October 31, 2016/Cordros Research

NESTLE released results for nine months and third quarter ended September 2016. The key features of the third quarter result are (1) 16.6% y/y and 10.7% q/q revenue growth; (2) significant y/y gross margin contraction; (3) net forex loss; and (4) a LAT of N5.1 billion, following 101% effective tax rate.

Over the nine months of 2016, NESTLE’s revenue was up 19.9% while PBT and PAT were down 73.6% and 97.2% respectively compared to 2015.

The revenue (N49.04 billion) reported in Q3 beat both our N46.5 billion estimate and consensus’ N44 billion. The y/y increase was both price and volume driven, but the increase over Q2-16 was largely as a result of price increase actions. NESTLE, like other FMCG companies, have taken PI actions lately to minimize the impact of rising costs on margins. 

Gross margin fell by 682bps y/y, but compared to Q2-16, gross margin actually increased by 542bps following recent price increases. Feedback from our routine check is that unlike most FMCG companies whose margins were also affected by negative energy substitution, higher raw material input prices — both local and foreign sourced — constituted the most pressure on NESTLE’s margins. The price increases taken so far are way behind the rate of cost inflation, thus suggesting that it is unlikely that 2016F gross margin will match 2015FY 44.5%, even with additional PIs (we expect two) before December ending. On q/q basis however, we expect PIs to continue to positively impact margins.

Finance costs continued to place pressure on earnings after a sevenfold increase to N7.1 billion, from the N1 billion recorded the previous year. While interest expense component of finance costs fell by 20.8% y/y, the core driver of the surge was the depreciation of the naira which resulted in a net forex loss (on NESTLE’s net dollar borrowings) of N6.3 billion (vs. N8 million in Q3-15). The forex loss, though expectedly lower than the N13.1 billion reported in Q2-16, was higher than the N4.7 billion we had estimated.

PBT was N4.6 billion, short of consensus’ N5.2 billion but in line with our N4.7 billion forecast. However, effective tax rate was 101%, swinging earnings for the period into negative. While we await clarity from management on this line, we would expect adjustments (if any) to bolster earnings in the fourth quarter.

Overall, NESTLE’s performance in Q3-16 significantly improved from the shock experienced in Q2-16. The plan, going forward, is for management to be more responsive to costs, hence our expectation of additional PIs and ultimately, a Q4-16 result that would outperform 2015 comparative.

We are Underweight NESTLE. Estimates are under review.