…say CBN’s FX restriction on milk importation to impact performance
By JULIUS ALAGBE
Analysts at WSTC Financial Service limited, formerly Wall Street Trust Company has downgraded Nestlé Nigeria Plc, citing potential impact of the Central Bank of Nigeria’s restriction of access to forex for milk importation which is a major ingredient in some of its products just as competition bites in the fast moving consumers’ goods (FMCG).
With market capitalisation of N1.03 trillion, Nestle stock has plunged more than 20% year to date. At the closing price of N1, 299.50 on July 30, 2019, WSTC Financial said that the stock is currently trading at 15% premium to its fair value estimate.
However, in the first half of 2019, Nestle Nigeria Plc maintained a 5% growth in top-line from N135.29 billion recorded in first half of 2018 (HY1’18), to N141.91 billion.
The company’s cost of sales declined by the same rate of 5% from N79.72 billion in H1’18, to N75.83 billion in HY1’19, thereby resulting in an impressive growth of 19% in gross profit, from N55.57 billion in HY1’18 to N66.01 billion in HY1’19.
In a similar trend, operating income rose by 26%, from N32.2 billion in HY1’18 to N40.4 billion in HY1’19.
This sterling performance strengthened the bottom line. Nestlé’s profit before tax grew by 27%, from N31.9 billion in HY1’18 to N40.4 billion in H1’19 while profit after tax grew by 22%, from N21.5 billion in HY1’18 to N26.2 billion in HY1’19.
Moderate growth amid rising competition
Nestle sustained its earnings growth amidst a relatively challenging operating environment, analysts at WSTC Financial reckoned. They stated that revenue growth of 5% from N135.29 billion, recorded in HY1’18 to N141.91 billion in HY1’19, was predominantly made up of sales in the domestic markets.
Revenue increased by 5% in the Nigerian market, from N133.69 billion in HY1’18 to N139.77 billion in HY1’19; while exports sales spiked by 33% to N2.14 billion, from N1.61 billion in HY1’18. Analysts said that due to the meager 2% contribution of export sales to the Group’s total revenue, the growth in the export sales did not amount to a significant impact on the top line.
Cost of sales declined by 5% year-on-year, from N79.72 billion in HY1’18 to N75.83 billion in HY1’19; which underscores the operating efficiency of the Group.
A combination of an increase in top line and a decline in cost of sales resulted in a gross profit increase of 19% year-on-year.
Amid increased competition in the markets, Nestlé’s marketing and administrative expenses increased by 12% year-on-year, from N19.03 billion in HY1’19 to N21.28 billion in HY1’19. On the other hand, administrative expense declined by 1% year-on-year, from N4.39 billion in HY1’19 to N4.37 billion in HY1’19.
Although administrative expenses decreased by 9% in the first quarter, an 8% increase in administrative expenses in the second quarter eroded the cost savings made in the first quarter. Overall, operating expenses grew by 9% year-on-year, with increases in marketing expenses as the primary driver.
Lower finance cost boosts bottom line
Buoyed by faster growth of 19% in operating income, relative to the 9% increase in operating expense, operating profit grew by 26% year-on-year, from N32.15bn in HY1’18 to N40.43 billion in HY1’19. Also, owing to a lower finance cost during the period, from N1. 12 billion in HY1’18 to N888.68 million in HY1’19, profit before tax grew by 27%.
Profit after tax, however, increased by 22%, from N21.46 billion in HY1’18 to N26.25 billion in HY1’19. The slower rate of 22% growth in profit after tax, relative to 27% growth in profit before tax was due to a higher effective tax rate of 35% in HY1’19 as against 33% in HY1’18.
Cash flows hit by faster payments to vendors and suppliers
The Group generated N26.76bn cash in HY1’19, relative to N50.35bn cash generated in the corresponding period of the previous year. The 47% decline in cash generated was primarily due to an already made payment of N9.43 billion to suppliers in HY1’19, in which N19.52 billion was outstanding (i.e. yet to be paid) in the corresponding period of the previous year.
Cash flows from investing activities remained flat at N1.62bn in HY1’19, mainly from finance income of N891.10 million compared with N838.16mn in HY1’18, and capital expenditure of N2.56 billion as against N2.52 billion in H1’18 invested during the period. Cash flows used in financing activities stood at N32.17 billion during the period, mainly resulting from the N30.75 billion, it was N30 billion in HY1’18, payment of final dividend of the 2018 financial year.
Consequently, the increase in cash and cash equivalents was negative at N7.039 billion, which resulted in ending cash balance at HY1’19 end to N7.33 billion, having started the year with a cash position of N14.37 billion.
In its review, WSTC Financial said that the released HY1’19 result was relatively in line with its estimates as at Q1’19. However, “we lower our revenue growth forecast to 5% for FY’19 compared with 7% previously estimated, owing to increased competition and rising pressure in consumer demand.
“Nonetheless, we expect the Group to leverage its operating efficiency in cost of sales, although we maintain that the Group will incur higher operating expenses in HY2’19, to boost the bottom line.
“Consequently, we project a FY’19 revenue and profit before tax of N279.59 billion and N70.65 billion respectively. We also expect the Group to report a profit after tax of N51.49 billion”, WSTC Financial stated.
WSTC Financial said, “We downgrade our rating on Nestle, on the back of weaker, but stable, revenue growth in the near to medium term. Also, a potential loss of market share, resulting from increased competition, a potential impact of CBN policy on forex restriction for milk importation; which is a major ingredient in some products, and weak demand”.
The firm stated that apart from these, there is dim macroeconomic outlook, thereby resulting in increased unemployment, lower income and which by extension, is expected to result to lower demand. In addition, there is reduction in cash flows generation, with the assumption that there will be no material upward adjustments in prices, following heightened competition in the market.
“Consequently, we cut our growth outlook for Nestle Nigeria Plc in the near to medium term. Using a blend of Free Cash Flow Valuation, Dividend Discount Model, and Residual Income Model valuation methodologies, we arrive at a fair value of N1, 100.02.
“At the closing price of N1, 299.50 on July 30, 2019, the stock is currently trading at 15% premium to our fair value estimate. Hence, we revise our recommendation to SELL”, WSTC Financial affirmed position.