East African Breweries Facing Major Kenya Challenge
Our Africa team expects the Kenyan economy to grow by 5.7% in 2014, with growth forecast to average more than 6% thereafter over the forecast period to 2023. We expect this outlook to drive growth in the food and drink sector, where Kenya has a number of very well-established companies, none more so than East African Breweries (EABL) - a unit of Diageo.
Kenya is firmly established as the hub of the East African Community (EAC) bloc. Interest from the global investment community in terms of its own story and the ability of many of its leading companies to expand in the wider region is expected to grow strongly over the coming years, particularly given the relatively well-developed state of Kenya's capital markets. With the benchmark Nairobi All-Share Index up by about 25% over the past year (a particularly strong showing given the widespread selling of EM assets over this period), the Food and Drink and Africa teams have been looking at potential Kenya-based additions to BMI's macro/industry strategy table. We have focused primarily on East African Breweries (EABL) for the following reasons:
Very strong position in Kenya and well placed in the wider EAC region, where we continue to see strong room for growth in low-cost and premium beer.
EABL is the second highest weighted (11%) company on the Nairobi All-Share Index behind Safaricom. It has a strong long-term growth track record as, along with the Nigerian pair of Nigerian Breweries and Guinness Nigeria, it is one of the three biggest African beer companies by sales (about USD695mn per annum), excluding those in South Africa.
EABL's share price is down by about 6% over the past year and is currently right on a major resistance line at KES278 per share, as the chart illustrates. A sustained break above this level would set the shares up for rally.
|Key Resistance Line|
|East African Breweries Daily Share Price (KES)|
However, EABL is facing some major issues in Kenya following the introduction of an excise tax levied against its key Senator Keg brand in October 2013. The introduction of the excise tax has been a major setback as Senator Keg is one of its most important brands. In its first-half results to December 2013, EABL announced that volumes for the brand were down by 85% following the excise hike. There are therefore major question marks about how it will manage to turn this around in 2014. This is the main point of concern we raise from a macro/industry point of view.
Going forward, a key strategic objective is likely to involve trimming the proportional contribution of Kenya to earnings. As the table shows, Kenya proportionally accounted for much more of operating income (92%) than sales revenues (71%) in FY12. The other major market is Uganda, and the main reason for the much higher margins in Kenya (32% in FY12 compared with 17% in Uganda) is the industry structure. EABL completely dominates in Kenya, where it has a monopoly, whereas it is neck-and-neck with SABMiller in Uganda. A long-term opportunity for EABL is Tanzania, where it owns Serengeti, which is the second biggest beer company behind SABMiller's Tanzania Breweries. However, it will take a few more years for Tanzania to develop into a significant contributor to earnings.
EABL has clearly been working towards growing its businesses outside Kenya over the past few years. The proportional capital expenditure to proportional asset contribution time series data shown in the table illustrates this. A ratio above 1 indicates that the segment is being allocated a greater proportion of capital expenditure than its proportion of total assets. Kenya's proportion declined between FY07 and FY12, whereas Uganda's was up strongly from 0.9 to 1.7, with a strong pickup in new capacity, new machinery and plants.
EABL's shares currently trade at a trailing price/earnings ratio of 32x, which compares with 26x and 23x for Nigerian Breweries and Guinness Nigeria. On a price/sales basis, EABL trades at 3.8x, which places it between the two Nigerian companies (its two main peers in our opinion). Therefore, given EABL's issues in Kenya, its reliance on the country and its relative valuation, we are holding off entering the company into our Macro/Industry Table.
|Contribution To Group Sales Revenues (% of total), FY12||Contribution To Group Operating Income (% of total), FY12||Operating Margin (%), FY12||Total Capex/Total Assets Proportions FY12||Total Capex/Total Assets Proportions FY07|
|Source: Bloomberg, BMI|