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Unilever Nigeria Plc. - Upward Revision to Estimates; SELL Rating Retained

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Thursday, April 06, 2017/3:26 PM/Cordros Capital 

In this update note on Unilever Nigeria Plc (UNILEVER), we make adjustments for:

1.       Finance charges, on potential savings from the refinancing of expensive local short term debts with cheaper USD loans.

2.      Continued impact on the top line and gross margin from pricing.

3.      Operating expenses, which we expect to increase after the tight control achieved in 2016.  

Overall, we think the positives will be sufficient for UNILEVER to achieve low single-digit PBT growth of N4.44 billion in 2017F -- which compares favourably to the N1.43 billion we had forecasted.  

In line with the raised earnings expectation, we have increased TP to N21.06, but retain SELL rating.  

A USD59.7 million loan facility was obtained in Q3-16 to refinance local short term bank overdraft and other facilities.  

Details of the USD facility, as revealed in the final 2016 account, show that:

1.       It is a one-year intercompany loan, with USD49.2 million drawn as at December 2016.

2.      Although larger in volume, it is priced cheaper than the refinanced NGN loan by up to 700bps.

3.      Reduced UNILEVER’s weighted average borrowing cost by about 620bps as at end-2016, compared to 2015.  

Although gross outstanding debt is currently at record level, we estimate finance charges to fall to N1.86 billion in 2017 (vs. N2.72 billion in 2016).  

And while we agree that the USD debt exposes the P/L to unrealized FX loss, we are reminded that:

1.       The CBN appears “determined” to hold the line on the Naira.

2.      Most manufacturers (Lafarge Africa Plc – Listed – is a case in point) are now taking advantage of the derivative products offered by the central bank to hedge FX transactions. 

That said, the USD debt, clearly, could potentially result in estimated FX loss of N2.9 billion – if:

1.       Unhedged

2.      The NGN/USD devalues to N352, the mid-point of the IMF’s suggested fair value -- and compress PBT estimate to N1.54 billion.
 

 

UNILEVER has further increased products prices in each of the last two months, with the aim to, by our hunch, realize historical average 36% gross margin.  

We understand that the PIs were taken both directly (such as for CloseUp, Knorr, and Lipton) and indirectly, through resizing products (such as for Omo and Sunlight detergents).  

Products in the Personal Care segment -- most affected by the weakened purchasing power -- were unaffected by the price increase.  

The 2x price increase comes to us as a fundamental shift from the expectation coming into the year that pricing will -- unlike in 2016 -- have less of an impact on producers’ revenue, given the modest outlook for inflation.  

For instance, a major company in the FMCG sector, which increased prices at one of the fastest pace in 2016, told us that it recently reduced its products prices in response to the appreciation of Naira exchange rate at the parallel market where it meets most of its FX requirements.  

Despite higher prices, we were told that UNILEVER reset key distributors’ (KDs) turnover targets higher.  

When asked if the KDs have performed strongly in line with targets, to our ears, the answer was not in the affirmative. 

It is too early to expect pricing will have the biggest impact on revenue this year, as the PIs have been accompanied with promotional activities, some of which are ongoing.  

KDs look for improved demand from the second half (in the absence of further PIs) at which time consumers might have adjusted to the latest price increases.  

As with most FMCG companies, UNILEVER closely controlled operating expenses in 2016 (achieved the first decline since 2008), where management deliberately scaled back brand and marketing spending (-25%), as bigger outlay may not have simultaneously translated to sales growth in a severely challenged consumer environment.  

But given we expect a relatively higher proportion of volume in the revenue mix this year, we look for higher spending on marketing and branding, potentially lifting opex (+15% Cordros estimate) from the decline recorded in 2016.  

UNILEVER’s linkage to FX via import channels remains substantial. And save for major improvement in the NGN/USD exchange rate (still at historical low level), or the moderation of raw material input prices, we are less convinced that the pricing decisions taken thus far are sufficient to realize 36% (vs. 31% Cordros estimate) gross margin.  

The company has in the past indicated plans to source 90% of its raw materials locally by 2020, but there has been no communication from management on specific internal measures with the potential to lower production costs in the interim. 

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