Slight changes to earning forecasts and price target
International Breweries (IB) strengthened its balance sheet in Q3'20 with an 82% y/y increase in its cash balance to NGN47bn, thanks to favourable working capital changes, a lower capex and proceeds from last year's rights issue. 9M'20 net debt/equity ratio also improved significantly to 0.3x from 31.1x in 9M 2019 on the back of the company's deleveraging exercise. As such, net interest expense declined by -32% y/y.
Despite these positives, earnings remain weighed down by fx inflation and non-cash expenses including elevated depreciation charges and fx losses. Sales growth of 23% y/y in Q3 - reflective of double-digit volume growth - was not strong enough to cover these costs. Gross margin contraction of -212bps y/y to 16.9% and other operating loss of -NGN759m (Q3'19: NGN412m) contributed materially to a pretax loss of -NGN5.7bn. Our recent channel checks suggest that innovative product offerings combined with price competition remains a core part of the company's medium-term strategy to drive earnings growth.
As a case in point, the company launched Trophy Extra stout in April to increase its presence in the premium segment of the stout market. We gather that Trophy stout has gained some level of acceptance as it is currently priced at a discount to segment leader Guinness Foreign Extra stout. Regardless, with IB continuing to undercut competition and subdued industry demand in the face of squeezed disposable incomes, we expect the company's earnings to remain in negative territory over forecast years.
Given that 9M pretax loss tracked our estimate closely, our average loss forecasts over the 2020-23f period remain broadly unchanged. Our new price target of NGN6.7 is however slightly lower by -2%. Year-to-date, IB shares have lost -24% and have underperformed the broad market index by -54%. Our new target price implies a -6% downside potential. We retain our Underperform rating on the stock given our weak earnings outlook.
Results show strong y/y improvement in Q3 bottomline
IB's pretax loss for Q3'20 was 58% lower y/y. The key drivers behind this improvement were a 23% y/y increase in sales, and -25% and -86% y/y declines in opex and net interest expense respectively. On a sequential basis, Q3 pretax loss worsened by 34% q/q, primarily due to a 36% q/q increase in opex. The impact of the increase eroded favourable q/q changes in sales (+39%), gross margin (+362bps) and net interest expense (-32).
Relative to our forecasts, the pretax loss missed by 6% also due to a 50% negative surprise in opex. Sales and gross margin beat by 52% and 294bps respectively, but these were more than offset by the opex miss.