AVI | Maintaining margins

The current down-cycle is affecting consumer spend, which is contributing to aggressive price competition from both multi-nationals and cheap product variants (import and local). As a result, AVI HEPS fell 5% y/y in FY '19 despite relief from low raw material prices. Restoring volume growth will be challenging in an intensely competitive environment. However, on balance AVI's strong food and beverage brands should hold market shares. The fashion sector is fragmenting with excess retail space and high discounting activity. AVI is attempting to turn the fortunes of Greencross through a multi-brand product offering and a more efficient, import driven supply chain. The initiatives to refresh the footwear and apparel businesses are risky in the current weak discretionary spend environment. Product innovation and strict cost discipline at AVI have been limiting the extent of profit compression but will not counter weaker trading conditions.

We estimate FY '20 Group diluted HEPS to grow by 7% to c.549cps (+4% y/y adjusting for once-offs in base), in line with revenues. AVI is more sensitive than peers to an improving economy given their discretionary goods portfolio (c.28% of revenues are from apparel). We forecast an acceleration of earnings growth to a CAGR of 9% with diluted HEPS of c.697cps in FY '23.

Our base case is for AVI to hold EBIITDA margins of c.24% given its moats of strong brands and scale. However, we believe the rating is already capturing these competitive advantages. Per our exercise on AVI's domestic margins, there is downside risk on current levels that are higher than its global peer Group average.

In our view, AVI's equity compounder characteristics support a c.15% premium valuation in the sector for AVI. We estimate that the counter is trading at a 16x one-year rolled forward PE (1.5x PE relative). We calculate a 12m TP of R96/share and upgrade to a MARKET PERFORM recommendation.