Egypt: Arabian Food Industries (Domty) – Too many uncertainties: HOLD
Statement from Renaissance Capital on its initiation of coverage of Domty shares:
We initiate coverage of Arabian Food Industries (Domty) with a HOLD rating and a TP of EGP8.8/share. We believe that cheese, which makes up c. 85% of revenue, will experience a slowdown in growth given the already high rates of per-capita consumption (PCC) in Egypt. We also expect the highly-competitive juice category to face volume and pricing pressure. Lastly, we believe the new strategy of trying to bring distribution in-house and entering the snack foods category could put pressure on margins. In view of these uncertainties, despite our forecast of a top-line CAGR of c. 23% and a bottom-line CAGR of 25% for FY16-21, we do not believe a forward P/E of 19.6x (on our estimates) is an attractive entry point.
Main source of revenue to slow and juice is highly competitive
Domty is the dominant player in the cheese segment in Egypt, with a total market share of 12% in 2015 but a share of 41% in white cheese. Domty offers four different categories of cheese and close to 200 SKUs. Cheese made up close to 85% of revenue as of FY15, and our analysis on the segment suggests that penetration levels are fairly high; we forecast that value growth in this category will slow to 20% pa in FY16-21, from 28%-plus growth historically. The juice category is a relatively new area for the company, and it went from zero market share in FY12 to 7% in FY15. However, we believe larger players with stronger balance sheets, such as Juhayna Food Industries (BUY, TP EGP9.00, CP EGP7.01) and Almarai (not covered), are already stepping up to limit Domty’s growth, which we believe was evident from Domty’s 1Q16 numbers, where juice gross profits dropped by >30%.
New categories outlook not certain and operational risks exist
Management is using the proceeds of the March 2016 IPO to change the distribution model and expand into the snack food industry. We believe margins will come under pressure from these changes, with SG&A costs already increased by >50% in 1Q16. We believe building brand loyalty for the cheese sandwich snack product will take time, as will bringing distribution in-house – the benefits of which are not guaranteed.
Not cheap enough to compensate for risks: Initiate with HOLD
We believe historical earnings growth has been too volatile to establish a clear trend, and the entry into new business segments could further amplify volatility in earnings and margins – something already suggested by the 1Q16 numbers. Despite our forecast of a top-line CAGR of c. 23% and a bottom-line CAGR of 25% for FY16-21, we believe this is all currently priced in. Domty trades on a forward P/E of 19.6x, on our estimates, vs the peer group’s 20x, which we think is not an attractive enough entry point to compensate for the uncertainties currently facing the business. Our DCF- (50%) and P/E- (50%) derived TP is EGP8.8/share, using WACC of 15.7% and terminal growth of 5%.