East African Breweries

(Market Cap USD 2.8bn)

2013e
p/e

21x

2013e
PEG

0.8x

2013e
EV/EBITDA

11.6x

Trailing
ROE

30%

Net Debt / EBITDA
1.2x

Dividend
Yield

2%

FCF
Yield

2%

Company Description

With a production capacity of 10.5m hl, and 2012 revenue of KES 55.5bn (USD 636m), EABL is East Africa’s largest alcohol beverage company. The company’s main operations are in Kenya (80% of revenue), with footprints in Uganda (17%) and Tanzania (2%), as well as imports to Rwanda, Burundi and South Sudan. 50.03% of EABL is owned by global alcohol producer Diageo.

Investment thesis

1. Well positioned to take advantage of top-down driver
EABL have a 90% market share of Kenya’s formal alcohol market.  Its closest rival is local competitor Keroche, with only 2% of the market. There are significant barriers to opening a brewery: not only is it capital intensive, but there are supply chain, distribution and technical barriers. As such, EABL’s dominant position will help it take advantage of a number of macro drivers over the coming years.

At present, alcohol consumption in Kenya is low. In 2012 Kenyans consumed 11 liters per capita, which compares with African and global averages of 14.6 liters and 22 liters respectively. Over each of the past 3 years, Kenya’s GDP has grown more than 5%. At current growth rates the country will be classified at Middle Income by 2020 – this growth should be a catalyst for alcohol sales.  Euromonitor expect Kenyan alcohol volumes to increase by a 2% CAGR for the coming 5 years.

For more details on Kenya’s macro and demographic driver, please see Africa Yield’s Kenyan Country Profile.

2. Strong brand portfolio
EABL have a wide portfolio of domestic brands that dominate all beer segments in Kenya. In addition, the company distributes Diageo spirits across its territories. Below is a list of major EABL / Diageo brands sold in Kenya:

- Larger: Tusker (the flagship brand), Senator, Bell Larger Pilsner
- Malt: Tusker Malt
- Stout: Guinness
- Spirits: Johnny Walker, Smirnoff, Baileys

The beer industry globally is marked by brand loyalty. This is one of the reasons why global brewers like Diageo enter high growth markets like Kenya by acquiring local brands. They augment and propel local products with their managerial excellence without destroying brands that have usually taken decades to establish. EABL, for example, began brewing in 1922.

Over the past 2 years, EABL’s volumes have grown by double digits in all categories.

EABL delineates its brands as premium, and emerging (i.e. mainstream and economy). Over 75% of the offering is in the premium segment – as such sales are relatively inelastic. There is, however, an opportunity for EABL to leverage its presence and grow more aggressively into the emerging segment.

A wider emerging offering will afford more Kenyan’s an entry into the formal beer market. At present 40% of alcohol brewed in Kenya is informal. The Government is keen to move drinkers towards formal products for reasons of health and safety. One can also assume, growth in the formal market will provide the state with additional tax revenue.

The company is leveraging its channels and brands to expand into niches such as low carbohydrates (which is mostly directed to women), cider, and wine.  At present, most alcohol in Kenya is sold in bars – in 2012 EABL started to implement supply chain improvements with an eye on increased penetration in the take home sector.

3. East African expansion
Uganda is EABL’s second largest market. The company has been present in Uganda since 1946, and enjoys a 48% market share. The market is characterized by a growing population and a move from informal to formal alcohol. In 1H11 EBIT decreased 21% – the result of capacity constraints. EABL immediately injected KES 1.6bn into a local bottling plant. In 2012 EABL commissioned a mash filter in Uganda. Increased production in Uganda brings tax benefits.

Below is a list of recent news, indicative of EABL’s growth across East Africa:
- Commissioned a brewery in Tanzania (Moshi)
- Announced plans for a Tanzanian bottling plant
- Commissioned a canning line in Kenya
- Plans for a 0.7 m hl plant in Juba South Sudan (scalable to 1m hl)

4. Lowering input costs
EABL’s EBITDA margins have contracted to 33.5% in 2012 from 41% in 2006. The company is responding in two ways:

- Cereals account for ~35% of EABL’s total costs. In 2009 the company initiated a program to replace barley inputs with lower cost sorghum. In the emerging beer segment the sorghum-to-barley ingredient ratio is 60:40. The company plans to increase the usage across brands and geographies. Other African breweries have taken similar steps. As discussed in Africa Yield’s Nigerian Breweries section, the inclusion of sorghum into the mix has helped the company maintain margin stability across the cycle.

- EABL has embarked on a plan to improve efficiency by reducing uses of power and water. In addition, the company is planning on building a biomass power plant.

Risks

1. Increasing competitive threats
While there are technical and capital barriers to opening and operating a brewery, EABL still faces the threat of new entrants, primarily from SAB Miller and Heineken.

- SAB Miller: In 2002 EABL acquired 20% of SAB’s Tanzania Breweries (TBL), and SAB acquired a 20% in EABL’s Kenyan interests. In 2009 the relationship faced complications with EABL claiming poor quality controls at TBL, and that restrictions had been placed on the distribution of Diageo products in Tanzania. Consequently, EABL purchased 51% of Serengeti Breweries (SBL) in Tanzania, and sold its stake in TBL on the Dar es Salaam stock exchange. Furthermore, EABL took a KES 19.5bn loan from Diageo to repurchase its Kenyan business from SAB.  While the breakdown in the relationship has allowed EABL free reign in Tanzania, it has opened the door for SAB in Kenya. In 2011 SAB purchased Kenyan water bottler Crown Foods, and has started using its distribution channels to sell its imported beers. The impact on EABL’s numbers was quick, contributing to an increase in sales and marketing as a percentage of GDP to 8.3% in 2012, from 7.7% in 2011.

- Heineken: In 2011 Heineken established a representative office in Kenya, and started increasing their marketing and distribution efforts.

Competition should continue to increase and impact margins and market share, albeit gradually over the coming years.

2. Foreign exchange, input costs, elasticity
In 2011 the Kenyan Shilling lost ~20% of its value against the US Dollar. This was largely the result of a ballooning current account deficit and inflation, the result of a severe drought. A swift tightening response by the central bank calmed inflation and the Shilling. Despite low FX volatility in 2012, investors should be aware that a weakened currency impacts the costs of EABL’s imported raw materials and fuel. In addition, it would  impact the company’s outstanding loan to Diageo – it is dollar denominated.

In 2011, Kenyan beer volumes contracted 1%. Despite low penetration, strong secular drivers, and a skew towards premium brands. 2011’s volatile macro environment illustrated a level of elasticity in Kenya’s beer market, despite its bias towards the premium segment.

3. Regulation
In 2010 the Kenyan Government enacted the Alcoholic Drinks Act, which made such provisions as follows:

- Drinking hours fixed in bars (5pm-11pm weekdays, and 2pm-11pm weekend)
- Promotional activity restricted to targeting people over 18
- Supermarkets require separate areas to display their alcoholic beverages

The act, while sensible, has had little impact on industry and EABL sales. A greater risk is the impact of excise duty. Most years the Kenyan Government increases excise duty on luxury goods. In 2012, for example, excise on beer was increased to KES 70 per liter, up from KES 55 the year before. Today, excise comprises around 40% of the average beer’s retail price. While there is no specific evidence of the impact on sales, beer has already proven to be a somewhat elastic product as discussed above.

4. Ethiopia
Ethiopia is home to 86.5 million people. The market was long expected to become a material revenue source for EABL. In 2012 the country tendered its state owned breweries. However, Diageo won a USD 225m bid for an Ethiopian brewery, ending EABL’s chances of domestic production. This will not, however, preclude the company from importing its African brands in to Ethiopia.

Valuation

The table below (click to enlarge) uses Bloomberg consensus data to compare EABL with African and global peers across a number of valuation metrics.

At first glance the company is not cheap. Its 2013 p/e of 21.1 is a sizable premium to both African and global peers. A 2% free cash flow yield is hardly compelling. In the context of increased competition one might take a negative view of EABL’s prospects.

Nonetheless, EABL’s 2014 0.6x PEG ratio is a hefty discount to peers, on the assumption of high medium term EPS growth (27% CAGR). The Street’s numbers likely reflect a view that secular top-down drivers, self-help (e.g. increased use of sorghum), and East African expansion will more than counter the impact of competition.

In Africa Yield’s experience, increasing competitive retail environments damage margins more markedly than the street tends to assume, even without a all out price war. Nonetheless,  it would take a 32% reduction in the street’s EPS growth assumptions to put EABL on par with African peer’s average 2014e PEG of 0.9x: a comfortable cushion against shocks.

Buying a sub-Saharan beer company is a play on the growing consumer power of the African population. EABL and Nigerian Breweries (NB) are the most liquid SSA breweries ex-South Africa. Consequently, most Pan-African portfolios would be advised to hold one or both of these companies, price permitting. The competitive threats in the Kenyan and East African markets will cause volatility in EABL’s stock over the coming periods. Nonetheless, comparing EABL and NB’s ratios, EABL provides a more comfortable entry point.

EABL comps

SWOT analysis

Challenges

Opportunities

Margin erosion: Lower margin beers become a greater proportion of sales and rising input costs.  This trend has been in
place since 2006 when the EBITDA margin was over 40% as opposed to 34% for
the first half of 2012.

Managing regional expansion; the best growth opportunities are outside Kenya; mainly Ethiopia (population 80m), Tanzania (population 45m) and South Sudan (population 11m) however EABL has already
grappled with salary costs in the past and requires expense management talent.  There has also been inorganic growth in the acquisition of Serengeti breweries in Tanzania.

Cost management; rising input costs
together with the need for either greenfield development of breweries or acquisitions put cash flow pressure on the company.

Legislation:  Excise duties and
taxes have a significant impact on sales.  
Various pieces of legislation exist
in Kenya and region to curtail alcoholism.  Governments in the region have used
excise duties on alcohol to raise funds.

New brands:  Despite the increase in lower margin bear, the increase in spirits as a proportion of revenues has offset this
trend (increased to 15% of sales from 11% in 2009).  Moreover, management has plans to
launch new brands and has invested capex in growth countries to realise this.

Consumption rates:  Growth opportunities throughout East Africa as consumption per capita increases; Ethiopia
(population 80m), Tanzania (population 45m) South Sudan (population 11m).   There are plans to open a greenfield operation there.

M&A:  Growing beer demand in Africa and rise of per capita incomes is attracting
investment interest of global brewers

Cereal substitution: 100% of cereal supplies are now from the local market as opposed to only 60% in 2010 with a
higher sorghum content.  Cereals account for 70% of costs.

Dividend payout:  The dividend payout ratio has averaged
90% over the past 3 years.

Comments are closed.