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Initial View - Nestle Nigeria Plc - Disappointing sales, cost pressure dampens earnings

• Nestle released 9M 19 result yesterday, with reported EPS expanding 11.2%YoY to N48 driven largely by the absence of impairment charge, which created a high base for input cost same period in the prior year. However, the quarterly numbers revealed a different story, as the ongoing competition in the seasoning market coupled with new cost pressures left earnings lower over Q3 19, with EPS declining 9.1% YoY to N13.37. Relative to our estimate, revenue fell short by 4.7%, while higher than expected cost estimate and taxes drove material deviation in PAT. On the 9M numbers, Nestle declared an interim dividend of N25 per share. Our full year dividend expectation of N68.75 translates to a dividend yield of 5.6% using the last closing price.
• Disappointing sales points to intense competition in seasoning market. The revenue picture over Q3 19 was quite disappointing with revenue ticking up by just 2.4% over the period – the least YoY revenue growth recorded since Q1 15. This largely reflects the increasing competition in the seasoning market from the smaller brands – given the seasoning accounts for almost 40% to 50% of the company’s product portfolio by our estimate. Consequently, revenue from food segment was flat over the period (-0.9% YoY to N6 billion). On the flipside the company seems to be holding its grip in the beverage segment, with sales expanding 8.3% YoY to N25.9 billion – giving a mild boost to overall sales.
• Surprisingly, cost pressure re-surfaces. Unlike H1 19 wherein Nestle reported expansion in gross margin excluding the base effect from impairment cost booked over 2018, Q3 standalone was bedevilled by cost pressure, with gross margin contracting 153bps YoY to 43.5% over Q3 19. The input cost (+5.2% YoY to N2 billion) pressure is surprising, as our channel checks reveals that prices of key raw materials were down over the period. Coupled with a relatively flat operating expense (+1.9% YoY), EBIT margin weakened further by 144bps to 23.9%. PBT was down by 0.6% to N16.1 billion and PAT down by 9.1% YoY to N10.6 billion mirroring higher taxes – with effective tax at 34.3% (+620bps YoY).
• Cash position drops. Q3 19 saw receivables days increase to 75 days from an average of 50 days over the last 7 quarters, which gives further credence to the company’s challenge in growing sales. For us, we believe the need to support revenue growth amidst the challenging environment drove the increase in receivable days. On that note, trade receivables went up by N1 billion between Q1 and Q3 19 with cash balance dropping to N12.6 billion from N33 billion reported for Q1 19.
• Nestle’s Q3 performance raises some concerns since we expected its brand loyalty to support sales growth above mid-single digit, as seen in prior years. For us, on expectation of flat pricing in a bid to support volumes amidst intense competition from smaller brands, we worry about what the future holds for the two top players in the seasoning market (Nestle and Unilever). Nonetheless, it is fair to state that Nestle’s history of being a defensive stock leaves the company as our top pick in the consumer space. We have an OVERWEIGHT rating on Nestle with a FVE of N1447.39 which presents 18% upside using last closing price. Nestle trades at a P/E of 20.7x which is a premium to Bloomberg MENA peer average of 20.6x, respectively. Albeit, relative to other Nestle peers, it’s at a significant discount (Nestle Pakistan: 35.18x, Nestle India:85.5x. Nestle Malaysia: 51.9x, Nestle SA: 33.81x).