(Company analysis) Packaged consumer good’s market: Can Nestle hold the lead?

By TESLIM SHITA-BEY

When Nestle Nigeria Plc’s stock soared like a cormorant in November 2014, it traded at a staggering N1, 249; four months after the global crude oil market went into a tailspin and sent international oil prices into free fall. By November 2015 the consumer packed goods (CPG’s) giant had seen its market price take a nasty 35 per cent tumble sliding to N810. In 2016 the stock price hardly did better as it sashayed between a low of N755 in June and a high of N820 in December. By February 2017 the company went into convulsive shock as it slumped by a thumping 30 per cent skidding from N810 in January to N570 in February before bouncing back up to N734 by March. ‘Nestle share price currently at N835 has been tossing about like a rudderless boat for more than five months; the problem has been that investors are undecided about the company’s underlying strength, at a price to earnings ratio (P/E) of 65.82 the stock still looks steeply priced’ notes Oluwarinu Olawale of stock broking house, Capital Express Securities.

However, a dipping stock price is the least of Nestlé’s worries. Nigeria’s largest PCG Company has had a truckload of challenges that have constrained corporate performance.  One of the company’s major problems is the creeping growth in its direct cost of production. A tumbling of the foreign exchange value of the naira in 2016 resulted in the company’s cost of sales rising from 55 per cent of its gross earnings in 2015 to two fifths or 59 per cent of sales in 2016. This has meant that gross profit margins have been pressed down from 45 per cent in 2015 to 41 per cent in the contemporary period of the following year, 2016. The underlying difficulties in containing costs may be no less pronounced in 2017 as there are only slim chances of exchange rate improvement in course of the year.

First quarter figures for 2017 have shown gross margins still struggling to claw their way back up the ladder as profit margins flipped downwards from 49 per cent in Q1 2016 to 38 per cent in Q1 2017, a painful slide of 22.4 per cent. This was despite a 69 per cent growth in gross revenues year on year from N36.1 billion in Q1 2016 to N61.2 billion in Q1 2017. Cost of sales equally jumped higher rising from N18.4 billion in Q1 2016 to N37.7 billion in Q1 2017, a leap of 105.3 per cent. Nobody envy’s Nestle. Spiraling costs and rising inventories (suggesting difficulties in selling finished goods) is ripping its profit and loss account apart.

Inventories rose 7 per cent between Q1 2016 and Q1 2017 with stocks of finished and semi-finished goods rising from N20.6 billion in 2016 to N22.1 billion in 2017. Thankfully this was a lot better that the huge piles of unsold goods staked by the baby food manufacturer between 2015 and 2016, when inventories rose from N10.8 billion in 2015 yearend to N20.6 billion by yearend 2016, a doubling of goods kept in the company’s warehouses. The slow year end movements of stocks also badly affected the company’s liquidity as bundles of cash got tied up in goods with no buyers.

A peep at the profit jar  

Nestlé’s unaudited books, nevertheless, still throw up a few pleasant surprises. The company’s Q1 2017 operating profits bounced joyfully to N13.2 billion in 2017 up from N9 billion in Q1 2016, representing a year on year growth of 47 per cent. Interestingly, much of that income growth came from a surge in sales and not a fall in costs. As sales went up so also did costs. However, the confectioner kept a tight lid over sales and distribution costs which grew by 19 per cent, while administrative expenses rose by a trimmer 11 per cent.    But just before hitting the big numbers at profit before tax Nestlé’s books show what has been called a ‘switcheroo’, a bit of fancy accounting gimmickry.  In Q1 2016 the company had a relatively immaterial income from financing activities of N480 million with a finance expense of N780 million which created a financing activity loss of N300million. By Q1 2017 the tables were turned. Nestle wangled a stunning finance income of N2.6 billion with a finance expense of N1.5 billion leaving a net finance surplus in excesses of one billion naira or 7 per cent of its published profit before tax. What analysts have found equally interesting is the fact that Nestle had an absolutely horrible first quarter in respect of foreign exchange management.

As the Central Bank of Nigeria’s monetary policy measures steered the US dollar to naira exchange rate around, the naira started gaining value and Nestle Nigeria’s books started bleeding losses. The first quarter saw the company suffer a foreign currency loss of N1.03 billion, a far cry from the N16.11million currency loss of the comparable period in 2016. The company’s finance expenses also lunged dangerously in Q1. The company’s finance expenses rose from N780.3 million in Q1 2016 to N1.53 billion in Q1 2017, or a growth in financing costs of 96 per cent. ‘If we consider foreign currency losses and finance costs alone and held finance income at the previous year’s level, Nestle would have had a Q1, 2017 that would have left everyone in tears, least of all shareholders’ observes Segun Atere, Investment strategist at Imperial Finance. According to Atere, ‘Nestle clearly has short term finance problems and even though it is making money from deposit placements, the company is a manufacturer and not a finance company so it should be more concerned about underlying profitability in its core business. So far manufacturing seems to be a trade for motley fools’.

In yearend 2016 the company’s finance charge was N20.9 billion or 327 per cent higher than the N4.9billion it posted a year earlier in 2015. Its finance income also scampered to a staggering N4.2 billion up from N444 million in 2015. In other words a lot of Nestles recent improved performance has come more from its accounts rather than its sales department; a sign that the sweet chocolate profits that were once the desert of the company’s sales and marketing managers are fast disappearing.

A season of cash

As profits become dodgier, the company’s assets also appear different in composition. In 2016 inventories (or the stock of goods the company keeps for production) spiraled from N10.8 billion in 2015 to N20.6 billion. Reflecting the dire impact a fall in disposable income was having on the ability of the company to grow its sales. But the company has been able to push up cash and cash equivalents which grew from N12.9 billion in 2015 to N51.4 billion in 2016, a rise of 298 per cent. This indicates that the company is operating at a higher level of liquidity making it easier for it to meet short term obligations. This in a sense is quite good but it does have its downside. Excessive cash could also mean that the company is not using its short term assets as efficiently as it should. However, this may not be the case here as the company made a tidy bundle from its short term investment activities that saw its interest income soar in the course of the year.

It is not certain that 2017 will follow the same pattern. Judging by Q1 figures for 2017 inventories rose by only a mild 10 per cent from N20.6 billion in Q1 2016 to N22.1 billion Q1 2017. Cash and cash equivalents rose from N57.4 billion in Q1 2016 to N68.4 billion in Q1 2017, a growth of 33 per cent. In other words the company’s balance sheet may appear a little more conventional in 2017 than it was last year.

On the other hand, working capital is a different kettle of fish. Hopefully the company will be able to reverse its pallid working capital position which was -N23.3 billion in Q1 2016 but fell to -N9.9 billion in Q1 2017, a major 57.5 per cent improvement. If the trend continues the company could hold back interest expenses and fatten its operating bottom line. An outcome several investors would like to see.

Liquidity …when cash is no longer king

Oddly, Nestlé’s growing cash mountain has not deterred its liquidity headaches. The company’s current asset as a proportion of current liabilities in Q1 2017 was 0.92 or 15 per cent higher than the 0.80 in Q1 of 2016. In other words the company’s liquidity has been rising but from a relatively low base. Most manufacturing companies would prefer to have liquid assets at least twice the size of their shorter term liabilities, Nestles figures which show ratios below one in both quarters give a sense of lean liquidity and tightness in the company’s short term financial operations. If interest rates rise in 2017 (as they could if the government fails to find external loans to cover the year’s fiscal deficit) then the company could find itself in cold waters. A rise in interest rate would crush operating profit gains unless interest income rises much faster than interest expenses. Besides, turnover needs to do better to enable the company pay down on loans and free up operations from meeting borrowing obligations.

Debt takes no prisoners

Borrowing will have to come down heavily in 2017 if the company has any serious hopes of appreciably improving earnings. Finance expenses has hitherto over the last two years taken a major toll on profit with loans and borrowings soaking up 27 per cent of current liabilities behind trade and other payables at 57 per cent. Admittedly borrowing as a proportion of current liabilities have begun to fall as Q1 2016 saw loans constitute 33 per cent of short term liabilities. The food beverage maker also needs to clean up its tax obligations or liabilities to the fiscal authorities. Although profit before tax rose by 56 per cent between Q1 2016 and Q1 2017 tax obligations recognized in the profit and loss statement flew by an unusual 189 per cent. Apparently the company did not charge tax on certain earnings in the past and more recent reconciliation with the authorities required it to provide an additional N2billion in tax liabilities. This may not happen again within the year and could be seen as a one off charge to profit.

 Looking ahead

Nestle may have to rethink is overall business strategy going forward. The fall in real consumer incomes has made it difficult for buyers of Nestles product to afford some of the premium prices they paid for items ranging from Milo food beverage, Nescafe instant coffee to Maggi seasoning cubes and products such as ‘Cerelac’ and ‘NAN’ formula food for babies and ’Golden Morn’ cereal. Nigerians with purses pierced by recession have traded down by buying cheaper local substitutes.

It might be true that in the various product segments that Nestle has chosen to play it remains a market leader, but that lead is becoming increasingly tenuous as smaller companies are providing cheaper even if (in some cases) inferior substitutes. The average middle and lower class Nigerian consumer is more interested in survival at lower costs than at keeping up with the Joneses. Nestlé’s food seasoning supremo, Maggi, which was once the generic name for food flavouring has since been relegated to a more modest market share by rivals such as Unilever’s Knorr and ‘Royco’ brands and indigenous company Doyin group’s, ‘Doyin cube’ and Promasidor’s seasoning powder ‘Onga’. The food seasoning business in Nigeria involves roughly 5,500 tonnes of food condiments consumed annually with a market value of N14.7 trillion.

The market has become vicious with the different players engaged in fierce territorial wars to retain top-of-the-mind control of consumer preferences. The market is essentially ‘oligopolistic’ or one that is dominated by a few producers who have absolutely no inclination to collude on prices as the name of the game, at least for now, appears to be market share dominance.

Nestle is facing similar onslaughts in other market segments. Younger (and even older) companies are coming in to snatch slices of its various businesses. Wyeth Nutrition is taking on Nestle with its reformulated SMA infant food formula to wrestle market share from Nestle brands like NAN and Cerelac.  SMA is no new kid on the bloc the brand is 102 years old and was once the brand of choice amongst Nigerian mothers of the 1970’s and 1980’s era. Mothers that cannot afford these packaged goods have resorted to soya beans and corn pap or a mixture of both with, in some instances, grounded fish or ginger for slightly older children.

Going forward Nestle will find itself under intense pressure to hold market share across its product segments as more competitors come into the market and consumer’s leaner pockets dictate a change in buying pattern and a reordering of consumption priorities. The Bible talks about the race not being to the swiftest nor the battle to the strongest, but time and chance happening to them all. Nestle is finding this out a bit late in the day.

Maurico Alarcon-MD Nestle Nigeria

Source: Nestle Nigeria Plc, Audited Annual Accounts, 2017f Business Hallmark forecast

Source: Nestle Nigeria Plc, Audited Annual Accounts, 2017f Business Hallmark forecast

Source: Nestle Nigeria Plc, Audited Annual Accounts, 2017f Business Hallmark forecast

Source: Nestle Nigeria Plc, Audited Annual Accounts, 2017f Business Hallmark forecast