Utopian Investments GIRC - EFOODS

7/28/2019 Utopian Investments GIRC - EFOODS

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Utopian Investments Research This report is published for educational purposes only bystudents competing in the CFA Institute ResearchChallenge.

Ticker: ● EFOODS:PA (Bloomberg) Recommendation: ● BUYPrice: ● Rs 23.92 Price Target: ● Rs 30.17

Highlights

• Our recommendation for Engro Foods is a buy based upon a stock price of Rs30.17 for 2012 which offers an upside of 26.1% over the current price of Rs23.92. The stock is currently undervalued evident with an intrinsic price of Rs 26.85for 2011 making it value stock. The valuation corresponds to Engro Foods positionof a growing company with a diverse portfolio and a new global presence withoperations in the Middle East and North America.

• The competitive positing of Engro Foods within the segments it competes invaries for each product segment. Engro Foods being the market leader in theAmbient UHT with a projected revenue contribution of Rs22,955 million for 2011and revenues of Rs 2,709 million in the ice-cream segment, at second in the market.

The CAGR revenue growth in each segment as per our estimates for 2011-2015 willbe: UHT-21.9%, Ice Cream- 81%, Milk Powder: 120.02% and Juices-99.6%.

• The company is expected to grow revenues at a CAGR of 41.7% till 2015. Theprofit margins are projected to increase with a mean YoY growth of 98.05% and thenet financial position is expected to remain within the company target of 50% debtand 50% equity.

• The valuation of the stock price has been carried out by using a two stage DCFmodel. The two stage model is based upon a first stage of ‘high growth’ for 5 yearsand a ‘decreasing growth stage’ for the next 10 years.

• The risks for Engro Foods are primarily its rapid expansion evident with newproduct launches and business acquisitions.Other risks include the fluctuation of the Rupee Dollar exchange rate, with the rupee having depreciated to its historicalhigh of Rs 89.45, if this trend continues then the purchase of Al-safa will become an

expensive proposition by 2013. The economic conditions also pose a viable threat tothe future performance considering the GDP growth has been very low at 2.39%from the second quarter of 2010 to the second quarter of 2011.

Engro Foods Ltd (EFOODS:PA)

Date20-12-2011

Food & Dairy Industr y

orecast Summary 2010 2011(P) 2012(P) 2013(P) 2014(P) 2015(P)

ales 20944943 26,063,727 43,263,007 50,150,587 64,691,656 103,506,650

BITDA 1670727 2,368,463 3,931,396 5,524,488 7,750,125 11,402,086

et Income 175953 632712 1088066 1990710 2958724 3761123

arnings per share 0.31 0.85 1.45 2.66 3.96 4.42

urce:tp://www.bloomberg.com/apps/quote?ticker=EFOODS:A



CFA Institute Research Challenge Date

2

gure1

ource: IPO document

Business DescriptionEngro is a Pakistani company that was a wholly owned subsidiary of ECorp till its IPO in mid 2011. Thecompany was formed in 2005 and within the span of almost 6 years has diversified its product range rathersuccessfully. It started out primarily in the Ambient UHT segment followed by the company’s entrance intothe ice-cream segment with Omore and the juices market with Olfrute in 2009. The company just entered intothe milk powder category with Tarang Powder and finally with Olper’s Lite. Furthermore, the company has

also entered the rice manufacturing and the Halal meat operations with Engro Corps purchase of Al-Safa. The company has its main strengths in being able to dominate the Ambient UHT market and its successfulentrance into other product categories. The annual sales have grown with a CAGR of 93.4%; from 2006 to2010. I t outdid its competitors such as Nestle in the Ambient UHT market by capturing a market share of 39% in 2010 and had a YoY EBITDA growth of 320% from 2009 - 2010% and showing an increase inrevenues from Rs 397.5 million to Rupees 1.67 billion.

Production Facilities, Product Segments & Business Units The business of the company is divided as per four product categories: Ambient UHT, Juices, Ice-cream andPowder Milk. The business units include the Engro Supply Chain and the Global Business Unit. Theproduction plants are located in Sind and Punjab for each product category.

Milk Production and Collection The milk collection is carried out by around 900 milk collection centers that collect milk from livestockfarmers. The other source of milk for Engro is its Diary Farm that has land coverage of 557 acres and canhouse 10,000 animals.

Ambient UHT The UHT processing plants are located in Sukkar and Sahiwal that process 1.4 million liters per dayamounting to 511 million liters being processed annually.

J uices The same plants that process the Ambient UHT also produce the juice products. The contribution to therevenues of Engro Foods of the Diary and Juices is 89% at Rupees 19,670 million collectively. Warehousesare located each in Sukkar, Sahiwal and Rawalpindi and logistics with over 250 towns directly and over 225distributors.

Ice-cream The ice cream plant is located at Sahiwal in the same facility as the Sahiwal diary plant with a production

capacity of 22 million liters per annum currently and as of 2011 has contributed to around Rupees 2,709million. The distribution of ice-cream comprises of over 5000 shops directly and over 30 towns indirectly,whereas the warehouses for the ice-cream products are in several locations including Karachi, Sahiwal,Lahore and Rawalpindi.

Powder Milk The powder plant is located at Sukkar and can produce 24 tons of powder milk each day. Currently, thecontribution of this plant is the least to the revenues being generated; however Engro Foods determines itself to increase its respective market share within the next five years.

Rice Plant The rice plant was commissioned in 2010 and had a capacity for 60 Kilo Tons of rice paddy and currentlyoperates a 120 Kilo Tons. The milling capacity of the plant is 56 kilo tones which equates to 120 Kilo Tonsof paddy. The advantage of the Rice Plant in terms of power generation is via the power source of the RiceHusk based boiler that covers for most of the power needs of the plant.

Engro Foods Supply ChainIt is the subsidiary of Engro Foods that interlinks the production facilities and distribution of all the productsbeing manufactured. This subsidiary was created primarily for the purpose of managing the logistics of EngroFoods.

Global Business Unit The purpose of establishing this unit was to explore the global opportunities for Engro Foods. The result of which was the acquisition of Alsafa the oldest Halal Meat brand in North America. The claim in favor of thisacquisition can be gain of a high market size of the Halal meat market that is US $ 253 billion and the lack of established brands that offer Halal meat in the West.

gure 2: Capital Expenditurer 2011

Segment Rs(mln)

%

Dairy & Juices

3,337 64.4%

IceCream

1,091 21.05

Farm 406 7.83

RicePlant

350 6.75

Total 5,184 100ource: IPO document




3

Business Strategy The strategy of the company is based upon improving current production capacity, diversification, marketdevelopment and product development, via acquisitions and vertical integration. Details are given below:

• The capital expenditures planned by Engro Foods for the year 2011 totals up to Pak Rupees 5.184

billion for its business and production units

• The acquisition of Al-safa a Halal Meat brand in North America by Engro Corp has been planned

to be purchased by Engro Foods by 2013.• The introduction of new products on a consistent basis (Figure1).

• Engro Foods has also decided to improve its position in the Powder Milk, Ice-Cream and Juices

market. In order to do this the 70% stake that Engro possesses in the Engro Supply Chain are now

being offered for RS10.64 per share.

However, at the same time Engro has introduced its latest brand Omung to capture the untapped unprocessed-milk market, is running the operation of Al-Safa a Halal meat business in North America and the hasimproved the production capacity of each of its product segments with capital expenditure as in Figure 2.

Industry Overview and Competitive Positioning

Overall: Appendix 1 The overall positioning of Engro Foods when compared to its competitors is stronger in terms of meeting theuntapped needs of consumers, evident with the introduction of Dairy Omung and entering the Halal MeatIndustry with the acquisition of Al-safa by Engro Corp. Additionally Engro Foods future growth is basedupon diversifying its product portfolio and expanding operations globally via operations in the Middle East,North America and Pakistan.

The analysis of the industry will be based upon the product categories in which Engro Foods competes.

Ambient UHT: FigureSegment Overview

4

The milk production growth rate of Pakistan is at 2% per annum, with the growth of the Ambient UHTsegment at a CAGR of 10% from 2006-10, with an expected CAGR of 11% from 2011-15. The projectedsize of the market is expected to be at 876 million liters in 2011 (refer to Figure 3). The competitionconcentration as per the HHI is at 58.2% for 2011.Engro Foods Position The market share of Engro Foods has increased from 39% in 2010 to 44% in 2011, a 5% increase with EngroFoods maintaining its market leadership in 2011, followed by Nestle and Haleeb with market shares of 35%

gure 4

urce: Company, Student

44%

35%

10%

11%

Ambient UHT MarketShare

E Foods

Nestle

Haleeb

Others

gure 3: Market Sizes of Product Segments: 2012 -2015: Units Liters (mln), Sales Rupees (mln)

YEAR

RODUCT SEGMENT 2010 2011 2012 2013 2014 2015

mbient UHT Units (Liters) 790 876 973 1,080 1,199 1,331

Sales (Rupees) 47,000 52,170 57,887 64,253 71,332 79,860

e Cream Units (Liters) 71 79 89 100 112 125Sales (Rupees) 8,800 9,791 11,030 12,394 13,882 15,493

lk Powder Units (Liters) 540 616 702 800 912 1,040

Sales (Rupees) 27,000 30,780 35,100 40,000 45,600 52,000

ces&Nectares Units (Liters) 507 519 532 544 557 571

Sales (Rupees) 31,000 31,741 32,529 33,262 34,057 34,913

urce: Engro Foods IPO, Student Estimates




4

and 10%. EFoods estimated sales in this segment is at Rs 22,955 million, with an YoY growth of 25% and acontribution of 86% of Engro Foods 2011 estimated sales of Rs 26,063 million.

Ice- Cream: FigureSegment Overview

5

The growth of the Ice-cream segment has been at 11% from 2006-10 with expectation of unspecified higher

growth for 2011-15. The projected market size as per our estimates for 2011 is 79 million liters at a CAGR of 12% for 2011-15, with estimated sales of Rs 9,791 million. The competition concentration is at 55.1% for2011 as per the HHI.Engro Foods Position The market share of Engro Foods is at 24% in 2011 an increase of 7% from 17% 2010. The Engro Foodsmaintains its position at 2nd place with Walls leading at 44% market share and Igloo 3rd at 16%. The sales of Engro Foods for this segment is at Rs 2,709 million an YoY increase of 72%, contributing to 10% of EFoods2011 sales.

J uices: FigureSegment Overview

7

The growth of the Juices&Nectares segment has been estimated to correspond to the annual GDP growth of 2011 at 2.39% for 2011-15. The market’s size is estimated at 519 million liters for 2011, with sales of Rs31,741 million. The competition concentration is at 59.9% as per the HHI, with higher concentration amongstcompetitors below the market leader Nestle. This segment is further divided as in Figure 6.

Engro Foods PositionEngro Foods being a new entrant is with a 2% market share with the aim of focusing growth in the

Juices&Nectares and the Value Added Still Drinks.

Powder M ilk: FigureSegment Overview

8

The growth of this market is estimated at a CAGR of 14% from 2011-15 with the market size being 616million liters and Rs 30,780 million in 2011. The competition is dominated by Nestle with 98% market share.Engro Foods PositionEngro is a new entrant in this segment with only 2% market share.

Halal Meat The company currently does not own Al-safa but is managing it; however, the company claims that theacquisition of Al-safa will be carried out by 2013, thereby accessing the revenues from a global halal meatmarket that is US Dollars 250 billion in size.

Portfolio Diversification and gaining competitive edge in new segments The approach of diversification and global expansion of Engro Foods will stretch its resources. However, itcan gain at least significant market share by concentrating upon utilizing an effective promotional campaignmuch along the lines of Olpers and Omore. It is the juices sector where Nestle dominates with its high qualityproducts and when it comes to the Powdered Milk segment where Tarang has appeal for the rural and lowerincome masses. However, in the Powdered Milk segment Nestle has several products being Nido, Everydayand also powdered Milk Pak compared to Engro’s single brand.

Hence, considering Engro’s diversification in the other segments and entering new markets, it would be bestfor Engro to concentrate its efforts upon the Juices&Nectares segment and the Powdered Milk Segment, viastrong promotion of the its current products in the respective segments. If successful we estimate that EngroFoods’ segment wise contribution to the overall revenues from the Juices&Nectares segment will improvefrom Rupees 310 million to Rupees 10,351 million by 2015, contributing to around 10% of the overallrevenue from 2011 to 2015; with its current share being 2% of the overall revenue. Similarly, we estimatethat Powdered Milk segment will contribute Rupees 14,491 million by 2015, which will be 13% of theoverall revenues of Rupees 103,507.

gure 5

urce: Company, Studenttimates

44%

24%

6%

8% 8%

Ice cream

Market ShareWalls

Engro

Foods

Igloo

Yummy

Others

gure 8

urce: Company Estimates

98%

2%Milk PowderMarket Share

Nestle

Engro

Foods

ure 6

urce:Engro Foods IPO Document

77%

10%

13%

Juices Market

Segmentation

Still Drinks

Value

Added Still

Drinks

Juices &

Nectares

gure 7

urce: Company, Studenttimates

54%

8%

5%

%11%

Juices Market Share

Nestle

Maza

Sheezan

Engro

Foods

Others*




5

Figure 9: Stock Chart for ENGRO FOODS LTD (EFOODS)

Engro Foods Share Price Comparison with its peers over the past months Source: http://investing.businessweek.com/research/stocks/charts/charts.asp?ticker=EFOODS:PA

Investment Summary

Our recommendation for Engro Foods is a buy based upon a stock price of Rs 30.17 for 2012 which offers anupside of 26.1% over the current price of Rs 23.92. The stock is currently undervalued evident with anintrinsic price of Rs 26.85 for 2011 making it a value stock.

The model used for the Engro Food valuation is the Discounted Cash flow Model. The model has a two stagegrowth, with the first 5 years being the ‘high growth stage’ and the next 10 years being ‘decreasing growthstage’ which is based upon exponential decay.

The net profitability of Egnro Foods is projected to increase till 2011with a CAGR of 56.14%. The top linegrowth of the company is expected to grow with a mean YoY growth of 39.07% for 2011-15, thecontribution of the UHT product segment is expected to continue forming a major part of the revenues with50% share, followed by the Ice Cream segment at 25% by 2015. Out of the two weak product segments Juices and Milk Powder we see the latter forming the larger share of revenues due to a higher market growthat 14% CAGR and the presence of one major competitor Nestle.

With the high growth that the company is projected to have it will be able to sustain its Debt to Equityproportion of 50:50, along with a stable financial leverage position at a mean of 4.07 and an increasingcurrent ratio with 4.93% CAGR. When compared to its competitors Engro Foods is currently not efficient

enough to ensure higher profit margins.

The major risks associated with Engo foods revolves around new product launches and diversification,floods, competition, economic slowdown, operational and financial risks.

gure 11

CF model assumption

ACC 12.34%

Stage Cashow Growthate

43%

Stage Cashrowth Timeeriod

5 years

Stage Cashow Growthate

22%exponentialdecay tillperpetuitygrowth rate

Stage Cashow Growthme Period

10 years

erpetuityrowth Rate

5%

me Period toerpetuity

15 years

urce: Student Estimates

gure 10: 2 Stage DCF model

gh Growth Stage

ecreasing growth stage

ource: Student Estimates




6

Valuation

The target price of the Engro Foods stock has been projected at Rs 30.17 for the year end of 2012, providingreturns of 26.1%; hence, our recommendation is a buy. With the intrinsic value of the share at Rs 26.85 for2011 and the current market price being at Rs 23.92, the stock is undervalued, thereby making it value stockand a viable investment for investors expecting the stock to grow in the future.

The Engro Foods stock is also suitable for investors considering a growth stock, because no announcementsfor dividend payouts have been made and the earnings generated are being reinvested into the company fordevelopment. Hence, investors looking for income stocks should not purchase the Engro Food shares.

Discounted Cash Flow model: Appendix 5 The discounted cash flow has been utilized for the valuation of this stock since; the free cash flow wouldappropriately represent the earnings, because of the intensive capital expenditure of the company. A twostage DCF has been used to represent a two stage growth of the company. (Figure 10)

The first stage being classified as the ‘high growth stage’ at 43% for 5 years and the second stage beingclassified as the ‘decreasing growth stage’ (Figure 11), with the rate of decrease being taken as anexponential decay rate of 22% for 10 years, decreasing till the point of reaching the perpetuity growth rate of 5%.

The length of 15 years has been taken due to the high growth prospects of the company evident from theprojected cash flow CAGR of 43%. The ‘decreasing growth stage’ has been used based upon the negativefree cash flow resulting in the 2015 projections. However, the growth is expected to gradually slow down tillit reaches 5%.

The negative projected free cash flow of 2015 resulted from the company trying to continue its 60% salesCAGR despite a lower sustainable growth rate target of 48.47% as indicated in the SGR of 2014. Thereby,indicating that the company will have to reduce its growth over next 10 years post 2015. Thus, graduallyreducing its capital expenditure that had an YoY growth of 150% for 2014-15, also reduce its reliance uponan unsustainable debt and equity proportion of 58.4% and 41.6%, which is higher than the intended companytarget of 50% debt and 50% equity balance.

The assumptions for WACC that have been used can be seen in Figure 13

Variability in the DCF model:Due to the unstable nature of the DCF model a sensitivity analysis has been carried based upon itsfundamental assumptions of the WACC and the growth rate of the ‘high growth stage’, as seen in Figure 14. The impact of the sensitivity, for 2011 upon the prices for 2012 has been shown in Figure 16.

gure13: WACC assumptions

ACC 12.34

st of Debt 9.06

st of Equity 14.14

sk Free Rate 12

x Rate 0.35

oportion of EBT

0.35

oportion of

QUITY

0.65

ETA 1.18

M 13.81

orrowing Rate 13.94


igure14: DCF Sensitivity Analysis Cash flow Growth Rate First 5 years (high growth stage)

WACC 34 37 40 43 46 49 52

9.34 33.62 35.16 36.78 38.5 40.31 42.22 44.2410.34 28.83 30.29 31.82 33.45 35.16 36.98 38.8911.34 25.4 26.77 28.23 29.77 31.4 33.12 34.93

12.34 22.78 24.08 25.47 26.85 28.47 30.1 29.54

13.34 20.69 21.93 23.24 24.63 26.1 27.65 29.29

14.34 18.89 20.16 21.41 22.72 24.12 25.59 27.1515.34 17.54 18.66 19.85 21.10 22.43 23.83 25.31


ure 12: FCF growth

rce: Student Estimates

0%5%10%15%20%25%30%

35%40%45%50%

0500,000000,000

500,000000,000500,000

000,000500,000000,000

500,000

0 10 20

FCF

DCFC

Growth Rate

Years

upees

F




7

Financial Analysis: Appendices2, 3 & 4

The growth Engro Foods revenues is expected to occur over the next five years on the basis of a diversifiedportfolio and measures taken to conduct its operations globally. The contributions of each product segmentfor 2011-15 change as per the current market position of the company in each segment and the level of competition present.

The projections for Engro Foods for 2011-15 have been based upon a sustainable growth rate for each year as

shown in Figure 15 The growth rates selected for each year help maintain the debt to equity proportion closeto 50:50 as per the company target, additionally increasing the profitability of the company with a mean YoYgrowth of 98.05%. The projections have a sensitivity analysis performed upon the basis shown in Figure 15(Appendices 6 to 20) to represent fluctuations that might occur.

Contribution to Engro Foods revenues as per product segments: Figure 17 & 18

Figure 15

Projection’s Sensitivity Analysis

Year SGR % CAGR % dec 10% Target% inc 10%

2010 60.60 93.11

2011 58.44 76.86 66.86 76.86 86.86

2012 53.95 75.00 65.00 75.00 85.002013 34.65 65.00 55.00 65.00 75.00

2014 48.47 60.00 50.00 60.00 70.00

2015 66.44 60.00 50.00 60.00 70.00

Source: Student Estimates

Figure 17: Product Segment Sales Contribution %: 2011-15


0%

20%

40%

60%

80%

100%

Milk

Powder

Juices

Ice-

cream

UHT

20152011 2012 2013 2014

Figure 18: Product Segment Sales Contribution: Rupees (000)

2011 2012 2013 2014 2015

Revenue 26,063,727 43,263,007 50,150,587 64,691,656 103,506,650

UHT 22,955,080 30,284,105 3,209,976 35,580,411 50.718,259

Ice Cream 2,606,373 5,191,560 752,338 12,938,331 27,946,796

J uices 635,529 3,461,041 451,403 7,762,999 10,350,665

Milk Powder 616,275 4,326,301 601,870 8,409,915 14,490,931


igure 16:Impact of 2011ensitivity f or the 2012arget price

2011 201217.54 19.7018.66 20.9618.89 21.2219.85 22.3020.16 22.6520.69 23.2421.10 23.7021.41 24.0521.93 24.6422.43 25.2022.72 25.5222.78 25.5923.24 26.1123.83 26.7724.08 27.0524.12 27.1024.63 27.6725.31 28.4325.40 28.5325.47 28.6125.59 28.7526.1 29.3226.77 30.0726.85 30.1627.15 30.5027.65 31.06

28.23 31.7128.47 31.9828.83 32.3929.29 32.9029.54 33.1929.77 33.4430.1 33.8130.29 34.0331.4 35.2731.82 35.7533.12 37.2133.45 37.5833.62 37.77

34.93 39.2435.16 39.5035.16 39.5036.78 41.3236.98 41.5438.5 43.2538.89 43.6940.31 45.2842.22 47.4344.24 49.70

ource: Student estimates




8

Ambient UHT The UHT segment maintains a prominent revenue contribution till 2015 at around 50% with the target tomaintain market leadership in market that is expected to grow at 10% CAGR and a competitive market with acompetition concentration of 58.2%.

Ice Cream

The contribution of ice-cream is projected to have around 25% contribution worth Rs 27,946 million by 2015to the overall revenues. Due to a growing market’s CAGR of 14% till 2015 and the company’s intendedtarget to maintain the 2nd position in this segment.

The competition concentration increasing from 52.7% to 55% as per the HHI corresponding with anincreasing market share of the company from 17% to 24% represents the segment competition concentrationin favor Engro Foods. Thus, forming the basis of our estimates for its increasing contribution to Engro Foodsrevenues.

Milk Powder The Milk Powder segment is expected to be the third largest contributor to the company’s revenues at Rs14,490 million by 2015 and share of 14% upon the basis of only one major competitor in the tea-whitenercategory that Engro Foods competes in. Hence, the lower switching costs for consumers will make it easier togrow the sales of this product.

J uices & Nectars The contribution of this segment will be the least at Rs 10,350 million by 2015, due to the high level of competition and concentration of competition at 60% as per the HHI.

Earnings The net profitability of the company is expected to grow at a CAGR of 56.14% and the revenues with aCAGR of 41.17%. The EBITDA and EBIT margins increase at CAGRs of 4.93% and 7.90% for the period2011-15, representing the increase in efficiency of the company’s operations. The utilization of assets togenerate sales improves with a reduction from 33.58% of sales to 19.16% to generate increasing revenues. The profitability margins and the profits as compared to the revenues can be seen in Figures 19 and 20.

Balance Sheet & Financing

gure 19: Revenues & Profit Margins: 2010-15


0.00%

5.00%

10.00%

15.00%

0

20000000

40000000

60000000

80000000

00000000 Net sales

EBT

Margin

EBITDA

Margin

EBIT

Margin

OCF to

sales*2010 2011 2012 2013 2014 2015

gure 20: Sales & Earnings


0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

0

20,000,000

40,000,000

60,000,000

80,000,000

100,000,000

120,000,000

Net sales Net profit EBT EBIT EBITDA OCF2010 2011 2012 2013 2014 2015

Rupees Rupees




9

The debt and equity proportion remains relatively stable with the means of the debt ratio and the equity ratiobeing 43.17% and 56.28% respectively for 2011-15, on an average being below the company target of 50:50debt to equity proportion.

The debt to equity ratio is maintained at an average of 0.82 for 2011-15 without any additional shares beingissued after the 48 million shares sold in 2011. The projected financial position allows the company to

facilitate its purchases of the Global Business Unit for Rs 800 million in 2012 from Engro Corp and theproposed purchase of Al-safa at US $ 10-15 million by 2013.

Cash Flow The projected free cash flows depict a healthy position for the company despite increasing capitalexpenditures growing at a CAGR of 46.5%. The OCF to sales remains stable with mean of 6%, standarddeviation of only 1% and growing at a CAGR of 3.9%. When it comes to the cash flows, the cash flow/shareremains positive and increases from 0.91/share to 2.65/share from 2011-14. However, the negative cash flowin 2015 is only temporary because of the increased investment for further growth taking into considerationthe growth prospects of Al-Safa with a global market of more than US Dollars 250 billion.

Competitive Comparison: Figures 21 and 22 The comparison of Engro Foods with its peers reveals that Engro Foods is not as profitable as its competitorssince its profits began generating in 2010. With the EBITDA margins Nestle out-performs Engro Foods byalmost twice with 15.06% and Unilever outperforms Engro Foods at 12.27%.

The returns generated for the amount of equity used by Engro Foods is projected at 9.09% compared toNestlé’s 69.65% and Unilever's 143.59%, this again can be attributed to the fact that Engro Foods is still in ahigh growth phase, with greater returns in the coming years.

The efficiency of Engro Foods in terms of generating sales is closely competitive at a projected 2.98 timesasset turnover outperforming Nestlé’s 2.4 times asset turnover and close to Unilever’s 3.5 times assetturnover. The projected 4.72% returns on assets reflects upon Engro’s Foods higher costs when compared toNestlé’s ROA of 18.92% and Unilever’s ROA of 24.55%, this shortfall can be attributed to Engro Foods’high growth stage.

Engro Foods And Corporate Social Responsibility In order to facilitate the farmers and help improve their production Engro foods has developed a program incollaboration with USAID. This program includes conducting workshops, providing training to the new

farmers, distribution of necessary material related to livestock, medical camps for the livestock andconstruction of facilities such as milk collection centers. Due to these services a farmer living in a far ruralarea can also gain knowledge of the modern agricultural techniques. All these services are offered to thefarmers free of cost, and also help in improving the production quantity and quality.

Investment Risks

Strategic RisksBecoming unsuccessful in gaining the market share in the Milk Powder and juices segments. The launch of new products such as Omung, Flavored might not be as successful as originally thought to be in terms of tapping up the unprocessed milk segment of the population. However, the masses might not look at it as anunprocessed processed since it is packaged milk. The risk of lack of consumption results from a matter of perception. The risk for the flavored milk lies in the apparent lack of demand for the product.

Strong Competition The Juices& Nectares segment is strong in terms of competition with a competition concentration of 60%may not let Engro foods capture market share as easily as has been the case in the Ambient UHT segment. The dominance of Nestle in the Milk Powder Segment will act as a barrier in terms of Nestle being able tocontrol the market pricing, the flexibility of Engro Foods to dictate pricing or alter their own to compete willbe difficult with a 98% competition concentration.

Financial & Business Risk: Appendix 21 The financial and business risk that the company faces can be measured via the coefficient of variation in theROIC which can be referred to as the business risk since it measures the operative risk in terms of the capitalinvested. The financial risk can be measured in terms of the variability of the EPS, the ROE and the EBIT. It

gure 21: Competitivemparison

atios Engro Foods Nestle

2010 2011(P)

TDArg .98% 9.09% 5.06%

OA 1.41% 4.72% 8.92%

OE .43% 9.09% 9.65%

Marg 0.97% 1.00% 6.26%

:Lt.A 2.38 2.98 2.4

PS 0.31 0.85 90.69

renttio

1.48 1.71 1.00

urce: Student estimates,p://investing.businessweek.com

gure 22: Competitivemparison

tios Engro Foods Unileve

2010 2011(P

BITDAMrg

7.98% 9.09% 12.27%

ROA 1.41% 4.72% 24.55%

ROE 3.43% 9.09% 143.59%

P Marg 20.97% 21.00 33.94%

es:Lt. 2.38 2.98 3.5

EPS 0.31 0.85 279.48

urrentRatio

1.48 1.71 0.70

urce: Student estimates,p://investing.businessweek.com




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can be seen in Figure 23 that the ROIC is the second most variable measurement because Engro Foods is agrowing company requiring heavy capital investment. The variability in the EBIT also signifies the business risk in terms of the operations costs which need tomonitored for growth in the event of revenue fluctuations. The highest variability is that of the EPS whichshows that with the growth oriented direction the fluctuations in growth targets will impact the earnings dueto possible debt financing and its leverage costs that the company would incur.

The different between the ROE and the ROIC shows that the company is using leverage and should continueto monitor is debt financing in order to maintain is financial leverage and proportion of debt and equity. Inorder to minimize these risks the company should monitor the SGR and maintain growth targets relative to itsthreshold.

Fluctuation of exchange rates The ever depreciating Pakistani Rupee against the US Dollar reached its record high at 89.45 in December2011. Though it may increase the exports of Engro Foods however, the bigger problem will be the purchaseof Al-safa from Engro Corp in 2013. The estimated cost of al-safa will be 10 to 15 million Us Dollars, if theRupee does not appreciate then the cost of purchasing will increase dramatically for Engro foods and hence,become a burden on their means of financing, increasing their tendency to borrow. The company has anagreement with Engro Corp of continuing its current status of managing Al-safa while Egro Corp continuesto own it, in the event of the company being unable to acquire Al-safa.

Economic conditions

The economic conditions in Pakistan have been generally deteriorating over past several years. The biggestconcern for Engro Foods would be the level of inflation in the country, which can in the future cause anincrease in the interest rate, increasing the cost of borrowing and making it difficult for Engro Food to relyupon debt financing however, currently the discount rate is low. The annual GDP growth has been 2.39%during the second quarter of 2011 over the same quarter of the previous year. The GDP growth of Pakistan isnot robust so the impact of improving economic conditions should not be relied upon but should beconsidered as detrimental for business activity, against which safeguards should be taken; such as usingResearch and Development, carrying out production and operations reviews in order to make product moreeconomical or of greater value or even reducing labor costs. (For economic indicators see Appendix 22)

Floods The floods can impact the production facilities; however, the company has taken protective measures such asinstalling water pumps to reduce any damage due to flooding.

Figure 23

Coe of Variation 10% inc Projections 10% inc

ROIC 0.09 0.32 0.12

ROE 0.31 0.46 0.25

EBIT 0.40 0.60 0.65

EPS 0.19 0.58 0.35

Mean 10% inc Projections 10% dec

ROIC 8.42% 16.81% 9.25%

ROE 8.48% 0.21 8.68%

EPS 0.66 2.67 0.92





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Disclosures:

Ownership and material conflicts of interest: The author(s), or a member of their household, of this report [holds/does not hold] a financial interest in the securities of this company. The author(s), or a member of their household, of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content orpublication of this report. [The conflict of interest is…]Receipt of compensation:Compensation of the author(s) of this report is not based on investment banking revenue.Position as a officer or director:

The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company.Market making:

The author(s) does [not] act as a market maker in the subject company’s securities.Ratings guide:

Banks rate companies as either a BUY , HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greaterover the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index.A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns overthe next twelve months.Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, butthe author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be usedas the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with [Society Name], CFAInstitute or the CFA Institute Research Challenge with regard to this company’s stock.

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