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E QUITY R ESEARCH

OMPANY R EPORT

  ...w e’ll see if it can get comfortable.

  JMT is the second largest Portuguese food retail company and the third largest by Market Cap listed on PSI 20. It operates in Portugal through its main insignias: Pingo Doce (supermarket) and Recheio (leader in Cash&Carry services). It also operates in Poland with more than 2000 hard discount stores (Biedronka) which ensure 60% of its net income. The company announced the start of operations in Colombia for the 1 st quarter of 2013.

  Company description

  0.70 ROIC 21.9% 21.5% 22.7% Capex (€mn) 449 701 568 Source: Nova ER Team Source:

  0.63

  0.54

  2011 2012E 2013F Revenues 9,838 10.891 12.403 EBITDA 722 808 911 EBITDA margin (%) 7.33% 7.42% 7.34% Net profit 342 400 440 EPS

  Source: Bloomberg Source: Bloomberg (Values in € millions)

  11.26-16.07 Market Cap (€m) 9.426.8B Outstanding Shares (m) 628.4

  14.98 Reuters: JMT.LS, Bloomberg: JMT.PL 52- week range (€)

  14.51 Price (as of 7-Jan-13)

  17.50 Vs Previous Price Target

  Recommendation: BUY Vs Previous Recommendation HOLD Price Target FY13:

  THIS REPORT WAS PREPARED BY M ADALENA F ELÍCIO , A M ASTERS IN F

  INANCE STUDENT OF THE N OVA S CHOOL OF B USINESS AND E CONOMICS ,

  ANUARY

  7 J

  F OOD R ETAIL

  J ERÓNIMO M ARTINS

, SGPS C

   Portugal: As Portuguese fight against their decreasing buying power, JM fights to keep its prices competitive by absorbing the increasing costs as these remain the key factor in the buying decision. We estimate a 2.7% CAGR of sales for the next 3 years for this sector but a general decrease in EBITDA margins.

   Poland: Polish economy remains strong despite European economic outlook. Biedronka keeps presenting strong results (we expect 16%/19% sales growth in euro/zlotys for 2012) as it is the leading insignia in this county and according to our estimates will debit a two digit CAGR for the next eight years of 13%. It will remain the main focus of investment of JM.

   Colombia: A country with 46 million inhabitants, high birth rate, fragmented retail market and a positive economic outlook (average GDP growth of 4.4% until 2016). Ingredients that lead us to believe the EUR 400mn initial investment will generate a good opportunity.

   Portuguese economical conditions will continue pressuring consumption and the company margins. JM priority is to maintain price competitiveness increasing its market share in every segment. We anticipate a 10bp decrease in EBITDA margin for the year and a 13bp reduction for 2013.

  and an EPS increase of 17% from the 0.54 reported in 2011 to 0.63 this year. Despite this recommendation, we were conservative concerning the new operation as we wait for the company to unveil more details.

  BUY. We estimate a growth potential for the target price of c.15%

   We anticipate an 8.5% CAGR for sales and 8.9% for EBITDA for the next 8 years having changed our recommendation from hold to

  NDRÉ WHO REVIEWED THE

  OSÁRIO A

  . T HIS REPORT WAS SUPERVISED BY R

  2013 S TUDENT : M ADALENA F ELÍCIO mst16000401@novasbe.pt Jerónimo gets new home...

  Table of Contents

Company Overview........................................................................................3

  Company Description ...................................................................................3 Performance Analysis ..................................................................................4 Sales and EBITDA ...............................................................................4 Investment .........................................................................................4 Market Performance .............................................................................5

  Shareholder Structure .................................................................................6

Portugal..........................................................................................................7

  Macroeconomic Analysis .............................................................................7 Portuguese Retail Market ............................................................................8 Overall Market ..................................................................................8 The Retail Market ..............................................................................9

  

Poland...........................................................................................................11

Macroeconomic Analysis ............................................................................11 Polish Retail Market ...................................................................................12

  

Colombia.......................................................................................................13

Macroeconomics Analysis ...........................................................................13 Colombian Retail Market .............................................................................14

  

Operational Forecasts..................................................................................15

Portugal ...................................................................................................15

  Pingo Doce ......................................................................................15 Recheio (Cash&Carry) .......................................................................16 Madeira ...........................................................................................18 Industry and Services ..........................................................................19

  Biedronka .........................................................................................20 Colombia ..........................................................................................22 Capex and Working Capital .........................................................................23

  

Valuation........................................................................................................25

Cost of Equity ............................................................................................26 Cost of Debt ..............................................................................................27 Comparables .............................................................................................30

  

Internationalization Problems......................................................................31

The Strategy ..........................................................................................31 What Went Wrong ..................................................................................32

  In Case Something Goes Wrong ...............................................................33

Financials......................................................................................................35

Financial Statements....................................................................................36

  Appendix .............................................................................................36

Disclosures and Disclamer..........................................................................37

Company overview

  Company description

  Jerónimo Martins is the second largest food retail company operating in Portugal

  owning an increasing 18.9% market share against the 25.4% of the market leader Sonae with the Continent supermarkets (see Exhibit 1) . The Group’s business is directed to three distinct areas: food distribution, manufacturing and services. With its Pingo Doce (supermarkets) and Recheio (Cash&Carry) insignias operates in the retail and wholesale formats (food distribution), respectively, having a prominent position recognized in both segments. In 1997 expanded to Poland after buying the

  • Exhibit 1: Market Share (2011)

  Source: Nova Equity Research Team supermarkets brand Biedronka, which is now one of the strongest food retail chains in the country operating under the hard discount format. The Polish brand is leader in the segment having a clear advantage over its competitors both in number of stores

  Exhibit 2: Sales (2011)

  (counting already with 2,000 stores) and brand recognition. In 2011 this brand alone represented almost 60% (EUR 5.8 bn

  • – see Exhibit 2) of the total sales of the company as well as 70% (EUR 312 mn – see Exhibit 3) of the total investment. In the food industry sector, JMT has a significant presence in Portugal being leader in various markets for fast moving consumer goods, through its holding shares in

  Source: Company Data Unilever Jerónimo Martins and Gallo Worldwide whose brands are leader in oil, margarine, ice creams and detergents markets. The Group’s portfolio also includes a

  Exhibit 3: CAPEX (2011)

  business area related to marketing services, representations and restoration that includes Jerónimo Martins Distribuição de Produtos de Consumo Lda (Distribution of

  Consumer Products - representing international brands in food and cosmetic

  segment), specialized retail chain Hussel (trade and manufacture of chocolates), Caterplus (trade and distribution of food products) and Jerónimo Martins Restauração e Serviços (Restorations Services – Jeronymo Café, Chili’s restaurant

  Source: Company Data and ice cream brands: Ben&Jerry and Olá) Moreover, at the end of 2011, Alexandre Soares dos Santos, the Chairman, announced Colombia as the new expansion geography, since this country meets the desired parameters of having more than 40mn inhabitants, being a democratic and politically stable country as having a good economic outlook, a matter we will develop ahead.

  

Performance analysis

   Sales and EBITDA

  During the first years of 2000 Jerónimo lived a domestic crisis as its business

  Keeps showing signs

  reached EUR 250 mn of negative results. After an internal restructuring it was of sustainability... able to turn around and is currently one of the most successful Portuguese companies with a solid growth structure. From 2008 until 2011 the sales grew

  Exhibit 4: Sales Breakdown at a CAGR of 12.6% amounting to EUR 9,839mn, while EBITDA also registered a double digit CAGR of 14.9% to EUR 722mn. The Group justified

  these results with its execution ability, particularly in Poland, where it proceeded with an ambitious expansion plan having opened almost 900 stores from 2008 until last year. The Portuguese business is now heads with a tough macroeconomic environment. However it has debited sales CAGR of 7% for the past four years. Source: Company Data

  This country, as mentioned before, is the growth driver of the company and its importance in the results has been increasing rapidly. In 2005 Biedronka contributed with 35% of sales, percentage that, in 2012 is expected to exceed

  Exhibit 5: EBITDA Breakdown 1 60% of the total, hitting EUR 6.5bn (see Exhibit 4), translating it into a CAGR of

  c.8%. On the other hand, the Polish EBITDA, was c.23% (in 2005) having seen its contribution more than tripling, hitting almost 70% in 2012, a total of EUR 2 0.46bn, growing at a CAGR of almost 17% (see Exhibit 5). While this business increases in significance, the Portuguese business, in contrast, has been losing its share. In 2005 the Retail Mainland sales represented c.40% of the total sales

  Source: Company Data (EUR 2,2bn) while its EBITDA slice was almost 50% reaching EUR 148mn (Recheio, Madeira, Industry and Services represented 25% of sales and 30% of EBITDA). Though, the maturity state of the market would eventually limit this growth and in 2012 we do not expect the sales from the Portuguese operations to reach 30% of the total and the EBITDA we estimated to be c.32% (Recheio, Madeira, Industry and Services c.13% of sales and 10% of EBITDA).

  Exhibit 6: Capex Breakdown (2005-11) Investment

   The belief in Biedronka’s potential can be also seen in the total investment the brand obtains (see Exhibit 6). Since 2005 it is observable the increasing amount of investment Jerónimo Martins provides this insignia alone. Until 2007 the main focus of investment was still the Portuguese Retail Mainland which was at that Source: Company Data.

  a) Acquisition of Portuguese and time receiving c.50% (EUR 240mn) of the total while all other business shared Polish Plus stores 1 the remaining amount. However, this tendency has changed and the polish brand 2 From 2005 to 2012

  From 2005 to 2012 has been watching its amount of investment increase (from 2005-2012) at a CAGR of 33%, having received in 2012 EUR c.520mn, c.70% of the total while Pingo Doce only accounted for 24% (EUR c.100mn). As a result, the company

  has been investing in store opening and renewing as a way of increasing proximity with customers while making stores more appealing and easier to

  circulate. Since 2007, after acquiring the Portuguese and Polish stores from Plus chain, JM has been absorbing its Feira Nova insignia converting it into Pingo Doce stores. This way the Group is being able to increase its market share and decrease advertising costs being focused in one insignia alone. In this brand

  The company bets in

  reposition it has bet in some factors to be set apart from the competition: i) high differentiation... bet in advertising the quality of its products, its own brand, ii) increased number of SKU’s in fresh products from national producers (that represent c.40% of purchases) but limited offer of other products (Pingo Doce offers 5,500 SKU’s 3 4 and Biedronka 900) iii) maintained its EDLP policy, as already happened in

  Biedronka.

  Market Performance 

  After receiving in 2011 the prize for best performance between the companies integrated in PSI-20 with an appreciation of 12.2% during the year (in 2010 also

  Exhibit 7: JMT (in blue) and PSI-20 (in pink) Performance in 2012 JM stock price increased c.700% in 10 years...

  Source: Bloomberg

  Exhibit 8: JM Share Price

  had the best performance with an appreciation of 63.2%), JM still presents

  Evolution (2001-12)

  consistent growth signs having grown c.14% during 2012 (see Exhibit 7). This year did not present the best performance as BPI, Mota Engil and Sonae SGPS presented a one year growth of 102%, 57% and 52%, outperforming by far the Portuguese index that revealed a 3% growth. In April the company reached the maximum value of the year (EUR 16.07) as it announced the approval of a

  Source: Bloomberg dividend distribution of 0.275 per share. Since 2001 JM stock has grown at a 3 CAGR of 20% having appreciated 690% for the past 11 years (see Exhibit 8).

  Source: Company Data. Around 2003 JM 4 offered around 12,000 SKU’s in Pingo Doce Every Day Low Prices

  • – pricing strategy that promises customers the lowest prices everyday without them having to resort to coupons or promotions. It is believed it creates customer loyalty.

Shareholder Structure

  

Exhibit 9: Shareholder Jerónimo Martins has four main shareholders in its structure: i) Sociedade

Structure Francisco Manuel dos Santos that currently owns 56.1% of the total being the

  one with the highest percentage of voting rights, ii) Heerema Holding Company Inc. is a Dutch-based multinational that operates in building industrial platforms for oil and gas transportation, that acquired 10% of the shares through

  Asteck,S.A. in 2007, iii) Carmignac Gestion is a French asset management

  company that acquired directly 2.74%, iv) in February 2007 BNP Paribas – the Source: Company Data third largest bank in the world - acquired 2.03% of JM shares through its investment fund, v) the remaining 29% of the company’s capital are floating and

  company own shares (see Exhibit 9).

  Concerning the business structure, the company holds several partnerships in its different segments. The retail mainland unit (Pingo Doce stores in the Continent) is shared with the Dutch retailer Ahold that owns 49%. The Portuguese retailer owns 75.5% of the units in Madeira, which include 13 Pingo Doce and 1 Recheio store, but hols 100% of the Cash&Carry and Biedronka businesses. In the manufacturing segment JM holds Joint Venture with both Gallo Worldwide and Unilever holding 45% of each. In the service division the company holds 100% of Jerónimo Martins Distribution of Consumer Products (JMDPC), while it shares Hussel, which resulted from a Joint Venture, with the German Douglas A.C. controlling 51% of it. This year the Group increased its share in Caterplus buying the remaining 51% to Sugadigal (see Exhibit 10).

  Exhibit 10: Jerónimo Martins Ownership Structure

  Source: Company Data

Portugal

  

Macroeconomic analysis

Exhibit 11: GDP growth 2006-17

  Portugal has been following EU up and down tendencies concerning GDP growth however showing a much lower growth than the average of its countries (see Exhibit

  11). During the year of 2009, Portugal followed EU in its recession period as a

  consequence of the global sovereign debt crisis that was aggravated by internal management measures that led the country to its weak competitive capacity. Since Source: IMF Economic Outlook 2007 that its public debt has been suffering major increases due to the excessive spending of money in public works (see Exhibit 12). In only 5 years it has gone from

  Exhibit 12: Public Debt 2006-12

  63.7% to 119 .1% (expected this year) of the country’s GDP. Furthermore, the Latin country suffered from increasing pressure in financial markets as it watched main 5 rating agencies downgrading its sovereign debt ratings to speculative grade . Hence, as investors perceived Portugal as a riskier country its ability to finance through the markets decreased, increasing its difficulties to comply with its external (e.g. debt

  Source: IMF Economic Outlook and interest payments) and internal obligations (e.g. salaries and pensions). th On April 7 of 2011, after Greece and Ireland, Portugal asked European

  Exhibit 13: Yields on 10y bonds

  Commission for a bailout subsequent to the Government being forced to pay 6 unsustainable interest rates on the market to issue debt (see Exhibit 13). Thus, with the purpose of receiving financial aid, the country is now committed with the European Union to achieve its convergence criteria by correcting the balance of payments and consequently restoring its capacity of issuing debt in the market at

  Source: Bloomberg reasonable rates. As a result it has announced a set of measures that started to be implemented in 2012, will be aggravated in 2013 and some will be extended further

  

Exhibit 14:Unemployment until balance is restored. With the purpose of reducing the deficit to 5% (in 2012) the

2006-17

  Government has imposed a set of heavy measures that were not well accepted by the Portuguese population. On the expenditure side: i) cut on workers’ wages and pensions, ii) cut on expenses of the health sector, iii) cut on number of public employees; on the revenue side: i) change on VAT structure increasing the number of goods and services being charged at the highest rate, ii) increase on direct taxes,

  Source: IMF Economic Outlook iii) reduction of deductions and exemptions, iv) revaluation of all real estate. As a consequence, unemployment rate exceeded 15% this year (see Exhibit 14) and is expected to reach 16% in 2013. At the same time the average disposable income has declined causing a drop in private consumption as well as worsening labour 5 market situation. The country is now committed in enhancing its growth capacity so

  Currently, the main rating agencies

  • – S&P (BB), Moody’s (Ba3) and Fitch (BB+) – see Portugal as a speculative
  • 6 economy and have a negative outlook on its future At the end of 2010 the Portuguese debt surpassed the 7% interest barrier that was established by the Finance Minister as the limit to ask for the European financial aid. that it can become more competitive while reducing its excess public debt. Thus it can restore investors’ confidence plus its investment grade level.

      Exhibit 15: Portuguese

    Portuguese Retail Market

      Problems in Paying Monthly Bills 2009-12 Overall market 

      When compared to the Euro zone big economies like Germany, Spain, France or Italy, Portugal is a small retail market. Its 10.5 million inhabitants have seen its average disposable income decrease due to the contraction of the economy.

      Source: Fundação Francisco With the help of Exhibit 15 we can understand the economic difficulties through

      Manuel dos Santos which the Portuguese are going through. Since 2009 the Portuguese average capability of paying bills has deteriorated with 2011 being the worst year for

      Exhibit 16: Private

      families. However, we expect a worsening difficulty as a consequence of the

      Consumption Expenditure 2005-13

      aggravation of the austerity measures for 2013. In line with this analysis is the evolution of private consumption expenses that we can see in Exhibit 16, for Portugal and the Euro zone countries. From 2010 to 2011 there was a drop in Portuguese family expenses of 3.9% that was aggravated this year falling 6.8%. The average consumption expenses for the Euro area for the same period remained more stable but also suffered a decrease of 0.5%. While it is expected a recovery for the European countries for the next year, Portugal will continue to

      Source: OECD Economic Outlook observe a contraction in familiar private expenses as severe budget measures have been approved by the Government for the next three years.

      Exhibit 17: Net Family Disposable Income 1990;

      It is important to bear in mind that food expenditures are one of the most

      2007- 12 (‘000 €)

      important in the family budget and one of the lasts to be cut on. In Exhibit 17 we observe the evolution of the average familiar disposable income, an analysis we believe being significant in order to understand the weight of each expense in the Portuguese private consumption exposed in Exhibit 18. Source: PorData

      Exhibit 18: Portuguese Consumption Structure 1990-2011

      i) Net

    • – total income deducted from taxes and loans

      40,0% 30,0% 20,0% 10,0%

      0,0% Food&NAB Transports Housing HoReCa Clothes Others 1990 2000 2005 2011

      Source: Fundação Francisco Manuel dos Santos

      Exhibit 19: Retail

      The average annual household income in 1990 was EUR c.16,500 and c.90%

      Consumption Breakdown

      was used to cover family expenses. Hence, 29.5% was spent on food & Non

      2007; 2011 and 2012E

      alcoholic beverages (EUR 4,380), 14.8% on transports (EUR 2,198), 12.4% on 7 housing (EUR 1,841) and c.10% on HoReCa (EUR 1,470). In 2011 families received an average of EUR 31,318 but annual expenses assumed a different structure. Housing, now assumed the biggest expense representing 29.2% (EUR 8,230) of the total, transports maintained its weight but increased in absolute

      Source: Bank of Portugal value to EUR 4,087 (14.5%). On the other hand food & Non alcoholic beverages decreased to 13.3% (EUR 3,749) and the HoReCa expenses maintained its weight, amounting to EUR 2,902 (10.3%).

      Exhibit 19 allows us to comprehend that with the aggravation of economical

      conditions people tend to channel their income to basic need goods. Thus, non food goods such as clothes, pharmaceuticals, books, fuels, etc. tend to suffer

      Non food goods suffer

      with the budget cut. These goods are expected to present a 4.2% fall with reduction of income... comparatively to 2011 that already presented a drop of 2.9% from the previous year, while food goods present a 0.1% fall in 2011 but is estimated a 2.2% increase for this year.

       We have been witnessing a structural change in the food distribution formats in Portugal. Traditional spaces have been losing weight for larger centres that are capable of offering a greater variety of products at lower prices and extended hours. Hence, the main format operating are supermarkets and increasingly

      

    The retail market

      JM keeps gaining market specialty and discount stores. share...

      Exhibit 20: Portuguese Retail Market Share Evolution 2007-11

      Source: APED The Portuguese retail market is now dominated by two national big players that, through acquisitions have been reinforcing their positions: Sonae with Continent department stores acquired Carrefour in 2007 for EUR 662mn, and Jerónimo Martins with Pingo Doce supermarkets purchased Portuguese and Polish Plus 7 stores in 2007/08 to the Tengelmann group for EUR 320mn. The top 6 retailers

      HoReCa

    • – Hotels, Restaurants and Cafes
    represent 76% of the total market, and in turn the 2 biggest players account for 44.3% of that total in a time where the market is suffering stagnation in sales. In

      Exhibit 20 we can observe that small retailers are losing its weight as the 2 biggest gain market share.

      In 2007 “Other” chains represented 34% of the market, a value that decrease 100bp until 2011. On the other hand Intermarché and Auchan insignia watched its market share decrease 15bp and 30 bp for the past five years while Sonae and Jerónimo Martins gained 70bp and 40bp for the same period. This is a consequence of the comparative advantage that great food distribution chains obtain from the exploitation of economies of scale that come with the application of new technologies in inventory management as well as the increasing understanding of the spending habits of consumers. Its greater capacity of performing marketing actions and promotional campaigns than

      Private brands increase

      smaller retailers increases its bargaining power with suppliers and this is 60% in purchases... reflected in the prices available to consumers. It is expected that both leaders keep increasing their market share at the expense of smaller retailers that face a higher difficulty in keeping up.

      Exhibit 21: Weight of Private Brands in Grocery, Super and Hyper 2008-11

      Source: Fundação Francisco Manuel dos Santos Retailers bargaining power is even higher when these compete directly with the suppliers products through their own private labels. This battle is uneven since suppliers have no control over the decisions of exposure and promotion of its products in commercial spaces under conditions identical to the ones of the branded distribution. It is important to mention that Jerónimo Martins has its own brand

    • – Pingo Doce – and has been watching its share increase for the past few years. In 2008 41.7% of its sales were from its private label, value that increased to c.50% in 2011 (see Exhibit 21). This is explained by the change in consumer’s perception in relation to this type of products which people used to associate to inferior quality. Although not being something new in the market Jerónimo Martins has been making a strong bet on its own brand reinforcing its EDLP policy. Internally it has been limiting the number of brands. Around 2000 the

      

    JM decreases offer of # of Group offered 7 to 8 products per category. Currently offers 1 to 3 brands with

    items per category...

      one of those being its private label and the other being the market leader brand. The purpose is to increase visibility and brand loyalty.

    Poland

      

    Macroeconomic analysis

    Exhibit 22: GDP Growth 2008-17

      Poland has been the only European Union member that has not presented negative GDP growth since the financial crisis hit Europe (see Exhibit 22) despite presenting levels of economic slowdown this year. The Polish economy has not suffered rating upgrades since the European crisis burst, hence S&P

      (A), Moody’s (A2) and Fitch (A) currently categorize it as an investment grade financial system with a stable outlook for the future. The positive economic growth can be explained by the high

      Source: IMF Economic Outlook levels of domestic demand, its main growth driver, and due to the fact that Poland’s

      GDP depends shortly on exports, so it is not being affected by the general decrease

      Exhibit 23: Public Debt of external demand. 2006-12

      It is also important to highlight that its public debt has always been in line with the 55% legal limit criteria (see Exhibit 23). The setback is that Poland is not a member of the Euro zone and has its own currency

    • – the Zloty – which causes it to contract a big part of its debt in foreign currency such as Euro and Dollars. Hence, it is subject

      Source: IMF Economic Outlook to currency risk that may result in a huge and sudden increase of its value (please rd see Apendix I in page 36). After suffering a large devaluation in the 3 quarter of 2011, the Polish public debt reached its highest values, according to the IMF, of

      Exhibit 24: Unemployment

      56.3% of its GDP. However the Government was able to change the debt accounting

      Rate 2006-17

      criteria’s (whenever debt reaches values between 50% and 55% of GDP) by including the cash available in hand as well as the exchange rate which would be the average of the year instead of the one of the last trading day of the year, making its value decrease to 53.3% of GDP.

      Source: IMF Economic Outlook This is a country with more than 38 million inhabitants which is facing the highest unemployment rate since 2006 of c.10% (see Exhibit 24), a value that is expected to remain stable and start decreasing after 2016 according to IMF predictions. On the

      

    Exhibit 25: Private other hand consumption has suffered a decrease since 2008 with private expenses

    Consumption Expenditure

      falling 2.1% not following the sharp fall of the countries within the euro area (see

      2005-13 Exhibit 25). However, since Poland is not integrated in the Euro area and though

      having its own tools for financial control, we believe it will show signs of recovery faster than the Euro zone expecting a higher increase in private consumption expenses after 2013. Concerning Polish expectations for 2012 60% believe its financial situation will remain or will worsen when compared to the 65% for 2011. Source: OECD Economic Outlook

      Polish Retail Market Exhibit 26: Retail Formats in Poland and Germany 2011

      The Polish market is still a fragmented one in which we observe significant competition between both foreign and local retailers that ultimately are helping this industry to grow. The Western country is among the least formalized markets in Europe, still having about 40% of informal retailers (being just ahead of Turkey 8

    • – 55% - and Russia – 80% ), a tendency we believe will decrease during the next few years as main retailers gain market share in different formats and put pressure on smaller sized stores. Regarding the formal retail in both Poland and Germany the hard discount is the dominant format accounting for 28% and 40% of the formal

      Source: Retail Poland and Tesco market respectively (see Exhibit 26). It is in this segment that JM acts with Report

      Biedronka’s insignia which is a clear leader with 70% of total sales (see Exhibit 27), having only other two main competitors in this format (Netto and Lidl). The three

      Exhibit 27: Polish Hard

      together represent 98% of sales in hard discount chains. Supermarkets also have a

      Discount Format Market Share 2011 significant weight in both countries accounting for 28% and 22% correspondingly.

      Exhibit 28: Polish Retail Market Share 2008

    • – 1H2012

      Source: PMR Source: Retail Poland and Company Data st

      In Exhibit 28 we have the market share breakdown for 2008 to compare with the 1 half of this year. Jerónimo Martins has been the company that accounted for the highest increase in the market, having gained c.3% during the past four years. The Schwarz Group with the sum of Lidl and Kaufland insignia shares accounts for 7.2% of the market, but with one insignia alone Tesco is the second leader with a share of 6.9%. In what regards food expenses, Poland is one of the least spending populations, consuming less than half than the average of the European Union. Poles spend EUR c.1,250 in food and non alcoholic beverages per year (per capita) while Europeans in

      JM keeps gaining gorund 9

      average spend EUR c.1,970 . It is also important to highlight that private labels in Poland... 10 (supermarket brand) are gaining adherents in this type of shopping. In 2011 c.14% 8 of the products bought in hypermarkets were private labelled ones (Biedronka sold 9 Source: Retail Poland 10 Source: Euromonitor information and Nova Team estimations

      PMR Publications

    • – “Importance of private label products in Poland”
    c.55% of private label), a value that has registered an increase due to macroeconomic reasons. Consumers are getting more and more sensitive to changes in price while fewer associate these brands with lower quality. Hence, it is 11 expected this value will reach 25% in five years . To be able to reach these prices associated with cost reductions and margins improvement, companies are cutting off in dispensable intermediaries (decreasing ex-factory prices).

    Colombia

      

    Macroeconomic analysis

    Exhibit 29: GDP growth 2008-17

      And as the majority of the analysts suspected, the retailer announced Colombia as the new investment opportunity and market where it will open its first stores until March of 2013. The Republic of Colombia is a democratic state of Law with great opening to private investment, then again has a significant population with c. 46 million

      Source: IMF Economic Outlook th nd inhabitants, being the 27 most populated country in the world and the 2 one in

      

    Exhibit 30: Public Debt Latin America, after Brazil. Its population has an average age of 30 years old and

    2006-12

      a high birth rate thus providing a big market with large growth capacity on the long run. Furthermore, this country has a stable economy, having received in 2011 an investment grade rating by the three main rating agencies (stable Baa3 by Moody’s; positive BBB+ by S&P; stable BBB by Fitch) while the IMF predicts a GDP constant growth of 4.5% until 2017 (see Exhibit 29). It is also a country

      Source: IMF Economic Outlook that, for the past decade has maintained a stable level of public debt around 30% of its total GDP (see Exhibit 30).

      Exhibit 31:Unemployment

      Colombia is a large producer of oil, being dependent and sensible to drops in the

      Rate 2008-17

      price of this commodity. This year it reached a personal record of producing circa 12 one million barrels per day (a value that only represents 1% of the world’s production but c.6% of the Colombian GDP). On the other hand it is a country 13 with elevated levels of corruption and criminality , though decreasing, that are aggravated by the high levels of unemployment (see Exhibit 31) and inequality

      Source: IMF Economic Outlook (0.585 in GINI index) where currently, more than 27% of the population lives on less than $2 a day.

      11 12 Source: Poland Retail Market

      Source: U.S. Energy Information and Administration. Saudi Arabia is the world leader producing c.11 million barrels 13 per day Source: Economy Watch. From 0 to 10 (being 10 the least corrupted) Colombia is classified with 3.5.

      Colombian Retail Market Exhibit 32: Dominant Formats

      The Colombian market retail is a very fragmented one, dominated by small

      in South America 2011

      independent retailers. In 2011 there were 2,373 companies specialized in retail sales registered in Superintendencia de Sociedades (Companies regulator) having only 6 of which sales over COP 1 trillion (more or less EUR 420mn). As regards the dominant formats in this country, traditional stores make up to 50% of the market while hypermarkets constitute c.30% of the total (see Exhibit 32). In

      Source: A.C. Nielsen South America, Mexico is the only country that is, as well, dominated by local shops, however in contrast Brazil is the most formalized retail market of Latin America where informal retail only accounts for only 15% of the market.

      Inside the modern format the main leader in this country, with only 7% of market share, is the Casino group with its Exito subsidiary that operates in almost all

      Exhibit 33: Leaders Within the 13% Total layouts: supermarkets (Cafam, Carulla), hypermarkets (Exito), convenience and

      discount stores (Bodega Surtimax). Together with the top 5 retailers their total market share is less than 13%. However, within this percentage Exito accounts 14 for 42% of the total, followed by Carrefour and Olimpica, the other two main retailers (see Exhibit 33). This fragmented market offers good entering

      Source: Nova Research and Exito opportunities to the Portuguese retailer also since the discount format only Investors Presentation accounts for c.3% of the total formats (“Bodega Surtimax” – Casino’s banner – is the only hard discount player in this market).

      The Colombians attend to the supermarket with frequency in order to do their weekly shopping preferring the ones within walking distances from their places. This happens especially in big cities where intense traffic makes customers visit far larger retail formats more sporadically. Moreover, with the global crisis, small outlets started gaining market share as they strengthened their relationships with customers making the larger format companies betting on this type of approach

      Colombians prefer

      and opening more local convenient layouts. Despite not having a lot of proximity... information about the strategy and the format that JMT will pursuit, with the experience it has in the EDLP strategy, both in Poland and Portugal, we believe it will try to replicate this format as well as the proximity to local housing approach. Jerónimo Martins goal is to be in the top three by 2015, suggesting revenues of c.EUR 1bn (Olimpica is the third biggest seller and in 2011 sold ≈ EUR 1,2bn).

      For now, the company is planning to invest around EUR 400mn until 2014 in opening and equipping the first stores.

      selling its Colombian business to the Chilean retailer Cencosud. Hence it is expected a change in the market share structure.

    Operational Forecasts

      Despite the negative economic environment in Portugal, the Group has been registering positive growth in revenue in all segments proving the sustainability of the company. The gross margin reduction by 60bp from 2011 to 2012 (22.8% to 15

      22.2%) reflects both the weight of Biedronka in the total business, since this

      Margins will suffer with

      segment was the one that registered a decrease in this margin, as well as the economical situtation... strong publicity on Pingo Doce. We anticipate an EBITDA of EUR 808 million for the cumulative year with a respective margin of 7.4%. However, in 2013 we believe it will suffer a sales and margin decrease due to i) economic conditions in Portugal that will slowdown consumption, ii) aggressive promotional campaigns in both countries, iii) increase in price of some raw materials and iv) absorbency by the company of determined costs not to affect prices. In this sector we estimate number of stores, sales per sqm, total area (sqm), as well as EBITDA margin and depreciations for every business until 2020 (for Colombia we estimated until 2025). Our assessment is based on data the company provided for the four previous years. We have assumed the area per store did not suffer 16 major changes , and we have as well incorporated in our model the fact that a 17 store is not fully operational during the first year of its opening .

      Exhibit 34: Sales per sqm evolution 2010-20F Portugal

       From 2008 until 2011 Pingo Doce sales grew at a CAGR of 8% due to the continuous investment the company does in increasing the sales area. In 2008 2 the total sales area was of c.433,000m , with a sales per square meter of EUR Source: Company Data and

      Pingo Doce

      5.5. With 13 more opened stores until 2011 Pingo Doce increased to 440,300 its Nova Research Team total sales area, at the same time as the sales per sq meter increased to EUR 6.9

      (see Exhibit 34).

      Exhibit 35: Retail Mainland Operational Forecasts (2008-20)

      Source: Company Data and Nova Research Team 15 16 Please refer to Exhibit 2 and 4 Average number of sqm per business store: Pingo Doce

    • – 1,268 sqm; Recheio – 3,150 sqm; Madeira – 950 sqm; Biedronka
    • 17 – 600 sqm; Colombia – 850 sqm I tis also important to mention that in the “% growth” caption that appears in every table, in the year 2020 (2025 for Colombian) is related to the last year presented, meaning the growth between 2020/2015. However, we were a bit pessimistic in terms of store opening for the next 8 years as the Portuguese retail market is reaching its maturity and consumption is under pressure. Hence, contradicting the company ’s expectations for the next two years

        Portuguese market

        of opening 10 Pingo Doce stores we believe JM will open 8 new stores until 2014 hinders organic growth... and only 3 more until 2020, increasing the total square meters to 456,800 by that time (at a CAGR of only 0.39%), simultaneously the sales per square meter will increase to EUR 8.1, just above inflation (see Exhibit 35).

        Exhibit 36: Retail Mainland Operational Forecasts (2008-20)

        Source: Company Data and Nova Research Team On the other hand the insignia sales will suffer a small slowdown as the consumers adjust to the reduction of their disposable income as a consequence of the austerity measures the country implemented that will be aggravated next year (CAGR will decrease from the 2008-11 8% to 1.94% in 2012-20) (see

        Exhibit 36). However, the company is as well adjusting to this macroeconomic We expect sales to

      slowdown and promotions environment and we believe this will have a positive impact in its private label

      18 to keep strong....

        that currently represent more than 41% of its sales. These type of products offer an inferior price relative to brand goods, another reason for which we believe the sales value will decrease. At the same time it offers ready to eat meals and promotions as well as its proximity strategy with the client. Concerning the EBITDA margin, we expect it to reflect the strong investment in promotional st campaigns the Group makes to reinforce its price positioning (e.g. 1 of May campaign where all purchases over €100 had 50% discount) which justifies the 40bp decrease. The company is trying to gain market share against its main competitor Sonae knowing that it has the advantage of having a greater leeway since the main source of results comes from Biedronka, while Sonae’s profit depends mainly on its Portuguese performance. Hence, it is able to proceed to more aggressive promotions and advertising campaigns as Pingo Doce represents 30% of its total EBITDA. Thus, we believe its margin will fall this year, will be stable in 2013 and will begin to recover after 2014.

        Exhibit 37: Sonae MC Main Indicators (2008-11)

        Source: Company Data and Nova Research Team Through Exhibit 37 we can compare JM main indicators with the ones from its major Portuguese competitor. From 2008 to 2011 Jerónimo sales per square meter increased at a CAGR of 8.12% (from EUR 5.5 to EUR 6.9), while Sonae did not present significant growth, maintaining a EUR 6,000 sales value per

        Perhaps Sonae should

        square meter. This can be justified by the fact that the sales value did not start being worried... accompany the sales area growth. During these four years Pingo Doce revenues grew at an 8% CAGR with the sales area increasing by less than 1%. On the other hand, the leading retailer saw these values increase by c.4% and 3.6%, respectively. Modelo and Continente opened 142 stores during these four years and Pingo Doce only 13. Concerning EBITDA, JM lower margins is explained by the company’s priority in maintaining price competitiveness investing in promotional activities and absorbing some of the products increasing costs (e.g.

        VAT). Also, as explained before, Sonae is highly dependent on its Portuguese margins, benefiting Jer ónimo’s capacity to decrease margins making its prices more appealing.

        Recheio (Cash&Carry) 

        With 36 cash & carry and 3 food & service platforms in Portugal (one of each in Madeira), Recheio is the operator that covers the highest area of national territory.

        Exhibit 38: Recheio Operational Forecasts (2008-20)

        Source: Company Data and Nova Research Team This insignia tries to respond to the needs of the traditional retail as well as the HoReCa chain. From 2008 until 2011 it sales area grew at a CAGR of 2.8% from 2 2

        116,000m to 126,000m (see Exhibit 38). We believe this value will suffer a slowdown until 2020 and grow at a CAGR of 1.2% reflecting the signs of maturity of the market. Hence, we estimate JM will open 4 more Recheio stores until 2020 and will reach a EUR 7 sales per sqm meter by then.

        Exhibit 39: Recheio Operational Forecasts (2008-20)

        Source: Company Data and Nova Research team In Exhibit 39 we can observe the evolution of sales and EBITDA in this insignia.

        We inferred a CAGR of 3% (from 2012 to 2020) that will not be accompanied by the increasing sales per square meter, as we predict this item to grow at a CAGR of 2% for the next eight years. We have to take into consideration the fact that the traditional retail (Cash & Carry customers) is losing its market share for modern retail, not being able to be competitive relatively to bigger surfaces that put a lot of pressure in smaller retailers due to its bargaining power with suppliers and current concern with proximity with the costumer. On the other hand, the

        Recheio is suffering with

        HoReCa chain is suffering in Portugal as a result of a severe fall of activity in this attack to HoReCa... sector as well as a VAT increase from 13% to 23% leading to a large number of 19 closing establishments . As a consequence of increasing difficulties JM reports in its 3Q2012 results an increase in store traffic but an average ticket decrease. On the other hand the EBITDA margin will also suffer as JM tries to absorb the maximum margin of VAT increase and bets in promotional activities. We believe this margin will decrease 40bp to 2013 but will slowly recover, reaching a 6.2% margin in 2020. The amount of depreciation is in line with the store opening and space reshuffle.

         Madeira

        JM operates in Madeira with 13 Pingo Doce and one Recheio store as well as one food and service platform. For Madeira we do not anticipate any store

        Madeira will remain

        opening for the next eight years. In our estimations, sales will grow in line with stable... inflation at a CAGR of 1.5% until 2020. The sales per square meter will accompany this tendency and by 2020 we expect them to reach EUR 12.7.

        Similar to what is happening in the Continent, 2012 and 2013 will be adjustment years as the country tries to achieve the deficit goal of 5% this year, thus, as 19 income taxes and VAT increased in the island we expect this to be reflected in According to AHRESP (Associação da Hotelaria, Restauração e Similares de Portugal) the 77% VAT increase bankrupted c.11 thousand companies and created 37 thousand new unemployed in 2012. It estimates the failure of

        28,000 companies next year plus 68,000 new unemployed. the company’s margin as JM absorbs this increase to maintain its price competitiveness. The level of depreciations represents maintenance needs for the normal function of the stores (see Exhibit 40).

        Exhibit 40: Madeira Operational Forecasts (2008-20)

        Source: Company Data and Nova Research Team

        Industry and Services 

        The industry segment includes Gallo Worldwide Company and the Joint Venture with Unilever. This year the Group has reported a 2.4% sales growth in this

        Exportations help

        segment after three years registering revenue decrease, which is mainly Industry grow... explained by the strong increase in olive oil exports. We estimate the industry sales to grow at a CAGR of 2.2% for the next 8 year (see Exhibit 41).

        Exhibit 41: Industry Operational Forecasts (2008-20)

        Source: Company data and Nova Research Team This insignia includes Out-of-Home and In-Home products, and we believe its margin is expect ed to reflect consumption’s recessive impact during the next 2 years especially in the Out-of-Home market since consumers are more worried in cutting back in what they can. For this reason, the Group will continue its aggressive promotional activity initiated in 2011, as is doing in other segments.

        On the other hand, 2012 end year’s margin is also expected to reflect an 20 increase in the prices of electricity and gas that will be absorbed by the company. We believe in 2013 there will be a higher contraction c.20bp as austerity measures will be even harder to support. It is important to highlight the investment JM has been making in order to extend Gallo brand to other geographies. Its major imports come from Brazil and Venezuela and the most 20 recent market entrance has been to Russia and China. We expect the expansion

        The Energy Services Regulatory Authority (ERSE) announced an increase in electricity and gas fares of 2.8% and 2.5% respectively, for 2013. This percentage will be revised every quarter. to these emerging markets to be reflected in the sales of this insignia providing a more stable growth between 1.5% and 2% until 2020.

        Exhibit 42: Services Operational Forecasts (2008-20)

        Source: Company Data and Nova Research Team The services segment closed 2011 with eighty six own stores and five franchised, twenty six more stores than in 2010. Like the other Portuguese insignias, services sales have registered a decrease this year due to economic factors regarding loss of purchasing power by families. We believe sales will remain low as people are cutting back in out-of-home expenses and for the next three to four years will not regain its previous growth of 6% (from 2008 to 2009). EBITDA margin is expected to remain relatively stable (see Exhibit 42).

        Exhibit 43: Industry & Services Operational Forecasts (2008-20)

        Source: Company Data and Nova Research Team Concerning depreciations our estimations include mainly store opening in the services insignia as well as store maintenance (see Exhibit 43).

        Biedronka 

        This segment continues showing strong signs of growth while it absorbs the largest share of investment. After reaching store number 2,000 (closing the year with 241 more stores than 2011) we believe the next 1,000 stores will be opened until 2015 where it will reach its next goal of having 3,000 operational stores, c.1,797 thousand square meters (see Exhibit 44).

        Exhibit 44: Biedronka Operational Forecasts (2008-20)

        Source: Company Data and Nova Research Team

        Exhibit 45: Tesco (in Poland) Main Indicatores (2008-12E)

        Source: Company Data and Nova Research Team In Exhibit 45 we can observe the same indicators for Biedronka

        ’s main competitor - Tesco. The Portuguese retailer is clearly ahead in number of stores and in terms of sales per sq meter Biedronka leaves no doubt about its leadership. In 2012 we estimate Biedronka to be selling PLN 21,800 per sq meter while Tesco expects a decrease in this indicator to PLN 12,600. For the next 8

        JM shows better indicatores than its

        years we estimate the number of square meters in Poland will increase at a closest competitor... CAGR of 5.8% almost reaching 2,000 thousand sqm in 2020. After closing this year with a cumulative sales growth of 16% (19% if we account in zlotys) we estimate this caption to continue having a sustainable double digit growth at a CAGR of 9.1% in EUR leading us to believe Biedronka will reinforce its strength in the country (Biedronka is market leader in price) and will be selling EUR 5,800 per square meter in 2015 and EUR 6,600 in 2020 (13.28% more than in 2015).

        Exhibit 46: Biedronka Operational Forecasts (2008-20)

        Source: Company Data and Nova Research Team The company proceeded to a layout conversion in almost every Biedronka store in order to respond to the new requirements of polish customers and improve the facilities to better preserve perishables and freshes. So, in order for margins don

        ’t suffer such a big impact with this measure, the Group cut back on promotional

        Layout conversion in

      every Biedronka store is activities this year. However, in 2013 we anticipate an agressive investment in

      finished...

        promotions and advertising. Hence, EBITDA will reflect these decisions and we estimate its growth at a 12.4% CAGR but its margin will reach 8.8% in 2020 through a 1% CAGR. Concerning depreciations, as JM will continue opening a great number of stores and will have to assure its maintenance, we think this value will grow at a CAGR of c.12% (see Exhibit 46). It is also important to highlight that, as Biedronka operates in a different currency - the zloty - it is

        Exhibit 47: Relation between

      EUR/PLN and Biedronka subject to currency risk. In Exhibit 47 we observe the impact that zloty

      Sales

        devaluation has in Biedronka’s sales. This happens because Jerónimo Martins converts all sales into the domestic currency

      • – euros – for reporting reasons and part of the value is lost in this trade. The other reason is that the company negotiates some polish rents in euros (between 15% and 30% of total polish rents), meaning that with zloty devaluation its value will increase pressuring negatively the company’s margins.

        Source: Bloomberg and Company Data

         It will be during the 1Q of 2013 that JM will open its first stores in this country and due to its relevance and proximity we decided to already include this business in our valuation. In this case, we have increased the number of forecasted years to 2025 because we believe that eight years of estimations (with the first 4 to 5 debiting negative results) would not provide a true long term value for Colombian operations. Thus, in order to obtain a proxy for the main indicators we will use as 21 comparable the two leading retailers in this country – Exito and Olimpica .

        Colombia

        Exhibit 48: Colombia ’s Two Main Retailers Indicatores (mn PLN) 2011

        Source: Company Data and Nova Research Team After analysing their annual reports we have concluded that Exito through its supermarket chain sells COP 12.67 thou sand per square meter (≈ EUR 5.47) 22 while Olimpica registers COP 12.79 23 thousand sales per sq meter (≈ EUR 5.52)

        (see Exhibit 48) . Hence, our estimates lead us to believe that JM will be able to 24 be selling COP 15.25 (≈ EUR 5.30 p/ sq m) by 2025 (see Exhibit 49).

        Exhibit 49: Colombia Operational Forecasts (2012-25) 21 Source: Company Data and Nova Research Team 22 The second one would be Carrefour that was sold this year to Chilean Cencosud (as already referred)

        Discounted at current spot rate 23 – 2,317

      Exito’s 8.4% EBITDA margin is for the entire busines. The company does not provide EBITDA breakdown per

        24 business Discounted at forward rate of 2017 of 2,845

        JM announced that the basic structure of the business is concluded: i) teams are selected, ii) brand, iii) communication, iv) suppliers, v) distribution centre being

        

      The structure is defined finalized, as well as first stores ready to be opened. It has also announced that by

      and JM expects minimum

        2015 wants to have a minimum of 150 opened stores. Therefore, in line with the of 150 stores by 2015... company’s goal of being in the top 3 retailers by 2015 and with its experience in this area we anticipate the opening of c.100 stores per year for the next three years having the Group opened 330 stores 2015. Despite this, we do not anticipate JM to be selling over EUR 1,2bn before 2017. By 2025 we estimate JM will have around 980 operating stores. Concerning the amount of square meters both comparables own stores with an average area between 630-950 thousand sq meters and so it seemed reasonable to us to assume for JM an average 850,000 sq meters per store.

        Exhibit 50: Colombia Operational Forecasts (20013-25)

        Source: Company Data and Nova Research Team During the first 3 years of operations we do not anticipate positive EBITDA margins due to the amount of costs the company will have to support before

        Negative margins for the

        revenues overcome losses. However in 2020 we believe JM will be able to reach

        first years but high sales

      growth... a margin around 6.2%. On the other hand, the company will register negative

        EBIT margins for a little longer due to depreciations overcoming EBITDA. We anticipate EUR 0.12 per sq meter, in line with Biedronka’s hard discount format value. Depreciations are in line with the useful life of 15 years the company determines for basic equipment (see Exhibit 50).

        Capex and Working Capital

        For these items we have used the information provided by Jerónimo as well as our estimations regarding the growth strategy outlined by the company. After last year’s announcement of an investment plan of EUR 1.7bn for the triennium 2011- 13, the Group revealed a new EUR 2.5bn investment from 2012 to 2015. However i n our estimates the company’s new investment plan will reach EUR 2.4bn. So as to proceed to this estimations we took into consideration the different types of capital expenditures JM does: i) distribution centres (DC), ii) store opening (expansion), iii) revamping (e.g. layout conversion) and iv) store maintenance. JM has just inaugurated 2 new DC in Poland (having invested EUR

        25

        20mn in each) as it tries to accompany the store expansion . Hence, according to our store opening estimation we expect the company to inaugurate at least 5 more new DC until 2015 (one in Colombia and four more in Poland).

        Exhibit 51: Capex Breakdown per Type of Investment (2012-20)

        Source: Company data and Nova Research Team Furthermore, at least every 7 years, stores suffer a revamp to an updated 26 layout , and we inferred an investment of EUR 370mn for this activity for the next three years. Still, the biggest slice of the investment is attributed to store expansion that will occur mainly in Poland and now Colombia. In Exhibit 51 it is

        Investment’s biggest slice still allocated in

        possible to observe our assessment by capex type. In 2012 total investment Poland... represented c.6.5% of revenues. We think this percentage will continue to decrease as the volume of sales increases and expansion starts to stabilize in Poland, accounting for 2.2% in 2020.

        Exhibit 52: Capex Breakdown per Business (2012-20)

        Source: Company Data and Nova Research Team

        Exhibit 52 complements this analysis as we can understand the weight of the

        investment in each business. In Portugal, as the market is becoming more and more saturated we believe JM will open around 15 Pingo Doce stores in the continent and none in Madeira for the next 8 years and we do not anticipate any openings after that period. Thus, our estimations of investment for this insignia 25 fall mainly on store remodelling and maintenance, EUR c.290mn for the next 3 26 Each DC serves up to 200 stores (JM statement)

        JM statement years. On the other hand, in Poland the Portuguese retailer is leader in a market that still has space to grow and, as we have seen earlier, is its main focus of investment. Of the total investment plan announced for the next three years 75% are going directly to Biedronka. The polish segment has just opened store 2,000 on October of this year but the ambition is to reach 3,000 stores in 2015, a goal that we think is achievable due to the fact that i) is the market leader and the most recognized brand by Poles ii) the knowledge the company already has on this market, iii) financial soundness and the amount of investment channelled to this operation alone (EUR 1.1bn 2013-15). Concerning the Colombian operation the Group announced the intention to invest EUR 400mn until 2015 to open the first stores and reach the top 3 by that year having opened around 330 stores by then. Thus, we estimate that JM already invested EUR c.60mn with the construction of the first stores in 2012 as well as the DC and will invest EUR

        Exhibit 54: JM Sales c.300mn until 2015. Breakdown 1H2012 Exhibit 53: Net Working Capital Breakdown (2011-20)

        Source: Company Data and Nova Research Team Regarding the net working capital we observe an improvement in its efficiency as

        Source: Fundação Francisco well as in short term financial health (see Exhibit 53). Despite the increase in the Manuel dos Santos average collection period, where we take into account the increasing difficulties suppliers and clients will struggle with at the time of paying the bill. However this

        

      Exhibit 55: JM and its Peers value will decrease to 9 days by 2020. On the other hand we believe the

      NWC in Days

        company will be paying to its suppliers in around 74 days, while the average replacement of the stock will decrease to 14 days as perishables need constant replacement and already represent c.30% of customers’ purchases (see Exhibit

        54). Furthermore it is possible to compare these indicators with JM European big players in Exhibit 55.

      Valuation

        Source: Bloomberg In order to proceed with the valuation of the business we chose the SOTP method as well as the multiples of the comparable companies. Since Jerónimo Martins has operations in Portugal, Poland and most recently in Colombia, we valued each business according to the characteristics of the country where it is operating.

        Cost of Equity 27 The cost of equity was calculated through the Capital Asset Pricing Model . To

        convert the risk free rate we have to use an yield that incorporates the least default risk possible. Thus, the alternative to a corporate bond yield is a Government one since the latter has financial mechanisms that allow it to control currency fluctuations decreasing the risk factor. Hence, we chose as the basis of the risk free rate a 10 year government bond yield denominated in local currency. However, and as mentioned, the Group operates in three different countries with three different currencies of which none of them is currently classified as a risk free one (see Exhibit 56).

        Exhibit 56: Rating Classification per Country in 2012

        Source: Bloomberg According to the three main rating agencies Germany is the country in the Euro area with the lowest default risk. Hence, since it trades in the same currency as Portugal we took 10 years of daily German government bond yield as the risk

        Germany is the country

        free rate for this country. Concerning Poland and Colombia, we proceeded to the

        with lowest default risk in

        conversion of the free cash flows from its original currency to Euros right before Euro area... discounting to WACC, hence as the German risk free is already in the same currency we have applied the same rate for the three countries.

        To estimate beta we compared two different approaches in order to get a beta range: i) the unlevered beta of the industry and ii) the average unlevered beta of comparables (see Exhibit 57). The first step was to obtain an industry unlevered beta range which we took from both Bloomberg and Damodaran’s data base [0.58 – 1.08]. Secondly we searched for the betas of the companies that presented a business structure similar to our company (e.g. format, capital structure, EBITDA margin, rating) which is possible to observe in the above exhibit. Here, we proceeded to find another interval in which one of the limits was the average beta of the companies that only operate in the hard discount formats (marked with *) and the other limit are these same chains plus the ones that operate as well within the supermarket layout (marked as **). We made this 27 distinction because we believe chains operating only in the hard discount format

        = + ∗ may present a higher beta value than companies operating with a more diversifiable business formats as there is not as much pressure in margins.

        Exhibit 57: Comparable Characteristics 2012

        Source: Bloomberg and Nova Research Team Furthermore we have to take into consideration the fact that a significant part of JM value comes from Pingo Doce that operates with supermarkets. With the 28 levered betas of each company we proceeded to the deleverage process through market D/E ratio of each company. With these values, we obtained a range of [0.54; 0.62]. Hence, within the purposed interval, we believe 0.8 is a good estimate of what would be the true beta of the company. After this we “releveraged” this estimate to the target long term capital structure of the company (50%), obtaining three different betas for the different geographies.

        Concerning the market risk premium we have assumed, in a long term 29 perspective, the market to produce a 6% premium .

        Cost of Debt

        Jerónimo Martins does not have a credit rating (neither his major peer Sonae), besides, the bonds it has been issuing are under EUR 100,000mn which we 28 consider as not being liquid enough to compute a suitable cost of debt.

        Beta 29 – 2 years of weekly data relative to the MSCI World index McKinsey & Company

        Exhibit 58: Characteristics of Issued Bonds

        Source: Bloomberg and Nova Research Team On the other hand, we have been witnessing an increase in bond issuance of Portuguese companies targeting private small investors, which made us turn to

        We took unto consideration bonds

        these other big Portuguese players and international retail companies with the issued by JM peers... intention of obtaining a cost of debt range that translates either the increasing yields of the national market as well as the company’s financial structure. In

        Exhibit 58 we can observe the characteristics of bonds issued by the Portuguese

        main companies, as well as JM international peers. As we have obtained several yields for a d ifferent number of maturities we have resorted on Bloomberg’s Industrial yield curve in order to understand what would be the value of the yield in case these companies issued a 10 year bond. For the BBB rated companies the converted yield would be around 2.9% while for the BB Portuguese rated companies these value increases to c.5.3%. Since the bond issuance would be made by the parent company, we took into consideration the Portuguese and 30 Dutch prevailing yields, applying a cost of debt equal for the three countries. We have assumed this rate as the basis to our cost of debt calculations for the three businesses, which we will now develop. Since our company operates in 31 three different currencies we had to take inflation effect and the results can be

        Exhibit 59: Cost of Debt

        observed in Exhibit 59. Furthermore, we also have to take into consideration the probability of default of the company as well as the recovery rate in case the 32 Source: Nova Research Team same enters in distress . The assumptions on both the recovery rate and probability of default were made based Moody’s report on this subject. Thus, we believe the first one to be around 85% as the retail business is a significant liquid one due to the amount of assets it has available, while the probability of default for this company we believe it to be around 6%.

        30 th

        On the 30 of December of 2011 Sociedade Francisco Manuel dos Santos (SFMS) SGPS sold its 56% share in JM to its subsidiary SFMS BV based in the Netherlands. Hence, we believe the company might consider issuing debt in this 31 country. 1+ , where Rlc stands for rate of local currency and Rfc is rate of foreign currency 32 = 1 + ∗ 1+

        = 1 − ∗ 1 + + ∗

        Exhibit 60: DCF Assumptions

        Source: Nova Research Estimates In Exhibit 60 we have the different WACC rates at which we will discount the individual free cash flows of each of the business units. We obtained 8.64%, 9.38% and 8.57% for Portugal, Poland and Colombia respectively. For the continuation value of all segments we assumed a nominal different growth rate

        We believe Colombia and

        according to the future market possibilities and taking into consideration industry

        Poland offer good growth potential...

        saturation. The Portuguese market we believe it does not offer a very attractive growth possibility as it’s reaching its saturation phase. Thus, we attributed it a

        1.5% rate, in line with predicted future inflation. On the other hand the Polish and the Colombian markets still offer development opportunities both being significantly fragmented providing good growth opportunities. For this reason we anticipate a nominal growth rate of 3% for Poland, c.1% above expected inflation while for Colombia we wanted to take a careful approach expecting c.2% real growth for this business.

        

      Exhibit 61: Sum of the Parts Valuation Summary

        Source: Nova Research Team In Exhibit 61 we present a summary of the present value of each Jerónimo Martins business. Biedronka is clearly the most valuable asset of the company providing c.79% of the total value of the company. In addition we also assess the Colombian business to contribute with c.8% for the company value.

        Comparables

        Performing the same analysis to the comparables as we did before for the calculation of WACC, we used the same comparable companies (see Exhibit 57) in order to check if our valuation was in line with the valuation based on the multiples approach. We chose EV/EBITDA and P/E ratios having in mind its drawbacks, but knowing the advantages of one over the other. The first one is not affected by the capital structure of the company helping to assess the value

        Multiples approach offers some drawbacks...

        of the business free of debt, including the cost of paying debt as well as non cash expenses such as depreciations. On the other hand the price earnings ratio has the advantage that is calculated with the official earnings reported by the company facilitating its calculation. Its drawback is that this value does not remain stable for the future obliging one to predict a growth rate to account for the company’s future growth potential, expectations that might be wrong affecting this ratio.

        Exhibit 62: Food Retail Comparables

      • – Multiples Approach

        Source: Bloomberg and Nova Research Team In order to replicate the Portuguese, the Polish and the new Colombian businesses we took into account comparables that operate in both mature

        We took into

        (subject to limited growth rates) and emerging markets (exposed to significantly

        consideration the weight

      of operations in different higher growth rates) (see Exhibit 62). We took into consideration the influence of

      markets...

        these characteristics in this valuation by applying the weight that the Polish and Colombian businesses have in the total value of JM (c.87%) to the multiples of the companies operating in emerging markets. We also took into consideration the fact that almost all companies we have considered as operating in mature markets have also operations in countries considered emerging. Hence, we accounted the percentage of sales in each of these companies that comes from

        33

        this last group . Analysing EV/EBITDA multiple in Exhibit 61 we can observe that JM is trading at premium when comparing with its peer in both markets with its valuation being closer to the emerging ones proving us the growth potential Biedronka provides. Concerning the P/E ratio and observing its values we can take similar conclusions.

      Internationalization

        The strategy

        In order to proceed with its growing strategy a company such as Jerónimo Martins needs to expand to other markets as the retail industry in Portugal becomes saturated and will limit its opportunities. After Poland the Group will initiate operations in Colombia next trimester where it looks to be one of the three biggest operators in 2015. The approach the company will follow is not yet known, but we believe it will follow an organic growth and will replicate the Polish discount format focusing in the EDLP approach. Yet, we can read in some

        The company might have

        Colombian retail news that the company Exito has been we opening a lot of small

        to consider the possibility of a future acquisition...

        stores in main cities with the purpose of saturating the market trying to decrease informal retail market share. So, we believe JM will be able to create organic growth for the first years but, in order to gain dimension, it will have to eventually consider a future acquisition strategy that can bring some advantages over organic growth (this strategy might be as well applied for the Polish business):

         Despite being significantly more expensive would provide a faster entry into the market. In JM case, as a second phase strategy, would provide a faster expansion;  Possible abolition of a competitor, which in a fragmented market as the

        Colombian it would rapidly lead JM to the top, then again would as well mean an increasing regional presence;  Acquisition of experienced and talented human capital with profound knowledge in the field;  It would also lead to economies of scale as it would allow the company to decrease the amount of operating costs;

        The day the Group announced Colombia as the new strategic geography there was not an obvious reaction from investors, maybe because JM did not anticipate 33 any details of the business or that investors did not know what to expect from this Operations in emerging markets: Tesco

      • – 13%, Carrefour – 30.5%, Metro – 25%, Ahold – 5,74%, Casino – 33%, Delhaize – 12%, Dia – 25%
      new country (see first chart from Exhibit 63). However, as the company unveils details of this operation investors show significant signs of satisfaction. On the th Investors Day (11 of December 2012) where some details were revealed Jerónimo Martins share price appreciated almost 7% reaching EUR 15.43 (see

        Investors show signs of agreement...

        second chart of Exhibit 63).

        Exhibit 63: Investors Reaction to the Unveiling of Colombia Business

        Source: Yahoo Finance

        

      What went wrong before

        However, in 220 years of existence, despite being experiencing sustainable growth for the past 10 years, the Group has registered some failures being more

        Learn from experience...

        aware about the market needs, as well as increasing its capability of anticipating some things that might go wrong. It is, therefore, important to understand the failures of previous internationalizations so not to repeat the same mistakes. The beginning of the XXI century did not bring a very favourable macroeconomic environment at the same time as consumers were becoming more aware of prices. In its English business (Lillywithes) the company reveals there was a strategic failure when choosing the leading team, a decisive asset in the success of any business. On the other hand, in Brazil JM admitted it was a premature decision since there were not enough experienced and trained human resources to assume such responsibility. The company was not able to be competitive among its peers and saw the amount of sales decreasing. Hence, in order to comply with suppliers there was a severe increase in the company debt (JM reached EUR 1,3bn in debt) while the cost of financing increased as well (the reference rate at that time almost doubled to 4.25% and the company also 34 decided to finance both Polish and Brazilian growth through local debt being subject to unfavourable exchange rates). Currently, JM has been decreasing its amount of long term debt (from 87% of total loans in 2007, presently reports c.53%) preferring to contract short term loans. Concerning foreign debt currently this represent c.8% of its total loans. In 1999 Jerónimo began reporting negative 34 results (c.EUR 72mn) that lasted until 2002 facing the urgent need of a Local debt reported reached EUR 600mn (c.40% of JM total debt). restructure of the business portfolio, a strengthening of its balance and a reformulation of the business formats. Hence, it was decided that the retailer would only focus on what it was its core business since the beginning – the industry and food distribution segment

      • – selling all assets outside this activity. In Portugal, by that time, the Pingo Doce insignia was an upscale brand The overturn...

        delivering high quality products at high prices. Consumers perceived it as expensive supermarkets, inconvenient in its locations. For this reason, it began by cutting the number of product references increasing bargaining power with suppliers and so operating costs decreased thus turning prices competitive. It also invested in the proximity with the client betting in stores close to local housing and made a massive investment in advertising its Every Day Low Prices policy in order to announce this new orientation as well as high quality products. Currently is the second biggest retailer in Portugal in the food distribution segment.

        When arriving to Poland, the company integrated the hard discount segment. JM The Polish success... faced fierce competition as Tesco increased its number of stores to around 50 through the acquisition of the largest food retailer at that time (HIT supermarkets) as well as Makro’s presence that counted with 13 stores. Both retailers wanted to offer high quality products with the lowest prices as well as to create value for clients earning their loyalty. However Biedronka applied the experience gained through Pingo Doce with its EDLP policy offering high quality products and, in order to obtain client loyalty bet on decreased margins and higher selling volume, as well as customer proximity. JM has been very successful in Poland becoming leader in this format.

      May something go wrong…

        In what concerns Colombia we inferred this is a fragmented market in which hard Future possible twists... discount accounts for 3% of the total. As previously said, JM did not unveil strategic details on how this process will be developed though we can anticipate it will be an organic growth. We also believe that, due to the country and market characteristics that we have already developed in this report, this operation will be a future growth driver. Furthermore, Jerónimo is a Group with more than two hundred years with bad, good and great full year results as we have just described which adds credibility to the considered decision.

        Nonetheless and despite expecting this business to be a success it is difficult to predict everything that might go wrong, operating in such diversifiable environments. For example: i) it is expected the aggravation of economic conditio ns in Portugal in 2013, however, few economists’ state the consequences will be much worse than likely, ii) how will zloty and peso develop hereinafter, iii) how Colombians will adhere to Jerónimo’s most recent brand, iv) will the Colombian operation be able to create value? With this thought in line we decided to infer the consequences in the price target of the company in case key drivers of growth of the new business (e.g. sales per sq meter, sales area, EBITDA, nominal growth rate) did not go according what is expected.

        In the first case scenario (see Exhibit 64) we estimated the evolution of the average number of square meters growth of the Colombian business until 2025 confronting it with the average sales per square meter growth until the same date. Our current valuation assumes an average growth area for the next eight years of c.20% while we expect sales per square meter to grow at an average of 7.5% obtaining a stock price of EUR 17.50. If the new business, in a worst case

        Exhibit 64: Scenario Analysis Sales per sqm vs Area Growth

        Source: Nova Research Team scenario only provides a sales growth of 3% with an area growth of only 8% our price target decreases to less than EUR 13.4 per stock. With an average area growth equal or higher than 20% during the next 10 years accompanied by an average sales per sq meter higher than 7.5% for the same period, all else remaining equal, we anticipate a large appreciation of the company’s share, possibility of doubling its value.

        Exhibit 65: Scenario Analysis Sales per sqm growth vs EBITDA growth

        Source: Nova Research Team Another scenario is EBITDA margin evolution versus sales per sq meter growth.

        On the left side of Exhibit 65 we present two numbers. The first one concerns average growth of EBITDA margin from 2017 (the first year of positive margin) to 2025, while the second number represents the effective margin (in 2025) that would result from that growth. Hence, we estimated Jerónimo to be able to grow this indicator by an average of 8.7% reaching 6.2% in 2025. However, if revenues do not reach our expected growth and the margins, by that time, are still pressured by operating costs not being able to have a sustainable increase we anticipate a price target of EUR 14.87. In Exhibit 66 we can understand the impact of Colombia growth in our valuation. Our worst case scenario predicts this business to grow around 50bp above expected inflation that, depending on the discounting rate, provides a significant

        Exhibit 65: Scenario Analysis Colombian WACC vs Nominal Growth Rate

        Source: Nova Research Team price increase. Within our WACC range and if these operations grow 100bp above expected inflation we could expect an appreciation of more than 20% per share.

        Financials

      Financial Statements

        APPENDIX I

      • – EUR/PLN (white), USD/PLN (orange), Polish Public Debt (green)

      Disclosures and Disclaimer

        Research Recommendations Buy Expected total return (including dividends) of more than 15% over a 12-month period. Hold Expected total return (including dividends) between 0% and 15% over a 12-month period. Sell Expected negative total return (including dividends) over a 12-month period.

        

      This report was prepared by Madalena Felício, a student of the NOVA School of Business and

      Economics, following the Masters in Finance Equity Research

      • – Field Lab Work Project, exclusively

        

      for academic purposes. Thus, the author, which is a Masters in Finance student, is the sole

      responsible for the information and estimates contained herein and for the opinions expressed, which

      reflect exclusively his/her own personal judgement. This report was supervised by professor Rosário

      André (registered with Comissão do Mercado de Valores Mobiliários as financial analyst) who revised

      the valuation methodology and the financial model. All opinions and estimates are subject to change

        without notice. NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report nor for any consequences of its use. The information contained herein has been compiled by students from public sources believed to be reliable, but NOVA SBE or the students make no representation that it is accurate or complete, and accept no liability whatsoever for any direct or indirect loss resulting from the use of this report or its content. The author hereby certifies that the views expressed in this report accurately reflect his/her personal opinion about the subject company and its securities. He/she has not received or been promised any direct or indirect compensation for expressing the opinions or recommendation included in this report. The author of this report may have a position, or otherwise be interested, in transactions in securities which are directly or indirectly the subject of this report. NOVA SBE may have received compensation from the subject company during the last 12 months related to its fund raising program. Nevertheless, no compensation eventually received by NOVA SBE is in any way related to or dependent on the opinions expressed in this report. The Nova School of Business and Economics, though registered with Comissão do Mercado de Valores Mobiliários, does not deal for or otherwise offers any investment or intermediation services to market counterparties, private or intermediate customers. This report may not be reproduced, distributed or published without the explicit previous consent of its author, unless when used by NOVA SBE for academic purposes only. At any time, NOVA SBE may decide to suspend this report reproduction or distribution without further notice.

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