INVESTMENT ADVISORY: Watching confectionary giants stumble

TESLIM SHITTA-BEY
There is a natural sense of satisfaction in being the biggest player in an industry renowned for fickleness. The Nigerian consumer products market is as fastidious as it is treacherous. Corporate behemoths like Nestle Nigeria Plc. (recent price N730.01), seem to have draped their arms around their businesses to turn them into phenomenal profit making machines, but their dominance comes at a cost. Nestle, the big Mac of Nigeria’s confectionary business is fast becoming a faltering giant.

Recent trade figures suggest that private spending on consumer retail goods has dropped steadily by an average of 15%on a compound annual basis over the last decade, but the impact of this secular decline in retail purchases has affected companies in rather different ways.  Nestle Plc, Nigeria’s largest confectionary firm, operates as a near monopoly in certain market segments, particularly the baby food market where its iconic brands, Golden Morn, Cerelac, Nutrend, Lactogen and NAN almost exclusively dominate the market space; but the company has had less of the play of the market when it comes to the confectionary business where it has had to fight toe to toe with smaller competitors and perhaps a fairly sizeable rival in Cadbury Nigeria Plc.

A good number of analysts recall with nostalgia the intense battles fought between Nestle and Cadbury in the confectionary business in the early 1980’s to mid- 1990’s when both companies slugged it out pound for pound, and toe to toe, but since the turn of the millennium Cadbury has been a slim shadow of its feisty self, creating unexpected opportunity for Nestle to gain and retain a commanding dominance of the local food and beverages market.

Grace Nkwocha, a 38 year old mother of two, who retails food seasoning and beverages at the popular Ereko market in Lagos notes that, ”In the eighties we used to sell equal number of cartons of Bournvita(a Cadbury brand) and Milo (a Nestle brand) a week, but today we generally sell about four times more cartons of Milo per week than Bournvita. The days of queuing up at Cadbury’s Ikeja factory have long since disappeared”.

This explains why Nestle Plc. currently trades at a factor of 88 times the value of Cadbury (recent price N9.00).

‘’This is not really a story of a David going up against a Goliath” says David Adorni, a leading stock broker and chief executive officer, ”it is increasingly becoming a tale of a Gulliver crushing a Lilliputian. Nestle is not just leading Cadbury in the confectionary wars, it is dusting it without even a trace of its tail lights”.

Comparing the two companies revenue figures for 2016, Nestle rustled up an impressive net sales figure of N133.1b and generated net operating income of N 27.8b translating to a profit margin of 21 per cent while Cadbury on the other hand grew net sales to N35.8b (up from N33.6b in 2015), and hammered out an operating income of N5.7b to give a profit margin of 16% or 5% lower than Nestlé’s figure.

Obviously Nestle carries the bigger punch in Nigeria’s food and confectionary business, but investors are increasingly wary of its high market price. The company is presently the most highly priced individual stock on the exchange. Confronted by a stingier business environment analysts are already balking at the company’s market value.

Over the last five years the company’s after tax profit has grown by a stunning 23% on a compound annual basis. Using an old (and probably forgotten) Securities & Exchange Commission (SEC)equity valuation method known as maintainable earnings; Nestles supposed ‘fair’ market price could be put at N 228.26 (assuming an industry capitalization rate of 3% or what is equivalent to a p/e of 33, as against the company’s current twelve month trailing p/e of 72.9).

Applying a bit of freshman college arithmetic shows that the after tax income of the company over the last five years, produces a weighted average maintainable earnings per share of N777.68 (at a p/e of 33).

This is about 22% lower than the company’s current market price and indicates a profit making opportunity of at least N200.

” You could love Nestle for its size and perhaps its consistent earnings” says Peter Folorunsho, Chief executive officer of Investment firm, freewill Nigeria Limited, ”but you must also be worried by its staggering price”.

Indeed the company’s price to earnings (p/e) ratio of 72.98 (compared to Cadbury’s 67.33) implies a capitalization rate of 1.4 %.

With domestic inflation galloping at a merry 18.77% per annum, the firms real rate of return is minus 17.3%,”You need to be thick in the head or suffer from post-marijuana cognitive disorder to think that Nestle is a good buy at current market value,” Says Folorunsho.

Nestlé’s strong operating cash flow and huge cash balances (N13.7b in 2016 up from N3.8b in 2015) makes it a superb candidate for long term investment consideration, but its current price of N730.01 is far from what local investors would call an,  ‘attractive pitch’.

Indeed, analysts reckon that the company should offer bonus shares to existing equity holders to reduce its earnings per share (eps)and cut back its market price by at least a third of its current value or simply pay higher dividends to hack down its post dividend valuation. In other words, no matter how strong this corporate Goliath appears, its major challenge is not a David with a sling; but the clunky weight of its own armour.