Updates: Fauji Foods to increase capital, retail network
Foods is a lucrative business in Pakistan that has a lot of potential for investment and Fauji Foods Limited is trying to tap this potential.
Fauji Foods Limited (FFL) is working to increase its capital to Rs 28 billion and increasing the size of the retail network in Pakistan to boost the company’s liquidity and revenue.
According to a report from Pakistan Insight that unveils the plans of Faujid Foods Limited, Fauji Foods Limited (FFL) altered its loan portfolio to boost the company’s liquidity. Furthermore, the FFL Board of Directors has suggested that the company’s permitted capital be increased from PKR10 billion to PKR18 billion.
We anticipate that the company will either issue common stock or convert its sponsors’ debt into equity, the report reveals.
This development will reduce the company’s debt servicing costs and improve its solvency ratios, it further said.
Increasing Retail Network
The new management’s priority is to increase the company’s revenue, and to that end, FFL is aggressively striving to extend its distribution network. According to management, the company has expanded its retail network in the northern areas and is also expanding its presence in the southern market by expanding its presence in Karachi.
Joint venture
The domestic dairy business has a lot of potentials in the foods sector in Pakistan, which is primarily driven by rising urbanization and changes in customer tastes. Given this environment, we believe FFL could be a viable target for international players looking to gain exposure in the rapidly rising dairy business, the report said.
Read More: Fauji Foods signs material business deal
To be sure, FFL has spent USD44 million on capital expenditures between 2016 and 2019, making it one of the most modern production facilities with cutting-edge technologies. The company’s current utilization rate is 30%, allowing for further volumetric sales.
We feel that bringing in a foreign partner will help the company’s balance sheet, even more, it further said.
Pakistan Fourth-Largest Milk Producer
As the world’s fourth-largest milk producer, Pakistan’s dairy sector offers tremendous opportunities for foods business to investors. However, due to competition from the informal sector (loose milk), regulatory impediments, lower return, and unavailability or lack of investment in infrastructure/cold storage, the official sector is unable to realize its full potential.
Similarly, FFL’s success has been underwhelming after its takeover by FFBL, where the company has encountered intense competition and regulatory challenges. However, we feel that the company’s fortunes are changing as a result of a leadership shift, new product releases, and an improved distribution network.
Background
Given the potential in the dairy sector, FFBL purchased Noon Pakistan Limited and renamed it Fauji Foods Limited (FFL). In 2016, the company debuted its liquid tea whitener ‘DOSTEA,’ as well as the relaunch of its Nurpur brand.
Furthermore, the company made significant investments in its infrastructure and implemented a vigorous marketing campaign. However, the company’s financial performance remained precarious, with FFL recording a cumulative operating loss of PKR10 billion from CY16 to CY20, putting a strain on FFBL’s profitability and liquidity position.
Read More: Fauji Foods further increases in market share
FFL has lost PKR14.5 billion since 2013, owing to stiff competition from the informal/loose milk segment, ii) negative campaigns against packaged milk, iii) removal from the zero-rating regime, iv) aggressive marketing expenses, iv) inability to pass on cost side pressures, v) increased debt servicing charges, and vi) abrupt PKR devaluation.
Stagnant topline growth combined with ongoing losses resulted in a large increase in the company’s debt (including sponsor loan: PKR5.9bn), which increased by 7x from PKR1.9bn in CY15 to PKR14bn in CY20.
FFL Equity
Furthermore, between 2016 and 2020, FFL raised equity four times (i.e. four times) via right shares and the conversion of sponsor debt into stock.
Having said that, we believe that change is in the air, as the company just restructured its corporate strategy and is on course to strengthen its financial condition.
The Facts of Fauji Foods
Commercialization of novel high-margin products
FFL’s topline has seen a dramatic turnaround, with the company recording revenue of PKR6.5 billion in the last nine months, with an average gross margin of 7%.
The company’s recent product introductions show that a change in management has resulted in a shift in strategy. In the last nine months, the company has introduced unsalted butter, butter tubs, dairy cream, and a cheese recipe improvement.
Read More: FFBL to invest Rs9.6 billion in Fauji Foods
FFL’s entire sales volume increased significantly during 1QCY21, owing to an improved distribution network, more effective procurement, and process improvements.
Industry Experts in Pakistan Fauji Foods
Over the last few years, FFL’s top leadership has undergone an aggressive change. The company’s topline and gross margins improved immediately after the change in management took effect. The table below summarises some of the notable changes in high management:
Capital Structure Optimization
In the previous five years, FFL’s debt has increased by 3.5x, putting further strain on the company’s bottom line. Furthermore, the company secured a loan from its sponsors (FFBL), which is currently valued at PKR5.9 billion.
FFL has a fixed asset turnover ratio of 0.97x, compared to FCEPL’s and NESTLE’s fixed asset turnover ratios of 3.39x and 3.6x, respectively. In addition, FFL’s capacity utilization is 30%. We estimate that by examining the industry’s fixed asset turnover ratio and FFL’s unused capacity, FFL can increase its top line by 4x (5-year CAGR: 27%) from current levels. During 1QY21, the company’s top line increased by 43% year on year to PKR2.3bn.
We anticipate that FFL’s topline will expand moderately as a result of I the addition of new goods to the portfolio, (ii) a greater emphasis on retail distribution, and (iii) an improved capital structure.
Similarly, gross margins have increased dramatically and now stand at 11%, compared to a three-year average of -7%. FCEPL’s three-year average gross margin is 14 percent.
Read More: Investors upbeat on Fauji Foods updated business plan
FFL’s gross margins have reversed due to increased contribution from high-margin items (cheese, butter, etc.) and improved fixed-cost absorption. Given the I higher sales volume expectation, (ii) improved margins, and (iii) debt restructuring (iii) We anticipate that the company’s bottom line will turn positive in CY23 because of the borrowing price differential between packaged and loose milk, and (iii) the recent change in taxation regime.
Significant Risks for Fauji Foods in Pakistan
Our investing premise is jeopardized by the following key risks:
- i) Revenue growth is lower than expected.
- ii) Increased competition
- iv) Regulatory/taxation regime changes
- iv) Inability to transfer cost-cutting measures
- v) An increasing price disparity between loose and packaged milk
- v) An increase in the interest rate
vii) Depreciation of the Pakistani rupiah (PKR).
