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Guinness Q2 2021 - Concerns remain around costs

• Guinness reported a surprising YoY growth in their revenue over Q221 (3 months ending in December) despite the muted holiday celebrations. However, their revenue performance was once again overshadowed by rising cost of sales (+4.2%YoY) which dragged gross profit down by 2.8%YoY. Further highlighting their issue with costs is the performance of their EBITDA which declined 12%YoY over H121 and now has a margin of 10.8% in H121 (vs13.1% in H120). Guinness are also facing financing cost pressure with interest expense rising for the 4th consecutive quarter and leading net finance expenses higher in Q221 by 165%YoY. Higher cost of sales and increased net finance cost were enough to see PBT fall by 30.1%YoY to N1.61 billion, despite improvement in OPEX. While we have a FVE of N28.41 on the stock upon adjusting our risk free rate to reflect current reality, we maintain a NEUTRAL rating on the stock following our concerns around upward pressure on Guinness’s cost of sales and rising interest charges.
• Higher costs sink gross profits again: Guinness’ revenue rose by 2.2%YoY in Q221 to N42.33 billion (Q121: N41.43 billion). Similar to what we saw in Q121, the growth in revenue was driven solely by a rise in domestic sales (+5.7%YoY) to N41.88 billion and we suspect that growth was as mainly a result of price increases imposed earlier in the year. Exports, on the other hand, declined by 75.2%YoY which is an even sharper decline than what was posted in Q121 (-46.1%YoY). However, for the second consecutive quarter, cost of sales rose (+4.2%YoY) faster than revenue and printed at N30.75 billion. The faster rise in cost meant that gross profit declined by 2.8%YoY to N11.57 billion with gross margin also coming in lower at 27.3% (vs 28.7% YoY). Over H121 revenue rose 5.9%YoY to N72.35 billion, led by both price and quantity, while costs grew by 10.9%YoY over the same period which implies that gross profit declined by 6.4% in H121 to N18.59 billion.
• One positive note from Guinness’ result is the continued decline in operating expense which has now fallen YoY for 3 consecutive quarters. In Q221, OPEX was down by 2.8%YoY to N8.94 billion following a 6.7% fall in sales and distribution costs. Other income surged by over 200%YoY to N490 million driven by an  unprecedented spike in the gain on disposal of PPE to N345 million. The fall in OPEX and rise in other income was enough to flip the decline in gross profit into an 8.7%YoY rise in operating profit (EBIT) to N3.13 billion. For the 6M period, operating profit came in at N3.72 billion, a 4.4%YoY growth and it also followed on from lower OPEX (-6.1%YoY) and higher other income (+147%YoY).
• Net finance expense rose by 165%YoY following the combination of a rise in finance expense (+121.9%YoY) and a fall in finance income (-337.8%YoY). The latter followed on from an approximate 86%YoY fall in total interest arising from financial assets as average fixed income yields declined by 885bps over the period to 2.41%. The rise in finance expense, on the other hand, was driven by a higher loss on re-measurement of FX balances. This higher net finance expense dragged PBT lower by 30.1%YoY to N1.61 billion and after a higher tax bill of N1.08 billion (76% higher than Q220’s N619 million), PAT declined by 68.9%YoY to N580 million. It was a similar story when looking at the 6M numbers as a 49%YoY increase in net finance cost led PBT lower by 33%YoY to N1.29 billion while an after-tax loss of N320 million was recorded.
• Ignore upside, stay neutral: In updating our valuation model, we reduced the risk free rate to reflect the decline in yields observed over the last year. This lower risk free rate largely led our FVE higher by 33% to N28.41, which based on previous close should translate to a buy rating. However, we are not comfortable with the rising cost of sales and increased financing cost pressures that the company is facing. As a result, we recommend that investors  stay neutral until margins start to paint a better picture of the company.