UAC of Nigeria Plc - The Fly in FMCG Ointment?


Tuesday, August 15, 2017 10:20AM / ARM Research

Despite the bull run across naira equities, which supported strong rally in the FMCG space (YTD, Food: 45%, HPC: +45%, Brewers: +30%), the share price of UACN continues to remain sticky with sentiments largely sour.

To our minds, the apathy reflects weak performance in the first half of the year (PAT: H1 17: -55%, Q2 17: -55%) as well as share dilution risk given expectation of equity capital raise by way of rights issue.

Food inflation weighs on margin

Whilst UACN’s performance remained fettered, the earnings of other coverage consumer names have since picked up from the troughs of 2016 as companies raised prices to combat rising input cost, FX challenges and higher finance charges. Although UACN also raised its prices, we believe the discretionary nature of its products capped the extent of pass through to top-line as volumes declined in key segments.

Particularly, in addition to weaker volumes at UACN’s Logistics subsidiary, pressures were also evidenced by reported lower income-induced slowdown in demand for animal feeds as well as continued sales contraction in real estate over Q2 17.

Furthermore, given the company’s heavy reliance on domestic farm products1, particularly cereals and legumes whose prices have been rising, input cost continues to track higher (YoY: H1 17: +33%, Q2 17: +42%). Hence, notwithstanding the price-induced growth in the company’s top-line (YoY: H1 17: +52%, Q2 17: +33.4%), gross margin still printed at a record low of 15.8% in H1 17 (Q2 17: 15%).

Figure 2: QoQ movements in prices of key inputs2 and Gross margin

Monetary tightening compounds earnings woes

Another key drag on the company’s performance was the elevated interest rate environment which raised the cost of refinancing its largely short tenured debts (86% of total borrowings).

For context, whilst the company took advantage of lower interest rate environment to obtain N15.9 billion loans (59% of total borrowings) at 11% in 2016, the current interest rate environment left the company with little choice but to refinance the noted obligation at 24% in the current year.

Consequently, bucking the trend across other consumer names, UACN’s earnings came in at a record low of N1.2 billion in H1 17—and we see scope for further earnings deterioration.

Figure 3: Trend in effective interest rate (N’ billion

Expensive debt to keep earnings depressed

Our outlook for the company’s earnings is hinged on developments on monetary policy and food inflationary fronts. On the latter, whilst we expect supply-side shocks to food inflation to subside on the back of lower diesel prices, reduced market supplies in the wake of ongoing lean season should limit substantial pass-through to farm produce over Q3 17.

Though improved market supply should temper input cost in the main harvest season of Q4, subsisting demand from neighboring West African countries should put a floor to the downtrend. In sum, we expect input cost pressures to linger over the rest of the year.

Elsewhere, though management guides to further borrowings LT borrowings Effective Interest rate (RHS) Monetary tightening compounds earnings woes Expensive debt to keep earnings depressed price hikes over the rest of the year, accompanying volume contraction should cap the scale of such price adjustments. Overall, we project a Gross margin of 16.6% over H2 17 (FY 17E: 16.2%).

In addition, sustained monetary tightening should keep finance expense elevated.Whilst, management guides to disposing a N5 billion investment property over H2 17 and raising a N15.4 billion rights issue in Q4 17 to refinance its debt obligations, the late timing of the planned capital raise should taper potential impact on interest charges over the rest year. Hence, we project a 125% YoY jump in interest charges to N6.6 billion over FY 17.

Leaving our OPEX largely unchanged at N10.8 billion, we project a 20% YoY contraction in earnings. The weak PAT outlook is despite expectations for sustained rise in revenue (FY 17: +20% YoY to N101.4 billion), and it largely reflects management’s guidance of sustained price hike, as well as higher other gains (+17% YoY to N4.5 billion)—with the latter representing potential gains from property disposal.

UACN trades at a current P/E of 10.0x vs. 18.7x for its Bloomberg Middle East and Africa peers. We have a NEUTRAL rating on the stock with a FVE of N17.92.

In the scenario that UACN raises the N15.4 billion rights (47% of current market capitalization), our FVE for the stock comes to N10.24 as the dilutive impact of the rights offset potential decline in interest expense.

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