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Unilever Nigeria Plc - Rights Issue: Dilution to take centre stage

• Yesterday, Unilever gained shareholders’ approval to raise N63 billion through the issuance of ordinary shares on such conditions and time the directors may deem fit. The rights approval was obtained after company’s shareholders assented to the creation of additional shares of 3.95 billion (current: 3.8 billion shares) new ordinary shares of 50 kobo each ranking in all respects parri passu with the existing shares of the company.

• Importantly, the terms of the issue authorize the directors of the company with the right to apply outstanding convertible loans or other loan facility towards payment for any shares subscribed for under the rights issue. This is in line with our prior prognosis for the parent company to convert its outstanding debt (FY 16: N18.5 billion) to equity. In our view, the rights issue provides Unilever UK with a more efficient window to increase its holdings in its Nigerian subsidiary after its less than successful bid in 2015. Given Unilever UK’s increased share buyback activity (FY 16: +1.53 pps YoY to 60.06%), we expect the rights issue to be fully subscribed. Thus, using current pricing, we project a 44% increase in Unilever’s shares outstanding to 5.5 billion.

• Debt reduction positive for earnings: In the event that Unilever’s rights issue is completed in FY17 and executed at current pricing of N36.01, we project an improvement in the company’s debt-to equity ratio to 0.1x (FY 16: 1.8x) and interest coverage ratio to 39x (FY 16: 2x). Overall, given the expected decline in Unilever’s gearing ratio and consequently interest expense (-87% to N297 million), we expect the rights issue to consolidate the company’s cost containment measures and price increase as it hopes to sustain earnings growth in an environment riddled with challenges. In addition, the conversion of foreign loans (entirely from the parent company) should also delink earnings from FX volatility. Thus, we estimate Unilever’s FY 17 earnings at N10.2 billion (prior: N8.8 billion) which is 3x higher YoY. Nevertheless, given the potential increment in shares outstanding, FY 17 EPS is forecasted to decline to N1.85 (from N0.81 in 2016). 

• Unilever trades at a current P/E of 38.82x vs 29.69x for Bloomberg MENA peers. We have a SELL rating on the stock with an FVE of N30.94.