September 18, 2017/Cordros Research

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CADBURY NIGERIA PLC (CADBURY) – SELL

▪ The shares of CADBURY closed lower last week by 3.58% to N10.51. CADBURY trades at a significant forward PE above its 5-year historical average of 24.9x.

▪ Q2-17 revenue was below of our estimate by 10% while loss after tax was reported, against the profit (N120 million) we had forecasted. Revenue grew by 20.6% y/y, as relatively higher average prices compensated for weak sales volume. Also on the positive, opex fell by 4.5% y/y while opex margin contracted by 676 bps relative to Q2-16, consistent with the low spending in 2016FY (+1.6% y/y). That said, a loss after tax of N860 million was reported (vs. loss of N530 million in Q2-16), owing to weaker gross margin (-722 bps y/y).

▪ We revise earnings estimates significantly lower largely to reflect the weaker-than-expected earnings reported YtD. In addition to revenue growth expected to trail the industry trend,
we now hold a more conservative view of margin. CADBURY’s situation is further compounded by lack visibility from management.

▪ We forecast a marginal revenue growth of 6.2% over 2017F (previously 15.2%), to be driven by relatively higher average prices. Management had said at the beginning of the year that it will support sales over 2017F by (1) driving efficiency from the newly commissioned, larger Bournvita production facility and (2) strengthening RTM initiative by leveraging on the remodeled sales force scheme to improve visibility of products. We had expected the price hikes implemented after Q1, in addition to the less inflationary environment (the FX crisis experienced between January and early February has subsided significantly), to drive recovery in gross margin as from Q2. However, with the reported margin of 17.4% significantly missing our estimate of 26%, we have revised overall estimate for 2017FY lower to 23.6%, from 25.8%.

DANGOTE SUGAR REFINERY PLC (DANGSUGAR) – HOLD

▪ The shares of DANGSUGAR lot by 2.50% last week to close at N13.65. DANGSUGAR trades at forward PE of 6.7x, below its 5-year historical average of 7.5x.

▪ Q2-17 revenue (56.3% y/y), EBITDA (173.1% y/y), and PAT (205.3% y/y) were well-ahead of Q2-16. The revenue growth was driven by the still significantly higher average price (88% y/y), which more than compensated for lower sales volume (17% y/y). Also positively impacting PAT was the significant increases in (1) gross margin (1900 bps q/q and 1332 bps y/y) and (2) investment income (475%). In addition, an amount of N160 million was reported as fair value adjustment on biological assets, compared to N70 million in Q2-16. We note that the gross margin realized during the period, mirroring the YtD moderation of raw sugar prices and lower energy costs, was significantly ahead of the 20% guided by management.

▪ We make the following changes to our estimates following better-than-anticipated Q2-17 result (1) -8% for sales volume (previously -20%) and (2) 16.7% gross margin (previously 14.7%). These translate to 39%, 71%, and 68% revenue, EBITDA, and EPS growth respectively, over 2016FY.

▪ On the 2016FY earnings call, management said it plans to achieve 20% gross margin in 2017F (vs. 13.5% in 2016FY), assuming (1) forex is purchased at a relatively lower average rate and (2) higher output is realized from Savannah where margins are higher. We should also add that the moderation of raw sugar price YtD and seemingly reduced energy costs will be margin accretive. But that said, we believe the margin guidance is quite ambitious. The N20,000 per tonne reduction of selling price implemented in March partly offsets savings from lower raw sugar import price. Besides, we will look for stability in gas supply to the refining plants, before strongly factoring in the lower energy cost achieved in Q2 into our estimates.

FLOUR MILLS OF NIGERIA PLC – HOLD

▪ The shares of FLOURMILL plunged by 8.67% last week to close at N27.40. FLOURMILL trades at 2018 PE of 9.2x, below its 5-year average of 19x.

▪ Q4-16 PBT of N179 million (vs. N1.5 billion in Q3) was reported, despite a net operating gain of N10.3 billion (vs. N11.8 billion loss as at end-December, owing to FX gain of N7.54 billion). During the period, the net operating gain and a 70.5% y/y growth were muted by a significant finance charge of N14.8 billion (the group’s highest in a quarter), 287 bps y/y and 279 bps q/q declines in gross margin to 9.8%, and 74% q/q increase in opex to the year’s peak of N9.3 billion. However, owing to the strong 9-months performance, the company reported its first operational profit of N10.47 billion in two years.

▪ High debt, and consequently finance charges, is a major investment case against FLOURMILL. And we believe this is one of the reasons investors remain skeptical about the group’s growth outlook, notwithstanding the visible results from its diversified business model. The group closed 2017FY with gross debt of N241.6 billion, from N165 billion in 2016FY.

Included in the debt is a long standing real estate USD-denominated liability (USD20 million) which exposes the group’s earnings to the risk of FX volatility.

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