Date: 10/4/2019

Simonds Farsons Cisk plc (MSE: SFC)

Current Price: € 8.75
Data Overview
Target Price
Recommendation
Potential Downside
Recommended buy price
Recommended sell price
Shares Outstanding
Market Capitalization
Dividend Yield
Industry
Book Value per Share
Price/Earnings (P/E)
Price/Book (P/B)
€8.38  Farsons has experienced modest growth over the past decade, and we
expect its portfolio of renowned brands it to generate further top-line
HOLD
expansion amidst positive economic environment, demographic and
4.5% tourism trends. Our outlook incorporates mid-single digits compound
€7.96 sales growth over the next 5 years.
€8.82
 The Company’s bottom line is well positioned to benefit from these trends
30.0 million as well. Its efforts by means of capital investments to improve operational
€262.5 million efficiencies remain fruitful as operating margin continued expanding.
1.4
1.4% Going forward, we expect present and future capital investment to boost
Brewery profitability further, albeit, to a lower degree.
€3.22  Our price target is €8.38 based on a 10 year discounted cash flow
18.2x valuation. The valuation is driven by our long-term assumptions on
2.7x growth, margins, cash flows and risk.

Company Overview
Simonds Farsons Cisk plc (“Farsons”, or the “Company”), originated in the 1920’s and has since grown to become Malta’s largest
beverage manufacturer. Complementing its core business, Farsons is also engaged in the importation, wholesale and retail of food
and beverages, as well as, the operation and management of franchised food retailing establishments in Malta. Accordingly, Farsons
reports its financial performance in three segments;
 Brewing, production and sale of branded beers & beverages – This segment represents the production, marketing and
distribution of a portfolio of branded beverages. These brands are either self-owned or are being represented under an
exclusive franchise agreement. Own brands include Kinnie, Cisk, Blue Label Ale, Hopleaf, Pale Ale, Classic Brews, Shandy,
Lacto and San Michel. Whilst brands held under an exclusive franchise agreement include Pepsi, 7UP, Mirinda, Budweiser,
Carlsberg, Skol and LikeCola. This segment accounted for 53.2% of revenue and 70.2% of operating income in FY2018.
 Importation, wholesale and retail of food and beverages, including wine and spirits – This segment represents food and
beverages which are imported and readily available for distribution. The Company’s portfolio consist of a wide array of
renowned international brands such as Danone, Tropicana, Walkers, Doritos, Quaker, Red Bull, and Jägermeister amongst
numerous others. This segment accounted for 30.5% of revenue and 18.3% of operating income in FY2018.
 Operation of franchised food retailing establishments – The Company manages under an exclusive agreement the KFC,
Burger King and Pizza Hut franchises in Malta. At present, the company operates fourteen restaurants. This segment
accounted for 16.3% of revenue and 11.4% of operating income in FY2018.

In FY2018, the Company generated €95.0 million in total revenue, representing an increase of 7.8% over the FY2017 figure of €88.1
million reflecting higher sales in all segments. Gross profit increased in line with revenue by 7.6% to €37.1 million in FY2018 from
€34.4 million the previous year. This translated into a marginal decrease in gross profit margin of 39.0% (FY2017: 39.1%).
Nevertheless, operating income (as we calculate it) increased by 12.3% to €14.8 million, significantly above FY2018 company
projections. This is largely attributed to improved operational efficiencies emanating from present and former investments.
Accordingly, operating margin improved by 63 basis points to 15.6% in FY2018 (FY2017: 14.9%)

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 Upside
 Favourable economic activity, demographic and tourism trends are driving top-line revenue – At present, although each of
these factors are growing to a lower degree to previous terms, they are nonetheless growing at a healthy rate and are
expected to keep doing so in the short- to medium-term. As a result, we expect this to contribute positively in generating
higher unit sales across all segments due to an increasing level of consumption in Malta.
 Strong brand portfolio – We believe Farsons benefits from a narrow competitive advantage emanating from its intangible
assets as Farsons’ portfolio of owned brands enjoy a fair degree of pricing power. This is indicative from the results attained
from the brewing, production and sale of branded beers and beverages segment in FY2018 which reported higher than the
average operating margin. Furthermore, Farsons’ large operational scale provides it with greater resources to reinvest in its
brands than smaller competitors, which in turn, gives it the ability to maintain and possibly widen its competitive edge.
 Solid relationship with distributors and retailers - With its strong portfolio of brands, Farsons maintains entrenched
relationships with distributors and retailers that have relied on these brands to drive growth. We presume these
relationships are to prove valuable as the firm maintains its distribution and seek additional shelf space for new products.
 Management successfully utilizing funds to increase operational efficiency – Farsons is in the maturity stage of the business
life cycle. Therefore, the management’s focus to derive value and remain profitable, has over the past decade turned to
increasing operational efficiencies and reducing costs. In this regard, the management has been successful as the operating
margin consistently improved from 3.6% in FY2009 to 15.6% in FY2018. More importantly, this led to higher returns on
capital which mushroomed from just 1.8% in FY2009 to 10.3% in FY2018, significantly above the cost of capital estimate of
4.8%.
 High barriers to entry - We think the possibility of a new large player in the market is highly unlikely given the limited market
capacity, which in turn, drives down the attractiveness of new investment in this area. In addition, the high barriers to entry
for alcoholic and non-alcoholic beverage manufacturers, including up-front capital investments and the need to secure
distribution and shelf space against well-established players, is likely to allow Farsons to continue generating excess
economic profits over the next decade.
Downside
 Unlikely to be successful in internationalising its business - In spite being very successful in developing and maintaining strong
brand names in Malta, we think the Company will be unable to replicate this success abroad. Our basis to this statement is
simple. If you grew up in Malta, your experience around brands such as Kinnie and Cisk are likely to have favourable
associations. By contrast, someone who grew up outside of Malta will not attribute much value to these brands because
they do not have the same experiences. In other words, for the Maltese consumer, Farsons’ main brands are not just
beverages, but rather an experience. Thus, we believe that Farsons will find it hard to expand internationally.
 Changing Consumer trends and increasing competition - The traditional carbonated soft drinks’ market, in many countries
including Malta, continues to face a number of challenges: the intense focus on sugar content and related nutritional
concerns and the focus on packaging particularly PET bottles. Consequently, there is an up rise for healthier alternatives
with a drastic increase in awareness and pressure for protection of the environment. On top of that, the fast-growing craft
beer industry is posing new challenges to the Company. Although the firm’s diverse portfolio mitigates this risk to a certain
extent, in the eventuality where the beer category loses significant share to craft beers, it could adversly weigh on
profitability given this segment contributes the majority of operating profits.
Valuation Hypothesis
Our model baseline price stands at €8.38, 4.5% lower than the current price of €8.75 (as of 10th April 2019). The model price is
calculated using a 10 year discounted free cash flow to the firm approach and a weighted average cost of capital (WACC) of 4.8%
decreasing down to 4.2% by the end of year 10 mainly reflecting a lower country risk premium and a terminal growth rate of 0.0%1.
The WACC is computed by using an after-tax cost of debt of 1.7% and a cost of equity of 5.4% with a weight of 15.4% and 84.6%
respectively. The weighting reflects the current market value of debt (€47.9 million2) and equity (€262.5 million) representing a debt
to equity ratio of 18.2%. We project the debt to equity of SFC to remain relatively stable over the 10-year period.
The after-tax cost of debt is obtained using a pre-tax cost of debt of 2.63% and a marginal tax rate of 35.0%.

1 For consistency purposes, the stable growth rate should not exceed the riskless rate used in the valuation.
2 This figure includes the present value of operating lease commitments amounting to €4.5 million.
2
 The cost of equity is computed by using the 10-year German government bond yield of 0.0% (as of 8th April 2019) as the risk free rate,
a Beta of 0.70 and an Equity Risk Premium of 7.6%, reflecting a country risk premium of 1.7% (A3 rating). We project Malta’s credit
rating to improve to Aa2 by the end of year 10 in line with that of the UK. We compute Beta using a bottom-up approach by computing
a weighted average by revenue of the unlevered Beta for the industry averages in which SFC operates in, and lever it to account for
the Company’s financial leverage.
Revenue
We forecast revenue to grow at a CAGR of 4.0% per annum to FY20233 largely in the wake of favourable economic activity along with
positive demographic and tourism trends in the short to medium-term. After 2023, we forecast revenue to grow by a CAGR of nearly
1.5% as the food and beverage industry in Malta reaches saturation.

Operating Margin
We estimate operating margin to gradually increase from 15.6% to 17.0% by the end of year 10, owing to: (i) a narrow competitive
advantage emanating from economies of scale, cost advantages and the Company’s strong brands (ii) and investment efforts in
relation to increasing operational efficiency.
Reinvestment 4
We estimate reinvestment-costs to exceed €50 million over the 10 year period.
Tax Rate
We use an effective tax rate of 35.0% reflecting the corporate tax rate in Malta once the current tax benefits are exhausted.
Monte Carlo Simulation
We run a Monte Carlo Simulation with 50,000 iterations to generate potential future scenarios according to our assumptions
(potential deviations from our baseline scenario). The current price of €8.75 is found to be above our baseline scenario price estimate
of €8.38 by nearly 4.5%. Conversely, the current price stands at circa the 75th percentile when compared to all potential outcomes.

Conclusion
Farsons’ stock price seem to be somewhat overvalued given the range of assumptions used in our model. Nonetheless, the intrinsic
value of SFC may still potentially lie above the current price at a probability of nearly 25%. As a result, we are placing a HOLD
recommendation on the stock. Yet, one ought to keep in mind that upside potential is lower (approx. 25%) than downside potential
(approx. 75%).

3 The CAGR are computed against the FY2018 reported figures.

4 Reinvestment = Net Capital Expenditure + Change in Working Capital
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 Ratio Analysis 5
Profitability Ratios FY2016 FY2017 FY2018
Gross Margin 38.9% 39.1% 39.0%
EBITDA Margins (without lease adjustment) 20.1% 22.4% 22.8%
EBITDA Margins (with lease adjustment) 20.3% 22.8% 22.9%
Operating Margins (without lease adjustment) 13.5% 14.6% 15.4%
Operating Margins (with lease adjustment) 13.7% 14.9% 15.6%
Net Margin 12.9% 13.5% 15.2%
Return on Equity 10.0% 9.6% 14.9%
Return on Capital 8.5% 8.0% 10.3%

Efficiency Ratios
Current Ratio 1.39x 1.39x 1.12x
Quick Ratio 0.87x 0.79x 0.70x
Cash Ratio 0.05x -0.05x -0.08x
Defensive Interval Ratio 96 days 81 days 74 days

Solvency Ratios
Gearing Ratio (without lease adjustment) 19.8% 22.6% 30.7%
Gearing Ratio (with lease adjustment) 22.0% 24.0% 32.9%
Net Debt to EBITDA (without lease adjustment) 1.5x 1.9x 2.1x
Net Debt to EBITDA (with lease adjustment) 1.7x 2.0x 2.3x
Interest coverage Ratio (without lease adjustment) 8.3x 8.7x 12.2x
Interest coverage Ratio (with lease adjustment) 7.9x 8.5x 11.2x

Price History (Currency: EUR)

€11 90
€10 80
€9 70
€8
60
€7
50

Volume
Price

€6
40
€5
30
€4
€3 20

€2 10

€1 0
2/22/2017 5/22/2017 8/22/2017 11/22/2017 2/22/2018 5/22/2018 8/22/2018 11/22/2018 2/22/2019

Volume ('000) Closing Price 50 Day MA 200 Day MA

5 Source: Own computations and SFC published Annual Reports

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Disclosure
The analysts contributing to this report holds shares of this stock. The revenue and stock price forecasts are the Gorilla’s Investment
Research (GIR) consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein
accurately reflect the analysts' personal views as to the subject securities and issuers. GIR certifies that no part of the analysts
compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in
the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data
obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because
of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any
investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an
offer to buy or sell the securities herein mentioned. GIR may have a position long or short in the securities mentioned and buy or sell
the securities from time to time. GIR uses the following rating system for the securities it covers which results from a proprietary
quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a
stock over the next 1 to 24 months. The model assigns each stock a rank from 1 through 5. GIR Rank 1 = Strong Buy. GIR Rank 2 =
Buy. GIR Rank 3 = Hold. GIR Rank 4 = Sell. GIR Rank 5 = Strong Sell.