Culled—Proshare

November 9, 2016/FBNQuest Research

Modest cut to estimates; PT unchanged
Unilever Nigeria’s Q3 2016 sales were stronger than we expected. However, PBT was weak and fell c.88% short of our estimate because of a negative surprise in net finance charges.

As such, we have cut our earnings (pre-tax profit) forecasts over the 2016-17E period by 9% on average. Despite the cut to our earnings estimates, we have left our price target unchanged at N20.40 as we believe the scale of the disappointment in the near term does not warrant a significant reduction in the long term fundamentals.

Having said that, while our long term sales growth outlook remains healthy, we have reduced our long term EBIT margin forecast by 200bps to 13%. Ytd, Unilever shares have appreciated by 11.1% (NSEASI: -6.3%).

In the last 3 months, the shares have gained 37.3% (ASI: -3.8%) which we find difficult justify. From current levels, the shares show a potential downside of -57.5% to our price target. We have retained our Underperform rating.

Finance costs and gross margins weighed on earnings
Q3 2016 results showed that sales of N17.6bn were up 26% y/y. While PBT of N24m was down by -78% y/y, PAT of N474m advanced by 755% y/y due to a tax credit of N450m during the quarter.

Despite the double-digit sales growth and opex declining by -21.1% y/y, these were not strong enough to offset a -1,187bp y/y gross margin contraction to 24.7% and a 33% y/y increase in net finance costs, hence the y/y decline in PBT.

On a sequential basis, sales grew by 14% q/q. While PBT fell by -65% q/q, PAT grew by over 800% q/q owing to the tax rebate. The positive q/q sales growth, along with a -16% q/q decline in opex, was offset by a -317bp q/q gross margin contraction and a 400% q/q rise in net interest expense.

Outlook: long road to recovery
Unilever’s earnings recovery in Q4 2015 and Q1 2016 was short-lived due to a combination of gross margin contractions and increase in net finance costs recorded in the succeeding quarters. We expect to see further y/y contractions in gross margins due to the CBN’s decision to float the naira.

The CBN’s new policy was implemented in June and saw the interbank rate move downwards by a further 10% over the Jun-Sep period, after an initial 30% as of end-June. Although the company plans to source 90% of its raw materials locally by 2020, we would need to see some progress on this for our view to turn positive.

We have also reflected (in our interest expense forecasts) the negative surprise in the Q3 results given that the company’s short-term loan book increased by 53% during the quarter. For 2016E, we see sales and PBT growing by 15.5% y/y and 2.4% y/y respectively.