Nestle Nigeria Plc: Impressive earnings outlook, expensive valuation   

21 November 2018 : Nestle’s 9M 18 result was decent and broadly in line with analyst's expectation. The only surprise was on the interest expense which came in higher than expectation and already tracking higher than analyst's FY 18 estimate. Accordingly, analysts revise their FY 18E earnings forecast lower by 5% to N56.82 after adjusting interest expense higher for the rest of the year. Farther out, analysts raise their EPS expectation over their forecast horizon (FY 19-23F) by 2.6% on average following moderation to their cost of sales ratio. Analysts have observed improvement in gross margin (excluding impairments) since Q1 18 helped by the stability in FX and moderation in domestic cereal prices. Following adjustments and having rolled forward their model, analysts raised their FVE on Nestle to N1,330.35 (previous: N1,287.54) but maintain their SELL rating on the stock. On their numbers, Nestle trades at a 2019 P/E of 21.7x compared to 5-year historical average of 27.3x and Bloomberg MENA peer average of 24.7x.


Food Segment to drive sales: Revenue growth over the nine- month period has been decent (+9.7% YoY). However, analysts are concerned about the recent downturn in Nestle’s beverage segment which declined 1.3% YoY after rising double-digit in Q1 and Q2. In their initial view on Nestle’s 9M 18 result, analysts attributed the decline to possible loss of volumes following the 6% price increase on beverage products. Given this, as well as slight underperformance of their 9M 18 revenue estimate, analysts revise their FY 18E revenue forecast lower by 0.8% to N272 billion with the festive season and strong performance in the food division (key products - Maggi and Golden Morn) expected to support topline in Q4 18F. Over their forecast horizon, analysts have left their revenue forecast unchanged. The implementation of the 67% hike in minimum wage is looking more possible in 2019 and analysts expect this alongside Nestle’s strong market presence to support volumes and revenue growth.


While analysts have maintained their cost to sales ratio forecast for FY 18E, analysts lowered the ratio over their forecast horizon to average 53.8% (previous: 54.2%) based on their expectation of a further increase to its local content and moderation in domestic commodity prices. Precisely, over the nine-month period, cost to sales ratio (excluding impairments1) moderated to 55.4% in 9M 18 vs. 59% in 9M 17 which in turn led gross margin (excluding impairments) to expand 364bps to 44.6%, higher than 5-year historical average of 42.5%. Analysts believe much of this reflects its increased local raw material sourcing (currently at 80%) alongside tamer prices for Maize, Sorghum and Palm Olein. The company is also committed towards increasing its local content beyond current levels which informed analyst's moderation in cost to sales ratio and gross margin estimate of 46.2% on average over their forecast horizon.


With analyst's OPEX to sales ratio of 18.7% in FY 18E and 19% over their forecast horizon, analysts project EBITDA margin of 28.7% in FY 18 and 29.7% on average in FY 19-23F, higher than 5-year historical EBITDA margin average of 25%.


Lower FCY loans to drive moderation in finance cost: Nestle’s total FCY debt currently stands at $41.2 million with $26 million due to be paid in 2018. With the FX debt already value dat~N360/$ on its balance sheet and their expectation of exchange rate stability, analysts do not envisage any material FX loss if the amount is fully settled in Q4 18. Analysts further highlight that as at 9M 18, Nestle has a net position of N15.7 billion, indicating its ability to sufficiently meet its debt obligations. Given this alongside upward review of their interest expense forecast following the surprise in Q3 18, analysts project finance expense of N3.2 billion (FY 17: N15.1 billion) in FY 18E. With the exchange rate stability and sizeable moderation in FX debt (-60% since 9M 17), their expectation going forward is for finance costs to be more reflective of interest expense rather than FX losses which materially impacted on earnings in FY 16 and FY 17.


Net impact of the above translates to an EPS of N56.89 and N68.58 in FY 18E and FY 19F. Over their forecast horizon, analysts project EPS to rise by a 5-year CAGR of 9.4%. In line with historical trend, analysts expect 100% dividend payout which translates to an expected dividend yield of 3.8% and 4.7% in FY 18E and FY 19F respectively based on the stock current market price.


Following revision to their forecasts and having rolled forward their model, analysts raise their FVE to N1,330.35 (previous: N1,287.54) which implies an 11.3% discount to current pricing thus, analysts maintain their SELL recommendation on the stock. On their numbers, Nestle trades at a 2019 P/E of 21.7x compared to 5-year historical average of 27.3x and Bloomberg MENA peer average of 24.7x.


Reporting for EasyKobo on Wednesday , 21 November 2018 in Lagos, Nigeria


Source: Olamide Adeboboye from ARM Securities Limited


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