Unimpressive earnings in Q3’19, albeit relatively better.
Nigerian Breweries (“The Group” or “The Company” or “NB”) reported an improved Q3’19 result although the Company made a loss in Q3’19. Net earnings in Q3’19 stood at a loss of N1.04bn in Q3’19 relative to a loss of N3.65bn in Q3’18. The reduced loss-making position stemmed from a 12% decline in cost of sales from N46.77bn in Q3’18 to N40.97bn in Q3’19, thus resulting in a cost savings of N6bn as net revenue remained flat at N65.40bn in both periods. However, the Company incurred higher operating expense (+6% from N22.74bn in Q3’18 to N24.17bn in Q3’19), and higher finance costs (+142% from N1.19bn in Q3’18 to N2.89bn in Q3’19); the savings of N6bn made from the cost of sales line was able to reduce the extent of losses incurred in Q3’19.
On a standalone basis, following a lower cost of sales in Q3’19, gross profit increased by 32% year-on-year from N18.63bn in Q3’18 to N24.52bn in Q3’19. Thus, the gross profit margin stood at 37%. Operating profit rose at N709.65mn, implying an operating margin of 1%. The wide disparity between a gross margin of 37% and an operating margin of 1% arose from higher operating expense during the period. Operating expense margin stood at 29% in Q3’19 (Q3’18: 26%) due to a 6% year-on-year increase in operating expense.
Consequent to a 140% increase in finance cost from N1.22bn in Q3’18 to N2.93bn in Q3’19, profit before tax nosedived into the negative territory, posting a loss of N2.19bn. The Company also reported a loss after tax of 1.04bn.
Brewers struggle amid unfavourable policies
The disappointing run continues for Nigerian Breweries, as evident in its 9M’19 numbers. Gross revenue in 9M’19 (January 1, 2019, to September 30, 2019) grew slightly by 2% year-on-year. However, a 43% increase in excise duty expense from N16.93bn in 9M’18 to N24.25bn in 9M’19 resulted in a 1% decline in net revenue from N238.07bn in 9M’18 to N235.68bn in 9M’19. On the excise duty policy, the Federal Government approved an increase in excise duties on tobacco and alcoholic beverages which became effective on June 4, 2018. The policy was to be introduced in phases over three years (from 2018 to 2020).
The sharp increase of 43% in excise duty was a combination of a low base in duties in the first half of the year (H1’18: N0.20 vs H1’19 N0.35) and higher excise duty in the third quarter of the year (Q3’18: N0.30 vs Q3’19: N0.35), as the excise duty became effective on June 4, 2019. (See table below).
Impact of heightened competition and weak macroeconomy depress bottom-line Although gross profit grew by 2% from N95.72bn in 9M’18 to N96.17bn in 9M’19, operating profit, however, declined by 9% year-on-year from N27.74bn in 9M’18 to N25.17bn in 9M’19. The decline in operating profit was owing to a 12% increase in marketing and distribution expenses. The rising competition in the breweries industry has prompted a rise in the sales and marketing expenses of the major players, in a bid to protect market share. Notably, administrative expenses declined by 12% year-on-year from N16.18bn in 9M’18 to N14.23bn in 9M’19; it was not enough to offset the 12% increase in sales and marketing expenses.
Finance cost spiked by 49% year-on-year, from N5.51bn in 9M’18 to N8.18bn in 9M’19. The increase in finance cost majorly arose from a 55% increase in average debt levels from N37.18bn 9M’18 to N72.82bn in 9M’19; majorly resulting from an increase in overdraft facility by N28.14bn. The group generated lower cash flows from operating activities in 9M’19 on the back of weak macroeconomic fundamentals. Lower revenues relative to higher cost of operations dampened the cash flows from operations, in which the Company had to drawdown overdraft facilities to support operations.
Consequently, profit before tax fell by 23% year-on-year from N22.48bn in 9M’18 to N17.22bn in 9M’19; while profit after tax fell by 17% year-on-year from N14.79bn in 9M’18 to N12.23bn in 9M’19.
We have revised our FY’19 EPS estimate from N1.62 to N1.73, following a better Q3’19 performance. The Company incurred a lower-than-expected finance cost in Q3’19 (WSTC estimate: N3.13bn vs NB actual: N2.93bn). As noted above, the major bottlenecks that dragged the performance of Nigerian Breweries in 9M’19 were higher excise duties, higher marketing expenses and higher finance costs. Although we expect the impact of increased excise duties to normalise in FY’20, however, we cut our FY’20 to FY’23 earnings estimate factoring adverse macroenvironment (unfavourable payment terms, uncertain account receivables) and heightened competition in the industry.
We also believe that the breweries industry is relatively fragmented, where no single player has enough influence to move the industry in a single direction. As a result, we do not see the possibility of a price increase in the near to medium term, especially considering the weak purchasing power of consumers. We also think that the direction of prices in the industry will be based on the actions of other market players in the industry.
We are valuing NB at a fair value of N51.36. We continue to see increased competition in the industry. Though we acknowledge that NB remains the market leader in the industry, we see the extent of leadership gap closing in the medium to long term. The downward revision of our fair value from N73.55 to N51.36 reflects the dimmer outlook of earnings, dividends, and cash flows.
In arriving at our fair value estimate of N51.36, we used a blend of Free Cash Flow, Dividend Discount Model, and Residual Income Model valuation methodologies. Our valuation inputs include a higher risk-free rate of 14.17% (previous: 13.68%), an equity risk premium of 6%, and an adjusted beta of 0.63. Thus, our cost of equity increased to 18% (previous: 17%). At the current price of N46.25, the stock trades at an 11% discount to our fair value estimate. Hence, we recommend a HOLD.
Financial statement summary