Nigerian Breweries Plc -Stock is expensive right now


Thursday, February 22, 2018/ 6.00 PM/ ARM Research 

Last week, Management of Nigerian Breweries (NB) hosted a conference call to discuss its FY 2017 results as well as provide its outlook for 2018. In this note, we update our views on NB following the FY 2017 results and revise our 2018 forecasts to ascertain if there is still any upside potential for the stock.

After touching a seven-month low in 2016 (N28.4 billion), earnings recovered in 2017, rising 16.2% YoY to N33 billion underpinned by an improvement in the operating environment relative to the prior year. However, earnings remained below pre-2016 trend level due to sustained weak consumer income and increased industry competition.

Notably, constrained consumer income adversely impacted on volumes with the company reporting a mid-single digit decline in sales volume over 2017. Precisely, management noted slight loss of market share in the review period on the back of strong price increases at the tail end of 2016 which was not implemented immediately by competition. In addition, NB’s parent company – Heineken– noted that consumer downtrading impacted negatively on sales for its premium brands while value brands continued to outperform the broader portfolio. Irrespective, revenue over 2017 rose 9.8% YoY to N344.5 billion, underpinned by higher YoY prices.

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Cost pressures prevail in the quarter
: Input cost pressures lingered in 2017 which drove a faster increase (+12.8% YoY) in Cost of Goods Sold (COGS) than revenue (+9.8% YoY). At the conference call, management explained that the pressure on COGS reflected higher domestic inflation. NB sources around 50% of its raw materials locally (Sorghum, Sugar and Cassava starch) which exposed the company to rising local prices. Precisely, the price of Sorghum rose 32% YoY which, we believe, impacted on COGS. Against this backdrop, gross margin contracted 153bps to 41.7%. In our view, the switch in FX sourcing to the NAFEX window from NIFEX also impacted on COGS. Irrespective, lower net finance expense (-21.9% YoY to N10.7 billion) masked the impact of top-line pressures on core earnings. The decline in finance expense stemmed from a substantial drop (-33.4% YoY to N5.0 billion) in foreign exchange losses due to currency stability over 2017. 

Other key highlights from the call
Consumer downtrading: Management stated that the pace of consumer downtrading slowed in the second half of 2017. Consequently, volumes were better in the second half when compared to the first with its international premium brand – Heineken – returning back to growth. 

New product
: In December 2017, Nigerian Breweries introduced a new lager brand – Stella beer – in a 60cl bottle across four key regions in Nigeria. Stella Beer is an international brand at a price point in the premium segment. According to management, initial feedback on the product was encouraging. 

Changes to the excise duty rate
: Management acknowledged that the government is proposing to make changes to the excise duty rate. NB mentioned that the government plans to change the structure of excise duties to a specific model (wherein tax is levied on volumes sold) from an ad valorem tax model which basically charges a rate (currently 20%) on production costs. According to management, the policy decision is positive for the brewery industry as the specific model is more efficient, transparent and easily administered. However, the company further stated that the implementation would have a negative impact on COGS and looks to pass on the increase to consumers in a more efficient manner. 

Sales growth momentum set to moderate
: In 2018, strategies to drive volume induced revenue growth seems to be the focus of management even as we envisage limited price increases in the year. Management plans to achieve volume growth via leveraging on its strong distribution network as well as increasing availability of products amidst rising industry competition. While we acknowledge these initiatives, we do not expect to see a sharp increase in revenue given that the operating environment remains challenging. In addition, the country’s exit from recession is yet to translate to a sizeable improvement in consumer wallets which also guides to a slow rebound in sales volume. Against these backdrop, we forecast a modest increase in revenue (+3.5% YoY to N356.6 billion) in 2018. 

We forecast COGS to rise 3.8% YoY to N208.6 billion to capture the impact of increasing cost of key raw materials including Sorghum and Barley. This, combined with our revenue expectation translates to a 3.1% YoY increase in gross profit to N148 billion which should see gross margin decline 16bps YoY to 41.5% (FY 17: 41.7%). Similarly, we forecast operating costs to rise modestly by 2.6% YoY to N90.9 billion, driven by a slight increase in marketing and distribution expenses (+2.9% YoY) to capture the company’s plan to drive visibility and availability of its products. The foregoing translates to EBIT of N57.1 billion (+3.9% YoY) with related margin forecasted to increase 7bps to 16.0%.

In view of our expectations for ongoing currency stability, we foresee lower FX losses in 2018. This, coupled with the low yield environment underpins our forecast of 2018 finance expense at N6.5 billion (-38.9% YoY). Net impact of our model revisions translates to PBT and PAT of N51.5 billion (+10.5% YoY) and N36.1 billion (+9.12% YoY) respectively.

Nigerian Breweries trades at a forward P/E of 28.4x vs. 32.9x for Bloomberg Middle East and Africa. NB has declined 5.1% YTD relative to a positive return of 10.2% for the NGSE INDX. We retain our SELL recommendation on the stock with a FVE of N121.30.

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