Chantal Marx
Rainbow Chicken - Listing on the JSE
Rainbow began as Rainbow Poultry Farms in 1960. In 2013, it acquired Foodcorp, one of South Africa's (SA) largest food producers - the company name then changed from Rainbow Chicken Limited to RCL Foods Limited, and in 2023, the re-transition of Rainbow to a standalone business was announced.
Rainbow is a fully-integrated poultry and animal feed producer, with operations across the entire chicken production value chain. Rainbow's fully-integrated business model incorporates all stages of chicken production, with Rainbow controlling and operating 165 farms, 1 288 houses, eight hatcheries, three primary processing plants, two further processing plants dedicated to added-value chicken products, six animal feed mills, and a 50% shareholding in a joint venture (Matzonox) which operates two waste-to- value plants.
Groceries (21% of RCL Revenue ex-Rainbow): The Groceries division includes many well-known consumer brands such as Yum Yum peanut butter, Nola mayonnaise, Number 1 Mageu, and Ouma rusks as well as a pet food offering spanning brands such as Canine Cuisine, Feline Cuisine, Bobtail and Catmor. Its brands generally have strong market shares in their respective categories. The division was heavily impacted by load-shedding (in terms of getting product to market) in FY23 and 1H24 (to end December), but several intervention strategies have now made the supply chain more resilient. In the last financial year, another major issue for this business has been to balance price increases (necessary to counter high raw material input costs) with volumes as consumer have been under financial strain.
Rainbow is structured into three reporting segments:
Operating landscape
As a leading producer, Rainbow plays a major role in the national supply of chicken. Key to its long-term sustainability and competitive positioning, chicken sales are balanced across two main channels namely, retail and wholesale, and food solutions. Through its Chicken division, Rainbow sells its products to and has strong relationships with most major retail and wholesale food and consumer packaged goods businesses across SA, including Shoprite, Checkers, Woolworths, Spar and Pick n Pay. Within the food solutions channel, the Rainbow Group offers a range of products for either in-store preparation or delivery of the final product in a form ready for immediate consumption. The products are versatile and can be tailored to meet specific customer needs, or customers can opt for an existing branded product range.
The group's strong positioning within the food service industry complements its retail and wholesale exposure through a significant volume of contractual supply and diversification of the overall revenue and margin mix, and allowing it to partner with key customers, meeting their product requirements as they expand their own national footprints. In respect of food solutions, Rainbow has a substantial and diversified customer base within the quick service restaurant segment in SA, where it is a leading supplier to popular franchises such as KFC, Chicken Licken, Nando's, Burger King, Pedros, Spur, Galito's and Hungry Lion, among others.
An egg-cellent opportunity?
The rationale for the listing and unbundling followed on from an extensive and detailed two-year analysis and review by the board of directors of RCL Foods. This was conducted in parallel with RCL Foods monitoring Rainbow's improving performance, in line with its overarching strategy of being a sustainable, market-leading, low-cost poultry producer. Rainbow has made meaningful strides in delivering on its strategy to restore through-the-cycle profitability through an appropriately structured and sustainable operational base. Given the traction displayed by Rainbow in this regard, particularly in relation to the successful implementation of a change of its chicken breed (a significant change to the genetics of its breeding stock), which was completed in the current financial year, and improved operational resilience, RCL is now confident in Rainbow's ability to operate on a standalone basis.
We believe that the unbundling of Rainbow will certainly reduce some of the earnings variability for RCL Foods, particularly in the context of input cost volatility and disease outbreaks and the associated costs. Rainbow has had its fair share of challenges and we agree that the business did not quite fit the rest of the RCL portfolio. Equally, RCL Foods shareholders will be afforded an enhanced ability to manage their preferred investment exposures to Rainbow and RCL Foods, respectively.
Fight or flight - Sector considerations
The South African Poultry Industry
The local poultry sector has been under immense strain for several years with a severe drought starting in 2015, which was followed by Highly Pathogenic Avian Influenza (HPAI) outbreaks in 2017 and 2021. The most recent outbreak of HPAI in 2023 severely impacted operations and the financial performance. These challenges were further exacerbated by elevated soft commodity prices between 2021 and 2023, and the impact of load-shedding.
Feed prices reached record highs in 2022 as raw material input costs soared, driven by inflated global prices for maize and soya beans on the back of droughts, the war in Ukraine and a weaker rand. Notably, there has been some recent relief on feed prices, although there is still a long way to go to comfortably restore poultry producer profitability.
Locally, demand for poultry meat has steadily increased since 2008, but the growing presence of cheap imports remains is a risk. This means that local production has not satisfied increased demand. As such, the combination of lower-priced imported and strained consumer disposable income has prohibited local producers from growing margins through price power.
In 2019 a Poultry Master Plan was signed by industry players and regulators, which was designed to promote the development and transformation of the industry. There has been some progress, with the implementation of anti-dumping duties being implemented to prevent predatory trade and illegal imports.
Listed competitors
The poultry value chain is concentrated at every level, and vertical integration typically means that the same large companies dominate at each level. According to a Poultry Market Inquiry report by the Competition Commission, the four largest chicken producers - Astral, RCL, Country Bird, and Sovereign - account for nearly 63% of South Africa's chicken production. Large players similarly dominate egg production with three firms (Quantum Foods, Sovereign Foods, Kuipers) supplying 51% of the market. Most eggs (~75%) end up in the formal sector through major retailers and the hospitality sector. In the Feed market in 2020, there were 30 feed companies where 75% of feed production was produced by three companies that are owned by the vertically-integrated companies - Meadow Feeds (part of Astral), Epol (part of RCL Foods) and Afgri. Another prominent feed manufacturer is Nova, which is part of Quantum Foods. Independent millers make up approximately 25% of the industry. Two companies, RCL and Astral, dominate the broiler production and supply market and have enjoyed a joint market share above 35% since 2015.
We consider Astral Foods to be Rainbow's closest competitor, with the company's main activities consisting of animal feed pre-mixes, manufacturing of animal feeds, broiler genetics, production and sale of day-old chicks and hatching eggs, integrated breeder and broiler production operations, abattoirs, and the sale and distribution of various key poultry brands. Quantum Foods operates on a smaller scale, with a focus leaning towards the egg market, therefore, we think that Astral Foods makes for a better peer comparison. Some of the brands housed by Astral Foods include Goldi, County Fair, Festive, and Mountain Valley.
Financial Performance
Revenue has grown strongly in FY22 (+10.1%) and FY23 (+18.3%) but profitability has been under pressure as input cost volatility combined with a pressured consumer has resulted in margins coming under strain. The EBITDA margin was 3% in FY22 and 0.3% in FY23. In the first half of FY24, the EBITDA margin was 3.7%.
Rainbow is structured into three reporting segments:
Outlook
Rainbow management is targeting revenue growth between 8% and 10% through its 2025 financial year. And 6% to 7% thereafter. The near-term uplift is a function of recovering macroeconomic fundamentals to drive volumes and higher pricing. A minimum sustainable EBITDA margin of 6.0% is targeted as the company continues to drive an improved farming performance, soft commodity prices normalise, and the full benefit of the new chicken breed takes effect.
Capital expenditure is expected to be elevated near term but will taper off to ~2% of revenue thereafter. The company does not expect to raise long-term debt medium term. The board will declare dividends on a discretionary basis for the time being and will revisit a more formal policy in due course.
Investment Case Summary
Risks
Valuation
