Seven-months ago, Nestle’s share price hovered around a five-year low of N591.95, which we linked to a combination of fundamental concerns and absence of portfolio flows (See report: Nestle Nigeria plc: Short on foreign love). Fast-forward to current period, the company’s stock price now trades at an unprecedented high of N1,208. In terms of fundamentals, the company has witnessed a marked turnaround in operating performance—a consequence of price hikes across product portfolio, operational efficiency, and tempered FX loss. In addition to these, the current share price rally appears to have benefited from improved foreign appetite for naira equities which greeted CBN’s introduction of the Investors and Exporters Window (IEW) in April – Nestle has gained 63% post the introduction of the I&E window. However, we think revenue growth momentum over the forecast horizon will be tamer relative to current run rate.
Price hikes and lower FX losses shore up earnings
Over H1 17, Nestle’s revenue surged 52% YoY to N121.9 billion largely reflecting the impact of price hikes across product portfolio (YoY: 40%-70%). That said, an upswing in prices of key inputs (YoY: Maize: +110%, Sorghum: +109%, Refined sugar: +99.5%) drove a 26.1pps YoY rise in COGS (H1 17: +54.2%). Consequently, gross margin contracted 100bps YoY to a low of 39.7% in H1 17 (6-year H1 average: 42%).
Further down, Nestle recorded lower FX losses in the review quarter (-60% YoY to N5.2 billion) which was underpinned by a softer YoY depreciation of the naira. Despite the improved year-on-year picture, Nestle’s Q2 17 FX loss of N4.1 billion was 3.4x higher QoQ. We attribute this quarterly jump to a revaluation of the company’s dollar-denominated shareholder loans at the recently introduced NAFEX rate. Overall, Nestle reported net finance expense of N2.2 billion (YoY: -84%, Q1 17: N1.1 billion in net finance income) in the review period.
In addition, Nestle also effected a part repayment of N20.8 billion on FCY loans owed (N38.3 billion due in 2017) that drove its cash balance lower to N57 billion (-17% QoQ).
The foregoing combined with lower effective taxes paid over H1 17(-7pps YoY to 32.3%) underpinned a 29.9x YoY jump in earnings to N16.5 billion. (EPS: N20.88)
Earnings momentum tapers beyond FY 17
Going into H2 17, we expect depressed real income to leave volume growth subdued across the product portfolio even as improved FX supply provides impetus for higher competition from imports and smaller domestic competitors. However, as in H1 17, Nestle’s upward price adjustment should keep revenue at elevated levels relative to 2016 albeit with tamer growth in YoY revenue 1 As at H1 17, Nestle’s net cash position stood at N14 billion (H2 16: N681.9 million). Earnings momentum tapers beyond FY 17 Price hikes and lower FX losses shore up earnings given the base effect from prices over H2 16. As such, we expect Nestle’s topline to rise 37.5% YoY to N250.1 billion (H1 17: +39.7% YoY) over FY 17.
For input costs, we expect a more modest rise as lower diesel prices taper transport-induced food inflation pressures with improved market supply in the seasonal main harvest of Q4 16 also expected to moderate prices of farm produce. Against this backdrop, we project a COGS to sales ratio of 59.1% over 2017 (H1: 60.3%, H2 17: 58.1%) which translates to a gross profit of N102.05 billion with corresponding margin of 41%.
We have similarly revised our projections for Nestle’s interest income more than two-fold higher YoY to N10.2 billion (H1 17: N5.2 billion) owing to the company’s sizeable cash balances (+55% YoY to N57 billion) while finance expense has been upwardly reviewed (-48% YoY to N10.8 billion) to reflect higher run rate on interest payments over H1 17. On balance, we forecast FY 17 net finance income of N590 million (FY 16: net finance expense: N16.7 billion). Cumulative impact of our adjustments translates to FY 17E PBT and PAT of N57.4 billion (2.7x YoY) and N39.1 billion (4.9x YoY) respectively.
Beyond 2017, we view price-induced revenue growth as unstainable and project a volume-led increase in turnover over our forecast horizon (2018- 2022). On this wise, we note rising cost of living and weak consumer income as potential drags to growth. Hence, we project a 9% revenue CAGR over our forecast horizon, which is much lower than the 13% in the five years ending December 2015. Whilst we project a slowdown in COGS (CAGR: +7%) over our forecast horizon, as the transitory nature of transport-induced food inflation wanes, the deceleration in top-line should apply downward pressure on gross profit (2017-2022 CAGR: +11% vs. 13% between 2010 and 2015). In addition, we have revised our projections for net finance expense lower over our forecast horizon as Nestle repays its outstanding FX debt to its parent (2017-2022 CAGR: +30% vs. 45% between 2010 and 2015). Leaving our OPEX growth unchanged at 14%, we project slower rise in earnings (2017-2022 CAGR: +7%) going forward.
Nestle trades at current and forward P/Es of 40x and 24.79x respectively vs. 29x and 17.4x for its Bloomberg MEA peers. Relative to its five-year historical average, the stock’s P/E is also higher. Given the more subdued economic picture (IMF’s average five-year growth forecast: Nigeria: 1.6%, MENA: 3.1%), we think that the premium is unjustified. We have a SELL rating on the stock with a FVE of N879.93.
