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UAC of Nigeria Plc- The Fly in FMCG ointment?

• Despite the bullish trend in the local bourse and the strong rally in the FMCG space (YTD, Food: 45%, HPC: +45%, Brewers: +30%), the share price of UACN continues to remain sticky with sentiments largely sour. To our minds, the apathy reflects weak performance in the first half of the year (PAT: H1 17: -55%, Q2 17: -55%) as well as share dilution risk given expectation of equity capital raise by way of rights issue.
• Food inflation weighs on margin: Given an import-COGS ratio of less than 1%, the company’s heavy reliance on domestic farm products (particularly cereals and legumes), whose prices have been rising, resulted in higher input cost (YoY: H1 17: +33%, Q2 17: +42%). Hence, notwithstanding the price-induced growth in the company’s top-line (YoY: H1 17: +52%, Q2 17: +33.4%), gross margin still printed at a record low of 15.8% in H1 17 (Q2 17: 15%).
• Monetary tightening compounds earnings woes: Another key drag on the company’s performance was an elevated interest rate environment which raised the cost of refinancing its largely short tenured debts (86% of total borrowings). For context, whilst the company took advantage of lower interest rate environment to obtain N9 billion loans (59% of total borrowings) at 11% in 2016, the current interest rate environment left the company with little choice but to refinance the noted obligation at 24% in the current year. Consequently, bucking the trend across other consumer names, UACN’s earnings came in at a record low of N1.2 billion in H1 17—and we see scope for further earnings deterioration.
• Expensive debt to keep earnings depressed: Our outlook for the company’s earnings is hinged on developments on monetary policy and food inflationary fronts. On the latter, whilst we expect supply-side shocks to food inflation to subside on the back of lower diesel prices, reduced market supplies in the wake of ongoing lean season should limit substantial pass-through to farm produce over Q3 17. Though improved market supply should temper input cost in the main harvest season of Q4, subsisting demand from neigbouring West African countries should put a floor to the downtrend. In sum, we expect input cost pressures to linger over the rest of the year. Elsewhere, though management guides to further price hikes over the rest of the year, accompanying volume contraction should cap the scale of such price adjustments. Overall, we project a gross margin of 16.6% over H2 17 (FY 17E: 16.2%). The foregoing alongside projected jump in finance charges (+125% YoY to N6 billion) underpins our prognosis for a 20% YoY contraction in earnings.
• UACN trades at a current P/E of 10.0x vs. 18.7x for its Bloomberg Middle East and Africa peers. We have a NEUTRAL rating on the stock with a FVE of N92. In the scenario that UACN raises the N15.4 billion rights (47% of current market capitalization), our FVE for the stock comes to N10.24 as the dilutive impact of the rights offset potential decline in interest expense.