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UAC of Nigeria Plc - Cheap valuation and upbeat outlook sustain BUY rating

• ​The share price of UAC of Nigeria (UACN) continues to ride bullish sentiment that trailed its FY 16 result with its QTD return (+18.85%) among the highest among the consumer goods sector. This upbeat equity return occurred in spite of the company’s disappointing Q1 17 bottom-line. Given the dissipating effect of drivers of earnings underperformance so far, as well as the company’s cheapness on a relative valuation basis, we think the positive sentiment might have been rightly triggered by value investors. In this report, we review the drivers of earnings weakness and our near-term expectation for the company’s operating performance.

• Q1 17 performance undermined by monetary burden: Despite the price-induced revenue growth (+41% YoY to N25.0 billion), Q1 17 earnings fell by more than half (from Q1 16) while PAT margin sank to a six-quarter low of 2.4%. Key drags on the performance were upsurge in input cost and elevated finance cost.

• Moderation in food prices buoys earnings outlook: Over the rest of the year, we expect a key drag on earnings performance to dissipate. Input cost pressures should subside following recent naira gains in the parallel market FX rate which should taper pressures from cross border exports to neighboring west African countries and apply downward pressure on diesel induced transportation costs. Furthermore, increased cultivation activities which trailed government’s improved support (cheap financing, access to inputs etc.) and favorable pricing environment should help bolster food production. Against this backdrop as well as FEWSNET’s guidance to above average output during the April 2017 dry harvest season, we project a moderation in FY 17 COGS-Sales ratio to 81.0% (Q1 17: 83.5%) translating to COGS of N87.1 billion (+29.6% YoY). In addition to the temperance in input cost inflation, UACN’s strategy of gradual price hikes, particularly at the ‘food and beverages’ and logistics businesses on one hand and the increased completion of real estate projects which should sustain UPDC’s strong sales on the other, buoys the conglomerate revenue picture, which we now forecast at N107.5 billion (+27.1% YoY). Whilst our expectations for an extended period of hawkish monetary policy should keep interest charges elevated (FY 17E: +127% YoY to N6.7 billion), gains from the operating level should still filter through, with 2017E earnings projected to rise 6.8% YoY of N6.1 billion.

• Currently, UACN trades a P/E of 8.46x vs. 18.72x for its Bloomberg middle east and Africa peers. Largely reflecting the upbeat outlook as well as its cheap valuation, we retain our BUY rating on the stock with a FVE of N18.66.