Nestle Nigeria Plc First Quarter 2015:

Decline in sales and increase in administrative and Finance expenses

Nestle Nigeria (Nestle) Plc is a renowned nutrition, health and wellness company in the food and beverages subsector in Nigeria.The Company is a subsidiary of the global nutrition giant, Nestle S.A, Switzerland. Nestlé Nigeria Plc was listed on the Nigerian Stock Exchange (NSE) on April 20, 1979 and is currently among the five most capitalized stock on the NSE. The company has two primary strategic business units: Foods which includes the production and sales of Maggi, Cerelac, Nutrend, Nan, Lactogen and Golden Morn; and Beverages which produces and sales of Milo, Chocomilo, Nido, Nescafe, and Nestle Pure Life. The sustained popularity of the Company’s brands as well as their superior quality continues to drive consumers’ demands.

CAUTIOUS CONSUMER SENTIMENTS ON POLITICAL RISKS CURTAILED SPENDING AND NESTLÉ’S REVENUE

In the Company’s recently released its financial results for the first quarter ended 31st March 2015, it reported declines across all its key statement of comprehensive income line items. Gross Revenue declined by 17.56% to N27.56 billion from N33.43 billion in the corresponding period of 2014. The weak sale performance was may have resulted from the slow consumer demand as the nation in the run up to the 2015 general elections amidst high political uncertainties during the first quarter of the year. In addition to this, it also appears that significant growth in performance continues to be challenged by increased competition across various product segments, insecurity in northern Nigeria, contraction in recurrent fiscal spending as government owed workers several months in salary arrears and lower discretionary income during the quarter.The Nigerian economy is estimated to have contracted by 11% during the same period. In tandem, costs of sales reduced by 17.20% to N15.3 billion from N18.56 billion in the prior corresponding period.The Company was therefore able to sustain stability in gross margin at 44.23% (44.47%) with a gross profit of N12.14 billion- an 18.01% decline compared to N14.86 billion in the prior year. Arguably, the Company benefitted from substantial local content in its raw material as the effect of the devaluation of the naira was negligible on the top line compared to peers.

INCREASE IN ADMINISTRATIVE EXPENSES ERODES GAINS FROM REDUCTION IN S&D EXPENSES

The Company also managed to curtail the distribution, sales & marketing (S&D) expenses by 17.37% to N4.7 billion from N5.61 billion in March 2014. However, the 25% increase in the administrative expenses to N1.9 billion from N1.49 billion in the prior corresponding period offset a sizeable chunk of the savings from the reduction in the S&D expenses during the period. Hence, total operating expenses declines by only 8.4% to N6.5 billion from N7.13 billion in prior corresponding period. This resulted in the expansion of operating expenses to sales ratio to 23.7% from 21.4% in the corresponding period of 2014 and a 27% decline in operating profits to N5.6billion from N7.7billion in prior period.

EXCHANGE RATE RELATED PRESSURE ON FINANCE COSTS CURTAILED NET EARNINGS

In the Fourth quarter of 2014, the performance of the Company was affected via a spike in finance costs that was linked to the 8% depreciation in the value of the Naira exchange rate at that time. This situation worsened in the first quarter of 2015 following the 17% devaluation of the Naira in February with the closure of the official foreign exchange window by the Central Bank of Nigeria (CBN). Nestle’s debt is made up of 65% dollar denominated loans. In addition, the company’s short term borrowings increased by 11.48% from N12.73 billion in March 2014 to N14.19 billion in March 2015 while long term borrowings increased by 22.04% from N18.39 billion to N22.44billion over the period. Its bank overdraft surged by 332% to N5.34 billion during the quarter from N1.23 billion in March 2014. These accounted for the significant increase in finance charge by 167.5% to N2.33 billion in March 2015 from N875.90m in March 2014. Due to the foregoing, both pre-tax and net earnings declined by 50.69% apiece to N3.49 billion and N2.95 billion in March 2015 from N7.07 billion and N6.00 billion in March 2014, respectively. The significant decline in the bottom line occurred despite a reduction in tax paid by 50.80% to N532m from N1.07 billion in the corresponding period of 2014.

CLEAR CONCERN OVER INCREASING SHORT AND LONG TERM BORROWING

Total assets marginally increased by 4.19% to N110.50 billion in the first quarter of 2015 from N106.06 billion as at full year ended December 2014. A 229.48% and 116.22% increase in both prepayment and cash equivalents respectively were the key drivers for the increase in total assets. On the flip side, total liabilities increased by 3.64% to N72.67 billion from N70.12 billion in 2014.The primary reason from the modest rise in liabilities can be traced to an 11.48% and 22.04% increase in short and long term borrowing’s to N14.19 billion and 22.44 billion from N12.73 billion and N18.39 billion respectively. Net asset increased by 8.04% from N35.83 billion to N38.94 billion over the period. We are worried with the increasing short and long term debt of the Company including the expanded operational borrowing in the first quarter of 2015. The leveraged ratio, excluding trade related exposures, represented by debt to equity ratio increased to 94% in March 2015 from 87% at the end of 2014 while debt to total assets ratio increased to 33% from 29% at the end of 2014. Notwithstanding the increase in both total assets and net asset, the 50.8% decline in net income during the period resulted in substantial decline in the Company’s efficiency ratios.The company’s return on assets (ROA) fell to 2.67% at the end of the first quarter of 2015 from 5.66% in the corresponding period of 2014. Return on equity (ROE) fell to 7.61% from 16.71% over the period.

WE RETAIN OUR HOLD RECOMMENDATION

Nestle Nigeria’s financial result for the first quarter ended 31st March 2015 was below expectations with regards to revenue and profitability as the company was unable to grow revenue and profitability due to weak sales performance in the period. However, it also appears that significant growth in performance continues to be challenged by increased competition across various product segments, insecurity in northern Nigeria. There are however respite for political instability with the successful completion of the general election and we expect improvement in discretionary income and hence consumer

THERE ARE HOWEVER RESPITE FOR POLITICAL INSTABILITY WITH THE SUCCESSFUL COMPLETION OF THE GENERAL ELECTION AND WE EXPECT IMPROVEMENT IN DISCRETIONARY INCOME AND HENCE CONSUMER SPENDING IN FAVOUR OF NESTLE PLC AS THE NEW GOVERNMENT IS EXPECTED TO IMPROVE THE POLITICAL PROFILE OF THE NATION

spending in favour of Nestle Plc as the new government is expected to improve the political profile of the Nation. Taking into account external business constraints in the current operating climate such as disruptive effects of the insurgency in the country and a persistent high interest rate environment and the devalued exchange rate, we revise our revenue estimate to N128.54 billion and net income of N19.92 billion for the full year ended December 2015; leading to a 12-month forward EPS of N25.14. Using a combination of the Price to Earnings (PE) and Price to Book Value method of valuation, we arrived at a 6 month target price range of between N973.35 and N588.37, averaging N780.86. Since our target price represents a downside of up to 8.13% on the current stock price, we maintain our HOLD recommendation on Nestle Nigeria Plc.