Food Empire Holdings - RHB Invest 2017-04-11: Rise Of The Empire

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FOOD EMPIRE HOLDINGS LIMITED F03.SI

Food Empire Holdings - Rise Of The Empire

• Food Empire is a dominant instant coffee mix player in the CIS countries. 
• With 45% of its revenue generated in Russia, we think this is a good investment proxy to leverage on the strengthening RUB. 
• Moving forward, the group is looking to deepen its penetration into the emerging markets in Asia. It is also expecting a turnaround of its associate – Caffé Bene – this year. 
• As we believe its results have bottomed out, we reinitiate coverage with a BUY recommendation and SGD0.76 TP (31% upside).

Company Background 

• Food Empire is a global food and beverage (F&B) company that manufactures and markets instant beverages, frozen convenience foods as well as confectionery and snack foods. 
• The company’s products can be found in over 50 countries across Asia, Africa, Middle East, North America and Europe. 
• Since its listing on the Singapore Exchange (SGX) in 2000, Food Empire has won numerous awards including twice being named by Forbes Magazine as one of Asia’s “Best Under a Billion” companies.  

Packaged food and beverages 

• Food Empire’s core product offering revolves around instant coffee beverages, which is marketed under the Klassno, FesAroma, Bésame and popular MacCoffee brands. Through the years, MacCoffee has managed to establish a strong consumer following and brand equity in Russia, Ukraine and Kazakhstan.

Expanding across the value chain 

• Food Empire’s growth strategy involves integrating its business along the F&B value chain. Food Empire has undertaken upstream green- field projects to manage raw material prices as well as quality control. This includes a non- dairy creamer plant, snack factory and beverage manufacturing facility in Malaysia as well as an instant coffee plant in India.

Investment Merits 

Leading coffee mix player in Russia. 

• Food Empire has a vast distribution network in Russia. Its flagship brand MacCoffee has a 50% market share in the Russian instant coffee mix segment. 
• The group was able to raise its coffee mix prices by 80% on a portfolio average basis to mitigate the decline in RUB in 2015 without significant impact in volumes. This is testament to the strong brand equity that it has cultivated throughout the years. 
• Moving forward, we believe the strengthening of RUB would help to offset increases in raw material prices. As such, we expect stronger gross margins in 2017.

Stronger margins on strengthening RUB. 

• 45% of Food Empire’s sales are generated from Russia. The strengthening of RUB is beneficial to the group on both translational and transactional ends. Since the company reports in USD while its functional currency is RUB, YTD appreciation of RUB would result in a translational gain. 
• Additionally, gross margin is likely to be enhanced since the bulk of raw material cost is denominated in USD.

Winging it in Vietnam. 

• Since the introduction of café PHO in 2013, we estimate that revenue from Vietnam has soared fivefold. Amidst intense competition from the local market, Food Empire is now the Top 5 coffee player in Vietnam. 
• Going forward, we believe the company would come up with a greater variety of coffee mixes to entice the market. 
• Towards the end of 2016, the company had introduced a hot coffee mix – café Me – to Vietnam. We expect to see more product innovation in the Vietnamese market in 2017.

From Indochina to China. 

• Contribution from Indochina has grown tremendously over the last three years due to strong inroads into Vietnam. In 2017, management has set its sights to deepen market penetration in Myanmar and China to tap into the two countries’ respective growing coffee culture. 
• Based on our channel checks, Food Empire’s MacCoffee has had many good reviews on JD.com. In Myanmar, MacCoffee also seems to be widely available in grocery stores. Hence, we believe that China and Myanmar could be the next potential growth markets for Food Empire.

Expected turnaround with potential listing of Caffé Bene. 

• Food Empire acquired a 20% stake in Caffé Bene, alongside Indonesia’s largest conglomerate Salim Group. Despite the coffee chain’s lacklustre financial performance, Food Empire’s management is confident that it can turn the business around. 
• Caffé Bene could potentially tap on Food Empire’s well-established coffee supply chain as well as the backing of Salim Group to turn profitable. Management also guided that it expects an early turnaround in 2017 aside from indicating that it may list Caffé Bene in two years.

Reinitiate coverage with a BUY recommendation based on 18x FY17F P/E. 

• Key risks to our call include geopolitical risk in Russia, Ukraine and other CIS markets as well as the downward movement of RUB and UAH.

Valuation 

Reinitiating coverage with a BUY recommendation and TP of SGD0.76 

• Food Empire’s TP of SGD0.76 is pegged to 18x forward P/E, in line with its peer average.

Key Risks 

Downward movement of RUB. 

• With almost 50% of revenue derived from the Russian market, Food Empire’s profitability is highly susceptible to a downward movement of RUB. 
• With no hedging strategies, Food Empire would offset currency fluctuations with price hikes, which may turn away price sensitive consumers.

Unable to successfully secure a foothold in Asia Pacific. 

• Asia Pacific’s coffee industry remains relatively consolidated with large players dominating the competitive scene. If Food Empire fails to secure a footing within Asia Pacific, further expansion may be difficult due to the higher cost from diseconomies of scale and more investments needed to build brand equity as well expanding distribution points.

Unable to turn Caffé Bene around. 

• Despite Caffé Bene’s short history, controversies within the management and business model have emerged. Prior to Food Empire’s venture, Caffé Bene went through various lawsuits between franchisees for violation of franchise contracts. 
• The Korea Fair Trade Commission (KFTC) ordered it to remedy its business practice and imposed a US$1.88m fine in 2014. If these underlying issues persist, Caffé Bene’s outlook may not be too promising. However, since then, a private equity firm has taken over as the largest shareholder and a new CEO brought in to deal with these issues. Further measures to streamline operations have also been undertaken.

Geopolitical risk within countries with operations. 

• Geopolitical tensions within the CIS countries still exist where cooperation between Russia and the other CIS countries are needed in order for this regional organisation to fully function. 
• Joint efforts to combat terrorism and meet impeding security challenges have yet to be laid out, hinting a lack of cooperation within the member countries. Such threats would negatively affect consumer sentiment and hinder operations within the CIS countries.

Financial Discussion 

Growth in revenue to be led by emerging markets while bottomline would be driven by gross margin expansion. 

• We project revenue to grow at 7% CAGR to USD298m over FY16-FY19, led by the expansion in Indochina and China (classified under “others”). Excluding non-recurring gains from forex, we expect recurring PATMI to grow at 22% CAGR over FY16-FY19. This is likely to be led by gross margin expansion in its largest market – Russia.
• Net gearing stood at a low of 0.07x in FY16, we believe this would allow Food Empire ample debt capacity to gear up to undertake any future acquisitions.

Earnings sensitivity to changes in USD/RUB rates. 

• We note that a change in RUB by 5% to our base case would lead to a change of 10% to our recurring PATMI.
• TP sensitivity to USD/SGD rates. A 5% change in USD/SGD rates would lead to a 5% change in TP.

Juliana Cai CFA RHB Invest | http://www.rhbinvest.com.sg/ 2017-04-11

RHB Invest SGX Stock Analyst Report BUY Initiate BUY 0.76 Same 0.76