Food Empire - UOB Kay Hian 2020-05-15: 1Q20 Ahead Of Expectations; Near-term Challenges From Potentially Weaker 2Q

FOOD EMPIRE HOLDINGS LIMITED (SGX:F03)

Food Empire - 1Q20 Ahead Of Expectations; Near-term Challenges From Potentially Weaker 2Q

Food Empire’s core earnings of US$9.5m (+33.0% y-o-y) was slightly ahead of our expectations, forming 34% of our full-year estimate. Earnings growth was boosted by core net margin expansion of 2.5ppt in 1Q20 and stable revenue growth of 5.0% y-o-y.
The outlook for 2Q20 appears challenging due to the lockdown measures in key markets and the depreciation of the ruble. We do however expect a recovery in 2H20, assuming lockdown measures ease and ASPs rise to mitigate the forex impact.

Food Empire (SGX:F03) reported net profit of US$6.6m for 1Q20. Core net profit (excluding FX loss) came in at US$9.5m (+33.0% y-o-y), forming 34% of our full year estimate, slightly ahead of our expectation.

Group revenue rose 5.0% y-o-y in 1Q20 on the back of higher sales in Ukraine, Kazakhstan and Commonwealth of Independent States (CIS) markets (+23.7% y-o-y). The strong revenue growth in these markets managed to offset the slightly weaker sales contribution from the Southeast Asia market (-1.7% y-o-y) due its exit from the Myanmar market which overshadowed the revenue growth from Vietnam. Sales revenue from Russia declined 2.0% y-o-y, attributed to lower translated revenue resulting from the depreciation of the ruble against the US dollar in Mar20.
Food Empire's core earnings were further boosted by the increase in core net profit margin to 12.8% (1Q19: 10.5%) as operating expenses remained relatively flat despite the sales growth. Furthermore, gross margin rose slightly to 40.4% (1Q19: 40.2%).

Food Empire is experiencing weaker offtake from stores in most of its markets due to lower customer footfall as various governments in key markets have implemented social distancing measures to contain the outbreak. Management remarked that key production, sales and distribution activities are still continuing, albeit with slight disruptions.

Mirroring the steep decline of oil prices, the ruble against the US dollar has experienced a sharp decline in Mar 20. The ruble averaged at 66.9 against the US dollar in 1Q20 and the rate is at 73.7 as of 12 May 20, compared to 61.9 as at 31 Dec 19. The currency depreciation would negatively impact Food Empire’s core earnings due to lower translated revenue and could also lead to pressure on gross margins as some of its raw materials are denominated in US dollars.
The impact of the currency depreciation would likely be more apparent in 2Q20 compared to 1Q20 as the depreciation of the ruble took place towards the second half of 1Q20/early-Mar 20.
That said, we do highlight that the group has initiated a series of gradual price increases on its products from Apr 20 to mitigate the forex impact. It would take approximately 2-3 months for the higher prices (approx 10%) to be fully implemented; thus, we expect the impact of the price hike to materialise closer to 3Q20. Lower commodity prices could also help mitigate the forex impact on gross margins.

Russia has been on a lockdown since late-March to stem the spread of the outbreak, with only essential industries allowed to continue operations. The government has announced a gradual easing of lockdown measures on 12 May 20. Moscow, its largest capital, is however expected to keep lockdown measures in place until May 31.
Similarly, Kazakhstan has been in a state of emergency since end Mar 20 and is currently gradually reopening businesses as it eases lockdown measures from 11 May 20. This is also the case for Ukraine. Against this backdrop, we reckon sales volumes would be weaker for Apr-May 20, at least for its Russian, Ukraine and CIS markets, thus adversely impacting earnings for 2Q20 on a y-o-y and q-o-q basis before recovering in 2H20, assuming lockdown measures are lifted/eased.

We reduce our 2020-22 earnings forecasts by 13-32% as we lower our revenue forecasts by 9-16%. We now expect earnings for 2020-22 to come in at US$19.1m (-32.4%), US$25.6m (-16.1%) and US$27.9m (-12.7%) respectively.
Our forecasts incorporate a lower translated revenue and weaker sales volume due to the ruble depreciation, lockdown measures in 2Q20 and overall weaker economic sentiment.
We also cautiously lower our gross profit margin forecast slightly. We expect a steeper revenue decline in 2Q20 before a partial recovery in 2H20 as lockdown measures ease and higher ASPs kick in.
Our forecast revenue breakdown is as follows: approximately -22% y-o-y for 2Q20 and -13% y-o-y for 2H20.

Maintain BUY with a lower PE-based target price of S$0.63, down from S$0.92. This is based on 12.6x 2020F PE, in line with its long-term historical average (excluding outliers). Our target price also incorporates a slightly higher S$/US$ rate of 1.40 (S$1.38 previously).
See Food Empire Share Price; Food Empire Target Price; Food Empire Analyst Reports; Food Empire Dividend History; Food Empire Announcements; Food Empire Latest News.
At current prices, Food Empire trades at an attractive valuation at 9.7x 2020F PE, a significant discount to peer average of 24.3x for 2020F, suggesting that the ruble depreciation and potential weakness in sales volume have been priced in.

Joohijit Kaur UOB Kay Hian Research | Clement Ho UOB Kay Hian | https://research.uobkayhian.com/ 2020-05-15

SGX Stock Analyst Report BUY MAINTAIN BUY 0.63 DOWN 0.920