Valuation and Recommendation
We forecasted the income statement for ECL for the next 5 financial years, with the forward EPS for FY2023 coming in at approximately J$0.27. Investors should note that the forecasted EPS is still below pre-COVID levels, with ECL’s EPS in FY2019 coming in at approximately J$0.35. This was influenced by multiple factors. Firstly, inflationary pressures are expected to persist at least for FY2023, hence a worsening of the gross profit margin was projected when compared to FY2019, albeit while showing an improvement over FY2022. Secondly, higher projected depreciation and amortisation costs due to the addition of the large right-of-use assets have negatively affected projected profits, particularly in the earlier years of the forecast period. Lastly, a higher projected interest expense due to a higher level of debt when compared to FY2019 weighs negatively on projected income. Key assumptions used in this forecast include a continuation of the revenue growth (%) that the company has reported in recent quarters, particularly as the tourism sector rebounds. Our projections also take into consideration the company’s increased cost of sales resulting from supply chain disruptions.
To arrive at our price target for ECL, a discounted cash flow model was used. We estimated the weighted average cost of capital (WACC) at 13.54% and estimated the terminal growth rate at 3.97%. Our estimate of the long-term growth rate was influenced by long-term trends in stopover arrivals. After forecasting free cash flow to the firm for the next 5 financial years and discounting these cash flows to present value using the WACC, we derived an estimate of fair value of $4.71 per share. This represents a potential downside of 15.98% compared to the last closing price. ECL’s trailing twelve month P/E ratio is 55.65x and its forward. (FY2023) P/E ratio is 20.55x with the decrease being due to a rebound in revenue as tourist arrivals also rebound and margin improvement. Using our estimate of fair value, the forward (FY2023) P/E ratio is approximately 17.26x.
While we do expect the tourism industry to continue rebounding and therefore expect ECL’s revenues to grow and surpass pre-covid levels by FY2023/FY2024, the inflationary pressures can not be ignored. The Company has already suffered from price increases in their input costs, shown by the contracting profit margins. While we expect the inflationary pressures to ease over time, at the very least, in the very near term (FY2023), we expect these inflationary pressures to remain at somewhat elevated levels which would negatively affect profits and profit margins when compared to pre-Covid margins. Also, the Company’s liquidity position, while on the face, may look strong, the fact that current assets are heavily concentrated in amount due from a related company and especially the fact that we can not analyze that related company and assess the probability of repayment, is concerning. The fact that this amount has no fixed repayment terms is also concerning. The solvency position is also concerning. The Debt-to-Equity ratio has spiked in FY2020 and FY2021 and while as at the end of 9 month 2022 the ratio has decreased, it is still in a concerning position. As it relates to the Company’s ROAE, while it has partially rebounded, it is still far below pre pandemic levels.
There is a chance that inflationary pressures may ease faster than expected and therefore cause margins to recover much quicker than expected which would then lead to higher profit and higher ROAE (all else being equal). However, we believe this to be a low probability scenario and believe that the scenario with inflation softening but remaining at somewhat elevated levels, at the very least in the near term, to be more likely.
Longer-term we do expect the company to reap the benefits of their expanded footprint within the Sangsters International Airport as well as the return to trend growth in stopover arrivals. This, when balanced with the factors highlighted throughout the analysis, as well as our expectations of earnings and cash flow generation going forward underscores our MARKETWEIGHT recommendation.
|Estimated Fair Value||J$4.71|
As at September 9, 2022
Express Catering Limited | Equity Analysis