Equity Analysis /
Sri Lanka

Cargills (Ceylon): Retail, FMCG key beneficiaries of spending pick-up; upgrade to Buy

    Asia Securities
    29 November 2019
    Published byAsia Securities

    We roll over our valuations to FY 21e and CARG is currently trading at 17.2x our FY 21e earnings, a c30.0% discount to its 3-year trading average. However, with growth in disposable income and expected demand expansion, we believe there is further upside to the stock. As such, including our estimate revisions and expected multiple expansion in FY 21e, our SOTP valuation-based TP goes to LKR 226/share (previously LKR 200/share). Including a DPS of LKR2.00, we expect a TSR of +16.9%. We revise our rating to Buy from Hold.

    Improvement in disposable income to drive consumer demand

    We view the recent changes to PAYE taxes and direct taxes as positive for the food retailing industry. Revisions to PAYE will result in an increase in disposable income, especially those earning a monthly income below the LKR 250,000 threshold. Added to this, ~1.4mn public sector employees will also see a salary increase in January 2020. We believe this will result in a notable pickup in demand for consumer goods starting December 2019 onwards. While the government announced reduction of VAT and removal of NBT, the mechanics of implementation including impact of input VAT have not been discussed yet. Should the tax changes go through as reported so far, this will result in an improvement to CARG’s topline and is a direct flow through to margins. Our calculations show a further ~LKR 0.52/share EPS improvement in FY21E. However, our estimates as of now does not take this change into consideration.

    Retail operations to see stronger footfall across its store base

    Unlike CCS, CARG with its 400-store network has exposure to markets across the island. Some stores located outside of the Western province saw slow growth over the past two years due to weather related issues and overall contraction in spending. However, with our expectations for a stronger pickup in spending, we expect CARG stores to see stronger footfall growth across its store base. As noted above, should the VAT implementation go through as planned, we believe there will be considerable savings at the topline. However, with no clarity, we do not include these savings in our estimates.

    FMCG business to grow on the back of demand for non-essential foods

    Growth in income also drives demand for non-essential foods and we expect CARG’s FMCG business to see solid double-digit volume growth. Over the past 2-3 years CARG invested in expending its product portfolio and capacity and we believe the stage is set for CARG to reap benefits from these investments. We expect its dairy and beverage (juice and nectars) to perform particularly well.

    Our target price moves to LKR 226/share and we revise our rating to a Buy

    We roll over our valuations to FY 21e and CARG is currently trading at 17.2x our FY 21e earnings, a c30.0% discount to its 3-yr trading average. However, with growth in disposable income and expected demand expansion, we believe there is further upside to the stock. As such, including our estimate revisions and expected multiple expansion in FY 21e, our SOTP valuation-based TP goes to LKR 226/share (previously LKR 200/share). Including a DPS of LKR2.00, we expect a TSR of +16.9%. We revise our rating to a Buy from Hold.

    Strong growth in the short run; widening fiscal deficit a long-term risk

    Our key concern over the long run with such a stimulus package is the potential for the economy to overheat as a result of strong consumer spending and on the other hand lead to a widening fiscal deficit. A similar situation was seen in CY 16 and CY 17, which led the then government to implement a number of fiscal tightening measures. This eventually resulted in consumer demand coming to a standstill through CY 17 and CY 18. While we continue to remain positive of earnings through FY 21e, we remain cautious of this long-term risk.