September 13, 2011

BUY
Price at Sept 13, 2011 Price Target 52-Week Range $9.00 $10.50 $2.50 – $9.55

Lasco Manufacturing Limited
Strong revenue growth, improved margins & tax break
Mario Ahjahorie Financial Analyst mahjahorie@scotiadbg.com

Company Overview Lasco Manufacturing (LASM) is a company which was formed over a year ago and is the product of two long standing subsidiaries Lasco Food Proccessor’s Limited and Lasco Food’s Limited which together produce Soy and Milk based products. The amalgamation of the entities was in anticipation of their initial public offering and their combined product lines include: 1. 2. 3. 4. 5. 6. Lasco Whole Milk Lasco Readi Milk Lasco Food Drink Lasco Lasoy Lactose Free Lasco Oats Porridge Lasco Milky Soy
Key Metrics
Gross Margin Operating Margin Net Margin Debt-to-Equity Current Ratio ROE ROA Book Value EPS (Last 4Q) Trailing PE PBV
Q1 2010 Q1 2011

29% 19% 12% 0% 95% 8% 29% $0.86 $0.73 8.48X N/A

31% 19% 19% 0% 62% 18% 31% $2.54 $1.22 7.37X 3.55X

Company’s Board and Management The company’s board and management have both its strengths and weaknesses. Amongst the good are the qualifications and experience of the board and management in the sector they operate. The allegiance (marriage) between the Chairman (Lascelles Chin) and Managing Director (Dr. Eileen Chin) are key weaknesses of the board and management structure. Potentially the board could make strategic decisions in favour of management instead of all shareholders. Additionally, the presence of 2 out of 5 non-independent directors is unfavourable as it fails to include a mechanism which is protective of the rights of minority shareholders. Business Model and Strategy The company attempts to deliver low cost products to suit the needs primarily of the Jamaican market. The company imports the raw materials, add flavours and packages them for distribution at retail and wholesale chains. Margins are moderately positioned as the company tries to keep product costs low for its consumers.

Figure 1: Lasco Manufacturing Timeline
1988 Lasco Group founded May 2010 Renamed to Lasco Man. Oct 2010 Listed on the JSE

1994 Incorporation of Lasco Foods

Sep 2010 Initial Public Offering

Figure 2: Shareholder Breakdown Shareholder Hon. Lascelles A. Chin, O.J. Wayne Chin Connected Parties* Public Investors*
* - Based on Sep 2010 prospectus

% Stake

80% 0.4% 8% 12%

Figure 3: Board of Directors
The Hon. Lascelles A. Chin, O.J. Chairman Dr. Eileen Chin Anthony Chang Lester Spaulding Prof. Rosalea Hamilton

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Business Environment Lasco Manufacturing is a Distributor Lasco Manufacturing interestingly is a misnomer for a company which is primarily considered a distributor, according to data collated from the Statistical Institute of Jamaica (STATIN). The Retail & Wholesale Industry, which LASM is a part of, is one of the largest contributors to the economy, however, it contracted for all quarters in 2010 and in the first quarter of 2011. Commendably, Lasco has been able to operate counter to this trend growing revenues an impressive 15% for 2011. Similar to all manufacturing companies in Jamaica, Lasco faces the risks of fluctuations in raw material costs and the impact of escalation in inflation and the exchange rate on operating costs. Historically, the exchange rate has exhibited a significant amount of volatility but has settled in recent times around the $86 mark, assisted by the IMF standby agreement. Similarly, the inflation rate has abated compared to previous periods and is targeted at single digit in 2011. The relatively benign inflation outlook coupled with a weak labor market should enable the company to control its operating expenses for the foreseeable future. High Electricity Costs – Not a Problem Unlike other manufacturing entities, an examination of Lasco’s financial data shows that high electricity cost is not a major problem for Lasco. This might be due to the fact that LASM is not involved in extensive manufacturing as alluded to above. The company’s production process results in utility costs (including electricity) accounting for a mere 5% of operating expenses. Economy weak, Lasco strong Producing for local consumption is challenging given the weak economic background. The economy eked out a growth rate of 1.5% for Q1 March 2011, after 3 years of contraction. It means consumers’ spending power is still lukewarm as the growth rate was not enough to make a meaningful dent on the unemployment rate. Fortunately for Lasco, their products are positioned at the lower end of the spectrum, which allowed them to benefit from a shift in consumer spending habits. On the flip side, a recovery in the economy could see consumers shifting away from Lasco products. To combat this, the company will have to ensure their products are not branded only as low cost alternatives but also as high quality products when consumers regain their
Figure 4: GDP Economy vs GDP Distribution
1.0% 0.0% Mar-08 -1.0% -2.0% -3.0% -4.0% Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11

Distribution GDP lagging Overall GDP rebound

GDP - Economy

GDP - Distribution

Figure 5: Inflation - Reducing
30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Inflation rate has abated and stabilized, allowing companies like Lasco to better control operating costs

Figure 6: Exchange Rate - Stabilizing
100 95 90 85 80 75 70 65
01-Apr-08 01-Oct-08 01-Apr-09 01-Oct-09 01-Apr-10 01-Oct-10

Jamaican Dollar exhibiting stability since 2009. Lasco therefore benefits from stable raw material costs.

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spending ability. Industry Specific Factors or Trends Major Competitors Lasco Manufacturing’s main Competitors in the food drink and powder milk industry are: 1. Gracekennedy 2. Nestle 3. Seprod And while the company's products have a presence in 18 countries outside Jamaica, its international sales account for a minor nine per cent of revenues.1 According to the company, they have an estimated market share of 73% in fortified drinks which comprise Lasco food drink and Lasoy. While for whole milk powder, the company estimated an 85% market share and 29% of the infant formula market. Oligopolistic Industry Two common measures of industry competitiveness are the Herfindahl-Hirschman Index (HHI) and the Four Firm Concentration Ratio. Based on data gathered, the HHI exceeds 5,329 which is extremely high and indicates an industry which is not very competitive. Similarly, the four firm concentration ratio which measures the market share of the top four firms exceeds 70%. This reading (above 60%) confirms an oligopolistic industry, which is dominated by Lasco. Industry Profit Margins – LASM ranks 3rd Lasco currently has the third most attractive net profit margin of all the manufacturing and distribution companies identified on the JSE, which include those listed on the junior and main market. Although the company primarily markets low priced products, they are still able to generate strong margins compared to its peers.
Figure 7: Foritified Drinks
SEP, GK, Nestle & Other 27%

Lasco Man. 73%

Figure 8: Whole Milk Powder
SEP, GK, Nestle &… LASM 85%

Figure 9: Infant Formula
LASM 29% SEP, GK, Nestle & Other 71%

Figure 10: Industry Margins
30% 20% 10% 0% JAMT GK JP CAR LASM SALF -10% -20% BPOW -3% CCC -20% SEP JBG LAS CPJ DG 26% 19% 14% 13% 12% 8% 7% 5% 5% 4% 2%

1

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Figure 11a: Porter’s Model – Five Industry Forces Competitive Force Risk Rationale
Threat of New Entrants High Lasco has economies of scale, brand loyalty and a dominant market position. However, with no major impediments to entering the market, there is a high risk of potential entrants. Already there are formidable competitors such as Seprod, GraceKennedy and Nestle. The company sources its raw materials (powdered milk) outside of Jamaica and their supplier(s) operate in a competitive market. The Herfindahl–Hirschman Index (HHI) and Four Firm concentration ratio would therefore be very low for the suppliers. Buyers are not concentrated as the target market is mostly retail. Therefore, measures such as the four firm concentration and the Herfindahl–Hirschman Index (HHI) would be low for customers. Again, there a number of substitutes on the market but none which are able to compete on pricing like Lasco. In fact, Lasco’s products act as substitutes in the infant formula market, in addition to their 29% market share of the infant formula market. Competitors such as GraceKennedy, Seprod & Nestle have not been able to make a significant dent into lasco’s market share of powder milk (73%) and fortified drinks (85%). However, Lasco as a recent entrant in the infant formula market only has 29% market which is still a strong position

Bargaining Power of Suppliers

Low

Bargaining Power of Buyers

Low

Availability of Substitutes

Medium

Rivalry Among Competitors

Medium

Figure 11b: Porter’s Model

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PEST Analysis of Jamaica Figure 12
Political  Complex taxation regime  Legislation only enables one power company  Lack of unity across Caricom  Slow implementation of government policies  High crime rate Social-Cultural  Consumer brand preferences  Inefficient workforce  Employee theft Technological  Dated production processes  Archaic distribution arrangement Economic  Weak local conditions  Tepid global growth  High electricity costs  High cost of capital

SWOT Analysis of Lasco Manufacturing Figure 13
STRENGTHS  Dominate the powdered milk market  Well recognized brand locally  Company is more distribution oriented, a positive considering high manufacturing costs in Jamaica OPPORTUNITIES  Tax break from listing on the JSE for the next 10 years  Stronger profit growth to fund retooling and business expansion WEAKNESSES  Products have a stigma of being low end  Concentration in one product type (powdered milk)  Low regional diversification, revenues concentrated in Jamaica  Alliance between Chairman and Managing Director THREATS  Though Lasco benefits from weak demand, continued weakness in the Jamaican economy could impact them.

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Financial Statement Analysis – June 2011 (See Appendix 1) Financial Performance – Very profitable Quarter Lasco’s first quarter ended June saw the company increase Revenues 24% to $784 million. This was achieved amidst a weak economic environment which saw the company’s low cost products reaping gains combined with greater visibility from the JSE Listing. The company’s Gross Profit surged 33% to $247 million as the company expanded its Gross margin ratio from 29% to 31% combined with revenue growth. Operating Expenses climbed 44% in the quarter to $102 million and was driven by plant expansion and the restructuring of the company. The effective taxation rate was 0% as the company has benefitted for the quarter from the tax break enjoyed from listing on the JSE Junior Market. Net profit rocketed 92% to $151 million for the quarter due to the combined effect of: a 15% growth in Revenues, 3% expansion in gross margins and a tax break. Balance Sheet Strength – Very Liquid The company’s total assets stood at $1.01 billion based on an equity base of $861 million. The equity base expanded 86% through raising ordinary share capital in addition to the full year retained earnings. (See Figure 15) The company’s long-term-debt to equity ratio stands at 0% after paying off its debts but is likely to surge in coming quarters as the company seeks to borrow J$1.12 billion for relocation, modernization and expansion. The company also maintained very healthy Liquidity ratios for the quarter. The current ratio stood at 5.6 times versus 2.0 times a year earlier. Closer inspection to identify if inventories were skewing the ratio, showed an equally strong Acid Test Ratio of 4.1X which was well above the prior year’s 1.6X.

Figure 14: Income Statement Highlights Income Statement June 2010 June 2011 Revenues Gross Profit Operating Expenses Net profit 634,715 185,565 70,958 78,802 784,554 246,916 102,295 150,987

% Change 24% 33% 44% 92%

Figure 15:Balance Sheet Highlights J$‘000 June 2010 June 2011 Total Assets Current Assets Inventories Cash & Equivalents Equity 935,367 935,367 188,517 272,427 330,964 1,009,924 829,492 219,493 150,274 981,233

% Change 8% -11% 16% -45% 196%

Figure 16:Key Ratios J$‘000 June 2010 Gross Margin Net Margin Current Ratio ROE 29% 12% 2.0 1.6

June 2011 31% 19% 5.6 4.1

% Change 8% 55% 180% 158%

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DuPont Analysis (ROE Decomposition) With one year of comparative data, we are able to estimate that Lasco’s improved ROE was driven by an improvement in net profit margins - which follows from the improved gross margins discussed earlier. Financial leverage declined as the company cleared its loans and the corresponding reduction in interest expenses assisted in the improvement of Net Profit Margin. Industry ROE Comparison – Lasco is 2nd best Compared to other manufacturing companies in Figure 18, only one other company (CPJ) has a better ROE and earnings growth rate than most companies over the last 5 years. A very high ROE and growth rate makes us undoubtedly have to classify Lasco as growth company. Cash Conversion Cycle Although the company’s balance sheet suggests that the company has very good liquidity, it is also important to measure the amount of working capital tied up in receivables, inventory and payables. Figure 19 shows that Days of Inventory, receivables conversion and payables conversion all increased over the period. This suggests the company extended its credit terms to customers, expanded its inventory base and lengthened the time it took to pay trade creditors. As a result, the rate of conversion of working capital to cash increased significantly from 16 days to 111 days. This is actually an unfavourable trend as it means the company is taking longer to convert its working capital to cash. In addition the trend is unsustainable and we expect a flat to reduced cycle next year.

Figure 17: ROE – Dupont Analysis
ROE – Dupont Analysis Asset Turnover xFinancial Leverage xNet Profit Margin =ROE YE 2010 YE 2011

2.29 2.87 6% 37%

2.22 1.61 14% 48%

Figure 18: ROE Comparison
70% 60% CPJ

ROE (Current)

50% 40% 30% JAMT DG GK 20% 10% JP 0% SEP JBG LAScelles

LASM

BPOW SALF

-40%

-20%

-10% 0%

20%

40%

60%

5 Year Growth Rate *

Figure 19 :Cash Conversion Cycle
Cash Conversion Cycle Days of Inventory Days of Receivables Days of Payables Cash Conversion Cycle YE 2010 YE 2011

45 31 60 16

54 87 31 111

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Projections & Valuations Dividend Policy The company has been listed on the exchange for less than a year and therefore has no record of dividend payments. However, in LASM’s prospectus, management has indicated a commitment to paying out no less than 15% of earnings, subject to the company’s need for reinvestment. For their first financial year ended March 2011, the company paid dividends of $0.15 which equated to 14% of earnings, marginally below the company’s target payout rate. Based on the current price, this equates to a dividend yield of 2.4%. Profit Projections For the year ending March 2012 we expect Lasco manufacturing to generate revenues of $3.56 billion with gross margins at 31%. Additionally, the company will pay zero taxation and net profit should amount to $552 million (EPS:$1.43) or 37% above the prior year. Based on the dividend policy highlighted above we expect a dividend per share $0.21. Intrinsic & Relative Valuation Based on the company’s stated dividend policy and adherence to date, it is appropriate to utilize a dividend discount model (DDM) to value the company. In this case we use a two stage model for an initial growth phase which is expected to last 10 years and stabilize thereafter. Based on the company’s expansion plans, we expect profit growth of approximately 25% for the next 10 years which should taper off to 10% thereafter. The intrinsic valuation therefore emerges at $10.50 using the DDM. Additionally, based on trailing earnings, the company’s PE is much lower than most market participants as illustrated in Figure 22. From the chart, the stock is below the PE line which suggests the stock has been undervalued by the stock market.
Figure 20: One year profit projection Mar Mar 2010 2011 Revenue 2,587,621 2,969,611 Gross Profit Op Expenses Op Profit Finance Cost Pretax Profit Taxation Net Profit 688,335 559,530 197,181 197,181 53,077 144,104 934,501 426,574 555,573 37,701 517,872 116,671 401,201

Projection 2012 3,563,533 1,121,401 477,762 686,519 134,400 552,119 552,119

Figure 21: Dividend Discount Model Dividend Discount Model Cost of Equity (CAPM) First Phase Growth Rate First Phase Growth Period Final Phase growth rate 16.20% 25.00% 10 Years 10.00%

Figure 22: Relative PE Valuations
16.0

OverValued
SALF SEP

12.0 CAR P/E 8.0 GK LAScelles 4.0 CPJ 0% 10% 20% 30% 40% 50% JBG

UnderValued LASM

0.0

5 Yr Growth Rate (%) Source: proprietary research

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Market Activity & Technical Analysis Volumes Traded – Strong Investor Interest In Figure 21 to the right, the orange bars confirm consistent level of trading activity and by extension investor interest. Peak volumes were reached in November 2010, shortly after the stock became listed. The stock traded 190 days out of a possible 218 days with an average daily volume of 167 thousand units. The stock therefore has strong liquidity and investor interest. Share Price - Soaring Since listing the share price has appreciated 251% from an IPO price of $2.50 to a recent closing price of $8.79. The stock appreciation is correlated with strong earnings throughout the period and a generally euphoric reception to junior market listings to date. Bid/Ask Analysis - Bullish In Figure 22, share liquidity is confirmed by a tight bid/ask spread of $8.60/$8.80. Currently, the stock is also heavily demanded based on the structure of the bids and asks. The most significant volumes are bid at $8.35 with a volume of 576 thousand units. On the other hand, the lowest significant Ask is for 60 thousand units at $10. Significantly stronger bid volumes suggest that the price will appreciate as bidders increase their bids to acquire LASM shares. Simple Moving Averages (SMA) - Bullish The simple moving averages (Figure 21) indicate a fairly bullish trend on the stock. A strong bullish signal arose when the 20 day SMA broke above the SMA 5o and SMA 100 in April 2011. Since then the market price has surged from $6 to a peak of $9. Confidence in this trend is also asserted by stable and consistent trading volumes. Fibonacci Retracements – Trading above support Fibonacci retracements (Figure 23) are one of the most widely used technical indicators and are used to identify resistance and support levels of a security. Lasco has rallied since inception to a high of $9.50 and has pulled back since hitting its peak. The first support level is found at $7.94 or at the 76.4% Fibonacci line which corresponds to a previous peak. The next support level which is considered a major support one is found at the 61.8% of the peak to trough, which is at $6.97. Notable, the stock also found support around $6.97 after a pullback from a $7.95 peak.
Figure 23: LASMPrice, Volume & SMA’s
10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 Oct-2010
ClosePrice

7 6 Volume 5 4 3 2 1 0 Jan-2011
SMA 20

Apr-2011
SMA 50

Jul-2011
SMA 100

Figure 24: Bid-Ask Analysis (August 31, 2011) Bid Ask Volume 11,600 15,666 576,054 30,000 700 Price ($) 8.60 8.40 8.35 8.30 8.12 Source:Bloomberg Price ($) 8.80 9.00 10.00 12.00 Volume 1,503 2,250 60,281 4,850

Figure 25: Fibonnaci Retracement of LASM
10.00
100% ($9.50)

9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 Oct-2010 Jan-2011 Apr-2011

$8.790 76.4% ($7.94) 61.8% ($6.97) 50.0% ($6.19) 38.2% ($5.40) 23.6% ($4.43)

0.0% ($2.87)

Jul-2011

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Conclusion & Recommendation Economy Weak but Lasco Benefits Lasco Manufacturing Limited is the largest producer of fortified drinks and powdered milk in Jamaica. Even though the company exports to other regions, its revenue generation is concentrated in Jamaica. Interestingly the Jamaican economy has been undergoing a severe contraction since 2007 and the implication is that consumers spending ability would have been hampered. However, throughout the downturn, the company has managed to significantly increase revenues and we attribute this to fact that the company’s low priced products are able to capitalize on a shift on consumer spending habits. Dominate the Sector Lasco dominate the Sector with their fortified drinks and powdered milk which account 73% and 85% of the market respectively. Notably, these products act as substitutes for infant formula in Jamaica but Lasco has its own brand of infant formula which claims 29% of that market. It highlights the dominant position the company enjoys, and the key seems to be that the company identifies that they are operating in a weak economy and therefore try to offer low cost products. Operating Very Profitably Although the company offers low priced products, they still enjoy reasonable margins. Gross margins were 31% as at March 2011 while net margins were 14%. This actually puts Lasco amongst the top three manufacturing and distribution companies in Jamaica based on these profitability measures. The companies ROE and growth rate are also amongst the highest of all the listed companies in Jamaica and highlights the company’s strong profitability. Aggressive Expansion Plans The company’s first expansion plan was to become listed on the JSE Junior market to expand its visibility and to take advantage of a 10 year tax break from listing. In the next few quarters, the company has disclosed an ambitious $1.12 billion plan to relocate, modernize and expand its plant in White Marl, St. Catherine. The move is expected to increase production capacity, operational efficiency and allow the company to broaden its product portfolio. The company’s expected payback period is 4 years and we expect these activities to be key drivers of profitability going forward. Valuation and Technicals favourable The expected dividend yield based on the current price and next year’s earnings is 2.4%. The intrinsic valuation based on this growing stream of dividends is $10.50 or a potential capital appreciation of 21%. An examination of technical indicators such as the Simple Moving Averages, Volumes traded, Bid-Ask spreads and Fibonacci retracements all suggest a very bullish trend which is strongly supported technically. With the expected capital appreciation of 21% and a consistent dividend stream, Lasco Manufacturing is recommended as a BUY.
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Appendix 1
$'000 Income Statement Revenue Cost of Sales Gross Profit Other Income Operating Expenses Profit from Operations Finance Cost Profit Before Taxation Taxation Net Profit 2,587,621 1,899,286 688,335 68,376 559,530 197,181 197,181 53,077 144,104 2,969,611 2,035,110 934,501 47,646 426,574 555,573 37,701 517,872 116,671 401,201 634,715 449,150 185,565 6,949 70,958 121,556 5,354 116,202 37,400 78,802 784,554 537,638 246,916 6,710 102,295 151,331 344 150,987 150,987 3,563,533 2,442,132 1,121,401 42,881 477,762 686,519 134,400 552,119 552,119 YE March 2010 YE March 2011 Q1 June 2010 Q1 June 2011 YE March 2012 Projection

Balance Sheet
Property, Plant & Equipment Current Assets Total Assets Current Liabilities Non-Current Liabilities Long Term Debt Equity 142,273 988,866 1,131,139 458144 278,346 262,760 394,649 192,055 1,145,493 1,337,548 463,939 31,598 830,246 935,367 935,367 471,440 262,791 247,205 330,964 180,432 829,492 1,009,924 149,244 31,598 981,233

Ratios
Gross Margin Operating Margin Net Margin LTD-to-Equity Financial Leverage ROE ROA DPR Current Ratio Acid Test Ratio Per Share Data Earnings Per Share Book Value Per Share Revenue Per Share Dividends Per Share 1.04 2.15 7.7 0.15 0.20 0.86 1.6 0.39 2.54 2.0 27% 8% 6% 67% 2.51 37% 15% 2.2 1.8 31% 19% 14% 0% 1.38 48% 35% 0.14 3.0 1.9 2.0 1.6 5.6 4.1 29% 19% 12% 0% 2.83 95% 8% 31% 19% 19% 0% 0.85 62% 18% 31% 19% 15%

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