WE Detailed Report March 2013 EFOODS - A seed turning into fruition We initiate

the coverage of Engro Foods Limited (EFOODS) with a Dec'13 Target Price of Rs
161/share, offers an upside of 29% -BUY. We have used (DCF, P/S ratio, P/E ratio and
P/BV method) to arrive the target price as it's a food group company and major
players of the group are NESTLE, UNILVER, MFFL & NATF. Our bullish view is on back
of increasing market share, uptick in milk prices, diversion of masses towards UHT
milk from unprocessed milk, followed by in-house milk procurement through Nara
farm and continuous expansion in other food group segments. We estimate top line
average growth of 22.21% (2013-2015), gross margins to average at 27% (20132015), average market share of 56% (2013- 2015), and milk price to grow at a
CAGR of 5% (2013-2015). The key risks to our estimates are 1) No barriers to entry
in the segment, 2) Upsurge in discount rate, 3) Failure of new business lines and 4)
high inflationary environment. CY13: A Booming Year l We expect CY13 to be a
booming year for Efoods as they are planning l to re-launch juice segment and
further new products are in the pipeline l Earnings to zoom +45% YoY in CY13
translating into PAT of Rs 3,769 l million (EPS: Rs 4.95) and ROE to clock in at
37.50% l We expect Nara Farm and Ice-cream segment to come into operating l
profit and would support the bottom-line l Going forward launch of powdered milk
plant would result cost efficien cy l and would help reaping higher margins EFOODS
Financial Snapshot CY12A CY13E CY14F CY15F Net Sales (Rs mn) 40,169 53,570
62,396 72,881 Profit after Taxation (Rs mn) 2,595 3,769 5,308 7,212 EPS (Rs) 3.41
4.95 6.97 9.47 Book Value (Rs/share) 13.21 18.16 25.13 34.61 DPS (Rs) - - 1.00 2.00
P/E (x) 35.83 24.67 17.52 12.89 P/BV (x) 9.25 6.73 4.86 3.53 P/S (x) 2.31 1.74 1.49
1.28 EBITDA Margin (%) 18.40 19.60 22.40 25.10 ROE (%) 25.8 27.3 27.7 27.4 ROA
(%) 11.70 13.87 16.52 19.01 Source: Company Reports & WE Research KEY DATA
KATS Code EFOODS Reuters Code ENFL.KA Current Price (Rs) 124.5 Year High, Low
(Rs) 134 , 92.33 Market Cap (Rs' bn) 95 Market Cap (US$ mn) 957 Shares
Outstanding (mn) 761 Free Float (%) 12 Source: KSE, Reuters & WE Research
Source: KSE Engro Foods Limited Price Relative to KSE 100 Index 10,000 12,000
14,000 16,000 18,000 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12
Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 20 50 80 110 140 KSE 100
INDEX EFOODS Index PKR 1 WE Detailed Report March 2013 Valuation: BUY with a
Target Price of Rs 161 We have used 4 different valuation methods to arrive at a
consensus target price. Our valuations in detail would be as follows which are based
on Discounted Cash Flows, Price to Sales Ratio, Price to Book Value and Price to
Earnings multiple. Method 1: Discounted Cash Flow Rs in million CY13E CY14F
CY15F CY16F Net Income 3,769 5,308 7,212 10,859 Non Cash Expense 1,446 1,685
1,909 2,133 Change in Working Cap 1,474 (327) (332) (365) CAPEX (2,738) (2,440)
(2,439) (2,441) Free Cash Flow to Equity 3,581 3,262 4,187 8,124 Discounted Free
Cash Flow 3,581 2,842 3,179 5,376 Terminal Value 98,674 PV Terminal Value 80,280
Shares Outstanding 761 Target Price Dec'13 (Rs) 106.02 Source: WE Estimates
Method 2: Price to Sales Ratio (Comparison with peers) Sector P/S ratio 2.34 Efoods
CY13E Sales/share 70.39 Target Price 165 Source: WE Estimates Method 3: Price to
Earnings Ratio (Comparison with peers) Sector P/E ratio 25.92 Efoods CY13E EPS

4.95 Target Price 128.34 Source: WE Estimates Method 4: Price to Book Ratio
(Comparison with peers) Sector P/B ratio 27.09 Efoods CY13E BV/share 18.16 Target
Price 491.91 Source: WE Estimates Final Valuation Fair Value Weightage %
Contribution in TP DCF 106.02 50% 53.01 P/S Ratio 164.71 20% 32.9 P/E Ratio
128.34 20% 25.7 P/BV Ratio 491.91 10% 49.19 Target Price 160.8 Source: WE
Estimates 2 WE Detailed Report March 2013 A quick look to CY12 Engro Foods has
posted PAT of Rs 2,595 million (EPS: Rs 3.40) up side of +191% YoY in bottom line
versus PAT of Rs 891 million (EPS: Rs 1.17) in CY11. Earnings growth came from
increase in top line by +35% YoY with support from increase in volumetric milk sales
by 25% YoY, increase in market share to 51% and increase in gross margins to
25.7% from 22.2% in CY11. EFOODS juices segment still incurring losses but
company is working in back yard to change their strategy for expansion. Ice cream
business is incurring gross loss but volumes and value have improved, moreover
market share is increasing gradually as Omore brand has established its significant
presence in the market. Company's indoor milk production farm finally made some
gain but a good gesture for contribution in 2013 is expected. What we see in 2013
and beyond EFOODS is importing powdered milk plant in CY13 and as per our
information plant likely to be commissioned between JulyAug'13, this would help
company to improve cost efficiencies resulting in better gross margins. Moreover
company is also considering launch of Halal meat Canada's product into local
market in order to tap the growing potential of packaged meat needs. In its analyst
briefing, company revealed that it is planning to improve its market share in ice
cream and juice businesses which still need to shoulder the single-handed growth
from milk business. We believe 2013 will be the big year for EFOODS in terms of
profitability and further diversification in food business. Foreigners Interest in
Strategic Investment? De-listing of UNILVER Pakistan is helping the company's
presence in the exchange, and foreigners are taking their positions in the stock
along with big local institutions despite low free float of 12%. Lately there were
rumours of Al Marai- KSA taking exposure in EFOODS but still no clarification from
the management. We believe any stake sell off by the ENGRO Corp would be above
Rs120/share particularly based on growth potential in the company. Earnings growth
came from increase in top line by +35% YoY with support from increase in
volumetric milk sales by 25% YoY, increase in market share to 51% and increase in
gross margins to 25.7% from 22.2% in CY11. EFOODS is importing powdered milk
plant in CY13 and as per our information plant likely to be commissioned between
July-Aug'13, this would help company to improve cost efficiencies resulting in better
gross margins. 3 WE Detailed Report March 2013 Efoods has changed the dynamics
of the sector Engro Foods since entering in 2005 has shown a tremendous growth
ever witnessed by a company in Pakistan's history. Previously dairy sector was
dominated by Nestle and other small/medium size players across the country
because at the time market had little space. Since launch of Efoods the sector
dynamics have changed, it has created public awareness towards processed milk
which resulted in CAGR of 10% (2006-2012) in UHT milk market which jumped up
from 515mn litres annual sales to 919mn litres in CY12. Whereas Efoods has shown

CAGR of 41% (2006-2012), consequently now it holds market share of 51% in

CY2012 up from 12% in CY06. The major turnaround has been in tea whitener
(Tarang) it's the leader in tea whitener segment and then followed by product DAIRY
OMUNG (cheaper than unprocessed milk) which resulted in lifting market share.
Other players in the industry also jumped in by launching their products which has
developed new market for UHT milk producers. Margins improved significantly
Efoods is part of FMCG sector where volumetric growth is the key factor that drives
the profitability. Efoods volumetric sales improved significantly over the years
followed by higher inflation scenario in last few years which forced milk prices to
tick up continuously (unprocessed and processed). Company has formed its own
Nara farm with more than 3,900 herds along with continuous CAPEX to make the
whole process more efficient. By launching various product lines other than UHT
milk (Olpers) i.e. TARANG, OLWEL, OLPERS LIGHT, OMUNG and Flavored Milk the
average sale price per litre comes up above Rs95/ litre currently, whereas milk
processing cost remains unchanged. Similarly expansion of ice cream business
supports the milk sale indirectly. Consequently company's Gross, EBITDA and Net
margins have shown tremendous growth over the years and likely to inch up. On
other side marketing expense ratio is on the declining side down to 11% in CY14E
from 16% in CY06, whereas both operating profit and volumetric sales increasing
YoY. Previously dairy sector was dominated by Nestle and other small/medium size
players across the country because at the time market had little space. Since launch
of Efoods the sector dynamics have changed, it has created public awareness
towards processed milk which resulted in CAGR of 10% (2006- 2012) in UHT milk
market which jumped up from 515mn litres annual sales to 919mn litres in CY12.
Source: We Research Source: We Research 4 Source: We Research Key Risk No
barriers to enter into milk/dairy business Pakistan's is the 6th largest milk producer
in the world and the local market is growing rapidly but still sizeable share is of
unprocessed milk (88%) where as other private sector players are jumping into the
business every year on medium to large scale. Pakistan is agrarian economy thus it
naturally supplement the business along with support from govt in terms of taxation
and financing. We believe expansion from Nestle or entry of any other big player
international/local player would hurt the market share of Efoods. Initially no one
expected that Efoods would replace Nestle in term of market share but now it's a
reality. We cannot rule out the fact that market share can be cut down for new entry
of any medium scale player as well. Upsurge in discount rate Pakistan is most likely
expected to go for another IMF loan program that would result in upward move in
discount rate, our valuations would go south in such scenario and we believe the
discount rate has bottomed out. Failure of business line Efoods profitability mainly
comes from milk business where as other segments juice/flavored milk and icecream have either made losses or struggling. Especially Efoods has rolled back its
juice segment which is likely to be re-launched in future. We believe other product
lines would be introduced in next 2 years and big failure from new products would
limit the profitability growth to some extent. High inflation Rising energy cost to
affect the general price level of commodities and would also affect the margins of

the company along with other than milk products volumetric sale. WE Detailed
Report March 2013 5 Company Introduction Engro Foods started its business in
CY05 and its principal business is to produce process and sell dairy and other food
products. Efoods has established plants at Sukkur and Sahiwal for processing and
selling branded UHT milk. It has a powdered milk plant in Sukkur (with an annual
capacity of 5,000 tons) and another is being built in Sahiwal (with an annual
capacity of 10,000 tons). It has an ice cream manufacturing facility in Sahiwal,
which has an annual capacity of 36m litres. It also has a fruit juice plant, a dairy
farm and more than 1,300 milk-collection centres spread across the provinces of
Punjab and Sindh. Efoods has attained clear market leadership in the Pakistan UHT
industry, with a share of 51% at the end of 2012. It has launched multiple new
products, including ice cream, flavored milk, fruit juices and milk powders that show
significant potential. As part of its growth strategy, Efoods is looking to become a
diversified food company with a complete range of products in all major segments,
from confectionary to culinary, infant foods and ready-to-cook meals. Efoods intends
to become the premier food company in Pakistan. WE Detailed Report March 2013
Source: Company Report 6 WE Detailed Report March 2013 EFOODS - Financial
Highlights Valuation CY12A CY13E CY14F CY15F EPS (Rs) 3.41 4.95 6.97 9.47 Book
Value (Rs/share) 13.21 18.16 25.13 34.61 DPS (Rs) - - 1.00 2.00 P/E (x) 35.83 24.67
17.52 12.89 P/BV (x) 9.25 6.73 4.86 3.53 P/S (x) 2.31 1.74 1.49 1.28 Source: WE
Research & Company Reports Key Ratios Analysis CY12A CY13E CY14F CY15F
Current Ratio (x) 1.76 1.70 1.68 1.65 ROE (%) 25.8 27.3 27.7 27.4 ROA (%) 11.70
13.87 16.52 19.01 Gross Margin (%) 25.69 26.39 27.02 27.08 Operating Margin (%)
12.00 12.70 14.31 15.91 EBITDA margin (%) 18.50 19.70 22.70 25.30 Net Margin
(%) 6.46 7.36 8.78 10.09 Sales Growth (%) 34.53 33.36 16.48 16.80 PAT Growth (%)
191.27 52.03 38.92 34.24 Source: WE Research & Company Reports Income
Statement Rs in million CY12A CY13E CY14F CY15F Sales 40,169 53,570 62,396
72,881 Cost of Sales 29,848 39,435 45,535 53,141 Gross Profit 10,321 14,135
16,861 19,739 Distribution & marketing. Expenses 4,709 6,428 6,864 7,288
Administrative Expenses 741 830 967 729 Other Operating Expenses 430 473 520
572 Operating Profit 4,823 6,805 8,932 11,593 Finance Cost 903 1,007 766 498
Profit before Taxation 3,921 5,798 8,166 11,095 Taxation 1,326 2,029 2,858 3,883
Profit after Taxation 2,595 3,769 5,308 7,212 Source: WE Research & Company
Reports 7 WE Detailed Report March 2013 Balance Sheet Rs in million CY12A CY13E
CY14F CY15F Share Capital 7,616 7,616 7,616 7,616 Shareholder Equity 10,054
13,823 19,131 26,342 Non Current Liabilities 7,693 8,017 6,787 3,920 Current
Liabilities 4,441 5,335 6,209 7,674 Total Liabilities 12,134 13,351 12,996 11,593
Non Current Assets 12,676 13,968 14,722 15,252 Current Assets 9,513 13,206
17,404 22,684 Total Assets 22,189 27,174 32,126 37,936 Source: WE Research &
Company Reports Cash Flow Statement Rs in million CY12A CY13E CY14F CY15F
Cash from Operations 2,898 4,037 5,564 7,352 Cash from Investing activities
(3,138) (2,738) (2,440) (2,439) Cash from Financing 1,726 (369) (1,758) (2,944) Net
change in Cash 1,486 930 1,366 1,969 Beginning Cash balance 1,645 3,131 4,061
5,427 Ending Cash balance 3,131 4,061 5,427 7,396 Source: WE Research &

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