Food & Dairy Industry

Utopian Investments Research

This report is published for educational purposes only by students competing in the CFA Institute Research Challenge.

Engro Foods Ltd (EFOODS:PA)

Recommendation: BUY Price Target: Rs 30.17
2013(P) 50,150,587 5,524,488 1990710 2.66 2014(P) 64,691,656 7,750,125 2958724 3.96 2015(P) 103,506,650 11,402,086 3761123 4.42

Date20-12-2011

Ticker: EFOODS:PA (Bloomberg) Price: Rs 23.92

2010 20944943 1670727 175953 0.31 2011(P) 26,063,727 2,368,463 632712 0.85 2012(P) 43,263,007 3,931,396 1088066 1.45

Forecast Summary

Sales
EBITDA Net Income Earnings per share

Highlights
Our recommendation for Engro Foods is a buy based upon a stock price of Rs 30.17 for 2012 which offers an upside of 26.1% over the current price of Rs 23.92. The stock is currently undervalued evident with an intrinsic price of Rs 26.85 for 2011 making it value stock. The valuation corresponds to Engro Foods position of a growing company with a diverse portfolio and a new global presence with operations in the Middle East and North America. The competitive positing of Engro Foods within the segments it competes in varies for each product segment. Engro Foods being the market leader in the Ambient UHT with a projected revenue contribution of Rs22,955 million for 2011 and revenues of Rs 2,709 million in the ice-cream segment, at second in the market. The CAGR revenue growth in each segment as per our estimates for 2011-2015 will be: UHT-21.9%, Ice Cream- 81%, Milk Powder: 120.02% and Juices-99.6%. The company is expected to grow revenues at a CAGR of 41.7% till 2015. The profit margins are projected to increase with a mean YoY growth of 98.05% and the net financial position is expected to remain within the company target of 50% debt and 50% equity. The valuation of the stock price has been carried out by using a two stage DCF model. The two stage model is based upon a first stage of high growth for 5 years and a decreasing growth stage for the next 10 years. The risks for Engro Foods are primarily its rapid expansion evident with new product launches and business acquisitions. Other risks include the fluctuation of the Rupee Dollar exchange rate, with the rupee having depreciated to its historical high of Rs 89.45, if this trend continues then the purchase of Al-safa will become an expensive proposition by 2013. The economic conditions also pose a viable threat to the future performance considering the GDP growth has been very low at 2.39% from the second quarter of 2010 to the second quarter of 2011.

Source: http://www.bloomberg.com/apps/quote?ticker=EFOODS: PA

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Figure1

Date

Business Description
Engro is a Pakistani company that was a wholly owned subsidiary of ECorp till its IPO in mid 2011. The company was formed in 2005 and within the span of almost 6 years has diversified its product range rather successfully. It started out primarily in the Ambient UHT segment followed by the companys entrance into the ice-cream segment with Omore and the juices market with Olfrute in 2009. The company just entered into the milk powder category with Tarang Powder and finally with Olpers Lite. Furthermore, the company has also entered the rice manufacturing and the Halal meat operations with Engro Corps purchase of Al-Safa. The company has its main strengths in being able to dominate the Ambient UHT market and its successful entrance into other product categories. The annual sales have grown with a CAGR of 93.4%; from 2006 to 2010. It outdid its competitors such as Nestle in the Ambient UHT market by capturing a market share of 39% in 2010 and had a YoY EBITDA growth of 320% from 2009 - 2010% and showing an increase in revenues from Rs 397.5 million to Rupees 1.67 billion. Production Facilities, Product Segments & Business Units The business of the company is divided as per four product categories: Ambient UHT, Juices, Ice-cream and Powder Milk. The business units include the Engro Supply Chain and the Global Business Unit. The production plants are located in Sind and Punjab for each product category. Milk Production and Collection The milk collection is carried out by around 900 milk collection centers that collect milk from livestock farmers. The other source of milk for Engro is its Diary Farm that has land coverage of 557 acres and can house 10,000 animals. Ambient UHT The UHT processing plants are located in Sukkar and Sahiwal that process 1.4 million liters per day amounting to 511 million liters being processed annually. Juices The same plants that process the Ambient UHT also produce the juice products. The contribution to the revenues of Engro Foods of the Diary and Juices is 89% at Rupees 19,670 million collectively. Warehouses are located each in Sukkar, Sahiwal and Rawalpindi and logistics with over 250 towns directly and over 225 distributors. Ice-cream The ice cream plant is located at Sahiwal in the same facility as the Sahiwal diary plant with a production capacity of 22 million liters per annum currently and as of 2011 has contributed to around Rupees 2,709 million. The distribution of ice-cream comprises of over 5000 shops directly and over 30 towns indirectly, whereas the warehouses for the ice-cream products are in several locations including Karachi, Sahiwal, Lahore and Rawalpindi. Powder Milk The powder plant is located at Sukkar and can produce 24 tons of powder milk each day. Currently, the contribution of this plant is the least to the revenues being generated; however Engro Foods determines itself to increase its respective market share within the next five years. Rice Plant The rice plant was commissioned in 2010 and had a capacity for 60 Kilo Tons of rice paddy and currently operates a 120 Kilo Tons. The milling capacity of the plant is 56 kilo tones which equates to 120 Kilo Tons of paddy. The advantage of the Rice Plant in terms of power generation is via the power source of the Rice Husk based boiler that covers for most of the power needs of the plant. Engro Foods Supply Chain It is the subsidiary of Engro Foods that interlinks the production facilities and distribution of all the products being manufactured. This subsidiary was created primarily for the purpose of managing the logistics of Engro Foods. Global Business Unit The purpose of establishing this unit was to explore the global opportunities for Engro Foods. The result of which was the acquisition of Alsafa the oldest Halal Meat brand in North America. The claim in favor of this acquisition can be gain of a high market size of the Halal meat market that is US $ 253 billion and the lack of established brands that offer Halal meat in the West.

Source: IPO document

Figure 2: Capital Expenditure for 2011 Segment Rs % (mln) 64.4% 1. Dairy & 3,337 Juices 1,091 21.05 2. Ice Cream 406 7.83 3. Farm Rice 350 Plant Total 5,184 Source: IPO document 4. 6.75 100

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Business Strategy The strategy of the company is based upon improving current production capacity, diversification, market development and product development, via acquisitions and vertical integration. Details are given below: The capital expenditures planned by Engro Foods for the year 2011 totals up to Pak Rupees 5.184 billion for its business and production units The acquisition of Al-safa a Halal Meat brand in North America by Engro Corp has been planned to be purchased by Engro Foods by 2013. The introduction of new products on a consistent basis (Figure1). Engro Foods has also decided to improve its position in the Powder Milk, Ice-Cream and Juices market. In order to do this the 70% stake that Engro possesses in the Engro Supply Chain are now being offered for RS10.64 per share. However, at the same time Engro has introduced its latest brand Omung to capture the untapped unprocessedmilk market, is running the operation of Al-Safa a Halal meat business in North America and the has improved the production capacity of each of its product segments with capital expenditure as in Figure 2.

Industry Overview and Competitive Positioning

Overall: Appendix 1 The overall positioning of Engro Foods when compared to its competitors is stronger in terms of meeting the untapped needs of consumers, evident with the introduction of Dairy Omung and entering the Halal Meat Industry with the acquisition of Al-safa by Engro Corp. Additionally Engro Foods future growth is based upon diversifying its product portfolio and expanding operations globally via operations in the Middle East, North America and Pakistan.

Figure 3: Market Sizes of Product Segments: 2012 -2015: Units Liters (mln), Sales Rupees (mln) PRODUCT SEGMENT Ambient UHT Ice Cream Milk Powder Juices&Nectares 2010 790 47,000 71 8,800 540 27,000 507 31,000 2011 876 52,170 79 9,791 616 30,780 519 31,741 YEAR 2012 2013 973 1,080 57,887 64,253 89 11,030 702 35,100 532 32,529 100 12,394 800 40,000 544 33,262 2014 1,199 71,332 112 13,882 912 45,600 557 34,057 2015 1,331 79,860 125 15,493 1,040 52,000 571 34,913

Units (Liters) Sales (Rupees) Units (Liters) Sales (Rupees) Units (Liters) Sales (Rupees) Units (Liters) Sales (Rupees)

Source: Engro Foods IPO, Student Estimates

Figure 4 Ambient UHT Market Share

The analysis of the industry will be based upon the product categories in which Engro Foods competes. Ambient UHT: Figure 4 Segment Overview The milk production growth rate of Pakistan is at 2% per annum, with the growth of the Ambient UHT segment at a CAGR of 10% from 2006-10, with an expected CAGR of 11% from 2011-15. The projected size of the market is expected to be at 876 million liters in 2011 (refer to Figure 3). The competition concentration as per the HHI is at 58.2% for 2011. Engro Foods Position The market share of Engro Foods has increased from 39% in 2010 to 44% in 2011, a 5% increase with Engro Foods maintaining its market leadership in 2011, followed by Nestle and Haleeb with market shares of 35%

11% 10% 35%

E Foods

44%

Nestle Haleeb Others

Source: Company, Student 3

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Figure 5 Ice cream Market Share
Walls Engro Foods

Date

and 10%. EFoods estimated sales in this segment is at Rs 22,955 million, with an YoY growth of 25% and a contribution of 86% of Engro Foods 2011 estimated sales of Rs 26,063 million. Ice- Cream: Figure 5 Segment Overview The growth of the Ice-cream segment has been at 11% from 2006-10 with expectation of unspecified higher growth for 2011-15. The projected market size as per our estimates for 2011 is 79 million liters at a CAGR of 12% for 2011-15, with estimated sales of Rs 9,791 million. The competition concentration is at 55.1% for 2011 as per the HHI. Engro Foods Position The market share of Engro Foods is at 24% in 2011 an increase of 7% from 17% 2010. The Engro Foods maintains its position at 2nd place with Walls leading at 44% market share and Igloo 3rd at 16%. The sales of Engro Foods for this segment is at Rs 2,709 million an YoY increase of 72%, contributing to 10% of EFoods 2011 sales. Juices: Figure 7 Segment Overview The growth of the Juices&Nectares segment has been estimated to correspond to the annual GDP growth of 2011 at 2.39% for 2011-15. The markets size is estimated at 519 million liters for 2011, with sales of Rs 31,741 million. The competition concentration is at 59.9% as per the HHI, with higher concentration amongst competitors below the market leader Nestle. This segment is further divided as in Figure 6. Engro Foods Position Engro Foods being a new entrant is with a 2% market share with the aim of focusing growth in the Juices&Nectares and the Value Added Still Drinks. Powder Milk: Figure 8 Segment Overview The growth of this market is estimated at a CAGR of 14% from 2011-15 with the market size being 616 million liters and Rs 30,780 million in 2011. The competition is dominated by Nestle with 98% market share. Engro Foods Position Engro is a new entrant in this segment with only 2% market share. Halal Meat The company currently does not own Al-safa but is managing it; however, the company claims that the acquisition of Al-safa will be carried out by 2013, thereby accessing the revenues from a global halal meat market that is US Dollars 250 billion in size. Portfolio Diversification and gaining competitive edge in new segments The approach of diversification and global expansion of Engro Foods will stretch its resources. However, it can gain at least significant market share by concentrating upon utilizing an effective promotional campaign much along the lines of Olpers and Omore. It is the juices sector where Nestle dominates with its high quality products and when it comes to the Powdered Milk segment where Tarang has appeal for the rural and lower income masses. However, in the Powdered Milk segment Nestle has several products being Nido, Everyday and also powdered Milk Pak compared to Engros single brand. Hence, considering Engros diversification in the other segments and entering new markets, it would be best for Engro to concentrate its efforts upon the Juices&Nectares segment and the Powdered Milk Segment, via strong promotion of the its current products in the respective segments. If successful we estimate that Engro Foods segment wise contribution to the overall revenues from the Juices&Nectares segment will improve from Rupees 310 million to Rupees 10,351 million by 2015, contributing to around 10% of the overall revenue from 2011 to 2015; with its current share being 2% of the overall revenue. Similarly, we estimate that Powdered Milk segment will contribute Rupees 14,491 million by 2015, which will be 13% of the overall revenues of Rupees 103,507.

8% 8% 16% 24% 44%

Igloo Yummy Others

Source: Company, Student Estimates

Figure 6

Juices Market Segmentation

Still Drinks

13% 10% 77%

Value Added Still Drinks Juices & Nectares

Source:Engro Foods IPO Document

Figure 7 Juices Market Share 2% 15% 11%

Nestle Maza Sheezan

54% 18%

Engro Foods Others*

Source: Company, Student Estimates Figure 8

Milk Powder Market Share

2%
Nestle

98%

Engro Foods

Source: Company Estimates 4

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Investment Summary
Our recommendation for Engro Foods is a buy based upon a stock price of Rs 30.17 for 2012 which offers an upside of 26.1% over the current price of Rs 23.92. The stock is currently undervalued evident with an intrinsic price of Rs 26.85 for 2011 making it a value stock. The model used for the Engro Food valuation is the Discounted Cash flow Model. The model has a two stage growth, with the first 5 years being the high growth stage and the next 10 years being decreasing growth stage which is based upon exponential decay.

Figure 10: 2 Stage DCF model High Growth Stage Decreasing growth stage Source: Student Estimates

The net profitability of Egnro Foods is projected to increase till 2011with a CAGR of 56.14%. The top line growth of the company is expected to grow with a mean YoY growth of 39.07% for 2011-15, the contribution of the UHT product segment is expected to continue forming a major part of the revenues with 50% share, followed by the Ice Cream segment at 25% by 2015. Out of the two weak product segments Juices and Milk Powder we see the latter forming the larger share of revenues due to a higher market growth at 14% CAGR and the presence of one major competitor Nestle. With the high growth that the company is projected to have it will be able to sustain its Debt to Equity proportion of 50:50, along with a stable financial leverage position at a mean of 4.07 and an increasing current ratio with 4.93% CAGR. When compared to its competitors Engro Foods is currently not efficient enough to ensure higher profit margins. The major risks associated with Engo foods revolves around new product launches and diversification, floods, competition, economic slowdown, operational and financial risks.

Figure 11 DCF model assumption WACC 1 Stage Cash Flow Growth Rate 1st Stage Cash Growth Time Period 2nd Stage Cash Flow Growth Rate
st

Figure 9: Stock Chart for ENGRO FOODS LTD (EFOODS)

12.34% 43%

5 years 22% exponential decay till perpetuity growth rate

2nd Stage Cash 10 years Flow Growth Time Period Perpetuity 5% Growth Rate Time Period to 15 years Perpetuity Source: Student Estimates

Engro Foods Share Price Comparison with its peers over the past months
Source: http://investing.businessweek.com/research/stocks/charts/charts.asp?ticker=EFOODS:PA

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Figure 12: FCF growth
4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 0

Date

Valuation
The target price of the Engro Foods stock has been projected at Rs 30.17 for the year end of 2012, providing returns of 26.1%; hence, our recommendation is a buy. With the intrinsic value of the share at Rs 26.85 for 2011 and the current market price being at Rs 23.92, the stock is undervalued, thereby making it value stock and a viable investment for investors expecting the stock to grow in the future. The Engro Foods stock is also suitable for investors considering a growth stock, because no announcements for dividend payouts have been made and the earnings generated are being reinvested into the company for development. Hence, investors looking for income stocks should not purchase the Engro Food shares. Discounted Cash Flow model: Appendix 5 The discounted cash flow has been utilized for the valuation of this stock since; the free cash flow would appropriately represent the earnings, because of the intensive capital expenditure of the company. A two stage DCF has been used to represent a two stage growth of the company. (Figure 10) The first stage being classified as the high growth stage at 43% for 5 years and the second stage being classified as the decreasing growth stage (Figure 11), with the rate of decrease being taken as an exponential decay rate of 22% for 10 years, decreasing till the point of reaching the perpetuity growth rate of 5%. The length of 15 years has been taken due to the high growth prospects of the company evident from the projected cash flow CAGR of 43%. The decreasing growth stage has been used based upon the negative free cash flow resulting in the 2015 projections. However, the growth is expected to gradually slow down till it reaches 5%. The negative projected free cash flow of 2015 resulted from the company trying to continue its 60% sales CAGR despite a lower sustainable growth rate target of 48.47% as indicated in the SGR of 2014. Thereby, indicating that the company will have to reduce its growth over next 10 years post 2015. Thus, gradually reducing its capital expenditure that had an YoY growth of 150% for 2014-15, also reduce its reliance upon an unsustainable debt and equity proportion of 58.4% and 41.6%, which is higher than the intended company target of 50% debt and 50% equity balance. The assumptions for WACC that have been used can be seen in Figure 13

Rupees

FCF DCFCF

Years

10

20

Growth Rate Source: Student Estimates

Figure13: WACC assumptions WACC 12.34 Cost of Debt Cost of Equity Risk Free Rate Tax Rate Proportion of DEBT Proportion of EQUITY BETA RM Borrowing Rate Source: Student Estimates 9.06 14.14 12 0.35 0.35 0.65 1.18 13.81 13.94

Variability in the DCF model: Due to the unstable nature of the DCF model a sensitivity analysis has been carried based upon its fundamental assumptions of the WACC and the growth rate of the high growth stage, as seen in Figure 14. The impact of the sensitivity, for 2011 upon the prices for 2012 has been shown in Figure 16.

Figure14: DCF Sensitivity Analysis

WACC 9.34 10.34 11.34 12.34 13.34 14.34 15.34

34 33.62 28.83 25.4 22.78 20.69 18.89 17.54

37 35.16 30.29 26.77 24.08 21.93 20.16 18.66

Cash flow Growth Rate First 5 years (high growth stage) 40 43 46 49 52 36.78 40.31 42.22 44.24 38.5 31.82 35.16 36.98 38.89 33.45 28.23 31.4 33.12 34.93 29.77 25.47 26.85 28.47 30.1 29.54 23.24 26.1 27.65 29.29 24.63 21.41 24.12 25.59 27.15 22.72 19.85 22.43 23.83 25.31 21.10

Source: Student Estimates 6

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Figure 15

Date Projections Sensitivity Analysis dec 10% SGR % CAGR % 60.60 93.11 58.44 76.86 66.86 53.95 75.00 65.00 34.65 65.00 55.00 48.47 60.00 50.00 66.44 60.00 50.00

Figure 16:Impact of 2011 sensitivity f or the 2012 target price 2011 2012 19.70 17.54 20.96 18.66 21.22 18.89 22.30 19.85 22.65 20.16 23.24 20.69 23.70 21.10 24.05 21.41 24.64 21.93 25.20 22.43 25.52 22.72 25.59 22.78 26.11 23.24 26.77 23.83 27.05 24.08 27.10 24.12 27.67 24.63 28.43 25.31 25.40 28.53 28.61 25.47 28.75 25.59 29.32 26.1 30.07 26.77 30.16 26.85 30.50 27.15 31.06 27.65 31.71 28.23 31.98 28.47 32.39 28.83 32.90 29.29 33.19 29.54 33.44 29.77 33.81 30.1 34.03 30.29 35.27 31.4 35.75 31.82 37.21 33.12 37.58 33.45 37.77 33.62 39.24 34.93 39.50 35.16 39.50 35.16 41.32 36.78 41.54 36.98 43.25 38.5 43.69 38.89 45.28 40.31 47.43 42.22 49.70 44.24 Source: Student estimates

Year 2010 2011 2012 2013 2014 2015

Target% 76.86 75.00 65.00 60.00 60.00

inc 10% 86.86 85.00 75.00 70.00 70.00

Source: Student Estimates

Financial Analysis: Appendices2, 3 & 4

The growth Engro Foods revenues is expected to occur over the next five years on the basis of a diversified portfolio and measures taken to conduct its operations globally. The contributions of each product segment for 2011-15 change as per the current market position of the company in each segment and the level of competition present. The projections for Engro Foods for 2011-15 have been based upon a sustainable growth rate for each year as shown in Figure 15 The growth rates selected for each year help maintain the debt to equity proportion close to 50:50 as per the company target, additionally increasing the profitability of the company with a mean YoY growth of 98.05%. The projections have a sensitivity analysis performed upon the basis shown in Figure 15 (Appendices 6 to 20) to represent fluctuations that might occur. Contribution to Engro Foods revenues as per product segments: Figure 17 & 18

Figure 17: Product Segment Sales Contribution %: 2011-15 100% 80% 60% 40% 20% 0% 2011 2012 2013 2014 2015
Milk Powder Juices Icecream UHT

Source: Student Estimates

Figure 18: Product Segment Sales Contribution: Rupees (000)

2011 Revenue UHT Ice Cream Juices Milk Powder 26,063,727 22,955,080 2,606,373 635,529 616,275

2012 43,263,007 30,284,105 5,191,560 3,461,041 4,326,301

2013 50,150,587 3,209,976 752,338 451,403 601,870

2014 64,691,656 35,580,411 12,938,331 7,762,999 8,409,915

2015 103,506,650 50.718,259 27,946,796 10,350,665 14,490,931

Source: Student Estimates

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Ambient UHT The UHT segment maintains a prominent revenue contribution till 2015 at around 50% with the target to maintain market leadership in market that is expected to grow at 10% CAGR and a competitive market with a competition concentration of 58.2%. Ice Cream The contribution of ice-cream is projected to have around 25% contribution worth Rs 27,946 million by 2015 to the overall revenues. Due to a growing markets CAGR of 14% till 2015 and the companys intended target to maintain the 2nd position in this segment. The competition concentration increasing from 52.7% to 55% as per the HHI corresponding with an increasing market share of the company from 17% to 24% represents the segment competition concentration in favor Engro Foods. Thus, forming the basis of our estimates for its increasing contribution to Engro Foods revenues. Milk Powder The Milk Powder segment is expected to be the third largest contributor to the companys revenues at Rs 14,490 million by 2015 and share of 14% upon the basis of only one major competitor in the tea-whitener category that Engro Foods competes in. Hence, the lower switching costs for consumers will make it easier to grow the sales of this product. Juices & Nectars The contribution of this segment will be the least at Rs 10,350 million by 2015, due to the high level of competition and concentration of competition at 60% as per the HHI. Earnings The net profitability of the company is expected to grow at a CAGR of 56.14% and the revenues with a CAGR of 41.17%. The EBITDA and EBIT margins increase at CAGRs of 4.93% and 7.90% for the period 2011-15, representing the increase in efficiency of the companys operations. The utilization of assets to generate sales improves with a reduction from 33.58% of sales to 19.16% to generate increasing revenues. The profitability margins and the profits as compared to the revenues can be seen in Figures 19 and 20.

Figure 19: Revenues & Profit Margins: 2010-15 100000000 80000000 60000000 40000000 20000000 0 2010 2011 2012 2013 2014 2015

15.00% 10.00% 5.00% 0.00%

Net sales EBT Margin EBITDA Margin EBIT Margin OCF to sales*

Source: Student Estimates Figure 20: Sales & Earnings 120,000,000 100,000,000 80,000,000 60,000,000 40,000,000 20,000,000

12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 Rupees 0

Rupees

Net sales

2010

Net profit

2011

2012

EBT
8

2013

EBIT

2014

EBITDA

2015

OCF

Balance Sheet & Financing

Source: Student Estimates

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Figure 21: Competitive comparison Ratios Engro Foods
2010 EBITDA Mrg ROA ROE GP Marg Sales:Lt.A EPS Current Ratio 2011(P)

Date

The debt and equity proportion remains relatively stable with the means of the debt ratio and the equity ratio being 43.17% and 56.28% respectively for 2011-15, on an average being below the company target of 50:50 debt to equity proportion.

Nestle
The debt to equity ratio is maintained at an average of 0.82 for 2011-15 without any additional shares being issued after the 48 million shares sold in 2011. The projected financial position allows the company to facilitate its purchases of the Global Business Unit for Rs 800 million in 2012 from Engro Corp and the proposed purchase of Al-safa at US $ 10-15 million by 2013. Cash Flow The projected free cash flows depict a healthy position for the company despite increasing capital expenditures growing at a CAGR of 46.5%. The OCF to sales remains stable with mean of 6%, standard deviation of only 1% and growing at a CAGR of 3.9%. When it comes to the cash flows, the cash flow/share remains positive and increases from 0.91/share to 2.65/share from 2011-14. However, the negative cash flow in 2015 is only temporary because of the increased investment for further growth taking into consideration the growth prospects of Al-Safa with a global market of more than US Dollars 250 billion. Competitive Comparison: Figures 21 and 22 The comparison of Engro Foods with its peers reveals that Engro Foods is not as profitable as its competitors since its profits began generating in 2010. With the EBITDA margins Nestle out-performs Engro Foods by almost twice with 15.06% and Unilever outperforms Engro Foods at 12.27%. The returns generated for the amount of equity used by Engro Foods is projected at 9.09% compared to Nestls 69.65% and Unilever's 143.59%, this again can be attributed to the fact that Engro Foods is still in a high growth phase, with greater returns in the coming years.

7.98% 9.09% 15.06% 1.41% 4.72% 18.92% 3.43% 9.09% 69.65% 20.97% 21.00% 26.26% 2.38 0.31 1.48 2.98 0.85 1.71 2.4 90.69 1.00

Source: Student estimates, http://investing.businessweek.com

Figure 22: Competitive comparison Ratios Engro Foods

2010 EBITDA Mrg ROA ROE GP Marg Sales:Lt.A EPS Current Ratio 2011(P)

Unilever

7.98% 1.41% 3.43%

9.09% 4.72%

The efficiency of Engro Foods in terms of generating sales is closely competitive at a projected 2.98 times asset turnover outperforming Nestls 2.4 times asset turnover and close to Unilevers 3.5 times asset 12.27% turnover. The projected 4.72% returns on assets reflects upon Engros Foods higher costs when compared to Nestls ROA of 18.92% and Unilevers ROA of 24.55%, this shortfall can be attributed to Engro Foods 24.55% high growth stage.

9.09% 143.59%

20.97% 21.00% 33.94% 2.38 0.31 1.48 2.98 0.85 1.71 3.5

Engro Foods And Corporate Social Responsibility

Source: Student estimates, http://investing.businessweek.com

In order to facilitate the farmers and help improve their production Engro foods has developed a program in collaboration with USAID. This program includes conducting workshops, providing training to the new 279.48 farmers, distribution of necessary material related to livestock, medical camps for the livestock and construction of facilities such as milk collection centers. Due to these services a farmer living in a far rural 0.70 area can also gain knowledge of the modern agricultural techniques. All these services are offered to the farmers free of cost, and also help in improving the production quantity and quality.

Investment Risks
Strategic Risks Becoming unsuccessful in gaining the market share in the Milk Powder and juices segments. The launch of new products such as Omung, Flavored might not be as successful as originally thought to be in terms of tapping up the unprocessed milk segment of the population. However, the masses might not look at it as an unprocessed processed since it is packaged milk. The risk of lack of consumption results from a matter of perception. The risk for the flavored milk lies in the apparent lack of demand for the product. Strong Competition The Juices& Nectares segment is strong in terms of competition with a competition concentration of 60% may not let Engro foods capture market share as easily as has been the case in the Ambient UHT segment. The dominance of Nestle in the Milk Powder Segment will act as a barrier in terms of Nestle being able to control the market pricing, the flexibility of Engro Foods to dictate pricing or alter their own to compete will be difficult with a 98% competition concentration. Financial & Business Risk: Appendix 21 The financial and business risk that the company faces can be measured via the coefficient of variation in the ROIC which can be referred to as the business risk since it measures the operative risk in terms of the capital invested. The financial risk can be measured in terms of the variability of the EPS, the ROE and the EBIT. It

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can be seen in Figure 23 that the ROIC is the second most variable measurement because Engro Foods is a growing company requiring heavy capital investment. The variability in the EBIT also signifies the business risk in terms of the operations costs which need to monitored for growth in the event of revenue fluctuations. The highest variability is that of the EPS which shows that with the growth oriented direction the fluctuations in growth targets will impact the earnings due to possible debt financing and its leverage costs that the company would incur. The different between the ROE and the ROIC shows that the company is using leverage and should continue to monitor is debt financing in order to maintain is financial leverage and proportion of debt and equity. In order to minimize these risks the company should monitor the SGR and maintain growth targets relative to its threshold. Fluctuation of exchange rates The ever depreciating Pakistani Rupee against the US Dollar reached its record high at 89.45 in December 2011. Though it may increase the exports of Engro Foods however, the bigger problem will be the purchase of Al-safa from Engro Corp in 2013. The estimated cost of al-safa will be 10 to 15 million Us Dollars, if the Rupee does not appreciate then the cost of purchasing will increase dramatically for Engro foods and hence, become a burden on their means of financing, increasing their tendency to borrow. The company has an agreement with Engro Corp of continuing its current status of managing Al-safa while Egro Corp continues to own it, in the event of the company being unable to acquire Al-safa. Economic conditions The economic conditions in Pakistan have been generally deteriorating over past several years. The biggest concern for Engro Foods would be the level of inflation in the country, which can in the future cause an increase in the interest rate, increasing the cost of borrowing and making it difficult for Engro Food to rely upon debt financing however, currently the discount rate is low. The annual GDP growth has been 2.39% during the second quarter of 2011 over the same quarter of the previous year. The GDP growth of Pakistan is not robust so the impact of improving economic conditions should not be relied upon but should be considered as detrimental for business activity, against which safeguards should be taken; such as using Research and Development, carrying out production and operations reviews in order to make product more economical or of greater value or even reducing labor costs. (For economic indicators see Appendix 22) Floods The floods can impact the production facilities; however, the company has taken protective measures such as installing water pumps to reduce any damage due to flooding.

Figure 23 Coe of Variation ROIC ROE EBIT EPS Mean ROIC ROE EPS Source: Student Estimates

10% inc 0.09 0.31 0.40 0.19 10% inc 8.42% 8.48% 0.66

Projections 0.32 0.46 0.60 0.58 Projections 16.81% 0.21 2.67

10% inc 0.12 0.25 0.65 0.35 10% dec 9.25% 8.68% 0.92

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Disclosures:
Ownership and material conflicts of interest: The author(s), or a member of their household, of this report [holds/does not hold] a financial interest in the securities of this company. The author(s), or a member of their household, of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content or publication of this report. [The conflict of interest is] Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company. Market making: The author(s) does [not] act as a market maker in the subject companys securities. Ratings guide: Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the securitys weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with [Society Name], CFA Institute or the CFA Institute Research Challenge with regard to this companys stock.

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