14 March 2019 : Nestle Nigeria Plc had an impressive performance in 2018 with EPS expanding 28% YoY to N54.26, as the benefits of lower FX loss (-83% YoY to N2.6 billion) following the pay down of its FCY borrowings provided strong support for earnings growth. While, earnings was in line with analyst's expectation of N56.89, the lower than expected numbers largely stemmed from elevated marketing & distribution expenses (+24% YoY to N43.5 billion) over 2018, without a corresponding translation into revenue (+9.1% YoY to N266.3 billion). Notably, analyst's market survey revealed that the company embarked on series of promotional offers during the year targeted at both distributors and consumers – including the ‘NESCAFE Get Started’ promotion – and series of advertisements.

Over 2019, analysts remain optimistic on the company’s earnings, driven by moderation in the prices of its key inputs – even with expectation of stable/declining product prices – which should translate into expansion in gross margin by 172bps YoY to 44.5%. However, with analyst's forecast opex to sales maintained at same level with FY 18 of 20% (previous: 19%), analysts expect slower expansion in EBIT margin to 25% (previous: 27%) over 2019. Further down, with the company extinguishing ~71% of its FCY loans in 2018, which necessitated lower FX loss during the period, analysts see further moderation on that line in 2019. Overall, analysts lowered their EPS estimate to N65.58 (previous: N68.58) in 2019. That said, while analysts think earnings growth story is compelling, it looks expensive from a valuation standpoint. Accordingly, analysts maintain their SELL recommendation with FVE of N1,411.29. On their numbers, Nestle trades at a 2019 P/E of 22.39x compared to 5-year historical average of 33.8x and Bloomberg MENA peer average of 18.7x.

Sales growth is expected to slow. As mentioned earlier, revenue over full year 2018 expanded by 9.1% YoY. However, it was slightly disappointing as growth in the food segment slowed in the last quarter of 2018, which is atypical (being the festive season) with Q4 18 revenue to FY 18 revenue printing at 24% relative to average in the last six years (excl. 2017) of 28%. To add, product prices remained low. Therefore, analysts foresee a new trend in the company’s receipts in coming years as analysts expect slower growth in volumes and lower prices to drive a modest revenue growth expectation over 2019. Thus, analysts expect revenue to grow by 9.8% YoY to N292.4 billion. Over their forecast period (2019F – 2023F), analysts expect revenue growth of 7.4% (5-yr CAGR) as analysts remain optimistic on the implementation of the minimum wage bill, coupled with Nestle’s aggressive promotional offers aimed at driving volumes. but lower input prices will support margin. On input cost, analysts reduced their cost to sales forecast for FY 19 to 56% (-112bps YoY) based on their expectation of a further moderation in the prices of its key inputs (Sugar, Maize and Sorghum).In addition, analysts foresee a non-recurrence of the impairment charge booked in 2018, which further supports their guidance of a moderation in its cost of sales. For clarity, over the first half of 2018, the company booked an impairment charge of N4.4 billion on its Abaji water factory and other assets which was included in its cost of sales. That said, analysts expect cost of sales to increase by 6.5% YoY to N162.3 billion, which in turn translates to a gross profit of N130.1 billion, with related margin of 44.5% (+172 bps YoY).

Aggressive S&D will tame margin expansion: Over 2018, Nestle operating expense increased with OPEX to sales at 20% (FY 17: 18.5%), propelled mainly by higher selling and distribution expenses as the company embarked on diverse promotional offers aimed at driving growth in volumes. With the impact not reflected on the company’s revenue growth over the period, analysts do not expect the company to backdown just yet given the increasing competitive landscape. That said, analysts leave their OPEX to sales unchanged at 20% - which overlaid with gains from the topline translates to an operating profit of N71.6 billion (+18.1% YoY).

Following the dollar debt repayment in 2018, to its parent company, which has led to sizable decline in its borrowings to N8.3 billion (2017: N24.2 billion) with FCY loan accounting for 71% of the total debt (2017: 88%), analysts expect further moderation in interest expense over 2019. Also, analysts highlight the company’s cash position, which stands at N14.4 billion, indicating the company’s ability to pay its obligations and earn a decent interest income, given the earliest debt maturity stands at 2020. That said, analysts expect the company to report a net interest income of N559.1 million (2018: net interest expense of N889 million)

Net impact of the above translates to an EPS of N65.58. Over their forecast horizon, analysts project EPS to rise by a 5-year CAGR of 9.2%. In line with historical trend, analysts expect 100% dividend payout. Following revision to their forecasts analysts raise their FVE to N1,411.29, 8.9% discount to current pricing, translating to SELL recommendation on the stock. On their numbers, Nestle trades at a 2019 P/E of 22.39x compared to 5-year historical average of 33.8x and Bloomberg MENA peer average of 18.7x.

Reporting for EasyKobo on Thursday , 14 March 2019 in Lagos, Nigeria

Source: Olamide Adeboboye from ARM Securities Limited

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