Nigerian Breweries has been running a very efficient business model for past few years delivering impressive returns on equity for its shareholders. For example in 2010 and 2011 its return on equity (ROE) was northwards of 60% respectively a remarkable feat for a company that one can say as attained the stage of maturity in its operations considering how old it is. In 2012 it was 44% and in 2013 it was 41%.
To understand what this really means, think of it as you buying a one year treasury bill from the CBN. What you get is 14% per annum at most. However, if you give Nigeria Breweries that money, you probably get a return of 40% per annum. That is the type of value investors crave for and it’s no wonder the share price has risen over 250% in the past five to six years.
But something remarkable happened in 2014, the return on equity dropped to 30% compared to 41% in 2013. The drop in ROE is even more remarkable when you observe that earnings only dropped year on year by 1.3% compared to an ROE drop of 27%. What then is the problem?
What we have seen is the effects of the Consolidated Breweries merger which was consummated late 2014. Nigerian Breweries merged with Consolidated Breweries with cash and equity as purchase consideration for the deal. The equity part of the deal cost Nigerian Breweries N4.5billion cash and N60billion in new equity (which it issued to Consolidated Breweries shareholders) in exchange for N34billion in Net Assets. So essentially they paid more than twice the equity of Consolidated Brewery.
The Consolidated Breweries deal by most account is seen by many as a deal instigated by the need to consolidate market share. Also, going by the valuation of Nigerian Breweries (NI65 ) at the time, the price isn’t that expensive. It will however remain a challenge to see how all this adds value to bottom line. Currently, lower returns o equity seems to be the first casualty.
Recently released 2015 results also suggest a downturn in ROE as it was 5.7% this quarter compared to 8.6% in 2014 Q1. 2015 Q1 ROE of 5.7% also suggest an annualized ROE of 23% even much lower than the 30% in 2014. With debts rising to N52billion already in first quarter 2015, there is even likely to be more pressure on ROE in the coming quarters. Add that to projected margin drops value brands provides and what you get are further headwinds.
If you are wondering how all this matter to share price think of it this way. A lower ROE and higher debts simple means lending will become more expensive in future putting pressure on the company to take in more expensive equity to dilute WACC. More expensive equity also means more pressure to deliver and perhaps a limited upside for capital appreciation. This could also mean less appetite for more mergers.
Disclosure – Nairametrics and the author of this article does not own shares in Nigerian Breweries Plc or Consolidated Breweries Plc and does not plan to buy shares in Nigerian Breweries Plc or Consolidated Breweries Plc in the next one week. The author of this article wrote it themselves, and did not write this article on behalf of Nigerian Breweries Plc or Consolidated Breweries Plc, its associates or representatives. The article is purely their opinion.