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FFL: Short term headwinds change our stance to SELL

• We change our recommendation to SELL on Fauji Foods Limited (FFL) due to a downward earnings revision for CY18, where we expect the gross margins to drag the profitability. Resultantly, we slash our Jun-19 PT to PKR 30/share, which indicates a downside of 11% from LDCP.

• We expect FFL liquid products’ sales to grow 57% YoY during CY18 on the back of increase in both UHT milk and Tea Whitener sales. Company’s market share in both the categories is likely to settle in at 7.0% and 24.0%, respectively during the period which is expected to grow on YoY basis due to strong marketing effort by the company. Beyond CY18, FFL liquid products sales growth is expected to slow down with a CAGR of 13% during CY19-20.

• We revise down our CY18 gross margins estimates to 8.6% (earlier 9.8%) post updating detailed accounts. Similarly, we revise our estimates down by 1pp YoY to 14.5% and 17.6% for CY19-20, respectively. Decline in SMP prices by 13% YoY to be offset by currency devaluation which would likely restrict margin growth during CY18.

• Higher marketing and promotional activities to lift company’s expenses by 6% YoY to PKR 2.5bn during CY18 which we believe to intact at the same levels going forward.

• Key risks to our investment thesis include i) above expected sales volume, ii) decline in prices of SMP and iii) above expected package milk prices.