agthia

rating

neutral

08 November 2010

Current Businesses Priced In, Valuation Sensitive to New Products; Initiate with Neutral
initiation of coverage consumer goods uae
Ahmed Gad, CFA +971 4 364 1904 agad@efg-hermes.com Gigi Tharian Varghese +968 24760023 gvarghese@efg-hermes.com STOCK DATA Price Fair Value
Last Div. / Ex Date Mkt. Cap / Shares (mn) Av. Mthly Liqdty (mn) 52-Week High / Low Bloomberg / Reuters Est. Free Float

Fair Value of AED2.32/Share; Initiate with Neutral Our DCF valuation of AED2.22/share, which is 4.9% above the current share price, suggests that the current business lines are fully priced into the stock. We assign a P/BV of 1.5x to the estimated investment cost of AED120 million for Agthias new products to arrive at AED0.10/share. Our fair value (FV) of AED2.32/share is 9.6% above the stock price; hence we initiate with a Neutral. Upside potential depends on the new business lines, which have yet to start. We expect the new business lines to need time to ramp up capacity and will require aggressive marketing expenses to achieve decent market share. A Commodity Play Despite Diversification Plans Our valuation for Agthia is highly sensitive to long-term wheat price forecasts; a 5% change in long-term wheat prices results in an 8.4% movement in our FV in the opposite direction. The flour and feed segment contributes 63% of the groups profitability during our forecast horizon despite the expected growth in the other divisions (i.e., water and beverages and processed fruits and vegetables). The flour and feed segment also exposes Agthia to quarterly earnings volatility. Acquisition of Strong Consumer Franchise Could Change Positioning We think Agthia can increase the pace of earnings growth, expected to peak in 2012, and defy its strong reliance on B2B sales and the Abu Dhabi market through the acquisition of a strong consumer franchise. We believe the spectrum for possible acquisitions include businesses related and unrelated to Agthias current operations. Agthia enjoys ample borrowing capacity to finance inorganic growth.

AED2.12* AED2.32
AED0.05 on 29 April 2010 AED1,272 / 600 AED 27.8 AED2.36 / AED1.58 AGTHIA UH /AGTH.AD 44.00%

SHARE PRICE PERFORMANCE RELATIVE TO ADI REBASED

Price (AED) ADI (Rebased)

2.4

2.0

1.6

1.2 07-Nov-09 07-Aug-10

KEY FINANCIAL HIGHLIGHTS December Year End (AED mn) Revenue EBITDA EBITDA Margin Net Profit EPS (AED) DPS (AED) Net Debt (Cash) P/E* (Attrib.) (x) EV / EBITDA (x) P/BV* (x) P/CF* (x) Div. Yield
*Price as at 07 November 2010 Source: EFG Hermes estimates

2009a 921 139 15.1% 106 0.18 0.05 (95) 12.0 8.7 1.6 5.1 2.4%

2010e 1,004 146 14.5% 111 0.18 0.06 (65) 11.5 8.3 1.4 10.5 2.8%

2011e 1,078 156 14.4% 121 0.20 0.06 (133) 10.5 7.7 1.3 8.5 2.7%

2012e 1,141 175 15.3% 138 0.23 0.07 (200) 9.2 6.9 1.2 8.1 3.1%

CONTENTS
I. VALUATION AND RECOMMENDATION II. INVESTMENT THESIS III. BUSINESS MODEL AND STRATEGY V. WATER AND BEVERAGE DIVERSIFICATION IS PAYING OFF VII. FINANCIAL STATEMENTS 2 4 7

IV. FLOUR AND FEED - THE KEY SEGMENT 10 15 20

VI. PROCESSED FRUITS AND VEGETABLES 18

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kindly refer to the important disclosures and disclaimers on back page

07-May-10

07-Nov-10

07-Feb-10

agthia

08 November 2010

consumer goods uae

I. VALUATION AND RECOMMENDATION

DCF VALUE OF AED2.22 PER SHARE FOR THE CURRENT OPERATIONS... We value Agthias existing operations using a DCF approach at AED2.22 per share, 4.9% above the current share price. We use a cost of equity of 11.8%, implying an equity risk premium (ERP) of 8% above the current yield on the Abu Dhabi Government USD-denominated bond maturing in 2019. This ERP is 50 bps above the higher end of the range that we apply to our consumer sector coverage in Saudi Arabia to account for market and liquidity risks (Agthia traded on average USD260,000 per day over the last six months). We assign a perpetual growth rate of 2.5% to account for possible expansion in the current business lines, especially in the scalable beverages division.
FIGURE 1: DCF VALUATION In AED million, unless otherwise stated 2010e COPAT Capex Change in Working Capital Free Cash Flow Discounted Free Cash Flow Terminal Value Perpetual Growth Rate WACC PV of Cash Flows 2010e-2014e PV of Perpetuity Total Firm Value Net (Debt) / Cash Equity Value No. of Shares (mn) DCF Value (AED) Current Price (AED) Upside / Downside
Source: EFG Hermes estimates

2011e 156 (47) (15) 94 83

2012e 174 (49) (27) 99 78

2013e 181 (38) (30) 112 80

2014e 183 (40) (15) 128 82

145 (88) (28) 7 7 1,519 2.5% 11.1% 332 978 1,309 25 1,334 600 2.22 2.12 4.9%

... AND AED0.10 PER SHARE FOR NEW PRODUCTS We apply a P/BV ratio of 1.5x to the estimated investment cost (cAED120 million) of the new products (frozen bakery, dairy and processing of fresh fruits and vegetables), in line with the P/BV of the current businesses implied by our DCF value (1.44x). This yields an additional value of AED60 million (net of required capex), or AED0.1 per share.
We do not include the new investments in our forecasts since we cannot assess the possible market share gains for Agthia in the respective markets at the moment.

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agthia

08 November 2010

consumer goods uae

VALUATION SENSITIVE TO NEW PRODUCTS; INITIATE WITH NEUTRAL We initiate coverage on Agthia with a fair value (FV) of AED2.32 per share, 9.6% above the current share price, and initiate coverage with a Neutral rating. The current share price reflects the existing operations, in our opinion. Our valuation, as well as the long-term stock performance, depends on the success of the new product initiatives, which have yet to be proven.
Forward integration into the frozen bakery segment, representing 54% of the cost of the new product initiatives, could come together with the current product mix faster than the other products due to Agthias leading position in the flour market and its knowledge of its client base, in our view. However, Agthia would face well-established competition in dairy and, to a lesser extent, fresh fruits and vegetables processing. The penetration of these new markets needs time and requires significant spending on marketing and advertising, in our opinion.

SENSITIVITY TO LONG-TERM WHEAT PRICES We run a sensitivity analysis for our FV to our assumptions for long-term US wheat prices and cost of equity. We use the Bloomberg consensus forecast for 2013 US wheat prices, at USD270 per tonne, as our long-term base case price assumption. This price is c7% below the current wheat price. We examine our FV sensitivity in 5% increments to our base case assumptions.
FIGURE 2: FV SENSITIVITY TO WHEAT PRICES AND COST OF EQUITY In AED per share, unless otherwise stated Change in Long-term US Wheat Price Assumption -10% 3.02 2.86 2.71 2.58 2.46 -5% 2.80 2.65 2.51 2.39 2.28 0% 2.58 2.44 2.32 2.21 2.11 5% 2.36 2.23 2.13 2.03 1.94 10% 2.13 2.03 1.93 1.85 1.77

10.8% 11.3% 11.8% 12.3% 12.8%

Source: EFG Hermes estimates

Our analysis reveals that our valuation for Agthia is highly sensitive to wheat prices; a 5% change in long-term wheat prices results in an 8.4% movement in our FV in the opposite direction, assuming a base case cost of equity of 11.8%. A rise in wheat prices negatively impacts Aghtias margins and thus its valuation, in our view, and vice versa. This highlights our opinion that Agthia remains exposed to commodity risk despite the growing significance of the other segments during our forecast horizon. As a result, the stocks trading multiples should be capped, in our view. Our FV implies estimated 2010 and 2011 P/E multiples of 12.0x and 11.0x, respectively. Our estimated 2010 and 2011 implied EV/EBITDA multiples also stand at 9.0x and 8.4x, respectively. These multiples are at a discount to Almarai (Price: SAR215, Fair Value: SAR219, Rating: Neutral), which enjoys an unrivalled business-to-consumer (B2C) platform and product mix in the GCC region, and are almost at parity with Juhaynas (Price: EGP5.53, Fair Value: EGP5.85, Rating: Neutral) despite the latters strong earnings potential and non-exposure to the lower margin flour business.

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Cost of Equity

agthia

08 November 2010

consumer goods uae

II. INVESTMENT THESIS

PHASE I OF THE TURNAROUND ACCOMPLISHED Agthias current management team was hired in 2005 to maximise the groups profitability. Since then, management has been able to record market share gains in all the constituents of its product mix, as well as grow the beverage segment organically and successfully integrate the fruits and vegetables processing segment. We consider the ongoing organic expansion in the flour and feed (FAF) segment and the beverage segment as the last episode of this turnaround. YET COMMODITY RISK AND CLIENT CONCENTRATION PERSIST Agthia is a price taker in the flour market, despite its leadership position, due to the Abu Dhabi governments flour subsidies. According to the agreement with the Abu Dhabi government, flour prices are fixed at AED70 per 50-kg bag (AED1,400 per tonne). Agthia cannot raise flour prices at will and is compensated for the difference between flour prices in Abu Dhabi and the northern emirates on a quarterly basis. As a result, Agthia is a price taker of its competitors pricing policy in the northern emirates.
We attribute this to Agthias focus on the Abu Dhabi market. Abu Dhabi represents the main market for Agthia, with the companys market shares in Abu Dhabi exceeding those in the UAE across all of its product groups, although Agthias products are sold across the GCC region. The business-to-business (B2B) FAF enjoy a combined 85% volume market share in Abu Dhabi and B2C FAF also enjoys a 75% volume market share in Abu Dhabi. Al-Ain Water enjoys a 41% volume market share in Abu Dhabi.

PHASE II OF THE TURNAROUND FOCUS ON VALUE-ADDED PRODUCTS Agthia plans to invest cAED120 million in new business lines, including in: i) a frozen bakery plant at an estimated cost of AED65 million, set to be operational in 1Q2012, ii) the penetration of the GCC regions dairy market after signing an exclusive manufacturing and distribution agreement with Yoplait in August 2010, and iii) the processing of fresh fruits and vegetables under the processed fruits and vegetables division. The common factor of the new products is that they are all value-added products. Agthia does not plan to venture in less value-added activities, such as sugar refinery, which might dilute the current operating margin. Additionally, Agthia is currently evaluating an investment in the poultry business. MORE FOCUS ON B2C We expect Agthia to address the B2C market with its new dairy and processed fruits and vegetables capacity. This should provide Agthia with cross-selling opportunities to its current distribution network (estimated at more than 1,000 clients). We also expect Agthia to attempt to add market share points outside of Abu Dhabi, which could require it to increase its advertising budget and target lower margin key B2B contracts, such as restaurants and airlines, to increase brand awareness. The water and beverage segments 9M2010 SG&A expenses, increased by 28% Y-o-Y to increase the divisions sales by 30% over the same period. EARNINGS STILL SENSITIVE TO FAF SEGMENT We still expect the FAF segment to represent c63.5% of Agthias net profit before unallocated items on average during our forecast horizon, although we expect the water and beverage segments net profit to grow by an estimated CAGR of 12.8% in 2009-2014. The expansion of the flour mill would the segments contribution to Agthias profitability at the current high levels. On the flip side, the FAF would keep Agthias earnings volatile.
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agthia

08 November 2010

consumer goods uae

For instance, we expect the recent rise in local flour prices to enhance the FAF segment profitability in 4Q2010, due to low-cost inventory, but to negatively affect the divisions profitability in 1H2011. The ability to pass on cost increases and the time lag between the change in input and output prices should keep quarterly earnings volatile.

CORE BUSINESS FUNNELLING CASH FOR FUTURE EXPANSION Agthias extensive product expansion plans require significant cash outlays, which are supported by the two cash-generating businesses (FAF and Beverage). Agthia reported free cash flow of AED172 million in FY2009 despite the expansion of the beverage segment and tomato paste factory in Egypt. We expect FCF will remain positive over our forecast horizon as our forecasts do not include expansion into dairy, frozen bakery and poultry businesses in FY2011. According to management, the approximate capital expenditure required to expand into these businesses is AED120 million. In our opinion, a strong balance sheet with a net cash balance of AED67.5 million and strong FCF provides flexibility for future expansion both organically and through acquisitions.
FIGURE 3: CORE BUSINESS FUNNELLING CASH FOR EXPANSION In AED million, unless otherwise stated
Capital Expenditure 250 200 150 100 50 0 FY10e FY11e FY12e FY13e FY14e Free Cash Flow Dividend End of Year Cash Balance

Source: EFG Hermes estimates

EARNINGS GROWTH TO PEAK IN 2012 We expect earnings to grow by 10% in 2011 due to both an estimated 17% growth in the water and beverage division and a sharp decline in losses by the processed fruits and vegetables division. We expect earnings growth to peak at 14% in 2012 as the new flour mill is fully operational and the processed fruits and vegetables division returns to profitability. Earnings growth would be muted beyond 2012 as we do not assume further capacity expansions. The addition of market share points should be challenging, in our view.
It is worth noting that we do not incorporate the new products (dairy, frozen bakery and processed fresh fruits and vegetables) into our forecasts. The scale of the new investments (AED120 million) should not significantly affect our earnings forecasts during our forecast horizon. If we assume annual sales for the new products of AED120 million (EV/sales of 1x) by 2013 at a net profit of 15% (accounting for high advertising expenses required for the launch of the new products), we would arrive at an additional net profit of AED18 million, a 12.5% addition to our 2013 net profit forecast of AED144 million. These back-of-the-envelope calculations assume a quick ramp-up of the new capacities and successful market penetration.

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agthia

08 November 2010

consumer goods uae

ACQUISITION OF STRONG CONSUMER FRANCHISE SHOULD ACCELERATE GROWTH We think that Agthia can increase the pace of earnings growth through the acquisition of a strong consumer franchise that would enrich Agthias product mix in the B2C market and provide Agthia with a growing footprint in the northern emirates and possibly the GCC region. We believe that the spectrum for possible acquisitions is diverse; one could take place in a business related to Agthias current segments, such as bakery, or in unrelated businesses such as poultry, in our view.
Agthia enjoys ample borrowing capacity to finance acquisitive growth. Agthia enjoys a net cash balance of AED25 million and gross debt of AED192 million. Only 10% of the debt is a term loan and the rest is short-term borrowing to finance working capital and the receivable on government compensation for flour subsidies.

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agthia

08 November 2010

consumer goods uae

III. BUSINESS MODEL AND STRATEGY

Agthia, formerly known as Emirates Foodstuff and Mineral Water Company, is a leading manufacturer and supplier of flour and animal feed, mineral water, tomato paste and nonalcoholic beverages in the UAE. The company is 51% owned by the General Holding Corporation (GHC), an Abu Dhabi government-related entity. GHC contributed in-kind assets worth AED590 million to raise Agthias capital to AED600 million in 2004. GHC offered 49% of the company to the public in 2005. Abu Dhabi Pension Fund owns 5% of the company and the balance (44%) is free float. Foreigners can hold up to 25% of the capital. The company fully owns four subsidiaries operating under three different segments. The FAF segment contributed 73% of the groups 2009 revenues and 80% of operating profit. The bottled water and beverages segment contributed 22% of 2009 revenues and 24% of operating profit. The processing of fruits and vegetables segment is the least contributor to revenues (5% in 2009) and the only segment with operational facility outside of the UAE (AlAin Foods and Beverages tomato paste factory in Egypt). The start-up costs of the Egyptian subsidiary caused the division to generate operational losses in 2009.
FIGURE 4: SNAP SHOT OF CONTRIBUTION OF DIFFERENT BUSINESS SEGMENT In AED million, unless otherwise stated
BUSINESS SEGMENT Operating Subsidiary Revenue (2009) 669 % of Market Capacity Gross Gross Segment Operating % of Total EBITDA EBITDA Total Share Margin Profit Margin Operating Margin Operating Profit Profit Revenue 73% 43% 575* 154 22.9% 115 17.2% 80% 132 19.8% ROA Assets % of Total Asset 60.2%

Flour & Feed

Grand Mills for Flour and Feed (GMFF)

19.8%

532

Water & Beverages

Al Ain Mineral Water (AAMW)

206

22%

24%

29.6**

89

43.2%

35

16.8%

24%

34

16.8%

13.5%

256

29.0%

Processed Fruits & Vegetables

Al Ain Vegetable Processing and Canning (UAE) & Al Ain Food and Beverages (Egypt)

46

5%

12%

49.8*

11

22.8%

-4.9

N/A

-3%

-1.9

-4.1%

N/A

96

10.9%

Total

921

100%

250 27.2%

108

11.7%

139

15.1%

1,190

*Thousand tonnes per annum **Million cartons per annum Sources: Agthia, EFG Hermes estimates

TURNAROUND AND SHAREHOLDER SUPPORT GHC brought in a new management team following the 2005 IPO to turn Agthia into a profitable and diversified consumer staple company. The current top level management brings notable experience from multinational consumer staples and agricultural development companies, including Gillette/P&G, PepsiCo USA, Johnson & Johnson and Bunge.
The companys key strategy has been margin management, which should enable it to reinvest and expand its product portfolio. Management has also adopted a product diversification strategy. Over the last two years, the company diversified its product portfolio to include processed vegetables and tomato paste in the product mix. Management also organically grew the bottled water capacity and ventured into the five-gallon home and office delivery (HOD) niche market.

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08 November 2010

consumer goods uae

Additionally, Agthia signed a franchise agreement with Capri Sun, the worlds third largest juice producer, to cover the GCC region (excluding Saudi Arabia). Agthia is assessing the addition of new products, including: i) fresh bakery under the FAF segment, ii) energy drinks, sports drinks and ready-to-drink (RTD) coffee and tea under the beverages segment, and iii) stable juices, jams and ready-to-eat (RTE) meals under the fruits and vegetables segment.
FIGURE 5: PRODUCT MIX Flour and Feed Traditional and specialty Current Products flours Mixes and improvers Frozen bakery (4Q2011) Feed Lifecycle Program Ideal Protein Fresh bread and bakery Products under Evaluation Health protection feed
Source: Agthia

Water and Juice Bottled water HOD five-gallon Flavoured water Enhanced water Juice

Fruits and Vegetables Tomato paste Tomato-based products Frozen vegetables Hot chilli paste Fruit puree Fresh fruits and vegetables (2011) Stable juices Jams RTE meals

Energy drinks Sports drinks RTD coffee and tea

However, Agthia largely remains a commodity play due to the high contribution from the FAF segment to revenues and operating profit. The rise in grain prices especially wheat, coupled with efficiency gains in the milling operations, has helped increase profitability per tonne and balance and at times even outweigh the increasing profitability of the beverage segment.
FIGURE 6: REVENUE BREAKDOWN
FAF Beverages Fruits abd Vegetables Processing

FIGURE 7: GROSS PROFIT BREAKDOWN

FAF Beverages Fruits abd Vegetables Processing 100% 85% 70% 55% 40% 25% 10% -5%

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2006 2007 2008 2009 1H2010

2006

2007

2008

2009

1H2010

Source: Agthia, EFG Hermes

Source: Agthia, EFG Hermes

GHC also supports Agthia by transferring assets at or below cost. Agthia realised income of AED35 million following the transfer of Al-Ain Vegetables assets to Agthia in 2008. GHC also handed over Cold Stores, a provider of refrigerated warehousing, to Agthia for free in 2008. Finally, GHC wrote back AED33 million in dues from Agthia in 2008.

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agthia

08 November 2010

consumer goods uae

FUTURE STRATEGY FOCUS ON NEW BUSINESS SEGMENTS Agthia plans to invest cAED120 million in new business lines as well as continue spending on organic growth of its existing business lines. The new business lines include: i) a frozen bakery plant at an estimated cost of AED65 million, set to be operational in 4Q2011, ii) the penetration of the GCC regions dairy market after signing an exclusive manufacturing and distribution agreement with Yoplait in August 2010, and iii) the processing of fresh fruits and vegetables under the processed fruits and vegetables division.
The common factor of the new products is that they are all value-added products. Agthia expects a gross margin of 45-50% for the dairy and fresh fruits and vegetables products, and 24-28% for the frozen bakery products. Agthia does not plan to venture into less value-added activities, such as sugar refinery, that might dilute the current operating margin. Additionally, Agthia is evaluating an investment in the poultry business.

CLIENT BASE Abu Dhabi represents the main market for Agthia, with the companys market share in Abu Dhabi exceeding that in the UAE across all its product groups, although Agthias products are sold across the GCC region. B2B flour and feed enjoy a combined 85% volume market share in Abu Dhabi versus 43% and 49% in the UAE, respectively. B2C flour also enjoys a 75% volume market share in Abu Dhabi versus 38% in the UAE. Al-Ain Water enjoys a 41% volume market share in Abu Dhabi versus 24% in the UAE.
The FAF segment historically exposed Agthia to an institutional client base, especially in the animal feed market. On the other hand, Al-Ain bottled water, Capri Sun and Al-Ain tomato paste and frozen vegetables are Agthias main retail brands. Management has been trying to increase its B2C business by introducing new brands, increasing brand awareness and expanding its distribution network. Al-Ain bottled water has even targeted lower margin B2B accounts, such as Emirates Airlines, and has become the top-selling water brand in UAE eateries (14% volume market share) all to increase the brand awareness amongst consumers. The drive to increase B2B business and gain market share has pressurised Agthias margins. Using the beverages segment as a proxy, the segments EBIT margin declined from 18.1% in 2008 to 16.8% in 2009 as selling and marketing expenses soared by 62%, in line with the introduction of Capri Sun and the HOD five-gallon bottles to the product mix. The segments EBIT margin reached a trough of 12.4% in 1Q2010 before recovering to 15.4% in 2Q2010.

INTERNATIONAL OPERATIONS Agthia ventured into tomato paste production outside the UAE by establishing a 30,000 tonne-per-annum factory in Egypt. The fully owned subsidiary aims to benefit from year-round tomato cultivation in Egypt to produce tomato paste in bulk and export it to the MENA region. The subsidiary has been affected by a decline in international tomato paste prices driven by cheap Chinese imports. The tomato crop in Egypt has also been significantly affected by a hot summer and pest disease. Consequently, the otherwise profitable fruits and vegetables division has been experiencing losses since 4Q2009.
Agthia introduced new products to counter the losses incurred by the Egyptian subsidiary. The plant currently produces frozen French fries and red chilli paste. More importantly, management plans to focus more on branded sales and move away from the low-margin private label export business.

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agthia

08 November 2010

consumer goods uae

IV. FLOUR AND FEED - THE KEY SEGMENT

DEMAND FOR FLOUR EXCEEDS CAPACITY The FAF business is the major driver of Agthias revenue and profitability. The capacity of Grand Mills is 200,000 tonnes of flour and 370,000 tonnes of animal feed. We estimate that Grand Mills consumes c270,000 tonnes of wheat to produce 200,000 tonnes of flour at an estimated conversion rate of 75%. Grand Mills sales volume has exceeded its capacity since 2006. To meet excess demand, Grand Mills outsources c40,000-50,000 tonnes of flour from competing mills. Agthia is currently adding 100,000 tonnes of flour milling capacity to Grand Mills, set to be operational in 2H2011.
Animal feed mill sales volume increased by a CAGR of 20% in 2006-2009, lifting capacity utilisation to 85% from 49%.
FIGURE 8: FLOUR CAPACITY UTILISATION In thousand tonnes (LHS) and In % (RHS)
Sales Volume (LHS) Capacity Utilisation (RHS) 275 250 225 110% 200 175 150 FY06
Source: Agthia

FIGURE 9: ANIMAL FEED CAPACITY UTILISATION In thousand tonnes (LHS) and In % (RHS)
Sales Volume (LHS) Capacity Utilisation (RHS)

150% 130%

350 300 250

90% 80% 70% 60%

90% 70% FY07 FY08 FY09

200 150 FY06

Source: Agthia

50% 40% FY07 FY08 FY09

MARKET LEADER WITH STRONG B2B FRANCHISE Agthia enjoys a dominant market share in the UAE with a 43% volume market share of the B2B flour market and 38% of the B2C flour market. Agthias market share in Abu Dhabi stands at 85% for the B2B flour market and 75% of the B2C flour market. Agthia enjoys a 49% market share of the UAE animal feed market (85% market share in Abu Dhabi). Agthia enjoys top market positions in all UAE feed segments: professional farms, municipalities and the open market. The UAE flour market size is estimated at USD285 million, growing at 6% per annum, while the UAE feed market size is estimated at USD222 million, growing at 7% per annum.
The flour market is highly concentrated, with Grand Mills and Al-Ghurair enjoying 76% of the market between them. Imports satisfy 10% of local consumption, paving the way for more market share gains for local producers. Grand Mills dominant market share in the feed business is unrivalled, with the rest of the market (51% market share) almost evenly split between three local companies. Circa 80% of the flour and 100% of feed production are sold in Abu Dhabi, while 20% of the flour production is sold in the northern emirates. Agthias main customer base is comprised of commercial bakeries, stores, and poultry and cattle farms.

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consumer goods uae

FIGURE 10: AGTHIA LEADS IN UAE B2B FLOUR MARKET: MORE ROOM FOR GROWTH IN THE B2C CATEGORY Category Flour- B2B (UAE) Flour- B2C (UAE) Flour- B2B (Abu Dhabi) Feed (UAE)
Source: Company Presentation

Market Share 41% 39% 90% 47%

STRONG MARKET FUNDAMENTALS The UAEs per capita wheat consumption is the highest in the world, according to the United Nations Food and Agriculture Organisation (FAO). The UAEs annual per capita wheat consumption, at 204 kg per capita, is three times the worlds average. Future demand growth is expected to be driven by population growth and the UAE governments plan to increase selfsufficiency in poultry production.
FIGURE 11: WHEAT CONSUMPTION PER CAPITA IN SELECTED COUNTRIES In Kg per capita per annum, unless otherwise stated
250 200 150 100 50 0

Argentina

Australia

France

Kuwait

Lebanon

Pakistan

India

KSA

Canada

UK

S. Africa

Egypt

USA

UAE

Source: FAO

REVENUE GROWTH CAPPED BY ABU DHABI GOVERNMENT SUBSIDY Rising raw material prices, especially wheat, have little impact on Agthias flour revenue ever since the Abu Dhabi government capped the retail flour price at AED1,400 per tonne in 2007. The Abu Dhabi government compensates Agthia through a subsidy system for quantities sold in Abu Dhabi. The subsidy is calculated at the end of every quarter based on the flour price differential between Abu Dhabi and the northern emirates. Agthia deducts this subsidy from its cost of goods sold.

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World

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08 November 2010

consumer goods uae

FIGURE 12: AVERAGE SELLING PRICE FOR FLOUR AND FEED In AED per tonne, unless otherwise stated
1,500 Feed Flour

FIGURE 13: LITTLE CORRELATION BETWEEN WHEAT PRICES AND FLOUR REVENUES
Wheat Price % Change 80% 60% 40% Flour Revenue % Change

1,300 1,100

20% 0% -20%

900

700 FY06
Source: Agthia, EFG Hermes

-40%
FY07 FY08 FY09

FY07
Source: Agthia, EFG Hermes

FY08

FY09

Animal feed prices have been declining since 2008. They are not only affected by wheat prices, but also by other input prices (like barley and corn).

PROFITABILITY DETERMINED BY COMMODITY PRICES Our analysis indicates that the FAF segments gross profit is a function of two variables: the carrying cost of wheat inventory and the premium of the flour selling price in the northern emirates over Abu Dhabis selling price.
Agthias inventory management is influenced by the price of wheat. Agthia procures wheat 45 days in advance on spot price. The company tends to increase inventory in the event of depressed wheat prices to benefit from the anomaly between wheat and flour prices. We note that the company has significantly benefited from these opportunistic windows since the start of the global financial crisis (1Q2009 in particular). On the flip side, the time lag between the change in wheat inventory costs and the change in flour price causes volatility in the segments earnings.
FIGURE 14: INCREASED PROCUREMENT AT PRICE DIPS In days (LHS) and In AED per tonne (RHS)
Inventory Days on Hand (LHS) 180 160 140 120 100 80 60 Wheat Price (RHS) 500 450 400 350 300 250 200
10% 0% 40% 30% 20%

FIGURE 15: GROSS MARGIN VOLATILITY

Gross Margin (LHS) Q-o-Q Wheat Price Change (RHS) Q-o-Q Flour Price Change ex-Abu Dhabi (RHS)

50% 40% 30% 20% 10% 0% -10% -20% -30%

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

Source: Agthia, EFG Hermes

2Q10

Source: Agthia, EFG Hermes

2Q10
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consumer goods uae

EXPANSION TO DRIVE REVENUE GROWTH IN THE LONG TERM The ongoing 50% expansion in the flour mill capacity is expected to enhance the FAF segments revenue growth outlook beyond 2011. Agthias current flour sales volume is affected by the capacity of third party mills used for outsourcing. We expect flour revenues to grow by an estimated CAGR of 9% in 2009-2012 due to the capacity expansion. Feed revenue growth should be muted, in our opinion. We do not expect the feed mill utilisation capacity to exceed 85%.
FIGURE 16: EXPECTED SALES VOLUMES AND PRICES In thousand tonnes (LHS), In AED per tonne (RHS)
Volume Sales- Flour Mill (LHS) Volume Sales- Feed mill (LHS) Selling Price- Flour (RHS) Selling Price- Animal Feed (RHS)

FIGURE 17: EXPECTED FAF REVENUE BREAKDOWN In AED million, unless otherwise stated
Flour Revenue 900 800 700 600 500 400 300 200 100 0 Feed Revenue

400 300 200 100 0

1,600 1,500 1,400 1,300 1,200 1,100 1,000 900

325

313

305

314

317

320

320

348

356

373

383

417

444

448

FY10e

FY11e

FY12e

FY13e

FY08e

FY09e

FY10e

FY11e

FY12e

FY13e

Source: EFG Hermes estimates

FY14e

Source: EFG Hermes estimates

SHORT-TERM VOLATILITY IN MARGINS We expect short-term volatility in the divisions gross and net margins. The gross margin in 3Q2010 came in at 14.4%, down from 21.7% in 1H2010, due to a decrease in flour volumes as one of the lines was temporarily shut down in July. The FAF segment also suffered from a drop in feed prices in 3Q2010. We expect a mild recovery in the gross margin to 15.0% in 4Q2010 as we expect a Q-o-Q recovery in flour volumes and prices. We also expect volatile margins in 2011. The rise in wheat inventory costs, amongst other inputs, should squeeze the divisions margins during 1H2011, in our view. We then expect margins to recover in 2H2011 as inventory costs slow down. We generally expect the FAF gross margin to drop from an estimated 18.1% in 2010 to 17.6% in 2011.

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FY08

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LONG-TERM NORMALISED GROSS MARGIN ESTIMATED AT 18-19% In the long-run, we estimate a sustainable gross margin of 18-19% for the FAF segment. We estimate gross margin to increase in FY2012 and beyond to reflect the replacement of lowmargin outsourced sales by in-house production. We expect the FAF net margin to stabilise at 14.4% at the end of our forecast horizon, up from our estimate of 13.7% in 2010.
FIGURE 18: FORECASTED PROFIT MARGINS In AED million (LHS), In % (RHS)
Gross Profit (LHS) Net Profit (LHS) Gross Margin (RHS) Operating Margin (RHS)

180 160 140 120 100 80 60 40 20 0 FY08 FY09

25% 20% 15% 10% 5% 0%

FY10e

FY11e

FY12e

FY13e

FY14e

Source: EFG Hermes estimates

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V. WATER AND BEVERAGE DIVERSIFICATION IS PAYING OFF

PRODUCT MIX AND MARKET SHARE The water and beverage division sells bottled water under the Al-Ain brand and five-gallon HOD water under the Al-Ain and Ice Crystal brands. The division also produces Capri Sun, the top selling juice worldwide, under licence in the GCC region (excluding Saudi Arabia).
The UAE water market size is estimated at USD235 million; USD163 million for bottled water and USD72 million for the HOD market. The UAE enjoys the highest per capita consumption of bottled water worldwide at 280 litres per annum. The bottled market has been growing at 10% per year, while the HOD market has been growing at 5-7%. Al-Ain is the second largest market player in the bottled market with a 24% volume market share, following the market leader Masafi with a 32% market share. Al-Ain enjoys a leading volume market share in Abu Dhabi at 41%, suggesting that the majority of sales occur in Abu Dhabi. Al-Ain has been penetrating the B2B market in order to increase brand awareness and gain market share. Al-Ain is the top supplier of bottled water to UAE eateries with a 14% market share, and became the supplier for Emirates Airlines in 2010. Al-Ains HOD market share is 7% given that Al-Ain started to offer this product only in 2008. Agthia ventured into the juice market in 1Q2009. Capri Suns current market share is 3.1% of the total UAE juice market and 9.5% of the still drinks subsector. Capri Sun is the third largest seller in the still drink market. The UAEs total juice market is estimated at USD261 million, of which the still drink market represents 32% (USD84 million). The UAE still drink market has been growing at 4% per year.
FIGURE 19: UAE BOTTLED WATER MARKET SHARES FIGURE 20: UAE JUICE MARKET SHARES
Capri Sun 3%

Others 31% Arwa (Coca Cola) 5% Aquafina (Pepsico) 8%

Al Ain 24%

Other Still Drinks 29%

Massafi 32%

Nectar and 100% Juice 68%

Source: Agthia

Source: Agthia

STRONG COMMITTED INVESTMENT IN THE DIVISION The company continues to invest heavily in the beverage segment. The company invested approximately AED108 million in in 2008-2009, which is approximately 58% of the total groups capital expenditure over that period. Agthia added an annual capacity of 4 million units of HOD five-gallon capacity in 2008 and an annual capacity of 3.2 million cartons of Capri Sun juice in 2009-2010. Al-Ain has just increased its bottled water capacity to 24 million cartons from 20 million cartons. Nevertheless, the segments asset turnover has increased from 0.5x in FY2006 to 0.8x in FY2006-2009. Additionally, Agthia broadened its product mix by offering value-added products such as flavoured water and enhanced water.

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GROWING SIGNIFICANCE IN THE GROUP Following these investments, the divisions revenues and net profit grew by 49% and 38%, respectively. The division contribution to the groups revenue increased to 26.3% in 9M2010 from 21.3% in FY2009. The divisions weight of net profit before unallocated items also increased to 34.0% in 9M2010 from 23.9% in FY2009. PROFITABILITY AFFECTED BY PACKAGING AND ADVERTISING EXPENSES Agthia procures water from Al-Ain Municipality at a fixed cost. The major contributor to the operating costs, as well as the swing factor, is the cost of polyethylene terephtalate (PET) used in bottling. Agthia procures the required PET from local producers at market prices. PET represents the majority of the operating costs for bottled water.
The gross margin on HOD sales is typically higher than that for bottled water due to the lower cost of packaging. However, this premium is wiped out by the high distribution and delivery costs associated with HOD sales. Agthia started trial production of a hot fill line in 3Q2010 to reduce PET requirements and save energy. We attribute the divisions gross margin expansion to 47.8% in 3Q2010 from 42.4% in 2Q2010 to the new hot fill line. Selling and marketing expenses associated with the new product launches, especially Capri Sun, determine the divisions net profit. Selling and marketing expenses in 9M2010 increased by 27.6% Y-o-Y. The marketing expenses associated with Capri Sun were responsible for c50% of the Y-o-Y increase in Agthias SG&A expenses for 9M2010.

CAPACITY UTILISATION AND COST SAVINGS TO DRIVE SALES GROWTH We expect utilisation rates and cost savings associated with the hot fill line to drive profitability. We do not factor in further capacity increases since current capacities are still running at below optimum levels and market share gains require strong spending on advertising and distribution. We also do not expect a major change in pricing policy.
We expect the gross margin to improve to 44% during our forecast horizon from 43% in 2010, lifting the net margin to 18.5% in 2010 and 19% in 2011 from 16.8% in 2009. We expect the divisions net profit growth to peak in 2010 at 43%, at 17% in 2011 and 3% in 2012. The division should contribute 35% to the groups net profit before unallocated items by the end of our forecast horizon, up from 24% in 2009.

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FIGURE 21: FORECASTED CAPACITY UTILISATION

Caprisun Bottled Water HOD (5-Gallons Business)

FIGURE 22: FORECASTED WATER AND BEVERAGES REVENUE BREAKDOWN In AED million, unless otherwise stated
Mineral Water Capri Sun 350 300 250 200 150 100 50 0 122 0 36 179 199 204 212 212 74 60 76 78 78 HOD (5-Gallon) Other

100% 70% 40% 10% -20%

154

FY08

FY09

FY10e

FY11e

FY12e

FY13e

FY10e

FY11e

FY12e

FY13e

Source: EFG Hermes estimates

FY14e

Source: EFG Hermes estimates

FIGURE 23: FORECASTED GROSS AND NET PROFIT In AED million(LHS), In % (RHS)
Gross Profit (LHS) Gross Margin (RHS) 160 140 120 100 80 60 40 20 0 Opearting Profit (LHS) Operating Profit Margin (RHS) 50% 40% 30% 20% 10%

FY10e

FY11e

FY12e

FY13e

Source: EFG Hermes estimates

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FY08

FY09

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FY08

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VI. PROCESSED FRUITS AND VEGETABLES

AT A BUDDING STAGE Agthia entered the processed fruits and vegetables segment with the acquisition of Al-Ain Vegetable factory in 2008 from the parent company GHC. Agthia has since diversified this segments product portfolio into frozen vegetables, extra virgin olive oil, soup mix, pasta sauces, and its flagship product: tomato paste.
Al-Ain Vegetable owns a factory in the UAE with c15,000 tonnes of capacity, including 5,000 tonnes of tomato paste. Agthia established Al-Ain Egypt in 2009 with a capacity of 30,000 tonnes, of which 24,000 tonnes are dedicated to tomato paste and the rest to frozen vegetables and fruit puree. The Egyptian subsidiary targets the export of bulk tomato paste to the MENA region.

LEADING MARKET SHARE IN A FRAGMENTED MARKET Al-Ain Vegetables enjoys a leading market share of 14.6%, slightly above that of its two direct competitors, in the USD12 million UAE tomato paste market. The market share stands at 19% in Abu Dhabi. Al-Ain is the fifth largest seller in the USD26 million UAE frozen vegetables market with a market share of 6%. The leading producer has a market share of 11%. Both markets are highly fragmented and there is strong room for market share gains, albeit at the cost of squeezed margins. LOSS-MAKING ON ACCOUNT OF EGYPT OPERATIONS This segment is a very small contributor to revenue and gross margins. The segment contributed 5.5% of 9M2010 revenues, although it has been mostly loss-making since its inception with the exception of a few quarters. Losses in 2008 and 9M2009 were attributed to the aggressive marketing campaign required to increase market share.
Starting in 4Q2009, the Egyptian operations wiped out the improvement in the UAE operations. The division experienced a cumulative loss of AED13.7 million in the nine months between September 2009 and June 2010. Tomato prices increased significantly in Egypt as the harvest dropped by c50% Y-o-Y in 2010 due to a hot summer and pest disease. The selling prices of tomato paste were also hurt by stiff competition from China. The UAE operations were also affected by the absence of government-subsidised tomatoes from the local market. The division reported lower losses of AED1.5 million in 3Q2010 as Agthia introduced new products to counter the losses incurred by the Egyptian subsidiary. The Egyptian plant currently produces frozen French fries and red chilli paste. More importantly, management plans to focus more on branded sales and move away from the low-margin, private label export business.

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FIGURE 24: RISING TOMATO PRICES AND COMPETITION LEAD TO LOSSES In AED million (LHS), In % (RHS)
Revenue 20 15 10 5 0 (5) (10) Gross Profit Operating Profit Gross Margin (RHS) 40% 30% 20% 10% 0% -10% -20% -30%

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

Source: Agthia, EFG Hermes

A TURNAROUND IN THE MAKING We expect the division to record a narrow loss of AED1 million in 2011 and to return to profitability in 2012 on recovery in gross margins and rationalisation of overhead expenses. A gross margin of 7.9% was witnessed in 3Q2010 despite the rise in tomato prices during the same period. Our forecasts are more sensitive to our assumptions for SG&A expenses. The significance of the segment to the group will stem from the swing from losses to profits rather than from its absolute profitability. We expect the contribution of the segment to the groups net profit before unallocated items to peak at 3.4% in 2014.
FIGURE 25: FORECASTED REVENUE BREAKDOWN In AED million, unless otherwise stated
Tomato Paste 150
20

FIGURE 26: FORECASTED MARGI In AED million (LHS), In % (RHS)

Gross Profit Net Profit Gross Margin (RHS) Net Margin (RHS)

Frozen Vegetables

3Q10

40% 20% 0% -20% -40%

120 90 40 60 30 0
FY08 FY09 FY10e FY11e FY12e FY13e FY14e

42 41 31 45 54 64 77

10 0 (10) (20)

7 36

8 38

17 41

FY10e

FY11e

FY12e

FY13e

Source: EFG Hermes estimates

Source: EFG Hermes estimates

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VII. FINANCIAL STATEMENTS

INCOME STATEMENT (DECEMBER YEAR END) In AED million, unless otherwise stated 2008a Revenue % Growth COGS Gross Profit Gross Profit Margin Other Operating Expenses / (Income) SG and A EBITDA EBITDA Margin Depreciation Amortization Net Operating Profit Net Interest Income / Expense Minority Interest Earnings before Taxes Taxes Net Profit EPS (AED)
Source: Agthia, EFG Hermes estimates

2009a 921 7.9% 671 250.3 27.2% (4) (146) 138.8 15.1% 42.2 0 108.2 (1.8) 106.4 0.7 106 0.18

2010e 1,004 9.0% 764 240.8 24.0% (12) (146) 145.5 14.5% 44.5 0 107.1 3.7 110.8 0.2 111 0.18

2011e 1,078 7.3% 815 263.3 24.4% (2) (150) 155.6 14.4% 46.6 0 115.4 6.0 121.4 121 0.20

2012e 1,141 5.8% 854 287.0 25.2% (2) (156) 175.1 15.3% 48.6 0 132.6 6.0 138.6 0.7 138 0.23

854 47.6% 675 178.5 20.9% (13) (114) 92.5 10.8% 38.4 0 77.8 (4.1) 73.7 74 0.12

BALANCE SHEET (DECEMBER YEAR END) In AED million, unless otherwise stated 2008a Cash & Liquid Assets Net Accounts Receivable Other Current Assets Total Current Assets Net Plant Goodwill Other Assets Total Assets Due to Banks CPLTD Total Payables Other Current liabilities Total Current Liabilities Long -term Loans Minority Interest Other Liabilities Total Liabilities and Provisions Shareholder Equity
Source: Agthia, EFG Hermes estimates

2009a 190.2 220.8 232.0 643.0 454.0 93.0 1,190 89.1 173.7 2.0 264.8 11.5 14.6 291.0 899.0

2010e 200.0 232.6 266.4 699.0 523.4 93.0 1,315 134.5 193.5 328.1 12.8 340.9 974.5

2011e 200.0 242.8 284.9 727.6 527.9 93.0 1,348 67.0 207.3 274.3 12.8 287.1 1,061

2012e 200.1 266.4 299.1 765.6 532.4 93.0 1,391 218.7 218.7 12.8 231.5 1,159

40.1 355.2 162.7 558.0 409.3 93.0 1,060 121.5 129.3 250.8 14.2 265.0 795.3

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CASH FLOW STATEMENT (DECEMBER YEAR END) In AED million, unless otherwise stated 2008a Cash Operating Profit after Tax Cash Flow after Change in Working Capital Capital Expenditure Free Cash Flow Non-operating Cash Flow Cash Flow before Financing Net Financing Change in Cash
Source: Agthia, EFG Hermes estimates

2009a 140 252 79 173 173 (22) 150

2010e 149 121 108 13 13 (3) 10

2011e 164 149 47 102 102 (102) -

2012e 183 156 49 107 107 (107) 0.1

107 (33) 109 (142) (8) (150) 85 (64)

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DISCLOSURES We, Ahmed Gad and Gigi Varghese, hereby certify that the views expressed in this document accurately reflect our personal views about the securities and companies that are the subject of this report. We also certify that neither I nor my spouse or dependants (if relevant) hold a beneficial interest in the securities that are traded in the UAE Stock Exchanges. EFG Hermes Holding SAE hereby certifies that neither it nor any of its subsidiaries owns any of the securities that are the subject of this report. Funds managed by EFG Hermes Holding SAE and its subsidiaries (together and separately, "EFG Hermes") for third parties may own the securities that are the subject of this report. EFG Hermes may own shares in one or more of the aforementioned funds or in funds managed by third parties. The authors of this report may own shares in funds open to the public that invest in the securities mentioned in this report as part of a diversified portfolio over which they have no discretion. The Investment Banking division of EFG Hermes may be in the process of soliciting or executing fee earning mandates for companies that are either the subject of this report or are mentioned in this report. DISCLAIMER This Research has been sent to you as a client of one of the entities in the EFG Hermes group. This Research must not be considered as advice nor be acted upon by you unless you have considered it in conjunction with additional advice from an EFG Hermes entity with which you have a client agreement. Our investment recommendations take into account both risk and expected return. We base our long-term fair value estimate on a fundamental analysis of the company's future prospects, after having taken perceived risk into consideration. We have conducted extensive research to arrive at our investment recommendations and fair value estimates for the company or companies mentioned in this report. Although the information in this report has been obtained from sources that EFG Hermes believes to be reliable, we have not independently verified such information and it may not be accurate or complete. EFG Hermes does not represent or warrant, either expressly or implied, the accuracy or completeness of the information or opinions contained within this report and no liability whatsoever is accepted by EFG Hermes or any other person for any loss howsoever arising, directly or indirectly, from any use of such information or opinions or otherwise arising in connection therewith. Readers should understand that financial projections, fair value estimates and statements regarding future prospects may not be realized. All opinions and estimates included in this report constitute our judgment as of this date and are subject to change without notice. This research report is prepared for general circulation to the clients of EFG Hermes and is intended for general information purposes only. It is not intended as an offer or solicitation or advice with respect to the purchase or sale of any security. It is not tailored to the specific investment objectives, financial situation or needs of any specific person that may receive this report. We strongly advise potential investors to seek financial guidance when determining whether an investment is appropriate to their needs.

GUIDE TO ANALYSIS EFG Hermes investment research is based on fundamental analysis of companies and stocks, the sectors that they are exposed to, as well as the country and regional economic environment. Effective 16 December 2009, EFG Hermes changed its investment rating approach to a three-tier, long-term rating approach, taking total return potential together with any applicable dividend yield into consideration. In special situations, EFG Hermes may assign a rating for a stock that is different from the one indicated by the 12-month expected return relative to the corresponding fair value. For the 12-month long-term ratings for any investment covered in our research, the ratings are defined by the following ranges in percentage terms: Rating Buy Neutral Sell Potential Upside (Downside) % Above 15% (10%) and 15% Below (10%)

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