DAIRY SECTOR : MARGIN RECOVERY IN PROCESS

June 6th, 2018 – HC Brokerage raised Juhayna’s 12-month target price c36% to EGP16.1/share. For Domty, they raise our 12-month target price c29% to EGP13.9/share and therefore maintain their Overweight rating for both companies.

Equity Analyst, Consumers Sector at HC Brokerage, Noha Baraka stated that, Market indicators suggest there was broad-based market slowdown in 2017 that was more aggressive than we initially anticipated. To us, the aggressive price hike environment has posed a drag on volumes, which indicates that demand was more elastic to price increases.

Although we expect to see an improvement throughout 2018e, as already evident by Juhayna and Domty’s 1Q18 results, the expected inflationary pressures stemming from another round of subsidy cut in July will likely further weigh on private consumption, in our view. Our new estimates point to volumes being fully restored by early 2019e, later than our previous 2H18e forecast, as inflation moderates to an average 12.8% from an expected 15.0% this year on the upcoming round of economic reform measures and the fuel and electricity subsidy adjustments. We still expect Domty to stand a better chance than Juhayna in terms of volume recovery despite fierce competition in part due to its cheese products, which are a low-cost, relatively high-protein food. This is in addition to the company ramping up utilization rates of its Domty Plus brand, which saw great acceptance from customers and has secured bulk sales to one of its big clients. Noha added.

Over the short term, we expect Domty’s margins to recover faster than Juhayna’s on a more favorable skimmed milk powder cost outlook, which is a key pillar for margin expansion. This, along with the company’s efforts to fully restore its raw milk price discount advantage, should accelerate margin recovery. Our numbers point to a c14% y-o-y drop in the blended milk cost in 2018e. Notwithstanding this, the aggressive pricing strategy in 2017 has allowed Domty to withstand a c13% higher EGP/USD rate, further supporting our estimates of 5.6 pp margin expansion in 2018e. As for Juhayna, we estimate its blended milk cost will grow c15% y-o-y in 2018e on a less favorable milk cost outlook, reflecting a higher EGP/USD rate given the depletion of the whole milk powdered milk inventory it had procured earlier at low prices.

However, we expect this to be largely offset by the price increases the company is planning to adopt throughout the year, thus implying a 1.3 pp increase in 2018e margins. Both companies’ ongoing cost efficiencies by localizing a big portion of their raw materials, continued sales‐mix shifts toward higher margin products, constant portfolio optimization, and boosting retail sales should also support restoring margins back to historical levels. According to Noha.

Noha Added, We still favor Juhayna on stronger balance sheet, healthier cash flow cycle, and higher potential return: We raise our valuation for both companies as we roll over our forecast period 1 year. We also adopt a blended moving WACC to account for potential interest rate cuts, which translates to a lower average cost of capital than we previously used. We continue to add a 1‐year semi‐explicit period to our forecasts to account for the lower growth in perpetuity, which has a significant impact on our FCF calculation for the terminal year. We raise Juhayna’s 12-month target price c36% to EGP16.1/share. Our new target price implies a 2019e P/E multiple of 16.0x and EV/EBITDA multiple of 9.6x, and offers a potential return of c28% over the 4 June closing price of EGP12.5/share. We therefore maintain our Overweight rating. In our view, the current valuation is compelling, with the stock trading at a c62% discount to its peers’ implied 2019e EV/EBITDA multiple of 19.0x. For Domty, we raise our 12-month target price c29% to EGP13.9/share. Our new target price implies a 2019e P/E multiple of 10.5x and EV/EBITDA multiple of 8.1x and offers a potential return of c27% over the 4 June closing price of EGP10.9/share. We therefore maintain our Overweight rating. The stock is trading at a c60% discount to its peers’ implied 2019e EV/EBITDA multiple of 16.2x.

Finally, Noha Said that Juhayna remains our top pick within the dairy sector on a stronger balance sheet, a healthier cash flow cycle translating to higher FCF yields, and a higher potential return.