September 3, 2020/United Capital Report

According to the latest financial result by Guinness Nigeria Plc (GUINNESS) for FY-2019/20 that ended in June-2020, Revenue sharply declined by 20.6% y/y to N104.4bn as tighter credit terms as well as restrictions in movement and social gatherings in Q2-2020 (April-June) worsened the company’s ability to push volumes during the period. Also, significant impairment charges further dragged the overall bottom-line performance. Accordingly, the company reported a Loss before and after tax of N17.1bn and N12.6bn, respectively. We update our estimates for the brewer based on the recently published numbers and state our expectations for FY-2020/21E below.

Revenue decline and other one-off charges drag performance: As expected, GUINNESS recorded a sharp decline in Revenue in FY-2019/20, down 20.6%y/y to N104.4bn (vs. our estimate of N110.4bn and Bloomberg consensus estimate of N115.1bn). Notably, Revenue tumbled  72.2%y/y to N8.4bn in Q4-2020 (ending June-2020) as the closure of on-trade channels (bars, restaurants, clubs, hotels and other social spots) due to lockdown measures across the country, and management’s decision to tighten credit terms during the period weakened volume growth. Also, performance across product segments was underwhelming, especially from January to June 2020, as product segment revenue declined by a simple average of 49.5% across the board. Accordingly, Revenue from Guinness Stouts & Gold (-17.0%y/y), Premium Spirits (-146.0% y/y), Ready to Drink (-26.0% y/y), Adult Premium Non-Alcoholic Drinks (-25.0% y/y), and Lager (-45.0% y/y) dipped in FY-2019/20, while that of Mainstream Spirits grew by c. 15.0% y/y thanks to strong performance in H1-2019/20 (+36.0% y/y).

Elsewhere, Cost of Sales (down 22.2% y/y to N71.0bn) declined faster than Revenue (-20.6% y/y/). Accordingly, Gross Profit fell by 16.9% y/y to N33.3bn and Gross margin improved from 30.5% in FY-2018/19 to 31.9% in FY-2019/20. Notably, the decline in Cost of Sales was as a result of weaker production in Q4-2020 (April to June 2020). The parent company, Diageo, had notified the public of production shut-ins at the company’s two production plants (Lagos and Edo) in April-2020 amid restrictions on social gatherings as well as inter-state travels in Nigeria. Meanwhile, for the first time in more than a decade, the company’s Operating Income (EBIT) turned negative at N12.8bn as the management reassessed most of the assets on the company’s balance sheet and wrote-off assets worth N10.3bn as well as recognized other impairment loss on PPE, Export Expansion Grant (EEG) receivable and Customer Deposit Liability (CDL) of N6.2bn.

Also, Net Finance Costs spiked by 1.3x y/y to N4.2bn. This was driven by Finance Costs which surged 73.8% y/y to N4.5bn while Finance Income fell 59.9% y/y to N301.0mn in FY-2019/20. We attribute the jump in Finance Cost to the 21.0% rise in total interest-bearing liabilities to N25.3bn, as well as the negative impact FX devaluation/depreciation had on the company’s related party FCY loan of $22.5mn (or N8.7bn) maturing May-2021, which the management noted it was unable to pay down due to FX scarcity. Accordingly, the company reported a Loss before and after tax of N17.1bn and N12.6bn, respectively.

Liquidity and solvency ratios compare favourably to peers: After two successive financial years of positive net working capital, GUINNESS’ working capital turned negative in FY-2019/20, wherein short-term liabilities outweighed liquid assets by N6.6bn. Accordingly, current ratio fell from 1.2x in FY-2018/19 to 0.9x in FY-2019/20.  Compared to NB’s 0.6x and INTBREW’s 0.4x, this reflects the tighter credit terms recently implemented by GUINNESS relative to peers.

Despite the underwhelming bottom-line performance, GUINNESS’ Net Operating Cash Flow rose by 14.1%y/y to N15.3bn. This was driven by the high non-cash expenses recognized in the income statement as well as the favourable change in working capital. Notably, the management noted that it ended contracts with some distributors and collected returned inventories, as it embarked on a destocking strategy and tightened credit policy in Q4-2020 (April to June 2020). Accordingly, Trade & Other Receivables dipped 28.1% y/y to N18.7bn while Trade & Other Payables remained flat.

Elsewhere, the company’s Debt/Equity ratio continued to trend upward, from a low of 15.7% in FY-2017/18 (following the Rights issue floated to de-lever the balance sheet in 2017) to 31.6% in FY-2019/20. The uptick in leverage is traceable to a new short-term loan of N2.0bn and the N4.8bn commercial paper issued earlier even as inter-company and trade finance facilities rose by 20.1% to c. N16.1bn. However, at a debt/equity ratio of 31.6%, GUINNESS seemed to be better off her peers (NB’s 86.6% and INTBREW’s 70.9%).

TP Reviewed to N14.91; HOLD: Looking ahead, we expect Revenue to gradually improve as on-trade channels (which contributes above 60.0% to Revenue) come back online as the lockdown measures continue to ease. However, with the high base-effect in H1-2019/20 (July to December 2019), we expect H1-2020/21 (July to December 2020) to relatively underperform y/y. Also, the strict credit terms implemented in Q4-2019/20, if sustained, is likely to further hurt beer volumes and Revenue over FY-2020/21, with less room for unilateral beer price adjustments amid stiff competition from NB and INTBREW. Accordingly, we expect GUINNESS to further concede market share within the beer segment to competitions.

Also, an increment in the excise duty on spirits from N175/litre to N200/litre (+14.3%) in June-2020 while duty on beer remains unchanged at N35/litre and wine at N150/litre, remains an issue for GUINNESS, given its Total Beverage Portfolio where Spirits now contributes c. 18.0% to top-line. Although the management noted that prices of mainstream spirits will be adjusted upward to reflect this charge, we doubt that the currently depressed market can conveniently accommodate an upward adjustment of up to 14.3%. Accordingly, we are of the view that the overall impact on spirits contribution margins will largely depend on the speed and size of such adjustment. Additionally, we expect consumer preference for value beer brands to persist due to continued weakness in purchasing power in the economy. Thus, we maintain that the management’s strategy to concentrate more on the high margin spirit segment, especially in view of the public health crisis which may linger over the next 12months, might not, very quickly, turn the fortune of the company around.

Again, the sustained inflationary pressures and the negative impact of currency depreciation/devaluation will pressure input cost, on commencement of full operation in FY-2020/21. Accordingly, we expect GUINNESS’s gross margins to weaken in the near-term. In all, we are of the view that GUINNESS must review its current operating module to win back market share. If the status quo is maintained, margins may further weaken even in the medium term. However, we note that as the overall Nigerian economic conditions improve, some impaired losses may be written-back, and this might provide support for the FY-2020/21E performance. We have also modelled a 50bp increase in our market risk-premium assumption to 8.0%. The effect of all these changes is a 47.1% reduction in our price target to N14.91. GUINNESS shares have sold off by -53.4% YTD, underperforming the broad market index by 48.4%. From current levels, our new price target implies a modest upside potential of 6.5%. We place a HOLD rating on the stock, amid likely pressure on earnings over the coming quarters.  

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