sale of meat & eggs (through its subsidiary Dhofar Poultry Co. SAOG) Sale of plastic products (through its subsidiary, International Plastics Co. LLC) Figure 1 : DCFI sales breakup as of June 30, 2009 Animal Feed Mill 23% Poultry 10% Agriculture 4% Plastics 1% Dairy & Beverages 61% DCFI sells its dairy, beverage and poultry products under the brand name A'Safwah. Dairy & beverages make up around 61% of total sales. The company has a milk processing plant with a production capacity of around 30 million litres per annum currently operating at 60% capacity utilization. The company owns a large herd of cattle in the Dhofar region which offers excellent climatic conditions for herd management. DCFI has built an in house PET bottle manufacturing facility for its dairy & beverage products besides processing and packaging facilities. Milk offers the highest profit margin in its product portfolio in excess of 15% closely followed by laban. The company faces stiff competition from GCC dairy producers such as Almarai, Al Rawabi etc. Nonetheless, the management believes that consumers in Oman still preferr local products owing to their unique taste besides being available fresh. Apart from its strong local presence, DCFI exports its products to countries like Yemen. In keeping with growing demand and need to increase its market share, local as welll as its exports, the company plans to set up a new state of the art milk parlour and is taking steps to improve the yield per cow. Further, DCFI owns about 500 acres of farmland at Salalah where it grows crops used as fodder for its livestock. Besides growing locally, fodder is imported in bulk whose prices tend to be volatile. The Government of Oman has imposed a ban on cultivation of hay as it consumes a large quantity of water. The company has therefore stopped growing hay and has switched to growing alternative crops like maize and sorghum which absorbb less water and at the same time nutritionally beneficial to its livestock. However, these crops require more cultivation time (around 4 months) compared to growing hay (around 35 to 40 days). The company has stated in its reports that it awaits clearance from the local administration to start a more efficient irrigation system in its fields once its land occupation issue is resolved. FINCOR P INVESTMENT RESEA RCH Page 2

3 Also the company has made a number of investments having diversified into business activities other than dairy, poultry & farming, besides owning an investment portfolio valued at RO 22.5 million at the end of H As of June 30, 2009 DCFI s direct investments in the form of subsidiaries and associates are as shown in table 2 below: TABLE 2: INVESTMENTS AS OF JUNE 30, 2009 SUBSIDIARIES COUNTRY HOLDING DHOFAR POULTRY CO. SAOG OMAN 85.00% INTERNATIONAL PLASTIC INDUSTRIES CO. LLC OMAN % ASSOCIATES OMAN VEGETABLE OILS & DERIVATIVES CO. LLC OMAN 37.50% DHOFAR BEVERAGES AND FOODSTUFFS CO. SAOG OMAN 30.45% Q PERFORMANCE DCFI has reported a turnover of RO 5.61 million for Q2 2009, registering a 6% YoY decline. On a sequential basis the company has reported an increase of 9% owing to an upward revision in prices. Gross profit margin improved substantially to 32% in Q from 19% in Q and 23% in Q as raw material costs came down sharply from the previous year s high prices. For the period H1 2009, DCFI reported a total turnover of RO million, a marginal decline from RO million in H We expect gross TABLE 3: CONSOLIDATED PROFIT/LOSS AT A GLANCE IN (RO 000) Q Q Q TURNOVER 5,612 5,158 5,975 COST OF GOODS SOLD 3,827 3,950 4,865 GROSS PROFIT 1,785 1,208 1,110 GPM% 32% 23% 19% TOTAL EXPENSES 1, ,009 OPERATING PROFIT OPM% 13% 6% 2% NET PROFIT* 1,037 (255) 2,321 NPM% 18% 5% 39% EPS (0.004) * Attributable to common equity margin to hold firm in the next two quarters as prices of agro based commodities including fruits have been declining steadily since the start of this year. The company is therefore expected to do well in its core business owing to lower raw material cost on one hand while demand for food products is largely unaffected by the economic slowdown. However, a sharp decline in the value of its investment portfolio as compared to that in Q has resulted in a net profit of only RO 1 million in Q2 2009, a decline of 55% YoY. Net profit rose on a sequential basis from a loss of RO 255K in Q due to higher gross profit and other income. EPS was RO in Q as against a loss of RO during Q For H1 2009, DCFI reported a consolidated net profit attributable to common stock at RO 0.78 million as against RO 4.29 million recorded in H EPS for H was at RO as against RO in the first half of the previous year. FINCORP INVESTMENT RESEARCH Page 3

4 Total assets of the company declined to RO 57 million in H as against RO 73 million in H The AFS portfolio currently makes up for approximately 40% of the total asset base of which RO 16 million are quoted investments. Much of the investments lie in the Banking/Investment sector amounting to a total of RO 9.81 million as of H Unquoted investments were valued at RO 7 million at the end of December 31, The management has appointed KPMG to revalue its unlisted portfolio which is expected to be reflected in the company s Q results. As a result there TABLE 4: CONSOLIDATED BALANCE SHEET AT A GLANCE IN (RO 000) H H PP&E 16,118 15,145 AFS 22,569 33,977 INVENTORIES 4,314 5,953 TOTAL RECEIVABLES 3,083 4,250 TOTAL ASSETS 57,109 72,693 TOTAL DEBT 17,225 17,035 TOTAL PAYABLES 2,534 3,841 NETWORTH* 37,072 51,572 NET ASSETS PER SHARE * Attributable to common equity is a risk of write down in the value of its unquoted investments which can result in a lower networth. The company s debt equity ratio declined from 0.62x in 2008 to 0.46x in H Total networth attributable to common stock amounted to RO 37 million and net assets per share at RO TABLE 5: SHAREHOLDING PATTERN SHAREHOLDER COUNTRY % HOLDING MUSCAT OVERSEAS MARKET CO. LLC OMAN 17.83% SHEIKH MUSTHAIL AHMED AL MASHINI OMAN 13.92% AL RAWAS INVESTMENTS & DEVELOPMENT CO. LLC OMAN 10.47% STOCK PRICE PERFORMANCE DCFI has underperformed the MSM index exhibiting YTD losses of 33% as against YTD gains of 16% on the MSM Index. The stock has a 3 year statistical beta of 0.33 which may not be exactly representative as it suffers from poor liquidity. We instead use its levered beta of % Figure 2: Price movement of DCFI 0% MSM DCFI 10% 20% 30% 40% 50% 60% 70% Source: MSM FINCORP INVESTMENT RESEARCH Page 4

5 VALUATION Dhofar Cattlefeed has a significant investment portfolio of appoximately RO 24.8 million in its balance sheet which made up 43% of its total assets at the end of June 30, Typically, the company s operating profit is far less volatile than its net profit as it does not include investment income, realized gains/losses etc. We therefore value this company using Sum of Parts technique where in we value its investment portfolio separately from its core operations. The value of its core business (non investment related) has been estimated using the Discounted Cash Flow method while the net asset value of its investment portfolio has been estimated as of August 31, DISCOUNTED CASH FLOW ANALYSIS We expect sales in Q to be 10% higher over Q due to higher demand during the holy month of Ramadan. However, sales are expected to be weak in Q due to drop in both volume and possible lowering of prices. We have assumed an EBIT margin of 5 6% in our explicit forecast. Weighted average cost of capital for DCFI turns out to be 7.66%. Capex and depreciation rates are assumed to be nearly the same between 5% and 6%. Terminal growth rate has been assumed at 2%. The fair value for the core operations of DCFI on a continuing basis is estimated as RO TABLE 6: FORECAST OF FCFF (RO 000s) E 2010E 2011E 2012E 2013E REVENUE 11,923 16,053 21,484 22,101 23,427 24,833 26,323 27,639 YoY GROWTH 35% 34% 3% 6% 6% 6% 5% EBIT 365 (402) 372 2,036 1,874 1,490 1,579 1,658 EBIT MARGIN 3% 3% 2% 9% 8% 6% 6% 6% PP&E 13,668 17,156 19,929 21,255 22,661 24,151 25,467 26,849 DEPRECIATION 1,309 1,577 1,063 1,133 1,208 1,273 1,342 DEPRECIATION/PP&E 0% 8% 8% 5% 5% 5% 5% 4% CAPEX (5,942) (4,835) (1,295) 1,326 1,406 1,490 1,316 1,382 CAPEX/SALES 50% 30% 6% 6% 6% 6% 6% 5% IN WCAP 1,331 (2,460) 108 IN WCAP/SALES 11.2% 15.3% 0.5% 0% 0% 0% 0% 0% TAX RATE 12% 12% 12% 12% 12% 12% 12% 12% FCFF 4,932 8,250 3,091 DISCOUNTED FCFF 1,528 1,377 1,029 1,097 1,162 Terminal Value 1,491 1, ,206 TABLE 7: WACC R f 4.50% R m 11.00% 3 YR BETA 0.59 COST OF EQUITY 8.32% PROPORTION OF EQUITY 69% PROPORTION OF DEBT 31% COST OF DEBT 6.16% TAX RATE 12% WACC 7.66% TABLE 8: FAIR VALUE COMPUTATION TERMINAL GROWTH RATE 2.00% DIS TERMINAL VALUE (RO 000) 15,206 DIS FCFF EXPLICIT 5,306 FIRM VALUE 20,512 NET DEBT 15,679 EQUITY VALUE (RO 000) 4,833 OUTSTANDING SHARES ( 000) 70,000 FAIR VALUE PER SHARE (RO) FINCORP INVESTMENT RESEARCH Page 5

6 NET ASSET VALUE OF INVESTMENT PORTFOLIO The company has reported the value of its quoted investments at RO 15.5 million at the end of June 30, We estimate the value of its quoted investments to be RO million applying the MSM 30 index return of 12% during the period June 30 August 31, The company has stated that it will be revaluing its unquoted investment portfolio at the end of Q As most of these investments are in the form of illiquid private equity investments we have assumed a 50% writedown in their value on a conservative basis. The net asset value of the company s investment portfolio works out to RO per share which is marginally higher than that reported as of Q In the event, the unquoted portfolio does not witness any significant impairement, then the net asset value will turn out to be much higher. TABLE 9: NET ASSET VALUE In RO Million June 30, 2009 August 31, 2009 (estimates) Quoted Investments Unquoted Investments Trading Portfolio Investment Properties Total No. of outstanding shares (million) Net Asset Value Per Share (RO) As shown in Table 10 below our target price turns out to be RO representing a potential upside of 23%, from the closing price of RO on September 08, TABLE 10: TARGET PRICE METHOD FAIR VALUE Discounted Cash Flow (Core operations) Net Asset Value (Investment Portfolio) EXPECTED FAIR VALUE PER SHARE (RO) RELATIVE VALUATION We have included Oman Flour Mills (OFMI) in the peer group of DCFI as OFMI has a feed mill division. The table below compares the valuation multiples amongst the peers. TABLE 11: PEER COMPARISON INDICATORS DHOFAR CATTLEFEED OMAN FLOUR MILLS SAUDIA DAIRY & FOODSTUFFS COUNTRY OMAN OMAN SAUDI ARABIA P/E TTM NEG P/BV EV/EBITDA ROE TTM NEG 14.31% 6.32% DIV YIELD 0.0% 5.0% 0.0% FINCORP INVESTMENT RESEARCH Page 6

7 INVESTMENT RESEARCH Anil Kumar VP Research (+968) Joyce Monteiro Analyst (+968) Ext. 340 Mable Pereira Analyst (+968) Ext. 340 BROKERAGE/CUSTOMER CARE Abdullah Al Hinai Broker (+968) Ext: 334 FAX (+968) Issam Ali Baqer Broker (+968) Ext: 332 FAX (+968) Abdul Kareem Online trading (+968) Ext: 306 Muna A. Al Hashimi Customer care (+968) Ext: 330 Disclaimer The research team of The Financial Corporation, SAOG (hereto referred as FINCORP) has prepared the information, analysis and expressed its opinion on the subject matter of this report. The information contained has been obtained from sources believed to be reliable and in good faith, but which may not be verified independently. While utmost care has been taken in preparing the above report, FINCORP makes no guarantee, representation or warranty, whether express or implied, and accepts no responsibility or liability as to its accuracy or completeness of the data, being provided. All investment information and opinions are subject to change without notice. The investor will indemnify FINCORP and its directors, officers, and employees against any loss or damage or other liabilities (including costs), which they may suffer as a result of reliance on this report. This report is not to be relied upon in substitution for the exercise of independent judgment. Also, not all customers may receive the material at the same time. This document is for private circulation and information purposes only. It does not and should not be construed as an offer to buy or sell securities mentioned herein. FINCORP will not be liable for any direct or indirect losses arising from the use thereof, and the investors are expected to use the information contained herein at their own risk. FINCORP and its affiliates or their officers, directors and employees may own or have positions in any investment mentioned herein or any investment related thereto and from time to time add to or dispose of any such investment. FINCORP and its affiliates may act as market maker or assume an underwriting position in the securities of banking companies discussed herein (or investments related thereto), and may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those banking companies. Authors or contributors of this report could have direct interest in the capital market or in the securities mentioned herein. The investments discussed or recommended in this report may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position, and using such independent advisors, as they believe necessary. Income from investments may fluctuate. The price or value of the investments, to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. This document is strictly for the use of recipients only. None of the material provided herein may be reproduced, rewritten, rehashed, published, resold or distributed in any manner whatsoever without the prior and explicit written permission of FINCORP. FINCORP INVESTMENT RESEARCH Page 7