JS Securities Limited – Morning Briefing

Karachi, May 16, 2019 (PPI-OT): Food sector: 1QCY19 margins dip on inflationary pressures, bottom-line down 29% YoY

The Food sector’s revenues witnessed a meagre growth on account of on-going slowdown in economic activity where sales growth during 1QCY19 clocked in at 2% YoY only.

However, as increase in revenue remained almost across the board, overall sector’s revenues remained almost flat due to decline in NETSLE’s revenues (45% of sector). Ex-NESTLE revenues augmented by 15% YoY.

Moreover, partial pass on of inflationary costs, rupee devaluation and higher interest rates took the bottom-line down by 29% YoY.

Going forward, we expect gross margins of the sector to remain under pressure, given potential increase in energy prices, rupee devaluation and continuing sluggish consumer demand.
1QCY19: Revenues increase, profits decline
We review Food sector’s 1QCY19 profitability where we have compiled a sample consisting of ten companies mentioned in the table at the end as a proxy to the listed food sector. The sector’s revenues grew by 2% YoY only during 1QCY19 in the on-going slowdown in economic activity. Moreover, cost push inflation led to gross margins shrinking by ~400bps YoY to 26% as we believe food companies prefer volumetric increases over price increases by passing incremental costs to the end consumer

In addition, higher working capital requirements, coupled with sharp rise in interest rates also led the finance cost to almost double during 1QCY19 (+92% YoY); where a 35% YoY jump in Short term Debt increased the sector’s Debt to Equity to 1.22x from 1.05x during the same period last year. As a result, the sector’s bottom line shrunk by 29% YoY, where Net margins slid down to 6%, from 9% during 1QCY18.

Heavy-weight NESTLE witnesses revenue decline

Increase in revenue was seen almost across the board, where Macto Foods’ (MFL) growth clocked in the highest among peers at 32% YoY. However, the giant food company Nestle Pakistan (NESTLE) and Fauji Foods (FFL) witnessed a decline in revenues during the same period. Ex-NESTLE the sector’s revenues augmented by 15% YoY. On the other hand, Ismail Industries (ISIL) was one of the only two companies (other: FFL, +59bps YoY) that managed to expand its gross margins (+490bps YoY) during the same period, however higher finance costs and loss from associate hit the company’s bottom-line growth.

Margins likely to remain under pressure

Pak Food sector underperformed the broader index by ~12% (-19% vs. -7% KSE100) during 1QCY19. Going forward, we expect gross margins of the sector to remain under pressure given (1) potential increase in energy prices, (2) rupee devaluation and (3) continuing sluggish consumer demand. Moreover, profitability is also likely to continue the declining trend amid higher interest rates. The sector trades at a trailing P/S and P/E of 2.1x and 30.6x, respectively.

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