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Initial View- Nigerian Breweries - NB growing sales at a higher cost

• Nigerian Breweries Plc released Q3 19 result last week, recording loss after tax of N1 billion (Q3 18 loss after tax of N6 billion). The poor earnings performance mirrors higher excise duty, elevated operating and finance expenses. The losses over Q3 19, trimmed 6M 19 EPS (N1.63) to N1.53 over the first nine months of the year. On its 9M 19 earnings, the company declared an interim dividend of N0.50. Our full year dividend forecast of N2.58 translates to dividend yield of 6% at current pricing.
• NB growing sales, at a higher cost. Akin to trend over the last three quarters, NB reported a 3% YoY growth in gross revenue to N2 billion, with management linking this to low-single digit growth in beer volumes and double-digit increase in the premium portfolio – driven by Heineken. However, on the heels of higher excise duty (+31% YoY to N7.7 billion), net revenue was largely flat at N65.4 billion from last year. On the positive, despite higher barley prices (+18% YoY), the company reported lower cost of sales (-12.4% YoY to N40.9 billion), which mirrors better economies of sales from higher beer volumes over the period. As a result, gross margin expanded to 37.4% in Q3 from 28.5% in Q3 18.
• While the company has successfully grown beer volumes despite intense industry competition, it has been doing so at a cost. For context over the last two quarters the company has reported OPEX to sales ratio higher than its historical average (5-year average: 26.8%). In fact, Q3 19 OPEX to sales of 36.9% is the highest since 2012. While this has resulted in positive sales growth over the last few quarters, we question the sustainability of this strategy going forward, as operating margins are nearing its trough (EBIT margin: 1.1% in Q3 19). Further exacerbating the weak operating profit, finance expense more than doubled, increasing to N9 billion (Q3 18: N1.2 billion) following increase in short term borrowings (+91% YoY to N32.8 billion).

• Despite growth in sales which have been the main pressure point for the company in time past, we question the sustainability of its higher operating expense and envisage either of the following in the coming quarters 1.) cut back its operating expenses 2.) increase in  prices to compensate for higher excise duties or 3.) a combination of 1 and 2. Based on our last communicated FVE of N75.82, we have a BUY recommendation on the company. NB trades at a P/E of 21.5x relative to 12.22x and 18.97x for Guinness and Bloomberg MENA peers.