February 27, 2019 09:38 AM / Afrinvest Research
Unarguably, Nigeria’s robust demographics, with an estimated population size of 197.0m people accounting for 18.3% of Sub-Saharan African population, remains a strong fundamental attraction to the FMCG sector. Since the crash of global oil prices in H2:2014 culminated in economic recession, the Nigerian consumer market is yet to recover from enormous adjustments in spending pattern despite the subsequent recovery witnessed in Q2:2017. FMCG companies in our coverage universe produce mostly necessity goods (flour, sugar, salt, beverages and personal care). Nigeria’s forex challenges, between 2014 and 2017 which climaxed in the ban of 41 items in 2015, elevated the vulnerabilities of the sector. However, the introduction of the Investor and Exporters’ (I&E) FX window in April 2017 provided succor. Post-I&E, calm is returning in access to forex although currency depreciation triggered higher cost of production which is being effectively passed through prices to final consumers, despite stiff competition.
Nigeria’s FMCG industry remains fundamentally attractive to investors across borders. Our coverage universe has counters that are favoured by local and foreign institutional investors. Disaggregating valuation across sub-sectors shows clear case of undervaluation and presents compelling opportunities for upside. Our comparison of average valuation metrics across flour milling companies in Africa (11.0x) shows undervaluation of Nigeria’s flour milling industry (4.1x). Similarly, average price to earnings (P/E) ratio of Sugar (Africa:14.5x; Nigeria: 6.0x), salt (Africa:29.5x; Nigeria: 9.9x) and personal care (Africa: 25.5x; Nigeria: 25.4x) are higher for African peers than those of their Nigerian counterparts. However, the beverage sector (28.7x) appears fully priced in Nigeria relative to the average pricing in Africa (18.2x).
Our intrinsic valuation perspectives viz a viz the readings of sentiment suggest market pricing will likely pick up post-2019 elections wind-up. We also anticipate the FY:2018 earnings to prop investor sentiment. On a fundamental basis, our valuation models show elevated cost of equity across securities, based on higher risk-free rate and risk premiums. We assumed conservative sustainable growth rates across companies. Of the 8 securities covered, we have “BUY” recommendations on two, “ACUMULATE” on two, “HOLD” on one “REDUCE” on one and “SELL” rating on two.
Against the perceived long-term 15-year average growth rate of 7.6% (2000-2014), the reality of Nigeria’s fiscal vulnerabilities crystalized in a 2-year (2017-2018) average GDP expansion of 1.4% post-2016 recession. Worse still, the economy remains laden with weak per capita income estimated at US$1,800 – relative to low income countries’ average of US$750.4 – as at the end of 2017.
Demand remains tepid despite intact consumer appetite. Weak income levels have necessitated painful adjustments that resulted in negative consequences on aggregate volume. Higher prices and aggravated general price levels have also constrained consumer spending power; discretionary incomes have shrunk though tax rate remains the same. Real income per-capita has fallen to US$974.3 (estimated) in 2018 from as high as US$1,881.4 in 2014. Consumer Confidence Index (CCI) also remained weak since 2016 though gradual recovery is becoming noticeable.
Notwithstanding, sector investment has been commendable in line with the enormous potential for growth given the compelling demographic configuration which places Nigeria as the largest consumer market in Sub-Saharan Africa. From our sector coverage estimates, average Capital Expenditure (capex) rose Y-o-Y by 151.4% in 2018 to N57.0bn from the 58.3% decline suffered in 2017 (N22.7bn). We expect tepid growth in capex for 2019 until income levels recover to prop demand. Industry appears to be optimal on capacity especially given the weak demand; investments in cost efficiency remains needed to optimize value for investors.
Between 2015 and our 2018 estimates, finance charges of players in our coverage universe grew from N33.0bn to N68.8bn. Overall, capital mix appears skewed towards debt than equity over the four-year period. In our view, the reality of debt burden going forward may shift focus to equity financing sources in our forecast period as we expect favourable market conditions to make equity financing options more compelling.
Beverage: Weak consumer spending power has constituted a drag to volume growth in real terms; however, higher prices that were effectively passed through to consumers made up for revenue, which on the average grew at a CAGR of 17.0% over 5 years.
Flour Milling: For the three flour millers – FLOURMILL, DANGFLOUR and HONYFLOUR – in our universe; direct cost burden was a common factor to all with an average industry cost to sales ratio of 79.4% in 2018 and a 5-year average median and high of 82.2% and 87.8% respectively. Although higher prices of wheat continue to eat into margins of players, industry efforts towards backward integrating are still preliminary. We believe revenues will remain stable for players as bread and other wheat derivative meals are still major staple foods in Nigeria. Although volume may contract as consumer income level continues to struggle amid weak economic prospects, higher prices, given the inelasticity of the products, will support revenues. We estimated 4-year revenue CAGR of 14.0% as at FY:2018 while we project a flattish revenue growth of -0.2% in 2019 financial year.
Sugar: The sugar market in Nigeria is growing very fast especially for industrial usage. The three biggest players – DANGSUGAR (1.44MMT), BUA SUGAR (1.44MMT) and GOLDEN SUGAR (0.85MMT) - all have total installed capacity of 3.73MMT per annum. The backward integration story has been most successful for the sugar industry as all the 3 biggest players have keyed into it in line with the National Sugar Master Plan (NSMP) rolled out by National Sugar Development Council (NSDC). We project a stable output increase in 2019 but gradually expect increasingly tepid growth over our forecast period at a CAGR of 1.7%.
Personal Care: PZ and UNILEVER are the corporates in our personal care industry universe. The sector has been dragged majorly by weak consumer spending. Given the nature of goods, product innovation and branding have been the bases of competition amongst players. Over a 5-year period, revenue grew at a CAGR of 8.3% with estimated growth rate of 4.9% in 2018 while 2019 is forecast to grow marginally by 0.5%.
In our coverage universe, revenue grew on a CAGR of 14.8% over a 4-year period with an estimated 2.7% decline in 2018. Sales growth remains strong across segments despite the noticeable trends on weaker volumes since 2015 as depressed consumer spending power is yet to recover. Internal efficiencies and effective cost pass through aided the OPEX margin which on the average moderated from a high of 16.2% in 2014 to an estimated 10.4% in 2018. As a result, average growth in EBITDA settled at 21.2% (10.0% estimates for 2018) over the period, with margin rising from 11.0% in 2014 to 15.3% in 2017. This is estimated to further rise to 17.3% in 2018. Profitability metrics improved as PBT and PAT grew at a CAGR of 21.5% and 20.8% while PBT and PAT margins are estimated at 13.4% and 9.4% in 2018 relative to prior 5-year averages of 7.8% and 5.9% respectively.
Dupont analysis of the FMCG sector shows that the sector’s return on equity (ROE) has been mainly driven by higher leverage and somewhat efficient asset turnover ratio. Beverage industry, NESTLE, remains efficient in sweating assets though leverage is also higher to produce a higher ROE. Flour milling companies’ ROEs are also driven by higher leverage and efficient asset turnover ratios while the same applies to the personal care industry, sugar and salt industries in our coverage universe. Overall, average ROE (28.0%) is being achieved at an average net margin of 11.7%, financial leverage of 2.9x and asset turnover ratio of 0.9x.
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