October 30, 2020/Cordros Report

NESTLE published its Q3-20 results after market close on Wednesday (28 October).  EPS declined 4.6% y/y in Q3, slower than expected growth in revenue and faster growth in cost of sales which resulted in a 283bps gross margin contraction. Annualised, the achieved revenue is 2.0% behind ours and consensus estimates for 2020E. Conversely, the annualised 9M-20 EPS is tracking ahead of our 2020E estimates by 3.4% but is 8.5% behind consensus estimates. On the 9M EPS of NGN40.29 (-13.3% vs. 9M-19), the board has proposed an interim dividend of NGN25.00/s, in line with our estimate.
 
Revenue grew by 3.3% y/y in Q3-20 driven by the 32.7% y/y surge in beverage sales. In our view, this can be partly explained by (1) higher average prices — Milo (+15.9% y/y) and Nescafé (+13.0% –18.3% y/y), and an improved volume outturn amidst the easing of the lockdown restrictions.
 
Food sales unexpectedly fell to an eleven-quarter low, declining by 14.2% y/y. Growth has been quite volatile in the segment, alternating between growth and declines in each quarter since Q3-19. Although, according to industry players, the market for seasonings (Maggi is the largest brand in NESTLE’s food segment) has become increasingly competitive in recent years, we had expected that the easing of the lockdown measures, and reopening of major demand channels, would offer a boost to food revenues. The company’s major competitor in the seasoning market, UNILEVER (SELL; TP: NGN10.46; CP: NGN13.15), recorded a 25.1% q/q growth in food revenue relative to a decline of 16.1% q/q for NESTLE. This performance would suggest that NESTLE ceded some market share to its competitors during the quarter.
 
Gross margin compressed by 283bps to 40.7%, the lowest since Q1-18, as the growth in cost of sales outpaced revenue. Cost of sales grew by 8.5%, which in our view, is indicative of the weaker currency and much higher local sourcing costs (NESTLE sources c.80% of its raw materials in Nigeria) amidst intensifying inflationary pressure within the country (food inflation in Nigeria averaged 15.6% in Q3-20).

Operating profit fell by 4.6% y/y as the gross profit contraction offset the decline in operating expense (-2.1% y/y). EBITDA fell by 3.2% y/y equating to an EBITDA margin of 24.8% (26.5% in Q3-19). This implies a contraction of 166bps in EBITDA margin.
Net finance costs fell by 8.1% as finance income (+24.0% y/y) grew faster than finance costs (+0.6% y/y). Despite the preceding, the operating profit weakness drove EPS down by 4.6% y/y/ to NGN12.76 in Q3-20

Compared to Q2-20, EPS was down 4.9% y/y, weighed down by the weaker gross margin (-57bps), higher OPEX (+7.6%) and higher net finance costs (+19.8%). The Effective tax rate in the quarter was 34.3%, compared to 35.2% and 35.9% in Q2 and Q1 respectively.
 
Notably, total debt (excl. leases) increased by 384.19% q/q to NGN28.34 billion (2.1x total debt at the end of 2019). The detailed breakdown of the debt composition is not disclosed but we recall that the company paid off its outstanding FX debt of NGN5.52 billion (USD15.25 million) due to its parent company in Q1-20. Between Q2 and Q3, the company took up a new long-term intercompany loan of NGN16.96 billion (USD43.98 million at the NAFEX rate) and NGN7.00 billion in bank loans.
 
Comment: NESTLE’s Q3 performance is unimpressive, in our view, especially with the significant decline in food revenue. Despite the weakness in Q3, we expect the focus to be on the still positive 9M earnings and dividend, hence, we do not foresee a negative reaction. Though currently tracking ahead, we expect the Q4 outturn to bring earnings in line with our 2020FY estimates. Per our numbers, the stock is trading at a forward (2020E) P/E of 24.9x, a significant premium to its Middle East and Africa peer average of 17.2x. Our estimates are under review.