Brewery Sector Update : The forgotten stone now the stumbling block.   

03 December 2018: The competition in the brewery sector took a new turn over 2018, with the impact now becoming noticeable on earnings of analyst's coverage brewers. The financial results of Nigerian Breweries Plc (NB) and Guinness Nigeria Plc (Guinness) in the past quarter were disappointing, with NB reporting a loss after tax of N3.6 billion in its third fiscal quarter of 2018 (Q3 18) while Guinness reported a 37.3% YoY decline in earnings (excluding FX losses) in its first fiscal quarter of 20191 (FQ1 19). The weaker earnings for both companies reflects the stiff competition from International Breweries (IB) which not only impacted on beer volumes for NB and Guinness but limited their ability to raise prices considering higher excise duty rates. Following the poor earnings outturn by NB, analysts make downward revisions to their estimate for FY 18E and FY 19-23F. Specifically in 2018, analysts forecast FY 18E EPS at N2.87 (previous: N3.69) for NB, due to weaker margins from rising competition which has limited its ability for an upward adjustment in prices and higher operating costs.


For both NB and Guinness, analysts see limited scope for margin expansion in FY 19F. Analyst's view is based on IB’s unrelenting push to increase national presence and drive up its market share, supported by the recent capacity expansion (added ~2.5 million hectoliters) at its Shagamu plant. Accordingly, analysts expect pressured volumes for other sector players in the medium term. Also, the next phase of excise duty increase (+17%) is expected to commence in early 2019. The 17% hike will see beer and spirit excise duty rates rise to N0.35 (previous: N0.30) and N1.75 (previous: N1.50) respectively per centiliter. While analysts expect some price hike to protect already weak margins, analysts think the increase will not be sufficient enough to fully offset the excise duty increase given the still pressured consumer wallets as well as intense competition for market share in the sector. On the back of this, analysts forecast FY 19F EBIT margin of 12.9% (FY 18E: 12.6%) and 8.6% (FY 18: 9.4%) for NB and Guinness respectively. On net, analysts forecast FY 19F EPS of N2.97 (FY 18E: N2.87) and N3.54 (FY 18: N3.07) for NB and Guinness respectively.


Competition bites sector heavy weights. The intense competition in the brewery sector was majorly from an existing player – International breweries – whose cheap pricing strategy, strong mainstream products (Trophy and Hero) and new capacity of ~2.5 million hectoliters, enabled it to gain market presence in major regions in the country. With muted growth in the overall beer market over the period, this meant weaker volumes and loss of market share for NB and Guinness. Precisely, over the 9M 18 period, IB reported a double- digit growth in volumes, according to commentary from its parent company. On the other hand, NB’s volume declined high single digit. Analysts also estimate muted beer growth for Guinness over the same period. While analysts expect growth in the beer market to pick up in FY 20-23F hinged on their expectation for improved macroeconomic environment, analysts think volume share gain for NB and Guinness will be limited due to IB’s drive to gain substantial footprint in the country.


Beer price increase on the cards but won’t be enough: The next phase of hike in excise duty rates on alcohol is set to commence in January with an expected increase of 17% over the last reviewed rate. The 17% hike will see beer & stout excise rate rise to N0.35 (previous: N0.30) while spirits rise to N1.75 (previous: N1.50) per centiliter. Analysts recall that a 36% hike on excise duty rate for alcohol was implemented beginning June 2018 which led NB and Guinness to hike product prices by an average of 12%. However, the hikes were reversed due to weaker sales volume, after IB decided to leave prices unchanged on its mainstream products. As a result, gross margin over the nine-month period contracted for brewers – NB (-230bps YoY to 40%), Guinness2 (226bps to 32.4%) and IB (-10ppts to 34.5%). Given currently weak margins and expectation of further pressure from the hike in excise duty rates in January, analysts believe all sector players will pass-through the increase to consumers through higher product prices in a bid to protect margins. However, analysts do not expect a full pass-through given still pressured consumer wallets. Basically, given that IB absorbed the initial increase in excise duty, analysts only expect a slight adjustment to the additional 17% increase in excise duty starting January. As a result, analysts estimate price hike in the low double-digit range over 2019. Already, current gross margin level for NB, Guinness and IB are below their respective 5-year historical average of 46.7%, 41.5% and 46%.


Nigerian Breweries Plc (N76.58, SELL)


Earnings on track to touch an all-time low: Nigerian Breweries earnings over 9M 18 came in below analyst's expectation (EPS: N1.85 vs. ARM estimate of N2.52) due to higher cost of sales from rise in barley prices (+11.9%) and higher cost per unit with decreasing scale – a fallout of weaker volumes. Reflecting the heated competition and further declines in volumes into Q4 18, analysts forecast FY 18E revenue to decline by 6.8% YoY to N321 billion. As stated earlier, with IB’s relentless drive to build presence in Nigeria as well as support from its new capacity, analysts expect volume pressure for NB in the medium term. Hence, analysts have cut their medium-term revenue forecast by 2% on average, representing a 5-year CAGR of 4%. Mainstream and affordable beer currently account for 80% of the total beer volume and also the segment that is contributing the most to IB’s volume growth. Analysts believe NB can regain market share, by increasing its product portfolio in the mainstream beer category although, analysts think it’s a remote possibility given that it’s a premium company in line with the strategy of its parent company – Heineken. Recent premium product innovations in 2018 – Stella and Tiger beer – attests to this.


Analysts forecast FY 18E cost of sales to decline slower by 5.4% YoY to N190 billion due to rising barley price and loss of economies of scale. Accordingly, analysts forecast FY 18E gross margin at 40.8% (FY 17: 41.7%) and EBIT margin of 12.6% (FY 17: 17%). The steep decline in analysts EBIT margin forecast stems from higher operating expenses (OPEX to sales ratio of 28.4% vs. 26.3% in 9M 17), particularly marketing and distribution expenses which was elevated due to marketing campaigns during the world cup as well as its continued push to remain visible in the tough competitive environment. Over their forecast horizon, analysts project average EBIT margin of 15.7%, lower than 5- year historical EBIT average of 21%.


Overall, despite analysts's tamer net finance cost expectation of N6.6 billion (-37% YoY) – on account of lower FX losses – their forecasts translate to FY 18E and FY 19F EPS of N2.87 (FY 17: N4.13) and N2.97 respectively . In line with historical trend of 100% dividend payout, analysts forecast dividend yield of 3.4% and 3.5% respectively.


Following adjustments to their forecasts and having rolled forward their model, analysts cut their FVE on NB to N76.58 (previous: N121.30), translating to a SELL rating on the stock based on current pricing. On their numbers, NB trades at a 2019 P/E of 28.6x (5-year historical average of 24.5x) relative to Guinness of 20.9x.                                                                                                                                                                                                                                                                                           


Guinness Nigeria Plc (N73.96, SELL)


Operating picture remains weak, but lower FX losses will support earnings: Guinness Nigeria started its 2019 fiscal year on a slow note with earnings (excluding FX losses) down 37.3% YoY due to a 6.8% decline in revenue and slower decline in cost of sales (-2.8%). The decline in revenue reflects weaker sales volume and higher excise duty rates, in analyst's view. Irrespective, for the FY 19 period, analysts forecast a 1.5% YoY growth in revenue to N145 billion due largely to higher prices following the implementation of the new excise duty rates. Analysts also expect some support from increased spirits contribution to revenue, particularly its resilient locally produced mainstream spirits products. Management guides to 20% spirits contribution to revenue by 2020 from 15% contribution in FY 18. Over FY 19-23F, analysts forecast revenue to rise by a 5-year CAGR of 3.9%.


In line with NB, cost to sales ratio rose (+226bps YoY to 67.6%) in FQ1 19 which analysts attribute to the rise in barley price (+11.9%) and higher cost per unit due to loss of diseconomies of scale following weaker volumes. Taking this into account, with analyst's FY 19F cost to sales ratio forecast of 66.1%, analysts forecast cost of sales at N96 billion, representing a 1.7% YoY increase from FY 18. Accordingly, analysts forecast FY 19F gross margin at 33.7% and 35% on average over FY 20-23F, lower than 5-year historical gross margin average of 41.5%. Competition is expected to heat up further in the brewery sector, hence, analysts foresee higher operating costs majorly from higher marketing expenses. With analyst's OPEX to sales ratio forecast of 25.7% (FY 18: 25.1%), analysts project FY 19F EBIT margin at 8.6% (FY 18: 9.4%). Over their forecast horizon, analysts forecast EBIT margin of 9.7%, relatively unchanged from 5-year historical EBIT margin average of 10%.


Guinness Nigeria successfully completed N40 billion rights issue in its 2018 fiscal year. The bulk of the proceeds was used to pay down its foreign currency denominated loans which previously inflicted pressure on finance costs via higher interest expense and FX losses. Precisely, the company’s debt to equity as at FQ1 19 stands at 17% from 98% as at FY 17 respectively. With tamer debts, moderation in its FCY loans and stability in the currency, analysts forecast net finance cost to decline by 59.1% YoY to N2.3 billion in FY 19F.


Solely on account of lower net finance costs, which offsets pressures from revenue and higher input & operating costs, analysts forecast EPS of N3.54 and DPS of N2 in FY 19F. Following adjustments to their forecasts and having rolled forward their model, analysts cut their FVE on Guinness Nigeria to N73.96 (previous: N88.21), translating to a SELL rating on the stock based on current pricing. On their numbers, GUINNESS trades at a 2019 P/E of 20.9x (5-year historical P/E average of 25.5x) relative to NB of 28.6x.


Reporting for EasyKobo on Monday , 03 December 2018 in Lagos, Nigeria


Source: Damilola Olupona from ARM Securities Limited


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