May 4, 2020/Cordros Report
Since the start of the year, NASCON’s share price has sustained its downward spiral, declining by 22.4% (All Share Index: -14.2% YTD). While we do not rule out COVID-19 induced risk-off sentiments, the impact of the reported earnings weaknesses – 2019FY EPS declined by a staggering 56.1% y/y on higher COGS (+20.4% y/y) and operating costs (+56.2% y/y), both of which outpaced revenue growth (+7.0% y/y) – must have aggravated the sell-off on the stock. The recently released Q1-20 earnings report was not entirely different, as the company started the year with a 9.7% y/y decline in EPS. For the rest of 2020E, NASCON’s performance is expected to remain broadly weak, owing to the (1) economic disruption from COVID-19 outbreak, (2) oil price collapse induced FX market pressure, (3) discontinued vegetable oil production, (4) rising debt profile after operating debt-free for the last few years, and (4) rising input cost pressures. Accordingly, we cut NASCON’s target price to NGN11.76/share (Previously: 12.21/share), and downgrade our rating on the stock to ‘HOLD’ (Previously: ‘BUY’).
Discontinued vegetable oil production to weigh on revenue growth: For much of 2019, NASCON was in a capacity expansion mode, delivering an additional 5,800MT capacity for seasonings production in November. While noting that seasonings only contribute 4.7% of aggregate revenue, the delay in the commissioning of the planned 250kMT additional capacity for refined salt production (Updated guidance: To be commissioned in Q3-20) largely contributed to the deviation in our revenue forecasts for 2019FY (6.3% variance) and Q1-20 (2.3% variance). Since NASCON’s capacity utilization for bulk non-refined salt is c.70% and about 80% for refined, the delay in the capacity expansion for refined salt, where management said it sees a massive opportunity for growth, placed a ceiling on salt sales and thus, informed the downward revision of our revenue estimate for 2020E by 5.3%. Aggerate revenue is now expected to grow by 8.4% y/y over 2020E.
Margin Improvement Contingent on Selling Price Recovery: We recall that gross margin deteriorated to 12.1% in Q4-19 (vs. 22.9% in Q4-18), as COGS grew 6.5% y/y amid a decline in revenue growth (-6.6% y/y). However, gross margin improved slightly in Q1-20 (+5.0pps), mostly driven by price-led revenue growth (+0.8% y/y) amid a 6.0% decline in COGS. Meanwhile, in a bid to continue to protect margin, especially in the face of higher raw material costs expectation from currency pressure, management said it has raised salt and seasoning prices by an additional 7.0% on average in April. Meanwhile, having announced that it has suspended the production of vegetable oil, which management said was margin dilutive, we expect gross margin to sustain its recovery in 2020E (+3.8 ppts y/y to 25.3%). However, the magnitude of the recovery in the margin is expected to be limited by naira weakness, following the precipitous decline in crude oil prices which has impaired the CBN’s ability to defend the currency.
Valuation: We downgrade NASCON’s rating to a HOLD with a lower target price of NGN11.76/share, as we do not anticipate any catalyst that would move the stock significantly higher in the near term. NASCON is trading on 2020E P/E and EV/EBITDA multiples of 9.4x and 3.5x, respectively.
Risk to Rating: A steeper than expected devaluation of the naira is a significant downside risk to our estimates, since raw salt is still 100% imported.
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