RCL Foods | Ruffled feathers

RCL Foods (RCL) has margin pressure in both chicken and sugar, due to lower y/y average price realisations. Chicken and sugar EBITDA (excluding impairments) fell by R621m y/y in FY '19. Management took a c.R762m impairment to the sugar business, with structurally lower sales and margins likely unless government takes action to protect an industry in crisis. Positively, RCL's grocery business has been gaining market share and improving efficiency, thereby delivering EBITDA growth of 24% y/y. Group EBITDA (including impairments) fell 63% y/y to R763m.

Excessive chicken supply (imports and local production) has led to a c.10% reduction of selling prices, amidst an 11% increase of feed prices. We expect input costs to grow with stabilisation of maize and soybean meal prices in FY '20. Despite a seasonal uptick in pricing in H1 '20 to Dec ‘19, we forecast RCL chicken profits to remain under pressure.

RCL has been subject to c.300kt lower local sugar demand due to the introduction of the Health Promotion Levy in SA. The higher surplus is being exported at a loss. We therefore expect the sugar division to remain loss making in FY ‘20. The sugar industry needs to downsize and consolidate for greater efficiency.

RCL is innovating and promoting groceries successfully. The shortcomings of peers over the last two years has been RCL's gain. However, the competition is recovering. Thus, we expect RCL to experience pressure on market share in FY '20.

We calculate a 12m TP of 11/share using a sum-of-the-parts DCF. We upgrade RCL to an OUTPERFORM rating. In our view, the share is oversold but will only re-rate on solid evidence of a turnaround in both chicken and sugar.