FX - Biggest Risk to Nestle's Earnings Outlook

Proshare

Thursday, August 11, 2016 9:58am /FBNQuest Research

44% cut to our EPS forecasts; Neutral rating maintained

In Q2 2016, Nestle Nigeria (Nestle) reported a loss before tax of –N7.8bn due to net fx losses of –N13.1bn. The latter resulted from revaluation of fx-denominated intercompany loans (c.US$120m) given the 30% slide of the naira during the period. A significant portion (c.70%) of these loans are maturing this year, suggesting that there’s more pain to come.

 

Management is yet to provide guidance on its next move. Regardless, we believe the firm’s fx loan exposure is likely to remain significant in the short to medium term given the firm’s preference for relatively cheaper foreign debt. In addition to fx risks, we also believe the 922bp y/y contraction in gross margin to 33.7% is worrying.

 

Similar to competition, the shortage of gas supplies due to disruptions in the Niger Delta region has led to an increased reliance on more expensive fuel alternatives. Additionally, prices have generally increased for production inputs such as grains, sugar and milk.

 

Our channel checks reveal that Nestle has raised prices for key products by high-single digits y/y on average. However, we do not believe mild price increases are enough to offset rising production costs. As such, we have cut our EPS estimates over the 2016-17E period by -44% on average.

 

We have also increased our risk free rate by 200bps to 14.5% given a higher interest rate environment. Our new price target of N720.0 is lower by around -10% because we have rolled forward our valuation to 2017. From current levels, this new price target shows a potential downside of -12.7%.

 

At current levels, Nestle shares are trading on a 2016E P/E multiple of 74.6x for 76% y/y average EPS growth over the 2017-18E period. The EPS growth is flattered by easy comparables. Ytd, Nestle shares have shed -4.1% (ASI: -4.3%). We have retained our Neutral rating.

Fx losses of c.-N13.4bn hit P&L in Q2

Nestle reported a loss before tax and loss after tax of –N7.8bn and –N6.2bn respectively in Q2 2016, despite an impressive sales growth of 16% y/y (sales grew by 30% y/y in Q1).

 

The losses were mainly driven by a significant rise in finance expenses as a result of an fx revaluation of the firm’s loan book following the recent introduction of a flexible fx policy by the CBN.

 

Sequentially, while sales grew by 23% q/q, Nestle’s losses compare with PBT and PAT of N8.7bn and N6.7bn respectively in Q1 2016. Compared with our estimates, sales were ahead by 11%; however, we forecasted the company to make a pre-tax profit of N8.7bn.

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