Eastern Company
 
Rating: Buy
Target Price: EGP408
Closing Price: EGP295

 Valuation gap to peers narrowing, has more legs as more price increases are rolled out 
We upgrade our TP 46% to EGP408/share (38% upside) as we factor in: i) more bullish price-increase expectations, given the high frequency of recent hikes (three-year historical ex-factory price CAGR of 15%; we now expect c10% increase, on average, other than implemented increases vs. 4% previously), with room for more in the ST, given expected tax changes (see below); ii) higher net cash (more than doubled in 9M16/17 to cEGP5bn, c18% of market cap); and iii) stronger near-term margins, partly on inventory benefits. Our valuation implies a FY18e P/E of 15x, still at a discount to global peers’ avg. of c18x; we remain Buyers of the name, as we expect the gap to continue narrowing as EC’s profitability improved substantially (FY18e 22% net margin with strong FCF generation) and a recent management change at EC’s largest shareholder Chemical Holdings Co. (SOE, 55% stake) could spearhead a drive for shareholder value creation with initiatives such as gradually raising DPO (details on p6).   
 
Another tax change in the works, to support pricing flexibility
EC raised prices for all three key brands from January to July 2017; the latest being best-seller Cleopatra King (c45% of volumes; retail price +10%, ex-factory +24%), as well as a second hike for Queen and Super. We see room for further increases, as the Ministry of Finance is mulling an EGP0.5-2.0/pack hike on fixed taxes (now EGP2.75 for all EC brands <EGP13, avg. portfolio selling price is cEGP11.5) that will likely come with tax-bracket adjustments as has typically been the case. The decision, which we expect to take place by Sep. 2017, should allow EC to raise ex-factory prices at least c15%, in our view (in line with previous instances). A widening of price brackets should give the company the flexibility to raise prices within the lowest tax bracket. Strong recent pricing moves, coupled with the benefit of the translation of the USD toll manufacturing segment (c22% of revenue), should drive a five-year revenue CAGR of 14% (after +40% in FY17e). 
 
Inventory stockpile buoys margins as prices adjust; consultant on board, may drive gains
EC has been able to defend margins, aided by inventory management and price hikes that have preceded the utilisation of tobacco bought at current FX levels (EBITDA margin +6pp in 9M16/17). While tobacco inventory fell to an all-time low of nine months (from peak of c22 months) due to FX shortages pre-EGP float, inventory is being restocked, and we expect a c8pp margin hit in FY18e. There is room for more margin gains, especially as EC hired a European consultant to outline ways to: i) increase efficiency/reduce costs; ii) optimise inventory management; iii) increase product quality; iv) raise exports; and v) develop a maintenance programme.

Nada Amin

Hatem Alaa, CFA