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Frieslandcampina Engro Pakistan has a long history of introducing innovative items

On average, we raise our CY21-25f EPS predictions by 14% due to increased sales/GMs in the following years. While our December 2022 target price (TP) of PKR110/sh remains constant due to a higher risk-free rate (11.0 percent), values appear tempting following the stock price drop of over 28 percent (from CY21td high). As a result, we’ve changed our recommendation to Buy.

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FCEPL has continuously developed new products, which, when combined with the company’s return to leadership in the UHT milk category and strong gross margins under the zero-rated system, we believe are more than enough to offset cost challenges.

We estimate 5yr earnings CAGR of 30% CY21-26f. This compares well against a CY22f P/E of 17.2x – much lower than the historical average of over 20x for Pakistan Consumer stocks.

Resume coverage with a Buy rating

We resume coverage on FrieslandCampina Engro Pakistan Ltd. with a Buy rating and a Dec’22 TP of PKR110/sh. This stems from an accelerated earnings growth trajectory (5-yr CAGR over 30%) courtesy, leadership position in UHT, consistent new product launches and reinstatement of the zero rated regime. Our CY22-25f earnings are now 14% higher vs. previous estimates, while we expect a sales CAGR of 11%. Our new CY22/23f EPS estimates stand at PKR5.19/7.07. That said, we incorporate a higher risk free rate of 11.0% vs. 10.5% previously which despite a rollover (to Dec 2022) leaves our TP unchanged.

Cost pressures are building for UHT players…

The PKR has slipped 9%CY21td leading to a sharp increase in commodity prices in 2021. The differential between loose and packaged milk is narrowing (partly due to the terms of agreement under the Zero Rated regime), where UHT milk producers have not raised prices since January 2021. Loose milk is now averaging PKR137/litre in Karachi and PKR112/litre is the national average compared with PKR155-160/litre for Olpers and NESTLE MilkPak. Moreover, Skim Milk Powder (SMP) – an essential input in the production of Tarang, has also witnessed large swings in prices increasing from c. US$2,900/MT in December 2020 to US$3627/MT in November 2021.

…but there is ample room to absorb

The existing zero rated regime will reduce the cost of doing business for UHT players, the benefit of which (PKR7-8/litre) has not been passed on to consumers. This, in our view, is more than adequate to absorb ongoing cost pressures while allocating funds for UHT awareness campaigns. We therefore expect GMs to rise from c. 18% in CY21f to c. 25% by CY26f. Additionally, higher differential between loose and packaged milk prices can prompt conversions, allowing for greater potential for sales growth for UHT players, in our view.

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Better fortunes in store for ice-cream

Sales from the FCEPL’s ice cream business have risen by a sharp 42%yoy to PKR4.9bn in 9MCY21. This has been driven by an enhanced trade footprint on extended working hours post lockdown measures and an early start to the summer season. With c.60% of the population below 30 years, the ice-cream segment is well positioned to capitalize on this niche market, where FCEPL has already cemented its position as the second largest player after Walls (c. 25% market share of Omore). The ice cream business is now contributing a large 37% to FCEPL’s post-tax bottom line, having helped the overall business breakeven last year while UHT was running losses.

Recent sharp price correction has unlocked valuations

We think the recent 28% pullback provides a decent entry point for direct exposure to a moderately liquid name, geared to Pakistan’s consumer growth story. Strong volume backdrop in dairy, opportunity in ice-cream and a stable margin trajectory in a benign regulatory environment (under the PTI Government) should cumulatively translate into a 5-year earnings CAGR of +30% (2021-26). Valuations are exciting with FCEPL currently trading at a P/E of 17.2x much lower than the historical sector average of +20x for Pakistan Consumers.

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