Lucky Lanka

INITIAL PUBLIC OFFERING

1 | P a g e July 2014, Sri Lanka Equity Research

LUCKY LANKA IPO

Rating: VOTING : DO NOT SUBSCRIBE ISSUE PRICE : Voting LKR6.00 NON VOTING : SUBSCRIBE Non Voting LKR3.00

Valuation

Voting Share

Based on a FCF valuation (WACC of 14.2% and terminal growth of 3%) the share is valued at

LKR6.8 per share with the offer price been at 11.8% discount to the same. However on a

relative basis the offer is at 21.4X FY15e earnings and 13.8X FY16e net profit which is at a

significant premium to the broad market trading on 13.0X FY15e net earnings. Albeit on PBV

basis the offer is fairly priced at 1.7X. Therefore given the premium vs the broad market and just

a marginal discount to FCF based share value, solely on a fundamental valuation point of view

our take is NOT TO SUBSCRIBE.

However given the success of this start-up entrepreneurial venture the popularity of the product

and company in Southern Sri Lanka and the marketing buzz given for the IPO in the current

interest rate environment with limited alternate investment the issue could be fully subscribed

with the intention of mainly short term return.

Non Voting Share

Offered at a 50% discount to boost the voting share, valued at 10.7X FY15e net profit and at

0.8X PBV, the non-voting share is attractive. Also we believe post IPO the voting & non-voting

discount would narrow and there would be 60-65% probability of the non-voting share price to

better the price performance of its voting counterpart. Hence SUBSCRIBE.

Key Strengths

In an era where the government is trying to up the local dairy industry we believe Lucky is on

the correct path to capture the growth of the local dairy industry. Further with the new expansion

they would be able to increase its capacity by c.50% and depicts strong growth prospects

mainly in the outstation areas where they have a much stronger presence than most of its

peers.

Key Risks

The valuations are derived based on the assumption that the government would continue to

support the local dairy industry using by discouraging imports. Therefore any adverse change in

government dairy strategy in future would impact our valuations negatively. Further the FY14

figures are unaudited and if the audited figures change negatively it would impact our

valuations.

Company Overview

Lucky Lanka is engaged in the process of collection (7 extraction centers) of locally produced

fresh milk from rural village farmers (more than 5,000) and process yoghurt and other milk

products and distribute island wide (50 distribution points and 105 vehicles) under the brand

name LUCKY. Company has a daily capacity of 20,000 litres in its production plant in

Kamburupitiya (171 Km south of Colombo) whilst currently has 400 direct employees and over

3,000 indirect employees.

Softlogic Stockbrokers (Pvt) Ltd #06,37

th Lane, Queens Road

Colombo 03, Sri Lanka +94 11 7277000

[email protected]

Lead Analyst : Asanka Ranasinghe

YE Mar/(LKR mn) FY12 FY13 FY14 FY15E FY16E

Net Profit LKR mn) 4.9 18.0 20.3 56.2 87.1

YoY growth (%) -32.7% 269.4% 13.1% 176.3% 54.9%

EPS (LKR) 0.0 0.1 0.1 0.3 0.4

YoY growth (%) -32.7% 269.4% 13.1% 176.3% 54.9%

BVPS (LKR) 1.5 1.6 1.8 3.5 3.9

DPS (LKR) - - - 0.04 0.07

ROE (%) 1.7% 5.8% 5.6% 7.9% 11.1%

Voting

PER (x) 246.5 66.8 59.0 21.4 13.8

PBV (x) 4.1 3.9 3.3 1.7 1.5

Div yield (%) 0.0% 0.0% 0.0% 0.7% 1.1%

Non Voting

PER (x) 123.3 33.4 29.5 10.7 6.9

PBV (x) 2.1 1.9 1.7 0.8 0.8

Div yield (%) 0.0% 0.0% 0.0% 1.4% 2.2%

ISSUE DETAILS

IPO Proceeds LKR mn

38 mn voting shares @ LKR6.00 228.00

24 mn voting shares @ LKR3.00 72.00

Total 300.00

To be listed on the Diri Savi Board of the CSE

USE OF IPO FUNDS (LKR mn)

Settlement of loans 200.00

Improving existing production plant 75.00

New project implementation 25.00

Opening date of the issue 07 July 2014

Closing date of the issue 24 July 2013

Or such other earlier date if the issue is

oversubscribed

on oversubscription

Minimum subscription (voting shares) 1,000

(Non-voting shares) 1,000

BASIS OF ALLOTMENT

Investor category %

Unit Trusts 10.0

Retail Individual Investors* 45.0

Non Retail Investors 45.0

*subscribe below LKR100,000/-

1,200.00

MAIN SHAREHOLDERS

Mr Lal K A Guanwardena 52.90%

Ms B A Gunawardena 7.56%

Ms D A Gunawardena 7.56%

Ms N A Gunawardena 7.56%

GOH Family Investment Holdings 2.84%

IPO Shares 21.59%
mailto:[email protected]



COMPANY OVERVIEW

The company was established in 1991 by Mr. Lal Keerthi Gunawardhana as a milk processing unit with a capacity of

300 cups per day. Over the past two decades the company has achieved significant growth and has its own

production plant in Kamburupitiya (171 Km south of Colombo) with a daily capacity of 20,000 litres.

Today Lucky Lanka is engaged in the process of collection (7 extraction centers) of locally produced fresh milk from

rural village farmers (more than 5,000) and process yoghurt and other milk products and distribute island wide (50

distribution points and 105 vehicles) under the brand name LUCKY.

The product range comprises of Vanilla, Strawberry, Chocolate, Treacle, Fruit Jelly and Fresh Fruit Yoghurts, Curd,

Pasteurized Milk, Sterilized Milk, UHT Milk, Flavoured Milk, Fruit Drink Bottles and Drinking Yoghurt. Lucky recently

introduced Lucky Milk Toffee also to the market.

Company currently has 400 direct employees and over 3,000 indirect employees. Lucky Yoghurt is the one and only

yoghurt manufacturer with SLS certification for the first time in Sri Lanka and also has ISO 22000, HACCP

international standards.

FINANCIAL OVERVIEW

Lucky Lankas revenue has grown at a 5 year CAGR of 15% FY10-FY14 to stand at LKR896.5 mn by FY14. During

the current financial year revenue growth has been rather slow at 6.5% YoY but we believe by using LKR100.0 mn of

the IPO proceeds company would be able to grow its revenue by 15.0% YoY and 25.0% YoY in FY15E and FY16E

respectively. Over the last 5 years the firm has enjoyed an average gross profit (GP) margin of 42.2% but on a

conservative basis we forecast a GP margin of 40.0% for the nest 2 years.

During the last 5 years (FY10-FY14) companys profit has grown at a slower pace (5 year CAGR of 2.5%) largely due

to higher operating costs and finance cost. We believe there would be a reduction in EBIT margins in the short term

due to higher distribution and promotional costs but lesser debt burden (LKR200.0 mn of IPO proceeds are used to

retire debt) would result in higher profitability. We forecast profit to grow c.1.5x in FY15E to LKR53.3 mn (NP margin

5.2%) and further expect 57.9% YoY growth in net profit to LKR84.2 mn (NP margin of 6.5%) in FY16E.

Over the years companys leverage has been rather high at 90% level. However going forward with the retirement of

debt we would expect a drastic improvement in its leverage to c.15%. Further the inflow LKR300.0 mn of capital would

further strengthen its equity position where its book value per share (BVPS) would increase to LKR3.5 compared to

LKR1.8 in FY14.

Revenue

0%

5%

10%

15%

20%

25%

30%

0

200

400

600

800

1,000

1,200

1,400

FY10 FY11 FY12 FY13 FY14 FY15E FY16E

(LKR mn)

Revenue YoY growth

PAT

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

0

10

20

30

40

50

60

70

80

90

100

FY10 FY11 FY12 FY13 FY14 FY15E FY16E

(LKR mn)

PAT YoY growth

Source : Softlogic Equity Research/ Lucky Lanka Prospectus




FUTURE STRATEGIES

1 Gedarata Kiri Project Company began this project in Matara district to promote the habit of drinking fresh milk in Sri Lanka. The second

stage of this project would start in Colombo.

Lucky Milk Bar Company has opened a modern retail outlet to sell all Lucky brand products at the entrance of the Southern Highway.

Firm is planning to establish 1,000 outlets of that nature Island-wide to increase its market share.

Retail Three-wheeler network

Lucky has decided to offer its products to the door step of the consumers using retail three-wheel network and the

project is implemented through franchising agreements with upcoming entrepreneurs.

National Policy of Standardization of School Canteens The company intends to increase the availability of high nutrition milk based products in school canteens that will support to boost the sales in this market segment. Introducing dry distribution channel Due to seasonal fluctuations of chill product range, the Company has identified the requirement of introducing dry

product range with separate distribution channel. This product range includes milk toffee, sterilized milk bottles and

flavoured milk bottles. Extension of the product range by introducing Lucky bottled water and Biscuit with yoghurt will

add high turnover on this channel. This distribution channel is planned to operate by 50 new vehicles.

MARKET FOR MILK PRODUCTS AND YOGHURT

Almost all the products in the market are priced at the same level and therefore we believe it is the quality and the

brand name is the driving force in increasing market share. We are of the view that Lucky has a relatively strong

presence in the Southern Province (market share information are not available) and the suburbs but we believe they

would face severe competition from other brands like Highland, Kotmale, Ambewela, Richlife and CIC in penetrating

the Colombo district.

Margins

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

GP margin EBIT margin NP margin




VALUATION

We believe the issue is fairly valued at an issue price of LKR6.0 per share. Based on free cash flow valuation (WACC

of 14.2% and terminal growth of 3.0%) we have derived a value of LKR6.8 per share which is at 11% premium to the

voting share. However with an issue price of LKR3.0, the non-voting share is significantly attractive at a 54% premium

to the free cash flow value.

Based on relative valuations, at an issue price of LKR6.0 the voting share is trading 21.4x FY15E earnings and 13.8x

FY16E earnings. The non-voting is attractive at 10.7x FY15E earnings and 6.9x FY16E earnings. On book value

multiples the voting is trading at 1.7x and the non-voting is trading at 0.8x for FY1515E.

We are of the view that the closest comparable local peer is Kotmale and it also trades at a discount to Lucky of FY15E earnings. We do not believe a higher PER of 21.7x is justifiable given the size of the company and its operations.

We believe the business case for Lucky is sound and has potential to grow. Based on the valuations we believe the

non-voting share offers value with a 54% discount to intrinsic value and trading at 10.7x FY15E earnings. Further the

gap between the voting and the non-voting share in the market is c.30%, hence non-voting share has more upside.

Recommend Subscribe

On the contrary we believe the voting share has limited upside given it is just 11% discount to our intrinsic value and

21.4x 1 year forward earnings multiple is also at a significant premium to the broader market 4 quarter trailing multiple

of 14.2x. Hence we believe there would be opportunity to accumulate the voting share at lower levels from the market.

Recommend Not Subscribe

KEY RISKS

The valuations are derived based on the assumption that the government would continue to support the local dairy

industry using by discouraging imports. Further compared to other countries the dairy industry in Sri Lanka is quite

small and fragmented. Therefore protectionism is needed to safeguard the local industry from competition. Any

adverse change in government dairy strategy in future would impact our valuations negatively.

FY14 figures presented in the prospectus are unaudited and therefore we believe if numbers negatively change

subsequent to the audit it would impact our valuations.

WACC and Terminal growth sensitivity

1.0% 2.0% 3.0% 4.0% 5.0%

10.0% 9.0 9.9 11.0 12.4 14.5

12.0% 7.3 7.9 8.5 9.3 10.3

14.2% 6.1 6.4 6.8 7.2 7.8

16.0% 5.3 5.5 5.8 6.1 6.5

18.0% 4.7 4.8 5.0 5.2 5.5

20.0% 4.2 4.3 4.4 4.6 4.8

Terminal Growth (%)

WACC (%)

Peer comparison

Peer comparison

Mkt Cap

(LKR mn) PER (x) PBV (x) ROE (%)

Div yield

(%)

Broader Market 2,554,134.0 14.2 2.2 11.4% 2.8%

Lucky Lanka - V 1,056.2 21.4 1.7 7.9% 0.7%

Lucky Lanka -NV 72.0 10.7 0.8 7.9% 1.4%

Lanka Milk Foods 4,500.0 175.4 0.5 0.3% 1.3%

Kotmale Holdings 1,649.0 16.6 1.6 9.9% N/A

* Broader market on 4 qtr trailling basis

** Other on 1 year forward basis

Source : Softlogic Equity Research Source : Softlogic Equity Research



INDUSTRY OVERVIEW

The agricultural sector contributes c.11% of GDP where the livestock subsector contributes only 0.7% of GDP. Dairy

sector is the most important of all livestock sub sectors. This is primarily because of the influence it can make on the

rural economy. Sri Lanka imports around 70,000-75,000 MT milk powder spending around LKR40.0 bn. Sri Lanka

produces c.300 mn litres domestically which is approximately 40% of the total requirement.

The government attention is most focused on the dairy sub sector; to develop this sector into a 'local industry'. The

government policy on dairy development is aimed at producing 50% of country's requirement of milk by the year 2015.

In order to achieve this target government plans to import high quality cows and plans to increase the annual average

yield in excess of 1,500 litres per cow. To further support the dairy sector a special loan scheme at an interest rate of

8% will be implemented in support of SMEs in the dairy sector to promote dairy farms, collection centers and

equipment, the development of animal feed etc and the high CESS will be maintained on the importation of butter,

yoghurt and dairy products.

Milk Production

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

50

100

150

200

250

300

350

20002001200220032004200520062007200820092010201120122013

(LKR mn)

Milk production (Mn Ltr) YoY growth

Milk items consumption and expenditure (Ave. monthly per person)

Milk items Unit QuantityValue (LKR)

Cow milk ml 110.33 7.34

Goat milk ml 7.67 1.16

Sterilized milk ml 5.70 0.60

Curd - 13.14

Yoghurt/Moru - 24.77

Condensed milk grams 2.09 1.74

Milk powder grams 341.36 271.21

Infant milk powder grams 25.12 30.69

Butter grams 5.18 4.88

Margarine grams 10.46 6.37

Cheese grams 2.46 4.03

Milk packets (liquid) number 0.13 2.63

Other milk & milk products - 3.56

Source : Dept. of Census & Statistics/ Softlogic Equity Research Source : Dept. of Census & Statistics/ Softlogic Equity Research



FINANCIAL SUMMARY

Income Statement

YE Mar/LKR mn FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

Revenue 440.6 514.1 546.2 681.6 841.8 896.5 1,031.0 1,288.7

Cost of sales 248.1 279.7 306.7 405.9 505.8 527.1 618.6 773.2

Gross profit 192.5 234.4 239.5 275.8 336.0 369.4 412.4 515.5

Other income 1.5 8.0 2.0 0.4 3.1 0.8 1.5 2.0

Operating cost 180.9 192.7 193.2 220.1 269.4 283.4 340.6 413.4

EBIT 13.0 49.8 48.3 56.0 69.7 86.8 73.3 104.1

Finance cost 7.3 31.3 41.0 51.2 51.7 66.4 17.1 17.1

PBT 5.7 18.4 7.2 4.9 18.0 20.3 56.2 87.1

Taxation - - - - - - - -

PAT 5.7 18.4 7.2 4.9 18.0 20.3 56.2 87.1

Balance Sheet


Non current assets 120.5 279.5 316.9 557.1 536.2 513.2 536.9 460.6

Current assets 73.2 98.0 91.2 123.4 183.6 252.6 382.4 562.2

TOTAL ASSETS 193.7 377.5 408.1 680.5 719.8 765.8 919.2 1,022.9

Equity 5.2 187.2 194.4 292.2 310.2 360.5 708.3 782.3

Non current liabilities 48.4 48.3 76.1 166.2 194.6 123.3 21.5 21.5

Current liabilities 140.8 142.1 137.6 222.1 214.9 282.0 189.4 219.1

TOTAL EQUITY & LIABILITIES 194.5 377.5 408.1 680.5 719.8 765.8 919.2 1,022.9

Ratios


GP margin (%) 43.7% 45.6% 43.8% 40.5% 39.9% 41.2% 40.0% 40.0%

EBIT margin (%) 3.0% 9.7% 8.8% 8.2% 8.3% 9.7% 7.1% 8.1%

NP margin (%) 1.3% 3.6% 1.3% 0.7% 2.1% 2.3% 5.5% 6.8%

OPEX/Revenue 41.1% 37.5% 35.4% 32.3% 32.0% 31.6% 33.0% 32.1%

ROE (%) 110.8% 9.8% 3.7% 1.7% 5.8% 5.6% 7.9% 11.1%

ROCE (%) 8.7% 6.8% 2.3% 0.9% 3.2% 3.5% 7.8% 10.9%

ROA (%) 3.0% 4.9% 1.8% 0.7% 2.5% 2.7% 6.1% 8.5%

EPS (LKR) 0.03 0.09 0.04 0.02 0.09 0.10 0.28 0.44

BVPS (LKR) 0.03 0.94 0.97 1.46 1.55 1.80 3.54 3.91

DPS (LKR) N/A N/A N/A N/A N/A N/A 0.04 0.07

Payout N/A N/A N/A N/A N/A N/A 15.0% 15.0%

Sales per share (LKR) 2.2 2.6 2.7 3.4 4.2 4.5 5.2 6.4

Inventory days 13 21 37 35 33 38 35 35

Receivable days 32 38 24 25 36 65 40 40

Payable days 143 76 63 93 73 68 70 70

WC days (99) (18) (2) (33) (5) 35 5 5

Inventory turnover (x) 29.1 17.8 9.9 10.4 11.1 9.5 10.4 10.4

Asset turnover (x) 2.3 1.4 1.3 1.0 1.2 1.2 1.1 1.3

Interest cover (x) 1.8 1.6 1.2 1.1 1.3 1.3 4.3 6.1

Current ratio 0.52 0.69 0.66 0.56 0.85 0.90 2.02 2.57

Quick ratio 0.46 0.58 0.44 0.38 0.64 0.70 1.71 2.30

Debt/Total Equity 17.67 0.69 0.80 0.95 0.97 0.83 0.12 0.11

Debt/Share Capital N/A 8.55 10.43 18.48 20.06 1.01 0.14 0.14

Debt/Total Capital 0.92 0.31 0.39 0.44 0.45 0.39 0.02 0.02

Revenue growth 16.7% 6.3% 24.8% 23.5% 6.5% 15.0% 25.0%

EBIT growth 281.4% -3.0% 16.1% 24.3% 24.6% -15.6% 42.1%

Profit growth 220.9% -60.8% -32.7% 269.4% 13.1% 176.3% 54.9%



Softlogic Stockbrokers (Pvt) Ltd # 06, 37

th Lane, Queens Road, Colombo 03

Sri Lanka

Telephone +94 117 277 000 |Fax +94 117 277 099

E-mail [email protected]

Equity Research Danushka Samarasinghe Asanka Ranasinghe Tharushi Perera

[email protected] [email protected] [email protected]

+94 11 7277001 + 94 11 7277052, +94 77-1078497 + 94 11 7277052, +94 77-3482321

Kavindu Ranasinghe Chamithri Ratnapala

[email protected] [email protected]

+94 11 7277031 + 94 11 7277033, +94 77-3723506

Imalka Hettiarachchi Nishanthi Hettiarachchi

[email protected] [email protected]

+94 11 7277032 +94 11 7277030, +94 11 77 1078499 Equity Sales Dihan Dedigama [email protected] 011 7277010 / 0117277055, 0777689933

Hussain Gani [email protected] 011 7277020 / 777209986

Prasanna Chandrasekera [email protected] 011 7277056

Eardley Kern [email protected] 011 7277053, 0777348018

Zimry Liyabdeen [email protected] 011 7277057

Achindi.Silva [email protected] 011 7277054 077 3825087

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Hisham Haniffa [email protected] 0773828781

Branches Horana

Madushanka Rathnayaka [email protected] 034 7451000 0773566465

Negombo

Krishan Williams [email protected] 031 7451000 0773569827 The information contained in this report is for general information purposes only. This report and its content is copyright of Softlogic Stockbrokers and all rights reserved. This report- in whole or in part- may not, except with the express written permission of Softlogic Stockbrokers be reproduced or distributed or commercially exploited in any material form by any means whether graphic, electronic, mechanical or any means. Nor may you transmit it or store it in any other website or other form of electronic retrieval system. Any unauthorised use of this report will result in immediate proceedings. The report has been prepared by Softlogic Stockbrokers (Private) Limited. The information and opinions contained herein has been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. Such information has not been independently verified and no guaranty, representation or warranty, express or implied is made as to its accuracy, completeness or correctness, reliability or suitability. All such information and opinions are subject to change without notice. This document is for information purposes only, descriptions of any company or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as, an offer, or solicitation of an offer, to buy or sell any securities or other financial instruments. In no event will Softlogic Stockbrokers be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising out of, or in connection with the use of this report and any reliance you place on such information is therefore strictly at your own risk. Softlogic Stockbrokers may, to the extent permissible by applicable law or regulation, use the above material, conclusions, research or analysis in which they are based before the material is disseminated to their customers. Not all customers will receive the material at the same time. Softlogic Stockbrokers, their respective directors, officers, representatives, employees, related persons and/or Softlogic Stockbrokers, may have a long or short position in any of the securities or other financial instruments mentioned or issuers described herein at any time and may make a purchase and/or sale, or offer to make a purchase and/or sale of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principal or agent. Softlogic Stockbrokers may make markets in securities or other financial instruments described in this publication, in securities of issuers described herein or in securities underlying or related to such securities. Softlogic Stockbrokers may have entirely underwritten the securities of an issuer mentioned herein.

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Lucky Lanka