H2 2018 Consumer Goods Outlook - Topline To Remain Volume Driven

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Wednesday, September 12, 2018    02:20 PM / Investment-One Research 

Topline To Remain Volume Driven

Following the release of the H1 2018 results of companies under our consumer goods coverage, we remain slightly optimistic in our view of top line performance in the second half of 2018. We expect the continued growth in GDP, although still fragile, accelerated implementation of the 2018 budget and election spending to support expansion in volume performance. 

This, combined with the relative stability in the FX environment and continued cost curtailment efforts, may be positive for PBT growth in H2 2018. With the exception of PZ Cussons Plc, whose released FY 2018 results (YE: May 2018) continued to reflect weak consumer spending and the challenges in the nation’s operating environment on a year-on-year basis, top line performance for most consumer goods players under our coverage improved in H1 2018. 

Although slower when compared to H1 2017, where top line saw support from price increases taken in 2016, H1 2018 topline performance has been largely volume driven, given that the ability to take further price increases was impaired by competition and fragile consumer spending. 

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 Evidently, Unilever Nigeria Plc and Nestle Nigeria Plc, despite relatively flat gross profit margins in H1 2018, published 15.41% y/y and 14.97% y/y rise in gross profit respectively, an indication of volume growth. However, for PZ Cussons, in its FY 2018 scorecard, gross profit margin was down 537bps y/y to 30.36% on account of input cost pressure, which partly explains the 12.50% contraction in gross profit in the period.

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The improvement in volume performance in H1 2018 may have been driven by the improving momentum in the domestic economy and the continued moderation in headline inflation. On a segmental basis, we point out the increasing competition in the food segment relative to the Home and Personal Care (HPC) segment of most players. 

Although the food segment continues to be the biggest contributor to Nestle’s top line performance, its growth slowed in H1 2018 to 8.91% y/y from 36.03% y/y in FY 2017 and 61.11% y/y in H1 2017. The same was the case in the beverage segment, which registered a 14.63% y/y growth in the period (H1 2018), a decline compared to the 31.21% y/y growth in FY 2017 and 37.05% y/y in H1 2017.

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Similarly, we point out the increasing influence of the HPC segment on Unilever Nigeria’s top line performance. The HPC segment, which accounted for 52.78% of revenue in FY 2017, now accounts for about 54.21% of the company’s top line in H1 2018. This indicates that the company may be facing intense competition in its food business as highlighted by management.

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For PZ Cussons, FY 2018 topline continued to remain pressured as highlighted before. The growth in the branded consumer goods segment grew 6.79% in FY 2018, compared to the growth of 22.24% in FY 2017. Revenue from the white goods segment recorded its second year of decline as consumers’ discretionary income remained pressured. 

This said, FY 2018 topline grew by just 2.99% y/y to N80.55billion. Going into H2 2018, we may see expansion in volume performance based on the recent passage of the 2018 budget. Although there was no improvement in the timing of the budget approval process, the Federal Government could accelerate the disbursement of funds for capex ahead of the forthcoming election, which may be positive for consumer spending. 

Furthermore, the on-going improvement in government revenues as a result of higher oil proceeds and the widening of the tax net should be a positive for states in meeting their salary, pension and debt obligations, which could also support consumer demand. 

Lower Margin Performance on Higher Cost Pressure

Although, top line performance for consumer goods names under our coverage increased y/y on the average in H1 2018, average gross profit margin remain pressured, weighed down heavily by PZ Cussons as Unilever and Nestle’s H1 2018 gross profit margin came in somewhat flat. While the inability to take significant price increases may have accounted for the flattish gross margin performance of both Unilever and Nestle, input cost pressure, as reflected in the results of consumer goods players, was also a contributing factor. 

We attribute these cost pressures to the uptick in global commodity prices as well as the slowdown in the growth of the nation’s agricultural productivity. On the domestic side of things, the unrest in the North East and lack of adequate infrastructure, particularly road and rail transportation, continues to plague the agriculture sector.

Thus, growth in the sector slowed to 1.19% y/y in Q2 2018, according to the data from the National Bureau of Statistics. This may be negative for the backward integration programme embarked upon by consumer players and may adversely impact on the cost of local inputs thereby neutralizing the conceived benefits that prompted the initiative. 

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Although FX continues to remain relatively stable due to CBN’s sustained intervention in this space, the gradual increase in the prices of some imported inputs in the global space is another source of concern for gross profit margin performance. Evidently, to mention a few, the prices of sorghum, wheat and maize have increased by 33.2%, 6.6% and 7.6%respectively year-to-date. This said, we remain largely conservative on the gross margin performance of consumer goods players under our coverage in the second half of 2018. 

The agricultural price index, which tracks the prices of some of the inputs used by our consumer names, such as maize and barley, is expected to rise by 2.20% in 2018 and 1.30% in 2019 due to current season’s reduced planting and some weather induced crop reductions in South America, according to World Bank. The prices of barley and maize is forecasted to grow by 29.00% and 6.45% to US$129 and US$165 respectively in 2018. We may see this continue to impact negatively on the cost of inputs, which may exact pressure on gross margin. 

Operating Efficiency to Buffer Performance

Operating expenses for our coverage of consumer names came in mixed in the first half of the year. While Nestle’s opex/sales ratio remained flat y/y, Unilevers’ increased 208bps to 18.94%. For PZ, FY 2018 opex/sales grew 131bps to 20.1%. In H2 2018, while we expect our consumer names to adopt stringent measures to curtail operating expenses in order to support bottomline performance, we highlight the potential rise in operating expenses that may result from increased promotional and marketing expenses. This may be aimed at driving volume growth amidst increased competition.

 

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Balance Sheet Deleveraging Continues To Support Performance

Another important driver of the performance of some consumer players under our coverage in H1 2018 was the benefit of balance sheet deleveraging, which they began in 2017. 

To mention a few, Unilever and Nestle reflected lower debt in FY 2017 compared to FY 2016. While Unilever Nigeria Plc achieved this by raising additional equity capital by way of a rights issue, we suspect Nestle may have repaid its debt from its operational cash. This led to an improvement in Unilever and Nestlé’s interest coverage ratio to 7.4x and 14.1x in FY 2017 from 3.4x and 8.3x in FY 2016 respectively. 

This said, Unilever Nigeria Plc and Nestle Nigeria Plc debt-to-equity ratio declined from 179.00% and 164.00% in FY 2016 to 1.00% and 54.00% in FY 2017 respectively. In H1 2018, Nestle debt further declined by 27.71% to N17.48 billion, bringing debt to equity ratio further down to 39.26%. However, for Unilever, H1 2018 debt to equity ratio increased to 5.51% as the company’s debt jumped 549.00% to N4.35billion. 

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While the deleveraging exercise may be supportive of the company’s bottomline performance in the near term, we highlight that the high interest rate environment may put upward pressure on interest expenses. 

Overall Cash Balance Remains Strong

With regards to cash generated from operations, our consumer goods coverage recorded mixed performance. For Unilever Nigeria Plc, although net cash generated from operating activities came in positive, it shed 77.80% y/y to N1.55billion, largely driven by increased inventory and lower trade and other payables despite higher y/y bottomline performance. However, overall cash balance continues to see support from the right issue undertaken in 2017, printing at N47.92billion in H1 2018, from N14.17billion in H1 2017. 

For Nestle Nigeria Plc, net cash flow from operation remains resilient on tighter credit management and increased trade and other payables. We highlight that the 51.97% y/y decline in cash and cash equivalent in H1 2018 may be largely attributable to the N30.00billion paid out to shareholders as dividends during the period. Consequently, while the cash conversion ratio for Nestle improved to 1.26x in H1 2018 from 0.86x in H1 2017, Unilever cash conversion ratio worsened to a negative 0.20x in H1 2018 from 0.95x in H1 2017. 

Despite its lackluster performance in FY 2018, with PBT shedding 51.90% y/y to N2.31billion, PZ Cussons’ net cash generated from operating activities improved, up 387.07% y/y to N11.16billion. This was largely driven by reduced inventory and decline in the deposit for imports. As a result, cash conversion ratio improved to 1.02x in FY 2018 from 0.14x in FY 2017.

 

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