Analysts with Nairobi-based Sterling Investment bank wrote to clients this month that “the opening up of the East African region” per last year’s EAC Common Market Protocol “[should] provide dilution to the monopolistic position of East African Breweries Ltd. (EABL:KN) in Kenya”, majority owned by industry heavyweight Diaego Plc, which along with SABMiller and Heineken has been aggressively building up [its] presence in emerging and frontier markets to drive future growth. SABMiller, for instance, recently beat its forecast by reporting a 3% rise in beer volumes in the first 3 month of 2011, a performance predominantly led by Africa and Asia, and is set to re-enter the Kenyan market after Diaego bought out its 20 percent stake in Kenya Breweries Ltd., EABL’s primary subsidiary, as part of an agreement to end cross-shareholdings in each other’s operations. Yet those sounding EABL’s death knell may wish to hold off: the firm’s EBITDA margin and ROE (33.1 and 36.89%) compare favorably to SABMiller (16.25 and 10.35%, respectively) and given its 90% Kenyan market share, an 8% growth in volumes last year and the fact that the country is still in the early stages of convergence vis a vis its per capita consumption (12 liters compared to South Africa, Nigeria and Botswana with 59, 53 and 40 respectively), the long run looks, shall we say, rather tasty.
Moreover in addition to increased competition EABL looks set to counter oft-cited near-term headwinds (i.e. an inflation-fueled consumer shift into low-end brands such as now legal, “traditional” brews, as well as the rising global cost of barley) comparatively favorably: Sterling notes, for instance, that the firm is “implementing a raw material substitution strategy that aims to reduce the barley reliance to 60% and increases sorghum (which is more cost effective) input to 40%”, a strategy which in turn will help augment production of its lower-end brand, Senator Keg, and also help cushion overall operating profits. To this end the firm has been contracting more sorghum famers to boost production since it estimates its demand for sorghum (currently 12 tons this year) to rise 4x by 2014″, while the Kenya Agricultural Research Institute has concurrently come up with “a variety of sorghum which is drought resistant and fast maturing which EABL has confirmed to have ideal carbohydrates for brewing.” Finally, while market share will be eroded somewhat in Kenya, EABL continues to look outward to fuel growth: its majority stake in Tanzania’s Serengeti Breweries, increased capacity in Uganda and planned capex in Sudan and acquisition in Ethiopia (where the government now seems set on further state-owned brewery privatization) is part of an overall vision to “increase its regional footprint from 7 to 13 countries” and underpinned by hitherto cash flow growth, which stood at Ksh7.99bn in cash and cash equivalents end-FY2010 with zero debt. On the downside, Sterling writes (its SELL recommendation in late May stated a Ksh154 price target versus 189 currently), remains soaring inflation, higher excise taxes and the Alcohol Control Act which “continue to undoubtedly pose a downside risk to volumes in its main market.” Duly noted, but keep this one in mind once the dust settles.