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Nestle Nig. Plc: Prospects of recovery hanging in balance

By Emeka Anaeto, Economy Editor

THERE were indications that investors in Nestle Nigeria Plc are not sure-footed on the outlook of the stock as they await the third quarter 2016 result due to be announced soon.

The stock price had reversed the downwards trend after bottoming out earlier this month at N800 per share, the investors appeared to have been positioning for a rally on the stock in expectation of further rebound in the financial results, leading to an uptick in the price to N805.57 previous week.

But the inch-up has been reversed last week back to N800 were to had stuck up till yesterday.

David Ifezulike
David Ifezulike

The initial uptick had brought Year-to-Date, YtD, returns to a   moderated losses at -2.9 per cent down from post-second quarter results, 2016 (Q2’16) bottom of -3.7 per cent. Both the delay in announcing the result and the uncertainties may have returned the YtD to -3.7 as at yesterday. Though the reversal of trend is yet to recover fully from the decline recorded this year, investors expect recovery and rebound beyond the +2.4 per cent recorded before its Q2’16 results.

Q2’16 results had pulled down the YtD to -3.7 per cent in the first week after the result’s announcement and further declines afterwards placed the YtD at -3.8 per cent.

Nestle’s  Financials

Though the Q2’16 results appeared resilient, especially on the strength of improved topline, investors were not impressed with the earnings figures, and the bottomline.

Despite 15 per cent Year-on-Year, YoY revenue growth, the multinational corporation reported 21 per cent decline in Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA).

Also the bottomline show a humbling 94 per cent drop in Profit After Tax to N535.8 million as against N8.9 billion in the corresponding period of 2015.

Key drivers of the adverse bottomline includes: elevated cost pressure and foreign exchange losses.

These two factors, according to analysts, are systemic in nature and will further impact performance, though, probably to a lesser extent in the second half of 2016, H2’16, financial year.

Consequently, analysts at Cordros Capital Limited, a Lagos based investment house, has forecast 2016 EBITDA and profit after tax, PAT, declining by 14 per cent and 72 per cent respectively.

On the foreign exchange related cost pressures, the subsequent depreciations in the Naira exchange rate against the US Dollar portend downside risk for margins.

Earnings constraints: While speaking at an event organised by Nigerian Stock Exchange and Bloomberg in Lagos, last month, Nestle’s chief executive officer, Mr. Dharnesh Gordhon, said that shortages of foreign exchange in the country was hampering business operations and ability to import equipments.

“It continues to be a major challenge. Imports of machine parts and some packaging have become more expensive, and even local suppliers are putting up their prices to compensate for a weakening Naira”, he stated.

Obviously, the concern here is on the potential impact of the depreciation on input cost of raw sugar and milk which the company still wholly imported. The other concern here is the import duties which has a direct link with the official exchange rate, and has witnessed a significant mark-up since H2’16. Notably, the management has attributed the weak bottomline in Q2’16 results, partly to transport cost increases due to hike in petroleum prices as well as other cost-push inflationary elements during the period. Industry observers expect the pass through impact to linger for the rest of the year.

Industry observers also believe the company would need to further drive its domestic raw materials input substitution measures to balance out the adverse effect of foreign currency induced cost pressures on margins.

The company also face the dilemma of a further significant price increases across principal products, and risk significant drop in sales volume with loss of market share to cheaper competing products, or stay with current prices and the narrow margins it entails.

Analysts believe the selective price increases effected by the company (on MILO, 15% average, GOLDERN, 7% average and MAGGI 15% average) have been the major driver of growth.

Though there is likelihood of management adjusting prices to fairly reflect costs in H2’16, the decision would be tough, considering the risk of losing grounds to competitors which has been observed as in the experience of MAGGI in Ghana.

However, price increases in the next one year cannot be ruled out, which would help recovery of margins.

It is not expected that the cost cutting measures being considered by the management will be of much impact on margins in the face of the above dilemma.

There are indications that foreign exchange related losses has widened following the full floating regime, with the Naira having, already lost over 10.7 per cent in the official interbank market and over 25 per cent in the parallel market window since end June level, when the Q2’16 losses were booked.

Analysts  conclusions

THERE were indications that investors in Nestle Nigeria Plc are not sure-footed on the outlook of the stock as they await the third quarter 2016 result due to be announced soon.

The stock price had reversed the downwards trend after bottoming out earlier this month at N800 per share, the investors appeared to have been positioning for a rally on the stock in expectation of further rebound in the financial results, leading to an uptick in the price to N805.57 previous week.

But the inch-up has been reversed last week back to N800 were to had stuck up till yesterday.

The initial uptick had brought Year-to-Date, YtD, returns to a   moderated losses at -2.9 per cent down from post-second quarter results, 2016 (Q2’16) bottom of -3.7 per cent. Both the delay in announcing the result and the uncertainties may have returned the YtD to -3.7 as at yesterday. Though the reversal of trend is yet to recover fully from the decline recorded this year, investors expect recovery and rebound beyond the +2.4 per cent recorded before its Q2’16 results.

Q2’16 results had pulled down the YtD to -3.7 per cent in the first week after the result’s announcement and further declines afterwards placed the YtD at -3.8 per cent.

Nestle’s  Financials

Though the Q2’16 results appeared resilient, especially on the strength of improved topline, investors were not impressed with the earnings figures, and the bottomline.

Despite 15 per cent Year-on-Year, YoY revenue growth, the multinational corporation reported 21 per cent decline in Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA).

Also the bottomline show a humbling 94 per cent drop in Profit After Tax to N535.8 million as against N8.9 billion in the corresponding period of 2015.

Key drivers of the adverse bottomline includes: elevated cost pressure and foreign exchange losses.

These two factors, according to analysts, are systemic in nature and will further impact performance, though, probably to a lesser extent in the second half of 2016, H2’16, financial year.

Consequently, analysts at Cordros Capital Limited, a Lagos based investment house, has forecast 2016 EBITDA and profit after tax, PAT, declining by 14 per cent and 72 per cent respectively.

On the foreign exchange related cost pressures, the subsequent depreciations in the Naira exchange rate against the US Dollar portend downside risk for margins.

Earnings constraints: While speaking at an event organised by Nigerian Stock Exchange and Bloomberg in Lagos, last month, Nestle’s chief executive officer, Mr. Dharnesh Gordhon, said that shortages of foreign exchange in the country was hampering business operations and ability to import equipments.

“It continues to be a major challenge. Imports of machine parts and some packaging have become more expensive, and even local suppliers are putting up their prices to compensate for a weakening Naira”, he stated.

Obviously, the concern here is on the potential impact of the depreciation on input cost of raw sugar and milk which the company still wholly imported. The other concern here is the import duties which has a direct link with the official exchange rate, and has witnessed a significant mark-up since H2’16. Notably, the management has attributed the weak bottomline in Q2’16 results, partly to transport cost increases due to hike in petroleum prices as well as other cost-push inflationary elements during the period. Industry observers expect the pass through impact to linger for the rest of the year.

Industry observers also believe the company would need to further drive its domestic raw materials input substitution measures to balance out the adverse effect of foreign currency induced cost pressures on margins.

The company also face the dilemma of a further significant price increases across principal products, and risk significant drop in sales volume with loss of market share to cheaper competing products, or stay with current prices and the narrow margins it entails.

Analysts believe the selective price increases effected by the company (on MILO, 15% average, GOLDERN, 7% average and MAGGI 15% average) have been the major driver of growth.

Though there is likelihood of management adjusting prices to fairly reflect costs in H2’16, the decision would be tough, considering the risk of losing grounds to competitors which has been observed as in the experience of MAGGI in Ghana.

However, price increases in the next one year cannot be ruled out, which would help recovery of margins.

It is not expected that the cost cutting measures being considered by the management will be of much impact on margins in the face of the above dilemma.

There are indications that foreign exchange related losses has widened following the full floating regime, with the Naira having, already lost over 10.7 per cent in the official interbank market and over 25 per cent in the parallel market window since end June level, when the Q2’16 losses were booked.

Analysts  conclusions

Cordros Capital said: “Amid further declines, it is not unlikely that Nestle’s net foreign exchange losses will reach (or breach) our target N18 billion for 2016FY. Interest expense on USD borrowings should also expand accordingly”.

The stock recovered from the YtD low in April to accumulate 38 per cent gain at the end of June, supported by some optimism following Q1’16 results and the general speculation that drove local equities’ prices higher. The current rebound, according to stock market dealers, is largely speculative, and the focus is on expectation of improvement in bottomline. But it appears the speculators are sensitive to the dilemma facing the company, a situation which may make the rebound short-lived.

On this Cordros Capital stated: “While we continue to have strong conviction on the company, we believe that risks remain on the downside and that the stock is overvalued”. They placed a ‘SELL’ recommendation on the stock.

Cordros Capital said: “Amid further declines, it is not unlikely that Nestle’s net foreign exchange losses will reach (or breach) our target N18 billion for 2016FY. Interest expense on USD borrowings should also expand accordingly”.

The stock recovered from the YtD low in April to accumulate 38 per cent gain at the end of June, supported by some optimism following Q1’16 results and the general speculation that drove local equities’ prices higher. The current rebound, according to stock market dealers, is largely speculative, and the focus is on expectation of improvement in bottomline. But it appears the speculators are sensitive to the dilemma facing the company, a situation which may make the rebound short-lived.

On this Cordros Capital stated: “While we continue to have strong conviction on the company, we believe that risks remain on the downside and that the stock is overvalued”. They placed a ‘SELL’ recommendation on the stock.

 


Disclaimer

Comments expressed here do not reflect the opinions of vanguard newspapers or any employee thereof.