August 3, 2018/InvestmentOne Report

Improved topline growth: up 0.6% q/q; 11.6% y/y

·         Expansion in gross margin: up 578bps q/q; 305bps y/y.

·         Mixed opex to sales ratio: up 131bps q/q, down 75bps y/y..

·         Higher PBT performance: up 33.7% q/q; 79.2% y/y. 

Nestle Nigeria Plc released its Q2 2018 results earlier this week, which came in very impressive. 

PBT margin jumped 1,013bps y/y to 26.88% in Q2 2018, majorly driven by the 305bps y/y expansion in gross margin, 75bps y/y contraction in opex/sales ratio and a net finance income of N598million against a net finance cost of N3.3billion in Q2 2017.   

We highlight that Nestle’s Q2 2018 topline performance was largely in line with our forecast of N66.05billion, although PBT came in higher than our expectation due to better gross margin and a net finance income of N598million in Q2 2018. 

Volume Driven Topline Growth 

Nestle’s topline grew by 11.62% y/y to N67.83billion in Q2 2018. We suspect that the growth in topline may have been largely volume driven, due to an absence of a significant price increase taken in Q2 2018, going by our price tracker. Similar to the last three quarters, the beverage segment (up 12.50% y/y) continued to grow faster than the food segment (up 11.09% y/y) in Q2 2018. This combined with relative stability in the FX market supported a moderation in input cost pressure, pushing gross margin up by 305bps y/y to 43.96%, the highest in the last three quarters. 

On a sequential basis, topline was flat with gross profit margin expanding by 578bps partly due to the low base effect of Q1 2018. We recall that the company took an impairment loss of N3.41billion on its water factory in Abaji, Abuja, which pressured gross margin in Q1 2018. 

Effective Cost Management 

Opex was up 7.17% y/y majorly due to the 13.46% y/y increase in marketing and distribution expenses, the highest in the last three quarters. Similarly, on a q/q basis, marketing and distribution expenses was also the driver of the 8.42% q/q increase in opex. This could be an indication of the company’s drive to improve market penetration.  

However, opex/sales ratio declined 75bps y/y to 17.96% in Q2 2018, better than Unilever Nigeria Plc whose opex/sales printed at 24.1% in Q2 2018, as the company continued to maintain opex/sales ratio below the 25% level since 2013. Consequently, Q2 2018 operating margin came in impressive, up 380bps y/y and 448bps q/q to 26.00%, the highest since Q3 2015. This came in better than Unilever Nigeria Plc’s operating margin (11.00% as at Q2 2018).  

Strong Cash Generation 

Despite the 53.47% y/y decline in interest income in Q2 2018, owing to the 54.40% reduction in cash balance to N25.99billion, Nestle Nigeria recorded a net finance income in Q2 2018 on account of the 90.00% y/y decline in finance cost, as total debt outstanding fell by 59.35% y/y to N17.48billion . Evidently, on its cash flow statement, the company recorded a repayment of N21.58billion of both intercompany and bank loan. While this may have contributed to the lower cash balance in Q2 2018, we suspect it also supported the massive reduction in finance expenses.  

We highlight that the company continued to demonstrate strong cash generation through its ability to pay its debt, effect dividend payment and manage working capital demands, similar to what we have observed in recent quarters. On the operating side of things, the strong cash generated from operations continued to be supported by improved profitability and higher trade payables.  

That said, although PBT performance recorded a 79.15% y/y growth in Q2 2018, we point out that it could have rolled in better, except that the company took an impairment loss of N1.04billion on property, plant and equipment of its food business. While we await management’s clarification on this, overall, Q2 2018 performance was stellar.  

Going forward, we expect topline growth in H2 2018 to continue to be driven by volume on the back of expansionary fiscal policy, election spending and the potential review of the minimum wage before the end of the year, which may bode well for consumer spending.  

However, topline growth may be moderated by the high base effect of 2017. Similar to recent performance, we believe gross margin performance in 2018 may continue to be supported by the relative stability in the FX environment. Nevertheless, we highlight political risk associated with the forthcoming election as well as unrest in the North East as potential drawback to Nestle Nigeria performance in 2018. 

While our pricing model is under review, we currently have a HOLD rating for the stock at a target price of N1,570. 

Source: Company financials, Investment One Research