Guinness Nigeria Plc: A differentiation play   

Feb 7 (Lagos) - Following the release of the FH1 19 earnings, we paid a visit to the Guinness brewing plant in Ogba Lagos where we engaged the management of Guinness Nigeria Plc to understand the drivers of earnings over its half-year 20191 and get insight into the outlook of the firm over the rest of the year.

No doubt, the ongoing contest for market share in the brewery sector has started taking a toll on margins for major sector players. This largely accounts for lackluster earnings performance of Nigerian Breweries (NB) and Guinness over the past few quarters. 

However, beaming our lights on the sector, we noticed flashes of differentiation which points towards a soft landing for Guinness compared to NB. To buttress, while the industry rivalry is expected to drive an 88bps plunge in FY 18E gross margin for NB, the wider portfolio mixes of Guinness which harbors Spirits provides a partial cover for Guinness gross margin (FY 19E: -31bps YoY to 33.7%). More so, reflecting lower finance cost for Guinness after recent deleveraging on FCY debt using proceeds from rights issue, we see improved profitability for the brewer. Hence, whilst we have a SELL rating on NB, we see upside opportunity (19% upside) for investors in Guinness with FVE of N77.31 which translates to an OVERWEIGHT rating on the stock. On our numbers, GUINNESS currently trades at a P/E of 18.23x relative to
26.08x and 24.5x for NB and Bloomberg MENA peers respectively.

Industry competition bites topline: As expected, following the ongoing bout for market
share in the Brewery sector, Guinness revenue contracted (-3.9% YoY to N67.7 billion) over
the period largely on the back of slower growth in Lager and Ready to drink (RTD) volumes.

In fact, the milder plunge in revenues reflects increased participation in APNADs (Adult
premium nonalcoholic drinks) and spirits (mainstream and premium) whose contribution to
revenue increased to 18% from 15% as at FY 18. For clarity, management stated that
excluding lager, overall volumes grew 4% but fell 13% with lager inclusive. In its spirits
segment, Bitters and Gin were the biggest contributors to revenue with a combined volume
and revenue share of 58.1% and 53.5% respectively.

• Lower finance expense provides respite: In addition, Guinness Nigeria Plc enjoyed the
benefits of a deleveraged balance sheet over the first half of its 2019 financial year (July –
December 2018), with EPS expanding 23% YoY to N2.58 billion. 

For clarity, while operating performance remained pressured by the ongoing industry competition, the improved earnings largely stemmed from a sharp drop in finance cost (-67.9% YoY to N1.54 billion) following the reduction of its foreign currency denominated loans with proceeds of its N 40 billion rights issue in its 2018 fiscal year. Still on its FCY debt with its parent company Diageo, management hinted that the remaining balance of $9.2 million attracts an interest rate of 7.5% which is still favorable compared to prevailing market rate in the domestic scene (YTD average bond yields: 15.2%).

Cost pressure persist: In addition to the slower growth in volumes over the period,
Guinness faced input cost pressure over the period. Although management linked this to pass
through from inflationary pressures and Lower fixed cost absorption rate, we think higher
barley prices (11% YoY) over the period also played a major role in driving the expansion in
input cost to 69.8% from 66% last year.

Spirits to the rescue in 2019: Going into the second half of its 2019 financial year (January
– June 2019), Guinness will have to contend with slower beer volumes due to intense industry
competition. Baring that in mind, in a bid to cushion margin loss from lower beer and RTD
volumes, management guided to increasing spirits contribution to overall revenue from 18%
in FH1 19 to 30% over the medium term. To affirm its commitments towards expanding its
spirits portfolio, Guinness recently launched three new products in the spirits category –
Johnnie walker 18, White walker Whisky and Baileys delight. 

Less scope for beer price increases: Whilst our expectation for increased spirit
contribution provides some respite for topline going forward, we remain less sanguine of any
notable growth in net revenue over the near term. 

Especially, given that the second phase of excise duty hike took effect in January 2019, we do not see Guinness passing on the excise duty cost to customers ahead of other industry players. Our view is hinged on possible reluctance by International Breweries to take a price increase given its strategy to gain market share, particularly to increase its fixed cost absorption rate at the Shagamu plant. Hence, we cut FY 19E net revenues by 1% to N 144.3 billion while we leave our COGs estimate unchanged at N95.7 billion. As a result, we envisage gross profit of N48.62 billion over FY 19E which remain little unchanged from the N48.63 billion recorded last year. As a result our gross margin expectation of 33.7% for FY 19E is broadly flat from 34% recorded in the prior year.

Efficiency drive to preserve margins: To further preserve EBIT margin, management
guided to maintaining its cost cutting in line with H1 19 wherein operating expense declined
7.3% YoY—from a drop in selling and distribution expense. As a result, we cut operating
expense by 3% to N36.4 billion, with related OPEX to sales ratio of 25.2% (FY 18: 25.1%)
and FY 19F EBIT margin of 9.1% (FY 18: 9.4%). Over our forecast horizon, our EBIT
margin remains broadly in line with 5-year historical average of 10%. 

Elsewhere, with interest income tracking ahead of our estimate (~84%) we raise our FY 19E finance income upward by 25% to N1.05 billion. This alongside tamer finance expense translates to our expectation of a softer net interest expense of N1.3 billion in FY 19E (vs N3.4 billion in FY 18).

Incorporating these changes, we expect FY 19 earnings to print at N 8.4 billion which
translates to an EPS of N3.81, representing a 24% growth in earnings. Consequently, we raise
our FVE by 4% to N77.31 (19% upside) which translates to an OVERWEIGHT rating on
the stock. On our numbers, GUINNESS currently trades at a P/E of 18.23x relative to 26.08x
and 24.5x for NB and Bloomberg MENA peers respectively.

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