March 4, 2021/InvestmentOne Report

·         Improved topline performance: up 3.7% q/q, 2.3% y/y.

·         Declining gross profit margin: down 140bps q/q; 450bps y/y.

·         Mixed Opex to sales ratio to 20.1%: up 152bps q/q; down 303bps y/y.

·         Weakened PBT margin: down 620bps q/q and 470bps y/y.

The earlier released FY/Q4 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 exercises still material, cost of goods sold printed as the major drawback during the quarter. Also, finance cost saw some deterioration as the company’s foreign intercompany loans induced a hike in interest payments and FX losses which combine to pressure bottom line. We also saw some pick up in the Food Segment during the quarter (up by 29.4% q/q and 9.2% y/y) as lockdown measures were alleviated.

Focus Remains on Rising Cost Pressures

Nestle Nigeria through FY 2020 was able to keep its topline stable (+1.1%) amidst a quite challenging year. The performance was led by a 6.9% rise in Beverages segment as the Food segment was impacted, dropping by 2.5% y/y. The dip in the Food segment may not have been unconnected with the weakening of consumer demand, impacted by the economic impacts induced by the widespread of Covid-19.  Additionally, according to management, heightened insecurity in the period under review compelled some distributors to shut down, even as closure and partial closure of key markets was also unsupportive of topline.

For us, our major concern remains the rising cost pressures, following the rapid rise in food inflation and recent devaluation exercises, biting into the company’s margins. The company reported having faced significant challenges sourcing for key raw and packaging materials as prices rose exponentially during the year on the back of supply chain issues. With that said, gross profit margin printed at 41.5% (down 360bps), dwindling through the quarters and representing the lowest figure since 2017. This was led by a sharp 7.7% y/y rise in COGS to c. N167.9billion in FY 2020. Going forward, we expect cost factors to be a challenge for FMCG companies. Notwithstanding, it is pertinent to note that the company sources about 70-80% of its products locally, thus shielding it from the weakening of the NGN to an extent. However, we see heightened food inflation as a major worry, which could serve to threaten the company’s local sourcing strategy if not checked. We suspect the company may have adopted a stockpiling strategy in the wake of rising input costs, with inventory build-up on the rise through the year (up by 57% y/y) led by raw and packaging materials and finished products.  This may present an upside for GPM performance going forward, albeit only a marginal one. We also commend the company on reducing its trade receivables (down by 56% y/y) as the company focuses on cash collections. We find encouragement in Nestle being able to manage its potential credit losses given the context of the economic landscape in the outgone year.   . We saw cash flows from operating activities improve significantly (about 2x), with cash and cash equivalents climbing to a healthy N58.7billion balance from about N7billion in 2019, albeit also supported by drawdowns on intercompany loans. We await management’s

Input and Finance Costs Bite Recovery

Taking a look at the bottom line, the company’s net profit margin printed at 13.7%, 240bps worse than FY 2019. We attribute the dip in PAT (-14.2% y/y to 39.2billion) to the rise in COGS, a sharp deterioration in its net finance cost driven by a N1.7billion foreign exchange loss. All factors which combined to offset the company’s efforts to drive down operational cost (-2.3% y/y), even while printing a 9.2% growth in its Food segment and a 2.3% increase in total turnover. Looking more closely at the numbers, opex/sales printed more positively, dropping by 66bps, as the company’s cost management ability amidst weak earnings prospects kicked in. This was particularly led by a 4.8% y/y dip in distribution costs, even as administrative expenses shot up by 9.4% y/y.

Weathering the Storm

Looking at Q4 2020 numbers, the material effects of the COVID-19 widespread on the company’s operations were 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 sharp increases in interest payments as well as net FX losses. Bottom-line saw some support from an 11.1% decline in operating expense driven by a 35.4% and 5.7% dip in admin expenses and distribution costs respectively. Overall topline saw  a slight improvement during the quarter (+2.3% y/y) owing to an 9.2% y/y rise in the Food segment. We attribute this to continuous easing of lockdown measures during the fourth quarter as consumer demand, particularly for food items, saw some recovery and supply chain improvements reflected as goods in transit eased slightly compared to Q3. Conversely, we saw an 8.4% dip in the beverages segment.

Nestle Nigeria has announced a final dividend of N35.50, representing a dividend yield of 2.45% on a trading price of N1,450.     

Cost Factors to Remain Investor Focus

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 relatively low interest rate environment, its superior ability to price cost reflectively and brand loyalty. Intercompany loans undertaken in 2020 may also provide some support for the company amidst the regime of dollar illiquidity. However, this could be detrimental to the company’s bottom line, with higher interest expenses and the possibilities of further devaluation.

Additionally, strong market shares in other regions of the country besides Lagos as well as being placed in a favourable position relating to local sourcing 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 major concern, however, lies on the impacts of heightened inflationary pressures, which has continued to bite into the company’s margins. Persistent challenges in the country’s food supply chain relating to conflicts in the Northern region, FX risks relating to further downside reviews amidst broadly weakened consumer demand mar the outlook for the FMCG leader. With that said, we expect Nestle to sustain its cost management strategies, which should be supportive for bottom line performance in the near term.