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  • At N5, Stock trades at premium

By JULIUS ALAGBE

International Breweries Plc, IntBrew, had been in troubled water long before COVID-19 outbreak, but the lockdown may have aggravated its situation. Experts seem to be raising the red flag over the stock that may no longer be able to deliver as its woes continue.

Analysts WSTC Securities Limited have advised investors to dump Interbrew stock as it dubbed the company a fish in trouble water. Taking stock of the financial statement, it was observed that the brewer that came into Nigeria’s market as a challenger has not been able to record profit in three consecutive years.

The brewer’s loss-making streak is due to its bloated operating expenses, competition and foreign exchange pressures among other operating issues. At ₦5 per share, IntBrew market capitalisation settled at ₦134.310 billion on 26,862,068,550 shares outstanding.

Analysts explained that when the global brewer, Anheuser-Busch InBev (ABInBev) considered expanding its business operations in the largest economy and the largest market in Africa, it possibly assessed the market potentials that the market holds.

“Characterised by a rapidly growing population, with a median age of 18, and a very low beer consumption per capita relative to peers; the Nigerian market seemed to present a lot of opportunities for investment”, the firm stated.

WSTC stated that the assessment presumably resulted in the entry of ABInBev. According to the firm, it stated that the entry came in the form of direct and indirect acquisitions of three breweries: Rivers state’s Pabod Breweries, Intafact Breweries, and International Breweries.

However, following the acquisitions, the three brewing companies were merged to one, with International Breweries as the surviving entity. Analysts stated that the successful merger in 2017 marked the beginning of a dynamic change in the breweries industry in Nigeria.

Following the successful merger, the Company embarked on a large-scale investment and aggressive growth activities. It commenced the construction of what would be the biggest brewery in West Africa – the Gateway brewery at Sagamu. The Company gave other big players in the industry a run for their money, especially on its value brand ‘Trophy’.

Coincidentally, WSTC explained that the entry of ABInbev in the Nigerian market coincided with a period where consumer expenditure was recovering, owing to the economic recession in 2016 which took its toll on household income and consumption. At that point, consumers down traded and consumed more goods with low pricing points.

Analysts at WSTC believe that the Company’s products found their way to consumers’ heart through this growth approach. Meanwhile, there were bottlenecks, analyst remarked.

According to analysts’ note, the aggressive growth strategy and increased investments by the Company resulted in significantly higher operating expenses, high leverage, and by extension weak margins. Analysts stated that the brewer, since its merger, has not reported any profit.

Losses before tax stood at ₦3.23 billion in the financial year 2017. Then, it worsened in 2018 to ₦8.12 billion and further worsened in FY’19 to ₦36.17 billion.

WSTC believed that the huge losses majorly resulted from higher operating expenses and higher finance costs. Furthermore, the cash flows generation trend of the brewer has been relatively unimpressive, owing to weak operating cash flows and haemorrhaging of margins.

Analysts said they also note the persistent working capital deficit of the company and the significant disparity between its long-term funds and long-term assets. The implication of the disparity is on the solvency and high financial risk of the company, analysts said.

To this end, the company’s management resolved to raise equity capital which it recently concluded, to deleverage and improve its capital structure. Beyond the internal operations of the company, the potentials of the brewing industries are hampered by external factors in the operating environment.

“In our view, this could limit the potentials of the industries”, analysts at WSTC posit.

Some of the bottlenecks faced by the company include weak consumer demand due to declining purchasing power, regulatory issues, and high cost of doing business.

In June 2018, a new policy on excise duty was implemented which saw an average of 34% increase in excise duties between 2018 and 2020. By default, analysts explained that the impact of higher excise duty should be reflected on prices of products. However, analysts stated that the brewing industry in Nigeria is characterised by high buyers’ power.

Also, given that brewery products are relatively elastic and are also discretionary goods, it was a herculean task to pass the cost directly to consumers, especially considering the heightened competition in the industry. Hence, the margins took the hit as a result.

“Although the management of the Company remains bullish about the prospects of the Nigerian markets and asserts that it is in for the long-term play, we are cautious about the uncertainty that the future holds in the brewing industry”, WSTC stated.

Nonetheless, the brewer has been able to significantly grow market share from 7% pre-merger to 24% post-merger.

Financial Performance in Q1’20

International Breweries revenue grew by 1% year-on-year from ₦35.09 billion in Q1’19 to ₦35.35bn in Q1’20. Cost of sales, however, rose by 12% in the same period, from ₦35.09 billion in Q1’19 to ₦35.35 billion in Q1’20. As a result, the cost margin rose by 800 basis points from 75% in Q1’19 to 83% in Q1’20.

This development reinforces the notion of the inability of the company to pass increased costs to consumers. WSTC highlighted that raw material costs increased by 13%, from ₦20.09 billion in Q1’19 to ₦22.61 billion in Q1’20. Consequent to the higher cost margin in Q1’20, gross profit dipped by 31% year on year from ₦8.95 billion to ₦6.17 billion.

Analysts stated that international breweries made a gain of ₦4.54 billion on derivative contracts during the period. Therefore, the company’s income line was supported by these derivatives gains.

However, the brewer yet recorded a ₦9.94 billion foreign exchange loss during the period, resulting from the exchange rate devaluation recently implemented by the Central Bank of Nigeria (CBN). Analysts said the company had significant FX exposure on its borrowings and payables.

Meanwhile, in a bid to protect margins, the International Breweries incurred a lower operating expense of ₦8.56 billion in Q1’20, representing a 3% decline from ₦8.82 billion in Q1’19. But the significant FX losses put a damper on the bottom line, WSTC held.

The brewer’s unaudited financial statement showed that operating losses worsened from ₦232.85 million in Q1’19 to ₦8.04 billion in Q1’20.

WSTC said: “To understand what could have been the true earnings position of the company had it not incurred an FX loss, we discounted the FX losses and the derivatives gains in both comparable years.

“By doing so, the company could have still reported an operating loss of ₦2.64 billion. This is so because of an operating expense of ₦8.56 billion relative to an operating income of ₦5.92 billion”.

Hence, analysts explained that they see another indicator of eroded profits due to higher cost of sales which could not be passed on to consumers. WSTC noted that capital raise reflected, but was unable to drive bottom-line growth in the period. The firm explained that finance cost declined by 81%, from ₦5.09 billion in Q1’19 to ₦984.21 million in Q1’20.

Analysts attributed this to the equity capital raised during the period to pay down debts on its books. On a year-on-year basis, total borrowings declined by 15% from an average of ₦221.02 billion in Q1’19 to ₦186.78 billion in Q1’20.

However, the gains of a lower finance cost were not enough to change the narrative due to the higher cost of sales incurred during the period, analysts remarked. On the other hand, finance income grew from ₦511 million in Q1’19 to ₦1.33 billion in Q1’20, due to higher cash position resulting from its recent equity raise.

Nonetheless, the losses of the company increased, reflected by the higher losses before tax of ₦7.69 billion in Q1’20, from a loss of ₦5.32bn in Q1’19. Losses after tax also increased by 42%, from a loss of ₦3.98 billion in Q1’19 to a loss of ₦5.65 billion in Q1’20.

Outlook

Analysts at WSTC have a weak growth outlook for International Breweries, especially amid the COVID-19 pandemic in the economy, which resulted in the closure of bars, hotels, and generally a lockdown in the economy.

“The economic implications are very pronounced for the brewing industry, due to the disruption in the supply chain as well as a potential loss of income by consumers thus, further weakening consumer demand”, analysts explained.

WSTC Securities, therefore, expects cash flows to be severely under pressure in FY’20.

“Although given the current state of the pandemic in Nigeria, we believe that the full impact cannot be measured yet, however, we think that economic recovery post-COVID will be very slow.

“In our view, the ability of companies who are directly affected by the pandemic to survive the storm depends on the working capital sufficiency and strong capitalization of companies.

“While we understand that the recent capital raise of the company provided buffers in terms of capitalisation, the brewer’s working capital is deficient, and might have to resort to increased short-term debt financing again to stay afloat”, analysts stated.

In its estimate for 2020, WSTC stated that it expects International Breweries to report losses in FY’20. It said the company’s average five-year return on equity (ROE) is estimated at -36% and analysts do not expect any dividends in FY’20.

“We estimate a fair value of ₦3.56 for the stock, which implies a 29% discount to the current market price of ₦5.00. We do not see any significant growth driver on the stock in the near to mid-term”, analysts at WSTC stated.

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