Cargills (Ceylon) PLC (CARG) 1QFY15 results

Sri Lanka Beverage, Food & Tobacco EQUITY RESEARCH Earnings review note 02 September 2014 Cargills (Ceylon) PLC (CARG) 1QFY15 results Key highlights and outlook Revenue grows, while margins are impacted by several charges: CARG posted revenue of LKR15.9bn (up 8.0% YoY) in 1QFY15, driven by growth of 9.0% YoY from the retail segment, which accounts for roughly 83% of group revenue. Higher operating costs, along with several other expenses (mainly an irrecoverable VAT charge of LKR190m, a loss of LKR116m arising from the scale down in brewery operations, and costs relating to restaurant refurbishment), which were not there in 1QFY14, resulted in the EBIT margin narrowing by 165bps to 2.6%. The lower net finance cost was not enough to offset a higher income tax expense that included a one-off tax charge of LKR101m due to the transfer of fixed assets as a part of the company s restructuring process. This resulted in CARG recording a net loss of LKR145m and a negative EPS of LKR0.65. Key developments: On June 20, CARG announced that it had entered into an agreement with Lion Brewery (Ceylon) PLC (LION) and Pearl Springs (Private) Limited (a wholly owned subsidiary of LION) to dispose of its stake in Millers Brewery Limited (CARG s brewery operations, which comes under the FMCG segment) for roughly LKR5.15bn. CARG expects the transaction to be completed during 2QFY15. Furthermore, on August 25, CARG announced that International Finance Corporation (IFC) plans to make a private equity investment in Cargills Foods Company (Pvt) Limited (CFC), a wholly owned subsidiary of CARG, which carries out its retail business. Under the proposed agreement, IFC will invest LKR2.55bn (roughly USD20m) to obtain an 8% stake in CFC. Revising our forecasts: We lower our FY15E revenue estimate to LKR62.0bn (from our prior estimate of LKR63.9bn) mainly to incorporate the revenue loss from the disposal of its brewery operations. However, we have maintained our FY15E EBIT margin at 4.3%, as we believe higher operating costs will be offset by a possible margin improvement in the FMCG segment, following the disposal of its brewery operation, which was incurring a loss. As a result, we lower our FY15E EPS estimate to LKR3.17 (from LKR3.32). Valuation outlook: After incorporating CARG s 1QFY15 results, our valuation range has slightly increased to LKR115-154 (versus our previous estimate of LKR111-148). Refer to page 2 for further details on our valuation outlook. Segmental review and our forecasts CARG s retail segment (83% of revenue in 1QFY15) grew 9.0% YoY to LKR13.1bn driven new store additions and possible growth in same store sales. According to our calculations, as of 30 June 2014, we believe CARG had 255 stores under operations. The segment s EBIT margin contracted by 257bps to 2.5% in 1QFY15 due mainly to an increase in costs associated with a LKR190m VAT adjustment. Furthermore, higher operating costs also dragged margins lower. We have maintained our FY15E retail segment revenue forecast at LKR49.3bn. However, we have slightly lowered the FY15E EBIT margin to 3.9% (down from prior 4.2%) to account for costs associated with the irrecoverable VAT impact, as a result of recent fiscal measures, which limit the volume of VAT-exempted supplies to 25% starting from January 2014. Key statistics CSE/Bloomberg tickers Share price (01 Sep 2014) No. of issued shares (m) Market cap (USDm) Enterprise value (USDm) Free float (%) 52-week range (H/L) Avg. daily vol (shares,1yr) Avg. daily turnover (USD 000) CARG.N0000/CARG SL LKR160 224 275 403 20% LKR165/135 17,441 20 Note: USD/LKR=130.8 (avg. for the one year ended 01 Sep 2014) Share price movement 130% 120% 110% 100% 90% 80% Aug-13 Nov-13 Jan-14 Apr-14 Jun-14 Sep-14 Share price performance 3m 6m 12m CARG 12.3% 18.5% 1.9% S&P SL 20 12.2% 20.3% 18.9% All Share Price Index 12.3% 18.4% 20.5% Summary financials LKRm (quarter end 30 June) 1QFY15 1QFY14 YoY change Revenue 15,906 14,727 8.0% EBITDA 942 1,045-9.8% EBIT 414 625-33.8% Net profit to equity holders CARG ASPI S&P SL 20 (145) 121 NM Reported EPS (0.65) 0.54 NM ROE (%) (4.8) 1.7 (6.45ppts) P/E (x) NM 174.4 NM 1

The FMCG segment (14% of revenue in 1QFY15) reported revenue of LKR2.2bn (up 3.3% YoY). We believe slow revenue growth could be primarily attributed to the scale down in production of its brewery operation in anticipation of the spin-off, which offset strong growth seen in diary operations, the largest business line within the segment. The segment s EBIT margin came in at 3.0% (up 444bps from the year-ago quarter) and was impacted by a LKR116m loss associated with the scale down in the brewery operation. We have lowered our FY15E revenue estimate to LKR10.3bn to incorporate the loss of revenue from its brewery operations. However, we have increased our EBIT margin to 4.2%, as we believe the disposal of the high-volume, low-margin brewery business, which had tempered the segment s margins, would provide a margin improvement going forward. CARG s restaurant segment (3% of revenue in 1QFY15) comprises the KFC chain of fast food outlets (28 in total as of end-1qfy15) and the TGI Friday s restaurant, which opened during FY14. Revenue came in at LKR544m, a modest growth of 5.4% YoY and posted a negative EBIT of LKR25m, as three restaurants were closed for refurbishment during the period, while operating costs continued to escalate. We have maintained our FY15E revenue forecast of LKR2.4bn; however, we have lowered our EBIT margin to 6.5% (versus prior 9.6%), as we expect the restaurant segment to continue to be impacted by lower diner footfall, which we believe is due to the increasing variety and number of restaurants currently in the market, as well as the presence of numerous lower-priced informal food outlets. At the end of 1QFY15, CARG s gearing level increased to 59.6% (up from 57.7% as at end-fy14) mainly the back of an 8.2% QoQ increase in short-term debt. Valuation outlook: After incorporating CARG s 1QFY15 results and the value from Cargills Bank Limited, our 12-month valuation range increase slightly to LKR115-154 (from LKR111-148), based on our DCF/SOTP and P/E analyses. Our DCF/SOTP valuation yields a share price range of LKR115-154 using our base-case assumptions of a risk-free rate of 9.0% and a market risk premium of 6.0%. We also use bull- and bear-case scenarios to arrive at this valuation range by considering a higher/lower number of Cargills store openings during our explicit forecast period of FY15E-FY17E, compared with our base-case forecast. Beyond FY17E, we consider an improved/worsened revenue performance compared with our base case, and also easing/worsening cost pressures affecting the margin. CARG currently trades at an FY15E P/E multiple of 50.5x, higher than its three-year normalized forward P/E of 40.0x. Our P/Ebased scenario analysis applies a 5% premium/discount to this multiple, resulting in a valuation range of LKR120-133. This multiple premium may be validated by better-than-expected growth in CARG s retail segment, on the back of improving consumer demand and an increase in the proportion of shopping done at supermarkets, while the discount could be justified based on sluggish consumption levels affecting the performance of the retail and FMCG segments. Figure 1: The valuation range analysis provides a range of LKR115-154 per share (current share price: LKR160) SOTP 115 154 160 P/E analysis 120 133 52-week range 135 165 100 125 150 175 200 Source: CARG, Bloomberg, Copal Amba estimates 2

Appendix 1: Results summary Income statement (LKRm, except where stated otherwise) 1QFY15 4QFY14 1QFY14 QoQ change (%) YoY change (%) Revenue 15,906 10,212 14,727 55.8% 8.0% Cost of goods sold 13,945 7,986 12,774 74.6% 9.2% Gross profit 1,962 2,226 1,954-11.9% 0.4% EBITDA 942 853 1,045 10.5% -9.8% EBIT 414 395 625 4.8% -33.8% Finance costs 327 722 402-54.7% -18.7% Profit before tax 84 384 243-78.0% -65.2% Tax expense 229 64 119 258.8% 91.4% Profit for the period (144) 320 123-145.0% -216.8% Net income attributable to equity holders of the parent (145) 319 121-145.5% -219.8% Diluted EPS (LKR) (0.65) 1.43 0.54-145.5% -219.8% Financial summary of key segments Revenue (LKRm) 1QFY15 1QFY14 % change FY15E FY16E FY17E Retail 13,115 12,036 9.0% 49,356 53,337 57,147 FMCG 2,247 2,175 3.3% 10,298 11,431 12,688 Restaurant 544 516 5.4% 2,369 2,433 2,497 EBIT (LKRm) 1QFY15 1QFY14 % change FY15E FY16E FY17E Retail 330 612-46.1% 1,945 2,293 2,572 FMCG 67 (32) -311.8% 428 475 527 Restaurant (25) 39-164.1% 154 163 172 Note: Full-year figures are for the year ended 31 March 3

Appendix 2: Key financial data Summary group financials (LKRm) INCOME STATEMENT 2012 2013 2014 2015E 2016E 2017E (For the year ended 31 March) Revenue 48,256 55,379 58,323 62,024 67,201 72,332 EBITDA 3,415 3,604 3,897 4,678 5,094 5,461 EBIT 2,241 2,262 2,211 2,693 3,097 3,437 Earnings before Tax (EBT) 1,558 2,143 1,130 1,329 1,667 1,981 Net profit available to equity holders 1,049 1,613 643 710 1,145 1,360 BALANCE SHEET 2012 2013 2014 2015E 2016E 2017E (As at 31 March) Current assets Cash and cash equivalents 518 887 602 981 1,433 1,614 Short-term investments 141 362 537 605 605 605 Total current assets 8,676 9,590 10,763 11,207 13,960 14,979 Non-current assets Property, plant and equipment 14,230 20,638 22,121 22,253 22,556 23,008 Intangible assets 1,731 1,665 1,708 1,706 1,706 1,706 Total non-current assets 16,261 25,981 28,582 29,730 31,034 32,486 Total assets 24,937 35,571 39,345 40,938 44,994 47,464 Current liabilities Short term debt 7,369 12,276 15,481 16,749 16,749 16,749 Total current liabilities 16,451 20,460 24,094 25,152 27,747 28,497 Non-current liabilities Long term debt 243 1,850 1,289 1,415 1,731 2,091 Total non-current liabilities 1,017 3,071 2,941 2,775 3,091 3,451 Equity Total equity 7,468 12,039 12,310 13,011 14,156 15,516 Total liabilities and equity 24,937 35,571 39,345 40,938 44,994 47,464 CASH FLOW STATEMENT 2012 2013 2014 2015E 2016E 2017E (For the year ended 31 March) Net cash flow from operating activities 4,076 2,106 2,754 3,529 4,855 4,742 Net cash flow from investing activities (3,848) (6,517) (3,472) (2,191) (2,300) (2,476) Net cash flow from financing activities (1,934) 4,631 2,887 (1,288) (2,103) (2,085) Net increase/(decrease) in cash and cash equivalents (1,706) 220 2,168 50 452 181 KEY RATIOS 2012 2013 2014 2015E 2016E 2017E EBIT margin (%) 4.6 4.1 3.8 4.3 4.6 4.8 Net profit margin (%) 2.2 2.9 1.1 1.1 1.7 1.9 ROE (%) 14.2 13.5 5.2 5.5 8.5 9.2 Debt/capital (%) 50.5 54.0 57.7 58.3 56.6 54.8 P/E (x) 37.2 21.1 47.6 50.5 31.3 26.4 4

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