The company watch list: AVI Limited - A combination of value and growth

by , 22 September 2017
The company watch list: AVI Limited - A combination of value and growth
AVI is a South African based company, listed on the JSE in the Food Products sector, and is centered on the FMCG market.

AVI's extensive brand portfolio includes more than 50 brands. The Group comprises of trading subsidiaries that manufacture, process, market & distribute branded consumer products.

AVI brands span across a range of categories including: hot beverages, sweet and savory biscuits and snacks, frozen convenience foods, out-of-home ranges, personal care products, cosmetics, shoes, accessories, and fashion apparel.

AVI offers investors a combination of value and growth

Investors love this counter because it offers a great combination of value and growth. It has been a consistent performer with double digit growth coupled with special dividends and increased payout ratio to 80%.
The last set of results confirmed the consistently impressive results that AVI has strung together for more than a decade. The group’s brands and hard assets remain well-invested for solid growth into the future.
The rating is stretched, but the stock is likely to remain well supported by a generous dividend policy, resilient operational performance and reassuringly positive news flow.

The broker's investment case for AVI

  • AVI boasts both an exceptional brand portfolio, which has been able to withstand difficult trading environments and a management team that invests capital with unusual acuity. Having market-leading brands is significant for two reasons: pricing power and economies of scale in both product and distribution.

    This competitive advantage directly translates into higher margins and better returns. This is great for shareholder value creation over time, even though valuations look demanding, I believe the premium rating should be sustained going into 2017.
  • Experienced management teams - AVI’s management continues to invest in efficiency enhancing processes and is able to increase prices without losing customers. This speaks to the skill of management. The management team has delivered ROEs of 34% currently versus 26% five years ago. They’ve produced consistent real earnings growth, managing 14% average earnings growth over last five years.
  • An expectation of a deal? - I remain confident AVI is well positioned to compete in the current difficult trading environment. Management reiterated that they will continue to pursue growth opportunities from the current brand portfolio, prudently manage fixed and variable costs and recognising the challenging environment, be alert for appropriate acquisition opportunities both domestically and regionally.
  • AVI should be able to achieve double digit organic earnings growth, but much of this will rely on the group’s ability to pass through price increases to consumers based on brand loyalty which has been one of their key strengths historically.
  • Improving ZAR outlook – with the end of double deficit in sight I believe there might be further  upside for the ZAR. It’s is traditionally at its strongest when South Africa has fiscal and current account surpluses.
The stronger rand will help reduce input cost for AVI sourced merchandise in Europe. The group has hedged programmes to provide protection for short term rand weaknesses. However, should there be a combination of events that result into prolonged rand weakness cost inputs could increase. The I & J exports should help to offset the negative forex translations. 

AVI's relative valuation

Exhibit 1. Food producers relative valuation multiples

AVI demonstrates compelling financial metrics and deservedly premium valuation versus peers. This is a consequence of the groups continued focus on the appropriate balance of prices, volumes and margins across the business.
AVI is a high quality company with attractive operating margins, a consistently good ROE, healthy dividend yield and healthy cash generation versus industry peers.
I appreciate the rating on AVI looks lofty, but I believe the ability to protect its margins across products is a big driver to a stronger share price performance in the next 12 months.

What are the risks with buying AVI stock?

  • Difficult consumer environment – without a doubt the consumer is constrained but I have observed that the MPC prefers to move towards neutral levels, which reduces the likelihood of further hikes, this may provide some cushion to consumer discretionary incomes.
  • Drought conditions across SA`s agricultural land – La Nina may be playing out, but the recent rains should alleviate some of the pressure on soft commodity prices as expectations of recovery increase. This is a major swing factor into the cyclical food producers.
  • Muted domestic economy - the mix of growth in 2017 is potentially a lot less beneficial to South Africa in that we are expecting stronger US growth (and higher Fed funds) and a less benign outlook from China. 
I’m bullish on this food producer in the current environment
I remain bullish on this food producer as input cost contract and margins expand, although we appreciate that this positive dynamic is increasingly priced into the market.
The group will remain cost conscious and continue to evaluate opportunities within the current portfolio and through acquisitions. I believe the group is well positioned to compete and excel in the current depressed conditions.
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The company watch list: AVI Limited - A combination of value and growth
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