Equity Analysis /
Egypt

Eastern Tobacco: Q3 18/19: Topline weakens sequentially, margins face pressure; maintain Overweight

    Mohamed Hamza

    Annual Topline Growth vs Sequential Drop

    EAST 3Q18/19 revenue increased by 4% YoY but fell 9% QoQ. Since the last price hike was implemented in July 2018, we believe the sequential drop in revenues is the result of slow volume growth, possibly due to weak purchasing power, or lower exports as a result of a stronger EGP/USD. The annual increase in revenues  was mostly price-driven, where ASP went up by c.15% in July 2018. We believe EAST’s revenues should be boosted by FY18/19-end following:

    1. Re-ignition of export contracts with Misr Duty Free Shops & Egypt Air that are worth USD4 million, which were announced last month, with management targeting USD20 million in export sales in FY18/19. 
    2. Announcement of a new shisha tobacco export contract with UAE’s Al-Wahdania General Trading Company; to be sold in UAE, Bahrain and Oman. 
    3. Finalization of toll-manufacturing contracts with a number of international companies in 3Q18/19.

    Higher Operational Costs & Lower Interest Income Pressure Margins

    GPM recorded 36.2% in 3Q18/19 versus 38.4% in 2Q18/19 and 40.1% in 3Q17/18. GPM was pressured on account of increased COGS components: wages (+12.2% YoY) and raw material (+7.4%% YoY). With stronger EGP/USD, raw material upturn is attributable to higher global tobacco prices. With SG&A/revenue minimally reduced from 5.4% in 3Q17/18 to 5.0% in 3Q18/19, EBITDA margin contraction is highly impacted by increased cost pressure (+11% YoY).  EAST also recorded lower NPM mainly due to interest income falling by 61% YoY and 38% QoQ (EGP67 million in 3Q18/19 vs EGP173 million in 3Q17/18 and EGP109 million in 2Q18/19). 

    Trading at Attractive Multiples; Awaits Catalysts

    EAST is trading at an EV/EBITDA19/20 of 5.5x and P/E19/20 of 8.9x, which are below peer group average of 10.6x and 14.5x, respectively.

    Management announced FY19/20 capex plans of EGP1.14 billion vs EGP1.24 billion targeted in FY18/19 (-8% YoY). EGP1.11 billion will be dedicated to machinery upgrades, EGP10 million in completing projects pending from FY18/19 and EGP25 million on new projects. Management aims to increase the volume of exports in FY19/20 by 88% YoY, through shisha tobacco sales increase by 50% driven by 25% YoY volume increase in FY19/20.

    Management aims to transfer unutilized land licenses from industrial to commercial and is looking into selling these plots. Total unutilized land is estimated at 50 feddans (200,000 square meter). This might generate EGP0.75-1.75 per share in sales proceeds. 

    Recently, it was reported that Egyptian and foreign cigarette companies will hold meetings with the Ministry of Finance to discuss proposals for the planned price increases in mid-FY19/20, mainly on higher health taxes. Historically, tobacco companies witnessed enhanced topline growth when a price-hike is implemented. Therefore, we maintain our DCF FV of EGP19.80 and Overweight recommendation.