April 4, 2012/ARM Research

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• UAC Nigeria Plc “UACN” recently released audited results for FY ended 31st December 2011. Revenue rose 22% to N63.5 billion in the review period from FY 2010 and ~3% lower than our forecast.
 

• The uptick in revenue growth compared to ~7% decline the previous year came on the back of a number of factors including additional production capacities at its food businesses – Grand Cereal Limited (GCL), SWAM waters and UAC Foods expanded production capacities - to meet growing demand; complemented by improvement in bank lending (CPS[1] rose 33[2]% YoY in 2011 compared to 5%[3] decline in 2010) that provided support for product uptake across the various business segments.
 

• In Q4 2011, revenue growth slowed to ~25% YoY from ~31%YoY in Q3 2011; translating to a 400bps dip to 30% in contribution to FY 2011 revenue from average over the last three years when it began the consolidation of the books of UPDC. The revenue slowdown came on the back of lost contribution from the additional restaurants it sold to franchises in pursuant of its full-franchise model strategy as well as supply challenges at its GCL due to ethnic tensions at its operational base in Plateau State. 
 

Margins crimped by higher cost

• Input cost rose faster than revenue and reflected in the 320bps decline in gross margin to 28% for FY 2011 from FY 2010, which was nevertheless 100bps ahead of our forecast. With the food and beverage segment accounting for ~67% of groups revenue, domestic food price pressures, along with higher cost of construction materials were the likely culprit. Operating margin declined 167bps YoY to 14.1%; 60bps lower than our forecast. 
 

Debt restructuring helps contain charges

• Despite a sharp rise in interest rates in Q4 2011, UACN reported a ~17% YoY decline in net interest expense to N1.55 billion for FY 2011—well short of our N1.9 billion forecast-- facilitated by the successful N15 billion bond issue by UAC Property Development Company “UPDC”, it real estate subsidiary, in August 2010 which allowed the company restructure its debt, reduce its effective cost of debt and largely avoid the impact of subsequent jump in market rates. 
 

Figure 5: Debt Maturity Bucket

Non-operating income masks flat core earnings

• The nine-fold increase in non-operating income to N7.2 billion includes the N5.7 billion receipt from the sale of 49% equity stake in its UAC Foods Limited to Tiger Brand of South Africa.
 

• Adjusting for non-operating income and an exceptional charge of N1.65 billion, pre-tax and net income rose 16% and 21% to N7.4 billion and N5.7 billion, respectively leaving pre-tax and net margin flat at 12% and 9% for FY 2011 compared to FY 2010. Adjusted PAT was 13% higher than our forecast on the back of the higher effective tax rate of 25% we applied, compared to the 21%actual, and our higher interest expense estimates.
 

• Management attributed the exceptional charge to impairments charges associated to closure of Nandos restaurants and MDS Logistics assets pursuant to restructuring as well as charges on UAC restaurants and Mr. Biggs Ghana assets pursuant to migration to a full franchise model. There was also an additional tax levied on prior year profits. 

Lower dividend payout given the number of plans in the pipeline

• The N5.7 billion cash receipt from the sale of its 41% stake to Tiger Brand provided support for 111% YoY rise in cash balances to N15.2 billion, the largest end of year cash balance in the company’s recent past. As a result, UACN increased its 2011 per share dividend by 36% to N1.50 from the previous year though payout ratio was lower at 33% (FY2010: 55%).
 

• Adjusting the cash balance for N2.4 billion in dividend payment, management expects to expend N3.5 billion in gratuity for staff disengaged in the adoption of the full-franchise model – the company had cut its headcount to less than 3000 from 4,150 in 2010 as it completes the franchising of all but 1 of its 152 Mr. Biggs outlets. It also plans to deploy N2 billion for the proposed right issue at Grand Cereal Limited (GCL) and N4 billion for its various expansion and acquisition plans.
 

• UPDC plans to issue a REIT in July/August; and is currently awaiting SEC approval. The proceeds are expected to augment the cash need for the various projects in the mid-tier housing segment and finance additional developments – a mall and short-stay apartments – by its Golden Tulip Hotel.


• Cash proceeds from the intended right issues at GCL will be invested in capacity expansion. It plans an 18,000 tonne/ month feed factory in Kano and 20,000 tonne/ month in the South-East region which accounts for ~40% of total revenues for the business.
 

• The growth in CPS will probably remain an important growth driver for revenues, supporting product uptake for its food businesses and also complementing what appears to be a successful strategy at its real estate subsidiary (UPDC’s revenue grew 35%YoY in Q3 2011 ) aimed at increasing exposure to the mid-tier market.
 

• Nevertheless, recent pressures on consumer discretionary provides less margin for transferring costs to the consumer even as disruptions to supply chains and production in the restive north suggest that expenses will continue to escalate.
 

• Whilst market leadership will provide some producers flexibility in responding to adverse movements in input costs, UACN position is particularly threatened by intense competition across all its product categories from imported animal feeds, new entrants in the packaged food space and the fierce competition in the mid-tier segment of the real estate market.
 

• GCL remains the single largest contributor to group’s revenue, and cemented this position after the 500bps rise in contribution to revenue to ~37% for FY2011 from FY 2010, benefitting from recent moves by the government to commercialize the agriculture sector. However, management views the incessant disturbances in the Northern region, where its production facility is located,  as a serious threat and reportedly leased the Bendel Feed and Flour Mills at Eru in Q4 2011 in its bid to reduce this risk and make up for the production downtime at GCL .
 

• Management could not provide firm guidance with regards the extent of revenue contribution and operating efficiency improvement expected from the joint venture with Tiger Brand as it rolls out its products via UACN’s supply chain. Nevertheless, we believe this could provide the company considerable upside.
 

• Management remains optimistic about addressing revenue leakages from its expanded franchise network as well as quality problems. It hopes franchisees will continue to maintain leadership position in this segment despite fierce competition. 
 

• Given the highlighted pressure points on revenue growth, we revise our FY 2012 revenue forecast lower to N70.5 billion from the previous N79.1 billion bringing it closer to management guidance and implying a~11% rise from FY 2011. The primary adjustments are for lost revenue from the restaurants business. We also revise our 2013-2014 revenue forecast lower.
 

• We revise our gross margin estimate for FY 2012 to 29% from 28% to reflect cost-savings from its full-franchise model although higher food prices, distribution cost associated to the high-risk Northern region remain key risks precluding more aggressive margin targets.
 

• We expect the transfer of technical expertise by Tiger Brand to UACN, as part of the joint venture agreement, to boost operating margin and forecast a 100bps rise in operating margin to 15.5% for FY 2012 from FY 2011.
 

• Given these changes, we forecast a 27% and 24% YoY rise in pre-tax profit and net income to N9.4 billion and N7.1 billion respectively, lower than our previous N10.3 billion and N7.8 billion forecasts. Adjusting for N3.5 billion in restructuring cost, we expect pre-tax profit and net income to decline 19% and 21% YoY to N6 billion and N4.5 billion respectively for FY 2012.
 

We revise our rating one-notch lower

• These adjustments, coupled with the lower revisions in our earnings forecast put the fair price for UACN at N34.05, a downward revision from N41.41 though still 17% higher  than today’s close. The result puts the company’s PE (adj) and P/EBIT at 8.16x and 5.19x which compares favourably to peer average at 18.9x and 13.1x, respectively. We revise our rating to OVERWEIGHT from the previous BUY.

ARM ratings and recommendations

ARM now employs a two-tier rating system which is based on systemic importance of the security under review and the deviation of our target price for the stock from current market price. We characterize systemic importance as a function of a stock’s ranking among the group of top 20 stocks by NSE market capitalization over a trailing 6 month period (minimum) to the review date. We adopt a 5 point rating system for this category of stocks and a 3 point rating system for stocks outside this group. The choice of top 20 stocks arises from the consideration that this group of stocks constitutes >75% of overall market capitalization and stocks outside this group are generally less liquid and individually account for <<1% of market capitalization. For stocks in both categories, the basis for ratings subject to target price deviation is outlined below:

Reference: UAC of Nigeria Plc rewards investors with N1.50k dividend in '11 Audited result.

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