June 25, 2018/Cordros Capital

CADBURY NIGERIA PLC (CADBURY) – SELL

▪ The shares of CADBURY closed flat at NGN13.00. CADBURY trades at a significant forward PE above its 5-year historical average of 24.9x.

▪ CADBURY published Q1-18 result, showing EBIT was higher by 76.2% while PBT was lower by 67.2%, both compared to Q1-17. We are not surprised by the lower PBT, which we had expected will be impacted by higher finance charges (+233% y/y), given the sizeable balance of borrowings at the beginning of this year, compared to 2017. Meanwhile, the reported PBT missed our estimate by 49%, owing specifically to the deviation on finance income line (46% below our estimate), but we expect this will normalize in subsequent quarters.

▪ Q1-18 revenue grew 2% y/y, consistent with our 1.8% growth estimate. Given base selling price is lower by marginal single-digit, we estimate flat to modest volume contraction must have been recorded during the just concluded quarter, compared to last year. Retaining our 8% revenue growth estimate for 2018E suggests we look for a faster growth in subsequent quarters, and will be largely volume-driven, on continued promotional activities, including price discounting. We are aware of an ongoing buy-1-get-1 free promo for the 450g Bournvita Hot Chocolate Drink.

▪ At 21.8%, CADBURY’s gross margin in Q1-18 is in line with our 21.9% estimate for the quarter, and 3 bps higher vs. Q1-17. We had stated in our last note on the company that we do not expect gross margin will be above the 22.5% rate achieved in 2017FY, and this view is unchanged. Margin headwinds are selling price competition (on stronger imports) and rising cocoa prices, while the tailwinds are stable FX and soft sugar (-28% YtD) and dairy prices (-6% YtD).

▪ The balance of short term borrowings was NGN4.3 billion, from the NGN3.6 billion at the beginning of the year. CADBURY’s loans are expensive (we estimated 22% at the end of 2017FY), and we are not aware that they are being refinanced through commercial papers in this period of generally declining interest rates. Finance cost in Q1-18 is in line with our estimate. Finance income was lower, but we expect this would increase and converge with our estimate for the year, as cash grows following the payment of 2017FY dividend.

▪ We maintain TP at NGN10.96. Our estimates are unchanged. On our estimates, CADBURY is trading at 2018F P/E multiple of 61.5x, a significant premium to the 5-year historical average of 31.1x.

DANGOTE SUGAR REFINERY PLC (DANGSUGAR) – HOLD

▪ The shares of DANGSUGAR closed lower by 2.06% to NGN19.00. DANGSUGAR trades at forward PE of 7.2x, lower than its 5-year historical average of 7.5x.

▪ DANGSUGAR published Q1-18 result, showing EPS grew 12% y/y but declined 59% q/q. The EPS growth came on the back of a higher gross margin compared to last year’s one-off low, masking a disappointing revenue performance. Should we adjust Q1-17 gross margin to Q1-18’s 25% (which is also the average achieved in 2017FY), we have EPS of -55% y/y and -60% q/q.

▪ According to management, Q1-18 sales volume was down 12% y/y (+2 q/q), despite selling price now lower by about 22% y/y. The volume outturn raises concern for 2018 revenue as a whole, given that the January-March quarter (and indeed, the first half) is seasonally strong for DANGSUGAR. On the 2017FY results call, management reiterated some of the volume concerns we had highlighted in previous notes – notably the activities of smugglers and the poor condition of the factory road – and added that the road to the North (accounting for 36% of revenue and where about the highest margin is derived) is equally deplorable, with negative impact on revenue.

▪ Also of concern is that the NGN13,056/tonne average selling price computed by management in the latest result is way below the NGN14,000/tonne price it said it was able to achieve during the last call held earlier this month. We have consequently revised our 2018E volume growth forecast to 5% (previously 9.5%) and cut average selling price estimate to NGN13,000/tonne – while acknowledging that the possibility of price further reducing has increased with the poor volume outturn in Q1.

▪ At 25%, the gross margin achieved in Q1-18 is about the 25.8% we estimated for 2018E. While noting that the downside risk to selling price, and consequently margin, has increased with this Q1 result, we should reiterate some tailwinds supporting our gross margin estimate as: (1) better energy mix, (2) stable and stronger exchange rate, (3) stable outlook of global raw sugar prices, and (4) positive mix from growing contribution of higher margin Savannah.

▪ We revise TP lower to NGN17.42 (previously NGN17.97). On our estimates, DANGSUGAR is trading at 2018F P/E and EV/EBITDA multiples of 7.6x and 4.x respectively, consistent with its five-year historical averages of 7.9x and 4.4x, but below the 14.3x and 9.4x Middle Eastern peer averages.

FLOUR MILLS OF NIGERIA PLC – HOLD

▪ The shares of FLOURMILL fell by 5.34% to N31.00 . FLOURMILL trades at 2018 PE of 4.9x, below its 5-year average of 19x.

▪ Following the conclusion of the NGN38 billion Rights Issue (RI) and our recent discussions with management, we revise our TP and earnings estimates for FLOURMILL. Feedback is that the RI was successful (oversubscribed). On net, we (1) increase the post-rights shares outstanding by 56% to 4.1 billion and WACC by 158 bps to 15.2% and consequently, (2) lower our TP for the stock by 21% to NGN30.56.

▪ Although we revised our net earnings estimates slightly higher, however, overlaid on the post-rights shares, we now look for 2019E and 2020E EPS of NGN4.8 (NGN7.5 ex new shares) and NGN6.4 (NGN10 ex new shares) respectively. FLOURMILL’s share price has accumulated 31% YtD and we maintain a HOLD rating on our new TP. On our estimates, FLOURMILL is trading on forward (FY18E) P/E and EV/EBITDA multiples of 6.1x and 3.7x respectively, at material discounts to the (1) peer average forward P/E of 11.5x and EV/EBITDA of 7.8x and (2) its five-year historical average of 14x and 8.1x respectively.

▪ Notwithstanding the impact of the RI on valuation and EPS, we have a fairly strong view of FLOURMILL over the medium term. From 1% average between 2014-2016 (2017 was an outlier, in our view) and 5% in 2018E, we forecast sales revenue growth to increase to 9% average over 2019-2020E. Management has continued to reiterate that its emphasis going forward is on driving returns from the investments of the recent years. And it is our view that the group’s focus on food-based and agro-allied products, whilst favoured by Nigeria’s demographic potential and spending patterns, also provides a good hedge against cyclicality effects in the FMCG industry.

▪ We also forecast EBITDA to grow steadily to NGN81 billion by 2020E, from NGN57 billion in 2017FY, and the margin to stabilize at 12% average, 300 bps above the rate achieved in the last five years. With a robust top-line, we view the sustenance of the opex margins of 4.5% achieved in 2017FY and 4% as at 9M-18, compared to 8% historical average, as positive for EBITDA formation going forward. Management said it does not expect opex-to-revenue ratio to change materially to the upside going forward, given its emphasis of growing revenue, while focusing strongly on containing costs.

GUINNESS NIGERIA PLC – SELL

▪ The shares of GUINNESS closed higher by 0.52% to N97.50. GUINNESS trades at 2018 PE of 25.3x, below its 5-year average of 27.7x.

▪ GUINNESS reported 40% y/y increase in Q3-18 net profit (EPS: -4% y/y), coming off better-than-expected revenue growth, and relatively lower operating expenses and finance charges. Both masked a disappointing gross margin, which has now weakened for four quarters in a row. Compared to consensus, the reported net profit was head by 131%, and beat our estimate by 47%.

▪ Following the Q3 and 9M-18 results, we raise our 2018E EPS estimate to NGN3.85 (previously NGN2.98), and for 2019E and 2020E to NGN4.71 (previously NGN4.30) and NGN5.14 (previously NGN5.12) respectively. The assumptions driving the single-digit increase in our 2019-2020E EPS estimates are the (1) increase in revenue growth forecast to 9% average (previously c.8% average) and (2) 400 bps downward revision of opex-to-revenue ratio estimate, offsetting the (3) 300 bps downward revision of gross margin estimate.

▪ Q3-18 revenue grew 15% y/y and beat our estimate and consensus’ by 4%. Consistently for three quarters, GUINNESS has reported revenue growth that exceeded both our estimate and that of the market. Whilst noting the impact of pricing, we are aware that volume has also contributed to the impressive revenue performance thus far, thanks especially to Guinness stout, mainstream spirits, and Dubic lager.

▪ Both we and consensus have been consistently disappointed by the outcome of GUINNESS’ gross margin since the surprise surge to record 55% in Q3-17 (although now restated to 42%). The latest gross margin contraction ( -922 bps y/y and 32 bps q/q) is even more worrying, when the (1) marked softening in the prices of local sorghum (especially in February and March), barley (-11% YtD and -6% y/y in Q1-18) and maize (-16% y/y), and importantly, (2) the stability of the naira, are taken into consideration. Consequently, we have revised gross margin estimate for 2018E to c.33% (previously 34%) and for 2019-2020E to 34% (previously 37%), more so, that the outlook for drinks’ prices generally is now to the downside.

▪ Outstanding borrowings as at end-March was NGN16.8 billion, comprising mainly of related party loans (48%) and letter of credit (42%), which we believe are quite cheap and have impacted little on finance costs thus far. Management had said it would retain some USD loans after the equity capital raise of last year. Capex as at 9M-18 was NGN8.4 billion, and at the run-rate, should equal 8% of revenue (same as for the last three years) by the end of the year.

▪ On our revised estimates, and with valuation rolled-forward to 2019E, we have a TP of NGN73.75/share (previously NGN68.59/share). The stock is trading on 2019F P/E and EV/EBITDA multiples of 21.8x and 8.6x respectively, which compares with SSA peers (20.6x and 9.5x respectively) – though we acknowledge that GUINNESS’ multiples are at considerable discounts relative to 5-year historical average (excluding 2016).

Click here to download full PDF copy of Cordros Weekly Valuation Summary June 25, 2018