27-Feb-2017
Mezzan Holding - A market laggard despite better earnings outlook; Upgrade to Buy
Rating: Buy
Target Price: KWD1.180
Closing Price: KWD0.980
Earnings to improve in 2017-18e for four reasons
We upgrade our rating for Mezzan to Buy from Neutral and maintain our target price of KWD1.180 (20% upside) as we expect earnings growth to improve (2017-18e CAGR 12%) as: i) the catering segment (c13% of 2016 revenue) returns to profitability after securing new contracts in 2H16 (revenue reversed a decline for four consecutive quarters in 3Q16); ii) newly-acquired Saudi snack operation’s losses narrow as we expect it to breakeven by year-end (losses of cKWD0.6mn in 2016 in addition to cKWD0.7mn transaction costs); iii) high-margin services segment (c9%) to sustain strong momentum seen in 4Q16 (+71% Y-o-Y) post new NATO contract; and iv) new water and snack capacities are added in Kuwait. Also, the stock has unjustifiably lagged the Kuwaiti market rally (+21% since Nov. 2016 vs. +6% for Mezzan) and valuation is not very demanding (c16x P/E), in our view.
Saudi acquisition: a budding operation in ramp-up mode
In line with its geographic diversification strategy, Mezzan acquired a 70% stake in Saudi-based start-up snack business Al Safi Food Co. via a KWD7.3mn capital injection in 3Q16, giving it a foothold in the KSA. It began a two-year turnaround plan, deploying some of the proceeds, to breakeven by 4Q17e (annualised 2016 revenue: KWD1.7mn, net loss: KWD1.8mn). Operational optimisation is underway (new mgmt, headcount cut and other opex cuts, SKU rationalisation, distribution investments) and it began exporting some snack products (biscuits from Kuwait and chips from the UAE) to the KSA. Also, utilisation is being ramped up (target of 80% from c40% at acquisition) and there are plans to add new product lines in the next two years (cKWD5mn investment). We believe that Saudi could be of decent size in the medium term (5-10% top line by 2018e); however, ST earnings impact will likely be small. (More details on p. 9).
Focus on own food brands remains; macro challenging nonetheless
Mezzan remains focused on growing its main segment - food manufacturing and distribution (c53% of 2016 revenue), particularly via its own-brands (quadrupling Kuwait’s water capacity in 2017e, doubling chips capacity in 2018e). The strategy should bode well for margins (c50% gross margin vs. c20% for agency brands). However, slower consumer spending is a risk; a trend that is evident in its FMCG & pharma segment (c22%; flat 2016 revenue, but better profitability on less low-margin govt. business). Other risks include volatility of Mezzan’s contract-based segments, regulations/reforms (sugar tax, higher utility/fuel costs – latest increase in fuel prices in Kuwait recently reversed) and slower collection from the government (evident from rise in receivable days in 2016).
Nada Amin
Hatem Alaa, CFA
Target Price: KWD1.180
Closing Price: KWD0.980
Earnings to improve in 2017-18e for four reasons
We upgrade our rating for Mezzan to Buy from Neutral and maintain our target price of KWD1.180 (20% upside) as we expect earnings growth to improve (2017-18e CAGR 12%) as: i) the catering segment (c13% of 2016 revenue) returns to profitability after securing new contracts in 2H16 (revenue reversed a decline for four consecutive quarters in 3Q16); ii) newly-acquired Saudi snack operation’s losses narrow as we expect it to breakeven by year-end (losses of cKWD0.6mn in 2016 in addition to cKWD0.7mn transaction costs); iii) high-margin services segment (c9%) to sustain strong momentum seen in 4Q16 (+71% Y-o-Y) post new NATO contract; and iv) new water and snack capacities are added in Kuwait. Also, the stock has unjustifiably lagged the Kuwaiti market rally (+21% since Nov. 2016 vs. +6% for Mezzan) and valuation is not very demanding (c16x P/E), in our view.
Saudi acquisition: a budding operation in ramp-up mode
In line with its geographic diversification strategy, Mezzan acquired a 70% stake in Saudi-based start-up snack business Al Safi Food Co. via a KWD7.3mn capital injection in 3Q16, giving it a foothold in the KSA. It began a two-year turnaround plan, deploying some of the proceeds, to breakeven by 4Q17e (annualised 2016 revenue: KWD1.7mn, net loss: KWD1.8mn). Operational optimisation is underway (new mgmt, headcount cut and other opex cuts, SKU rationalisation, distribution investments) and it began exporting some snack products (biscuits from Kuwait and chips from the UAE) to the KSA. Also, utilisation is being ramped up (target of 80% from c40% at acquisition) and there are plans to add new product lines in the next two years (cKWD5mn investment). We believe that Saudi could be of decent size in the medium term (5-10% top line by 2018e); however, ST earnings impact will likely be small. (More details on p. 9).
Focus on own food brands remains; macro challenging nonetheless
Mezzan remains focused on growing its main segment - food manufacturing and distribution (c53% of 2016 revenue), particularly via its own-brands (quadrupling Kuwait’s water capacity in 2017e, doubling chips capacity in 2018e). The strategy should bode well for margins (c50% gross margin vs. c20% for agency brands). However, slower consumer spending is a risk; a trend that is evident in its FMCG & pharma segment (c22%; flat 2016 revenue, but better profitability on less low-margin govt. business). Other risks include volatility of Mezzan’s contract-based segments, regulations/reforms (sugar tax, higher utility/fuel costs – latest increase in fuel prices in Kuwait recently reversed) and slower collection from the government (evident from rise in receivable days in 2016).
Nada Amin
Hatem Alaa, CFA