Small and Mid Cap - Egypt
A closer look at the overlooked; launching Egypt's Small and Mid Cap coverage
by Ahmed Hazem Maher
SMCs have lots to offer; tackling the best of the best
We launch coverage of our Small and Mid-Cap (SMC) product for Egypt and initiate on 11 stocks that we believe have gone unnoticed for too long. The stocks are a diverse bunch that operate across a number of sectors. Our top picks all share common themes i) financially sound; ii) high-quality earnings; and iii) attractive valuations. Our high conviction Buys are: i) Alexandria Containers (TP: EGP22 0/share); ii) MOPCO (TP: EGP105/share); and iii) Canal Shipping Agencies (TP: EGP1 0/share). These companies also share other similar characteristics: i) cash-rich balance sheets; ii) USD-geared earnings and cash flows; iii) attractive return profile and ability to generate free cash flow; and iv) trading at a deep discount. Overall, Egypt's SMCs have enjoyed a good run since the EGP float in November 2016. Yet, we believe we will see further re ratings for some of the names
Stock selection is key; focus on quality
We believe stock selection is key when investing in the SMC universe and a focus on value creation and balance sheet strength is a must. Apart from our high conviction Buy calls, we also have Buys on solid names that offer value and are priced at a discount. These include i) Maridive (TP: USDO 55/share); ii) General Silos (TP: EGP40/share); and ii1) Sout h Valley Cement (TP: EGP7.0/share). While on our radar screen, we see some names that may become attractive, should a meaningful correction take place; these are i) AMOC (TP: EGP97.0/sh are); ii) A rab Cotton Ginning (TP: EGP4.75/share); and iii) Arabia Investment and Development (TP: EGP1.1/share). We only have one Sell in our SMC coverage, KIMA (TP: EGPS .O/share), as we think its expensive expansion plan is destroying share holder value
Searching for a game changer; privatisation could unlock liquidity
While liquidity for SMCs is lower than for Egypt's blue-chips,we have seen SMC stock turnovers spike over the past few months- especially m high quality names, such as our top picks. We also highlight that recent talk of privatisation could unlock massive pent-up liquidity, which is closely held by government-owned entities. Candidates of such a boost in liquidity include, AMOC, MOPCO, and Alexandria Containers
A rich menu of offerings
We launch our Small and Mid-Cap (SMC) product with an initiation of coverage on 11 of Egypt's small- and mid-cap stocks. Our stock selection methodology is based on the following criteria: i) free-float adjusted market cap (a stock must be amongst the bottom 20% in the market); ii) trading days (a stock must have traded a minimum of 95% of days last year); and iii) daily turnover (stock must fall within 95% of EGX's cumulative traded value).
We then segmented the stocks by financ ial soundness, earnings quality and valuation's appeal. We valued each stocks, predominantly based on a DCF methodology, reflecting vary1ng levels of risks and opportunities. Of the different themes at play, we prefer stocks with i) USD-based cash flow generation; ii) relatively high earnings visibility; and iii) yet-undemanding valuations after EGX rallied c36% since 3 November 2016, whe n the EGP floatation took place . We highlight, though, that the level of disclosure and transparency across some of these companies might be lower than blue-chip peers.
The best of the best: Our Top SMC picks
Our high-conviction Buy includes: Alexandria Containers (TP: EFGP220/share, Buy), Canal Shipping (TP: EGP10/share, Buy), MOPCO (TP: EGP105/share, Buy). These stocks combine favourable exposure to USD cash flow, earning visibility and deep value, in our view.
Alexandria Containers (TP EGP220/share) - The best of the crop
ALCN is an exclusive operator of the container-handling terminal at the port of Alexandria and Dekhela with annual handling of c1mn TEU of containers. The company is highly geared to benefit from EGP devaluation, as prices are set in USD terms, while c95% of costs are in EGP. 2017's volumes, though, are expected to be weaker than previous years, as ALCN is expanding one of it docks. We expect healthy earnings growth from i) higher rates; as well as ii) higher volumes passing through its exclusively operated ports in Alexandria. ALCN's clean balance sheet also offers room for attractive dividend distributions going forward
Canal Shipping |Agencies (TP EGP10.0/share) - Similar to ALCN, but a large rally laggard
Canal Shipping's core operations are mainly focused on clearance operations for vessels passing through the Suez Canal. Yet, its real value is derived from CSAG's equity investments in port-handling operations at Port Said and Damietta, which have an identical business model as Alexandria Containers. CSAG is a beneficiary of EGP devaluation as prices are in USD, while costs are in EGP. Despite a similar business model to ALCN, it has lagged ALCN's rally post of the EGP float. We believe CSAG has potential for further re-rating; hence, our Buy rating
MOPCO (TP EGP105/share) - Cheap feedstock, export-oriented with expanding production
MOPCO is Egypt's largest, mostly export-oriented, urea producer (2mtpa). The company has recently expanded capacity, which came online in mid-2016. MOPCO enjoys attractive feedstock pricing, which lets the company pay little as USD2/mmbtu in case of depressed urea prices. MOPCO should benefit from massive growth in earnings from new expansion, the value of which has been neglected by the market, in our view. While heavily indebted, we think MOPCO's massive cash flow generation will allow the company to easily deleverage in a few years' time, transforming into a cash cow (dividend yields north of c14% by 2018)
We also see value in...
We also see opportunities for value creation and have Buys on the below stocks that offer healthy returns, but may have some inherently higher risks due to their respective industries. These names include:
Egypt's exclusive operator in charge of wheat storage activities. The company stores an annual volume of c7mn tonnes, mainly from imported wheat volumes that are dedicated to Egypt's subsidised bread programme. We think the company's volumes are mostly secure due to the sensitive nature of bread availability to the public. However, pricing is fixed to only EGP100/tonne, which is diluted even further, as the company outsources some of its services. The company's working capital structure, fixed price nature and limited exposure mean that free cash flows and earnings are generally stable
Maridive (TP: USD0.55/share)- Vessels at deep discount to replacement value
Maridive is an offshore oil and gas services provider with a fleet size of c62 vessels. The USD denominated stock has been hit aggressively by FX shortage; hence, developing into a deep-value play. The stock was also hammered by the distressed oil and gas services operating environment, which led to cuts in dally rates and utilisation. However, we think the stock has been unjustly penalised and deserves to re-rate to levels that justify its rich asset base
South Valley Cement (TP: EGP7.0/share) -Improving business with possible expansion around the corner
South Valley cement is a 1.5mtpa grey cement producer that utilises fuel oil as its main source of feedstock. While being one of Egypt's less efficient cement producers historically, the company has been improving 1ts production levels and better managing its sales. However, this has come at the expense of higher SG&A expenses, as the company is offering traders incentives. The company is recently perusing a 2mtpa brownfield expansion, which it has JUSt acquired a licence, but we exclude this from our numbers, given the poor executional track record. On valuation, SVCE is currently being offered at cheap levels (EV/T of cUSD40 vs. typical brownfields at USD90/t and Greenfields at USD150/t); hence, we see room for the stock tore-rate and offer upside
Arabian Cement (Egypt) (TP: EGP10/share)- Pioneering the energy transition move
The fifth largest cement producer and one of Egypt's most profitable and cash-generating firms. The company has been one of the first in the industry to change its fuel mix by substituting natural gas with cheaper coal and RDF; hence, allowing the company to be relatively in a better position vs. peers after the EGP flotation. ARCC has recently started exporting to Yemen and expects c.500k tonnes to be exported by end of 2017 that will provide the company with USD to repay its USD debts. ACC trades slightly below peers although 1t deserves to trade at a premium to local peers, 1n our view, g1ven its competitiveness and above-peer-average profitability
Domty (TP: EGP10.2/share) -The no.1 white cheese producer
We are Buyers of the name as it trades at a discount to global dairy peers' c21x despite strong growth prospects (five-year earnings CAGR of 21 %), driven by capacity additions, product diversification and the shift away from distribution agents. Also, the company raised its prices by c70% in 2016 on average, which we believe should mitigate pressures from higher raw material costs (c79% of cash costs are imported), albeit gradually, as demand begins to recover in 2H17
Giza General Contracting (TP: EGP1.9/share)- Long-term play on government spending
The company is a local contractor, with pure exposure to the Egyptian market and a total backlog estimated to have reached cEGP1 bn in December 2016. We flag GGCC as a long-term play on government spending on housing projects in the middle- and low-income segments, which is the company's core business. We acknowledge the rising concerns over the impact of the high inflationary environment in Egypt on the company's cost structure, due to increased costs of building materials and introduction of a 5% VAT. Nevertheless, we argue th at these concerns are overestimated by the market, as evident in the stock's undemanding multiples
On our radar screen; potential upgrades on significant corrections
We have Neutral ratings on the following names. whose fundamentals seem to be largely priced 1n at current valuations, although we believe any significant market correction could create decent buying opportunities.
Alexandria Mineral Oils (AMOC) (TP: EGP97/share)- Solid characteristics, but full on valuation
We like the company as it is a natural hedge against EGP devaluation and as it benefits from products being priced to USD benchmarks, while feedstocks are also set in USD terms. We also like that it is a consistent dividend payer (c85% payout), which is a dollar-linked dividend, in our view, given its pricing and cost structure. Nevertheless, we think its valuation is full at current levels, with the only upside coming from upcoming expansions, which we have not accounted for yet, but believe they may be accretive. Overall, we are Neutral on the stock
Arab Cotton Ginning (TP: EGP4.75/share)- An asset play that will be very difficult to realise
One of the largest operators in Egypt's cotton space, with wide exposure to a number of other operating assets in the cotton industry. The company also owns a massive land bank that is spread, geographically, across prime locations. The company is currently in the process of breaking up the company into two entities: i) one would hold the land bank portfolio; while the other ii) would include the cotton-based operations, as well as the company's non-core Investments. Overall, we think that its valuation is full at current levels as 1) core operations seem to be already priced; and 11) land assets are priced in at a 40% discount to their independent valuation of EGP1 bn
Arabia lnv. and Dev. Company (AIND)(TP: EGP1.1/share)- Better auto plays out there
AIND is the sole distributor of Peugeot passenger cars in Egypt, with a market share of c2.5% during 2016. The company also has a wide portfolio of Investments in i) leasing (Rawaj and Upper Egypt); ii) electromechanical contracting (Kahromica); and iii) building materials (Toblat). We think AIND will face a weaker passenger car market (its main cash flow contributor) post recent hike in prices, which drove demand away. With fundamentals fully priced in, we think room for upside is limited
Egyptian Resorts (TP: EGP1.2/share)- Tourism factor weighs heavily on stock/business
ERC is the master developer of the Sahl Hasheesh project on the Red Sea coast. The company currently owns a limited landbank (3.2mn sqm). It has a high-risk profile, in our view, given its link to tourism in the country. This makes it a less attractive investment opportunity compared to its local peers. ERC has been facing increased challenges since the beginning of 2H15, as evident in: i) weak land sales; ii) weak revenue recognition of old land sales, a reflection of weak receivables collection; and iii) cases of land plot returns. The return of the company's 20mn sqm phase Ill land (unlikely in the short term) would improve the company's outlook
Porto Group (TP: EGP0.27/share)- Concerns on business model
The company was established in August 2015 as a purely real estate development company, resulting from the spin-off exercise undertaken by Amer Group. Porto Group has a land bank of 4.7mn sqm, across primary and secondary home projects. We believe the stock offers a less attractive investment opportunity compared to its local peers, given the company's: i) full reliance on property sales, in the absence of a recurring source of income (albeit geographically diversified between Egypt and Jordan); ii) depleting land bank, particularly in Egypt, which increases uncertainty around the company's long-term prospects; iii) concentration of company valuation in one project (Porto October); and iv) arising affordability concerns within the segment Porto is targeting
Upper Egypt General Contracting (TP: EGP0.67/share)- Promising LT future weighed down by fair valuation
The company is a local contractor, with operations concentrated in its home market w1th a total backlog estimated to reach cEG P 1.5bn in December 2016. UEGC's superior market position as a preferred contractor of major public entities in Egypt (including the Housing Ministry, the Engineering Authori ty of the Ar med forces. syndicates and governorates) makes the long-term story quite appea ling, in light of the wide (and growing) need for low- and middle-income housing projects in Egypt and supporting infrastructure and increased government focus to address these needs. That said, current valuation a nd ST challenges warrant a Neutral rating
Sell KIMA: An expensive offering...
The sole company that has fallen in our Sell band is Egyptian Chemical Industries Company (KIMA). The stock has recently witnessed a superb performance, on the back of the company's rehabilitation programme pushing ahead. Yet, we argue that the project will not likely be accretive, and that the share price has already reflected the project's returns and more.
Egyptian Chemical Industries Company (KIMA)(TP: EGPS.O/share)- Flown too high, too fast