• Raise earnings & FV; valuation excessively cheap, low-single-digit P/E We increase our earnings forecasts by c25% on average mainly to reflect faster-than-expected deleveraging and a lower tax rate (22.5% versus 30% previously). However, we raise our FV by only 5% to EGP310/share as the higher earnings are offset by a c1pp increase in WACC. We remain buyers of EC with our FV offering significant upside of 94%. The stock has fallen 9% YTD and 13% in 2015, which we believe is unjustified given strong recurring earnings growth (FY14/15 +91% Y-o-Y, 1H15/16 +45%) that is likely to continue in the short term aided by further deleveraging. The stock now trades at c5x FY15/16 P/E, significantly below c17x for global tobacco peers.
• Three non-core projects scrapped, aids deleveraging-driven EPS growth EC cancelled plans for three projects: Malawi factory, a hospital, and railway project (see note for details) partly due to too-high capex needs, but it will still set up employee housing near its plant and a commercial project on vacated land (likely via a JV, limited capex). Other plans under study include the sale of a small land plot and cultivation of raw tobacco leafs under the auspice of the Armed Forces. We are positive on the cancellations of these non-core projects especially as this bodes well for deleveraging (net cash EGP500mn+, net finance costs including leases -45% Y-o-Y in 1H2015/16). Deleveraging has been a key earnings growth driver and led to higher FCF generation (impressive c14% FY14/15 FCF yield) and dividend payout (assume c40% in line with recent run rate but could easily go up to c80%).
• Impact of higher raw tobacco customs small; prices could surprise Customs on raw tobacco were raised to EGP9.0/kg from EGP6.1 as of 1 February 2016 as part of a hike in duties on c500 imported items. The incremental cost addition is only cEGP24mn/year as it is applicable only on raw molasses tobacco (c15% of total of c55ktpa used annually). This translates to c1% of FY14/15 cash costs and c2% of recurring earnings. EC plans to raise prices for some local molasses products (3% of FY14/15 sales) and introduce a third mid-tier brand (EGP13/pack) to offset the relatively negligible added costs. We do not forecast further ex-factory price increases (likely in our view; last was in February 2015) that pose a key upside risk to our numbers.

Nada Amin
Hatem Alaa, CFA