EUR 26.12 For Business Accounts Only

Valuation exaggerated; Downgrade to UW from N

Overplayed. Eastern hiked its end-retail price by c3.3x since 2011, narrowing the gap to global prices (in USD terms and on an income-adjusted basis) to 35%. We raise our 12M TP by 39% to EGP490/share, as we rollover our DCF and raise TGR to 5% from 2.5%, on a more positive price outlook. We assume an ex-factory price CAGR of 19% over FY17/20, to close this gap to the world average, and assume contained overheads, this time, giving management benefit of their ability in following-through on operational efficiency. However, valuation is demanding, with a 16x 2018e P/E (18x on consensus) vs. peers’ 15x; hence, we cut our rating to UW from Neutral. FTSE index inclusion (effective 19 March), and the 25 March EGM, to decide on a 3:1 stock split and interim DPS, are ST catalysts, but not fundamental.

Volumes suffering from the last price hike. We are cautious on the mix of future price vs. volume growth, after the Nov-17 hike left Dec-Mar volumes down by c8%. However, we believe that the government will opt for price increases, as a source of funding, particularly in light of higher oil prices and the new health insurance law. As a result, we assume a FY17/20 ex-factory price CAGR of 19% (vs. 28% in FY16/18), but against annual volume growth of 1.9% in 2018-20 vs. 3% in 2015-16. Other than direct price hikes, managing overheads (c25% of CoGS) is also a main value driver. Despite the improbability of direct layoffs, we assume the total wage bill will grow at a 5-year CAGR of 10% vs. 22% historically, assuming cost control. Our TP is highly sensitive to prices; +/-10% in ex-factory prices is +/-20% to EPS.

Margins to bottom out in FY19e. Raw tobacco inventory fell to 10.5 months in Dec-17 from a historical run-rate of 20-22 months, inflating Eastern’s FY16/17 margins, as low-cost inventory got depleted. We look for an EBITDA margin drop to 36.9% in FY19 vs. 40.2% in 1H17/18, before rebounding to 40.9% in FY20.

Dividends on the rise but no longer attractive. We expect a FY18 DPS of EGP25.0, implying a yield of 4.1% vs. peers’ 4.6%, and a pay-out ratio of 65% vs. 42% in FY17. Going forward, we assume the company will pay c95% of its FCF in cash dividends, but that would still imply a single-digit yield in FY19-20.