Lessons From Beer: Making Consumer Goods Affordable In Africa…


Affordability in Africa

The rise of the African consumer continues to present a significant opportunity for local and multinational consumer companies operating in the region, given relatively strong economic prospects over the medium to long-term and favourable demographics. However, there is growing frustration among these companies over whether this opportunity will be realised, given disappointing sales growth in the region in recent years owing to weak consumer spending underpinned by a broadly weak macroeconomic environment (characterised by high inflationary pressure and severe currency weakness) and political uncertainty. This resulted in a lacklustre performance and even the demise of a number of local and multinational firms. Examples include Tiger Brand’s divestment from Dangote Flour in 2015, its planned divestiture of Haco Industries in Kenya and Truworth’s closure of its operations in Nigeria in 2016.

We share these frustrations. After all, the net earnings of our universe of consumer companies in Africa (28 companies in 9 of the region’s largest markets) have grown merely 2% pa in local currency over the 5-year period FY11-FY16; much worse in dollar terms owing to local currency weakness over the same period. Figure 1 above highlights the notable weakness in net earnings in FY13, FY14, FY15 and FY16, which coincides with the deterioration in GDP growth across the region, highlighted in Figure 2.

Adoption of affordability has been low

That said, we argue that the challenges and underwhelming performance of most of these companies are not because the opportunity does not exist, but because of their inability to adapt adequately to local nuances. In particular, that of consumer affordability, which essentially is the production and sale of consumer products and services at price points that are within reach of most consumers. This would include the use of lower and affordable packaging formats – the most notable being sachets. This is not a new concept in the region as it has been adopted to a partial extent by a wide range of regional consumer companies. However, what is lacking is the depth of focus on affordability, for reasons we discuss later. Nevertheless, we observe there has been notable adoption in the beer industry, which in our opinion will shape the future of the industry in the coming years. We believe that this could spread to other consumer segments in the medium term, as adoption accelerates.

In the following sections, we discuss why we think that affordability is critical, why we believe that its importance has risen to prominence recently, the factors that will enable its greater adoption and the implication for investments in the region.

Why is affordability important in Africa?

Affordability in an African consumer context is important because it opens up the consumption of products and services to a group of consumers who previously could not access them, enabling consumer companies to realise the Africa consumer opportunity more quickly. In other words: Africa is a poor economy, and to succeed consumer companies need to sell affordable products. We think that affordability is and will continue to be a critical theme for the success of consumer companies operating in the region, primarily because of the region’s demographics, particularly: (1) relatively low household income; and (2) a large informal consumer market. We discuss these below.

Relatively low household income. Relative to more developed markets, household incomes in Africa are low, with a significant part of the population living below the national poverty line, mainly due to inequality in the distribution of wealth. Figure 3 below highlights that 64% of Africa households survive on less than US$2,600 annually, according to the Centre for Affordable Housing in Africa. This reflects why the focus of expenditure of the average African household is on essential products and services such as food, beverages and housing, emphasising the region’s relatively low gearing
to discretionary products. While we expect household income will grow over the longer term, helping to realise the Africa consumer promise, growth over the medium term will be marginal at best, in our view, given low regional GDP growth – albeit an improvement vs the recent past.

A large informal consumer market. Africa has a large informal sector, which applies to the consumption of products and services due to the availability of lower priced goods and services in informal markets, even though they come at the expense of quality. According to a recent IMF study, SSA’s informal market represented 38% of its total output, the second highest region in the world after Latin America, as highlighted in Figure 4. Notably, SSA markets such as Nigeria and Tanzania are at the high end of the regional spectrum, with informal markets of 65% and 54% respectively. This represents both an opportunity and challenge for consumer companies, in that those consumers could be converted to formal/branded products. However, at the same time, capturing that opportunity can be difficult depending on the operating model of the business. We expect that over the medium to long term, the size of the informal market will continue to shrink in favour of the formal market, as a result of improvements in household income and affordability. Progress over the past 20 years has been marginal, with only a 4% move to the formal sector in the region, but we believe that much more can be achieved with the accelerated adoption of affordability in corporate strategy.

Given this backdrop, we believe that it is essential for consumer companies seeking to build scale and achieve sustainability in earnings growth over the medium to long-term to incorporate affordability as a significant part of their strategy. Based on the performance of consumer companies in our universe, we observe that firms which made greater moves to tackle affordability were more resilient over the past two tumultuous years, relative to those who did not.

Affordability has broader positive implications for the economy

On a much broader note, potential growth from consumer affordability has much larger implications for the economy as it will contribute to greater economic activity by bringing more activity/consumption into the formal economy and creating jobs. This is why government policy is also critical to the development of the affordability theme.

Why now?

The reason why the affordable theme is more important now is because of recent changes to the consumer environment, particularly pertaining to:

  1. weakness in consumer spending across the region on the back of a weaker macro backdrop;
  2. greater inflationary pressure;
  3. greater competitive pressure; and
  4. higher direct and indirect taxes as the authorities respond to greater fiscal pressure.

A more pronounced impact on the beer industry So far, the impact has been more pronounced in the beer industry and by extension spirits, where we have seen dramatic downtrading in favour of affordable beer and spirits. This shift has had quite a disruptive effect on regional markets, particularly Nigeria and Tanzania likely due to their relatively larger informal market. We also believe that the deliberate affordable strategy adopted by key players in those markets also exacerbated the trend. The impact was more severe on beer producers such as Guinness Nigeria, which was unprepared given its relatively higher gearing to premium and mainstream products. We discussed this in research we published on Nigeria beer producers on 30 May 2017, titled “Nigerian brewers – cost efficiencies critical amid flight to affordable beers”.

In the research, we noted that affordable beer had grown to represent 44% of total beer sales in Nigeria in 2016 vs 21% in 2013 and would likely continue to grow, reaching 58% in 2019. We believe that the impact on the beer industry has been profound, owing to a low base effect vs other consumer industries where there had been earlier adoption of affordability, albeit largely in the form of smaller pack formats, notably in food and HPC products.

In addition, we note:

  1. greater competitive pressure, particularly as affordability represented a core strategy for AB InBev’s businesses in the region; and
  2. supportive government policy, particularly in the east and southern Africa, where lower excise duties on opaque beers have bolstered growth.

Affordability was the single largest driver of the relatively strong performance of AB InBev’s subsidiaries in the region – notably, International Breweries and Tanzania Breweries. Others such as Nigerian Breweries and East African Breweries, which have grown their affordable beer portfolio in recent years, recorded a relatively resilient earnings performance in their most recent annual and interim results.

Owing to the catalyst for adoption of affordability in the beer industry mentioned above, we expect that the penetration of affordable beer will continue to increase in the region, especially as other beer producers raise their adoption to improve their competitiveness and boost sales growth. Consequently, we believe that over the long term, affordability could well be the single largest determining theme for winners and losers in the region’s beer market. Of the major brewers in the region, only AB InBev has shown commitment to producing and selling affordable beer as a strategy to develop beer consumption in the region. With respect to the others – Heineken, Diageo and Castel – we are not so sure that affordability will be core to their strategy in the region, despite having varied degrees of exposure to affordable beer as a result of market dynamics driving their business, instead of the other way around.

Affordability in other consumer industries could begin to accelerate

Developments in affordability in the beer industry, as well as the broadly weaker consumer environment in Africa, will reinforce the need for greater adoption of affordability in other consumer industries over the medium term, particularly those geared to discretionary income i.e. packaged food and drinks, HPC and electricals. Key players have an opportunity to differentiate themselves by innovating in affordability in this increasingly competitive environment.

As we noted earlier, the adoption of affordability by other regional consumer industries has been mainly via offerings in single-serve formats. This should expand over the medium term, but we would like to see more innovation in local brands, particularly from multinationals, which have historically focused on international brands that are out of reach of most regional consumers. The success of indigenous players in this regard is evidence that the multinationals can also be successful. The challenge that indigenous players have had maintaining that success has been related to challenges funding their business, following recent macroeconomic headwinds, particularly the devaluation of local currency, scarcity of FX and high inflation. The advantage for the multinationals is that they are better capitalised than their local peers and are therefore less vulnerable to macro headwinds.

Challenges with the low adoption of affordability

We gather that some of the challenges with the low adoption of affordability in the sector are:

  1. quality of earnings dilution, given that affordable products generally have lower margins and profitability profiles;
  2. lack of adequate local raw materials, often forcing local consumer companies to rely on imports, which are highly susceptible to currency fluctuation and global market sentiment;
  3. scarcity of lower currency denomination; and
  4. global brand mentality – mainly exploited by the multinationals for scale and synergies, which do not necessarily apply in the region.

Enablers of affordability in the future

In order to accelerate the development and adoption of affordability, we identify four enablers that Africa consumer companies will have to lobby for or develop in the future. These are (1) supportive government policy; (2) a robust local supply chain; (3) greater operating efficiency; and (4) a stronger RTM.

Supportive government policy. We think that the success of affordability in Africa will require some level of supportive government policy by way of concessionary taxes on products, on the grounds that the production of such products have a disproportionally greater socioeconomic impact on local households and will eventually raise tax revenue (i.e. VAT, CIT and PIT) on account of greater volumes and jobs created. Such policies include excise duty concessions in markets such as Kenya, Tanzania, Uganda, Mozambique, Zimbabwe and Ghana for beer producers who use locally sourced grains to produce beer. Other similar tax concessions for the production of other consumer products include lower VAT on the production of staples in markets such as Egypt and Kenya. We believe that corporate engagement with the government on policies like these needs to be intensified in order to broaden the scope of incentives and markets.

Robust supply chain. This is an equally important factor given that Africa consumer companies have a high dependence on imported raw materials as well as the relative sensitivity of affordable products to changes in input cost inflation. For affordable products to be sustainably well priced and profitable over the medium to long-term, input cost inflation needs to be moderate. To achieve this, there must be an adequate local supply chain for raw materials. We observe that there are a number of consumer companies in the region working closely with local farmers to develop this, but we do not believe that these efforts have been as effective as they could be given that: (1) investments in this regard are still meagre, probably because it is easier to import from abroad, especially during times when the local currency is relatively stable; and (2) such investment can be an uphill task, particularly with little government involvement or incentive.

Greater operating efficiency. This is also essential in order to price affordable products competitively, as the economics of such a product can be sensitive, as we
mentioned earlier, given they generally have a lower profit margin vs mainstream and premium products. It is therefore important that consumer companies that adopt affordability are operating as efficiently as possible to maximise profitability and reduce vulnerabilities.

Stronger RTM. We believe that a stronger corporate-led RTM would further enable affordability, given the poor transportation infrastructure in most African markets as well as a relatively high dependence on third-party distribution, both of which restrict product accessibility. A large number of potential consumers are in locations cut-off from companies’ networks. Therefore corporates would have to build adequate RTM solutions that would help them reach the consumer, including storage, training and smart devices to track the trade remotely. We are observing a number of corporates in the region taking more ownership of their distribution, particularly those that are taking the lead in the adoption of affordability.

Investment implications

Affordability is a strong theme and should be a strategy that consumer companies adopt in the region. However, by itself , t is not a guarantee of success. We believe that other factors such as cost efficiency in production and distribution also play a strong role in a consumer company’s success. Consequently, we believe that African consumer companies that are able to develop models that fuse both initiatives together are likely to do well despite the challenges that are peculiar to operating in the region. AB InBev subsidiaries such as International Breweries and Tanzania Breweries have demonstrated that they can run affordable beer businesses at profit margins that exceed those of peers that have greater mainstream and premium beer exposure. This is why, in the context of the affordability theme, these two companies are our preferred names in our universe. We believe that given AB InBev’s relative success, other regional brewers are likely to
adopt a similar strategy, but we note that the group’s relatively large global procurement makes it more competitive than its global peers – a strength that its local subsidiaries will likely continue to benefit from. From a market perspective, we believe that markets such as Nigeria, Tanzania and Angola are amongst the largest opportunities given their relatively large informal market and population – see Figure 7. It is therefore no surprise that our preferred plays in the context of the affordability theme are companies operating in these markets. Top picks

Tanzania Breweries. We have a Buy recommendation on the company’s stock on account of (1) strong anticipated earnings growth over the medium term driven by a recovery in beer and spirit volumes, particularly in the affordable segment; (2) the company’s strong and sustainable market position in Tanzania, c79% market share; (3) robust and relatively superior profit margins; and (4) its effective management team.

International Breweries. We have a HOLD recommendation on the following grounds: (1) its valuations are now fully priced-in, trading on a FY18f P/E and EV/EBITDA of 27.5x and 13.3x respectively, pricing in its merger with sister companies Intafact Beverages and Pabod Breweries vs GEM beer peers trading on FY18f P/E and EV/EBITDA of 21.2x and 11.5x respectively; (2) we do not have sufficient visibility on the implications of additional debt, which will be used to fund new capacity of 3.0-3.5mnhl; (3) a robust earnings outlook – we project EPS will accelerate 67% pa over the medium term (FY17 ending March to FY19 ending December) on the back of relatively strong beer volume growth.

The following is an excerpt from an Exotix Capital report, titled Affordability in Africa.