We initiate coverage on Food Empire with a BUY and TP of S$0.72, derived from 17x FY12F earnings, in-line with the industry average. We expect 2012-14F earnings  growth  to  be  driven  by:  1)  Steady  growth  in  existing  markets,  2) Expanding  gross  margins  from  lower  raw  material  prices  namely  coffee  and sugar  as  well  as  3)  Operational  efficiencies  from  higher  volumes.  We  also highlight that the Group  intends to expand its reach into Asia via the acquisition of  an  existing  player  giving  it  an  instant  platform  into  the  market.  As  at  30  Sep 2012, the Group is sitting on net cash of US$29.8m. While we have not included the potential of this inorganic growth into our estimates, we expect any news on this front to provide some positive boost to the stock price.

Number  one  player  in  Russia.  According  to  data  from  AC  Nielson,  Food Empire is the number one player within the instant coffee space in Russia, where it  derives  57%  of  its  revenue.  Post  the  2009  crisis,  sales  in  Russia  has  been delivering  double-digit  growth  (2010:  +47%,  2011:  +29%)  with  sales  in  2011 surpassing its 2008 post crisis high.

Steady  growth  in  Russia,  high  growth  in  newer  markets.  We  have  been conservative  to  assume  annual  2%  YoY  growth  in  Russia  over  2012-14  due  to the  appreciation  of  USD  against  the  Russian  Ruble  which  has  negatively impacted sales reported in USD. We are forecasting +7% annual sales growth in Eastern Europe and Central Asia, and a more bullish +15% annual sales growth in the Middle East. 

Margins set to expand. We note that the Group has the highest gross margins among peers at 43.8% vs Super at 34.1% and VizBrandz at 32.2%. However in terms  of  net  margins,  it  lags  behind  at  6.6%  vs  a  high  of  14.0%  for  Super. Margins are expected to expand as the Group engages in backward integration. It  is  in  the  midst  of  building  a  non-dairy  creamer  plant  in  Malaysia  and  an ingredients  plant  in  India.  Capex  for  this  is  estimated  to  be  US$20-30m  over  a two to three year period.

COMPANY  

Food  Empire  is  a  global  food  and  beverage  company  that  manufactures  and  markets  a comprehensive  range  of  award-winning  instant  beverage  products,  frozen  convenience food, confectionery and snack food.
 
The  Group's  products  are  exported  to  over  60  countries  such  as  Russia,  Ukraine, Kazakhstan,  Central  Asia,  China,  Indochina,  the  Middle  East,  Mongolia  and  the  US.  The Group  has  a  network  of  18  offices  (representative  and  liason)  in  Russia,  Ukraine, Kazakhstan, Uzbekistan, Iran, Poland, Turkey, Bahrain, Mongolia and Vietnam.

Production Process

The  main  raw  materials  that  go  into  the  production  of  Food  Empire's  three-in-one  instant coffees are refined sugar, creamer and coffee powder.

The  Group  sources  its  refined  sugar  from  Thailand  or  Malaysia  but  also  gets  it  from  Britain and  Australia.  Its  instant  coffee  powder  which  is  made  from  coffee  beans  are  sourced  from Colombia,  Brazil  and  India.    Non-dairy  creamer  are  sourced  from  Malaysia,  Indonesia, Holland  and  China.  All  raw  materials  are  shipped  to  Singapore  with  only  one  type  of  raw material air-flown - aroma extracts. Aroma extracts come in powder form from countries such as Germany, Switzerland, the UK and the USA and include hazelnut, cognac, rum and Irish cream.


Products

The Group's products include regular and flavoured coffee mixes and cappucinos, chocolate drinks,  instant  breakfast  cereal  and  flavoured  fruit  teas.  It  also  markets  a  range  of  food products  including  snack  food  such  as  potato  crisps,  confectionery  and  an  assortment  of frozen convenience food such as bite-sized seafood, dim sum and spring rolls.

Among  the  brands  under  the  Group's  stable  include  MacCoffee,  Petrovskaya,  Sloboda, Klassno, Hyson, OrienBites and Kracks, which have collectively spun off more than 200 types of products. 

MacCoffee,  the  Group's  flagship  brand  has  been  consistently  ranked  as  the  leading  3-in-1 instant  coffee  brand  in  the  Group's  core  markets  which  includes  Russia,  Ukraine  and Kazakhstan.

Since  its  public  listing  in  2000,  Food  Empire  has  won  numerous  accolades  and  awards including being ranked as one of 'The Most Valuable Singapore Brands' at the national brand award  organised by IE  Singapore. MacCoffee  was ranked one of 'The Strongest Singapore Brands'  and  the  Company  has  been  named  one  of  the  'Best  under  a  Billion'  companies  in Asia by Forbes Magazine.

The Group recently recorded its best performing year ever in 2011, with a record revenue of US$225.7m and earnings of US$14.8m, an 8.4% increase on a yoy basis. 

INVESTMENT MERITS

Number  one  player  in  the  instant  coffee  space  in  Russia.  According  to  data  from  AC Nielson,  Food  Empire  remains  the  number  one  instant  coffee  company  in  Russia  with MacCoffee sales volume leading the way. Nestle is the number two contender.

MacCoffee is the number one brand in Russia since 2007. MacCoffee is the clear market leading brand in Russia, entrenched in that position since 2007. 

Falling  raw  material  prices  to  boost  gross  margins,  giving  a  boost  to  earnings.  Thethree main ingredients that go into the production of Food Empire's 3-in-1 coffee is of coursecoffee powder, sugar and non-dairy creamer.

We note that the price of robusta coffee beans which can be used a gauge for the price ocoffee  powder  has  tapered  off  its  highs  from  a  year  ago.  It  is  now  hovering  around  its  oneyear average of US$2,038.

Highest  gross  margin  among  peers.  Food  Empire  possesses  the  highest  gross  margin among its SGX-listed peers Super Group and Viz Brandz. This is consistently so for the past five years. 

But  net  margin  lags  behind,  suggesting  that  operational  improvements  can  further boost  earnings.  While  Food  Empire's  gross  margin  remains  the  highest  among  peers,  in terms of net margin, it falters behind.

Backward integration can be a boost to operating margins. The Group is currently in the midst of building an ingredients plant in India and a non-dairy creamer plant in Malaysia as part  of  their  plans  for  backward  integration.  It  is  expected  that  this  will  help  the  Group improve  margins  and  ensure  smooth  supply  of  raw  materials.  The  venture  is  expected  to result  in  capex  of  US$20-30m  over  a  two  to  three  year  period  and  as  such  any  potential benefit has not been included into our forecast yet.

Capable management who are major shareholders. Mr Tan Wang Cheow is the founder and current Executive Chairman of the Group. He  is  also a major shareholder with  a 9.9% share of the Company. Mr  Sudeep Nair is the newly  appointed  Managing Director. He  has been with the Group over the past 15 years in various capacities that includes being Country Manager  and  an  Executive  Director  of  the  Group's  subsidiary  companies.  He  was responsible  for  the  group's  operations  in  Russia  and  other  countries  within  the Commonwealth Independent States (CIS). We note that Mr Nair is also a major shareholder with a 6.8% share.

Constant product innovation to stir demand. We note that the Group is quite proactive in product innovation, launching new products every year to keep up with the times.

In 2011, the selection of products offered under its flagship MacCoffee brand was expanded with  the  launch  of  new  products.  MacCoffee  Max  which  was  introduced  in  2010  was  well-received in different markets. This is a powerful and intense version of its best selling 3-in-1
instant  coffee  product.  To  cater  to  the  growing  health  conscious  consumer,  the  Group introduced MacCoffee Wellness which combines the popular MacCoffee taste with ginseng and collagen.  Extending  its popular existing 3-in-1 range,  MacCoffee Freeze  Dried Gold 3-in-1 is a premium drink using a blend of Arabica and Robusta coffee beans.

The  Group's  Klassno  range  also  expanded  with  the  launch  of  White  Coffee  3-in-1,  Rich Chocolate and Freeze Dried Premium 3-in-1. Its snack brand Kracks added Corn Crunches to  its  range  with  four  flavours:  Creamy,  Sour  and  Onion,  Barbecue  and  Taco.  The  Group also introduced a savoury crunching peanut coated snack called MacCreezz.

Management  has  been  particularly  very  pleased  with  the  performance  of  its  Freeze  Dried range of coffee products.

Commitment  to  Brand  Building.  The  Group  is  committed  to  brand  building.  Among  the activities undertaken by the Group to enhance the brand awareness of its products include in-store promotions, advertising, trade shows and sponsorships.

EARNINGS OUTLOOK

Expect 2012-2014F earnings CAGR of 9%. We are expecting Group earnings to grow at a CAGR of 9.3% between 2012 to 2014, driven by rising sales to existing markets from deeper market  penetration  as  well  as  new  product  launches.  In  addition  to  that,  we  also  expect improved gross margins from lower coffee prices and improved operational efficiencies.

Conservative growth forecast in Russia due to forex. While we expect demand in Russia to remain healthy with Food Empire retaining its number one position in the marketplace for its 3-in-1 instant coffee beverages, we are forecasting a conservative growth for sales due to forex.  The  USD  has  been  appreciating  against  the  Russian  Ruble  which  has  impacted  the translation into USD sales. 

Forecast  +7%  annual  growth  for  Eastern  Europe  and  Central  Asia.  We  forecast  +7% annual  sales  growth  for  Eastern  Europe  and  Central  Asia,  taking  cue  from  the  Group's 1H2012 results which reflect a 6% growth. We note that this figure is more conservative than management's expectations of low double-digit.

Eastern  Europe  comprise  of  Ukraine,  Kazakhstan  and  the  Commonwealth  Independent States  (CIS)  region.  In  2011,  sales  to  Ukraine  rose  by  30%  YoY  while  sales  to  Kazakhstan rose by 40% YoY.

Bullish  on  revenue  growth  to  'Other  Markets'  due  to  low  base.  We  are  bullish  on revenue  growth  to  the  Middle  East  which  is  reflected  under  'Other  Markets'  in  the  Group's financials.  We  have  seen  sales  grow  at  a  healthy  pace  of    15%  in  2010  and  subsequently 24% in 2011. For 1H2012, growth has remained robust at 15% YoY.

Expect  margin  expansion.  We  expect  gross  margins  to  expand  on  account  of  falling  raw material  prices  which  largely  consist  of  coffee.  In  addition  to  that  we  also  expect  some operational efficiency cost savings.

INVESTMENT RISKS

Rising raw material prices. There is a risk for coffee prices to revert back to the highs seen last year although prices seem stable at current prices now. Any increase in coffee prices is expected  to  compress  gross  margins  and  negatively  affect  margins.  While  management might be able to pass on some of these cost increase to customers, there will usually a lag period for these effects to pass. However we think it is quite unlikely for coffee prices to rise back to such a high in the near future.

Continued appreciation of USD against Russian Rubles. Our pessimistic growth forecast for sales to Russia of +2% YoY annually for 2012-2014 already reflects a high USD|Russian Rubles assumption. However we are cautious of a further negative movement in forex.

Competitive pressures. There is always the risk of competition ramping up advertising and promotions to steal market share from market leader Food Empire. However, the Group has been quite capable of maintaining its dominant position throughout the  years. Furthermore, given  that  the  Group  is  quite  active  in  product  innovation,  we  feel  that  it  will  be  able  to withstand competitive pressures.

Food  safety  issues.  With  any  food  and  beverage  company,  there  is  always  the  issue  of potential  safety  issues  which  will  deter  and  affect  customer  confidence.  Throughout  its operating history, there has been no such scares for the company.

Fresh  coffee  gains  popularity.  We  note  that  sales  of  upmarket  filtered  coffee  which  are used to make espressos, cappuccino and lattes have increased substantially in recent years while sales of cheap granules have fallen. This reflects the growing coffee shop trend which has  persuaded  customers  to  swap  from  instant  coffee  to  a  bag  of  proper  coffee  at  the supermarket.  According  to  market  research  company,  Mintel,  sales  of  upmarket  filtered coffee  have  risen  by  49%  over  the  past  five  year  while  regular  instant  coffee  sales  have fallen by 36%  in the same  period. While  we find  this  trend  worrisome for Food Empire, we believe Food Empire is still faced with bright prospects as consumers in emerging markets do not have the wealth to consume more expensive fresh filtered coffee hence demand will still be growing.

VALUATION
   
Cheapest 3-in-1 beverage player on SGX.  Among the 3-in-1 beverage counters listed on the SGX, Food Empire is trading at 14x P/E versus Super at 21x and Viz Branz at 15x.

Valuing  it  at  industry  average  of  17x  P/E.  The  stock  appears  to  be  undervalued  and  we are valuing it at 17x P/E, close to the industry average. Our TP of S$0.72 represents a 26% upside to last close. While the stock has recently advanced from its sleepy lows of S$0.485 last month, we believe valuation still looks fair.

Source: OSK