November 6, 2020/InvestmentOne Report

·         Stable topline performance: up 1.4% q/q, 3.3% y/y.

·         Declining gross profit margin: down 60bps q/q; 280bps y/y.

·         Mixed Opex to sales ratio: up 110bps q/q; down 100bps y/y, to 18.6%.

·         Weakened PBT margin: down 170bps q/q and y/y.

The earlier released Q3 2020 Nestle scorecard reflected some of the Covid-19 inflicted challenges, majorly accentuated in the company’s input costs. With inflation on an uptrend and the effects of the recent devaluation still material, cost of goods sold printed as the major drawback during the quarter even as operational costs and net finance cost were supportive of bottom-line. We also raise concern on the material 14.2% y/y revenue dip in the Food segment. 

Focus Remains Rising Cost Pressures

On a y/y basis, Nestle recorded a slight increase in turnover driven largely by a 3.3% revenue growth in the Beverages segment, which was enough to overshadow the 14.2% drop in the Food Segment. The dip in the food segment may not be unconnected with the weakening in consumer demand, impacted by the economic ravage induced by the widespread of Covid-19. In contrast, there has been a demand for beverage products in the year with social distancing measures largely at play.  Going down the P&L, gross profit margin weakened by 280bps to 40.7% continuing a downward trend and marking the lowest level since Q1 2018. This was reflective of heightened inflationary pressures relating to recent devaluation exercises and higher costs of locally sourced inputs as the agricultural space continues to be laden with operational challenges. Going forward, we expect this to continue to be a challenge for FMCG companies. Notwithstanding, it is pertinent to note that the company sources 80% of its products locally, thus shielding it from the weakening of the NGN to an extent. Since the onset of the year, the company seems have adopted a stockpiling strategy in the wake of rising input costs. As such, inventory buildup has been on the rise, up by about 58% y/y as at 9M 2020. We expect this to present an upside for GPM performance going forward, albeit only a marginal one. 

Increasing Input Cost to be a Challenge

Taking a look at the bottom line, the company’s PBT margin printed at 14.1%, 120bps worse than Q3 2019. We attribute the dip in PAT (-4.6% y/y to 10.11billion) to the decline in gross margin (-327bps y/y), which was enough to offset the company’s efforts to drive down operational cost (-2.1% y/y) and a more favorable net finance cost (-8.1% y/y).  Looking more closely at the numbers, opex/sales printed more positively, dropping by 100bps, further showcasing the company’s cost management ability amidst weak earnings prospects. This was on the back of the growth in topline and a more accentuated 7.3% dip in administrative expenses as well as a slight dip in distribution costs.  

Weathering the Storm

Looking at 9M 2020 numbers, the material effects of the COVID-19 widespread on the company’s operations have been evident. The FMCG leader has recorded a 13.3% dip in net profit following a 6.5% drop in gross profit driven by higher COGS and an 86% y/y rise in net finance cost. Bottom-line was further exacerbated by a 1.5% rise in opex driven by a 29% rise in administrative costs. Overall topline has seen a slight improvement (+0.7% y/y) owing to an 12.3% growth witnessed in the beverages segment, which has been enough to offset the 6.4% drop in the Food segment this year.

Also positive for the company’s cash generation is the 19.6% ytd drop in trade receivables, highlighting the company’s robust credit terms in spite of a difficult year for consumers.

Nestle Nigeria has announced an interim dividend of N25.0, representing a dividend yield of 1.93% on a trading price of N1,292.5.        

Outlook

Going forward, we expect that topline growth may continue to be stifled by the intense competition in the consumer space, particularly as the economic effects of the COVID-19 pandemic hampers consumer demand. This may further limit the company’s ability to undertake price increases in line with economic realities. However, we expect company performance to continue to see support from its stockpiling strategy, the lower interest rate environment, its superior ability to price cost reflectively and brand loyalty.

Additionally, strong market share in other regions of the country besides Lagos as well as being placed in a favorable position relating to local sourcing (80:20 domestic to foreign sourcing of raw materials) puts the company in pole position compared to competitors. Nestle ’s inclusion in the list of companies allowed to import milk should also bode well for company operations.

Our concern, however, lies in the prospect of continued dollar illiquidity particularly in the context of a devaluation, as its supply chain is still subject to FX risks relating to pricing. With that said, we expect Nestle to sustain its cost management strategies, which should be supportive for bottom line performance in the near term.

Source: Company’s Financials, Investment One Research