Guinness Nigeria Plc reported a year-on-year profit decline in its Q2’20, to follow up from a relatively weak Q1’20. Although revenue grew for the first time in the last five quarters, higher operating expenses and higher finance costs dampened the bottom-line.
Impact
Negative – We think that lack of improvements, in the form of increased earnings, will continue to worry the already unconvinced investors (reflected in the drastic decline in stock prices), especially for shareholders who had expected increased profitability owing to the capital raising exercise conducted in 2017. In addition, we think that slower-than-expected revenue growth in its beer segment will raise concerns about the Company’s overall revenue growth potential in FY’20. Overall, we think that a weaker macro demand environment combined with the increase in excise duties, and heightened competition in the industry is taking a toll on the Company, as the current trend is also peculiar among its industry peers.
Forecasts
We forecast that by FY’20, revenue will grow by 1% to N133.30bn. The basis for our forecast is on the back of slightly improved sales in H2’20. The annual increase in excise duties already ended in December 2019 (except for spirits, an area where Guinness has a significant presence in). Nonetheless, we expect the top-line to normalize. However, owing to weak demand and the intense battle for market share, we believe that brewing companies will continue to hemorrhage margins, to keep the price-sensitive consumers at bay. Consequently, we have an FY’20 EPS estimate of N1.67, 33% lower than FY’19 actual EPS of N2.50.
Valuation
Given our lower estimates, we arrived at a lower fair value estimate of N30.63 from N48.65, or approximately 18x our FY’20 estimates. At our fair value price, earnings yield stands at 5%. Based on our dividend forecast of N1.00, the dividend yield estimate is 3%. Furthermore, the estimated return on equity of 4% for FY’20 is below our estimated cost of equity of c.20% – 22% for the Company.
Recommendation
We are unconvinced about the prospects of Guinness Nigeria Plc, due to the current
bottlenecks to growth in the industry where it operates. While we expect an overall
improvement in sales growth, we believe that margins will continue to be under pressure. The stock currently trades at our fair value estimate. Hence, we recommend a hold for the stock.
Tailwinds
Rebound in revenue growth after 5 consecutive quarters of decline: Revenue grew by 4% in Q2’20, the first quarter of revenue growth since Q4’18. We also realized that revenues from both the domestic markets and export sales grew in Q2’20. In Q1’20, export sales declined by as much as 75% to N692.46mn from N2.79bn. The rebound in exports sales in Q2’20 supported revenue growth.
Improved cash flows generation: Operating cash flows rose by 22% year-on-year from N14.81bn in 6M’19 to N18.38bn in 6M’20, majorly resulting from reduced inventories during the period. Meanwhile, free cash flow (FCF) spiked by 80% to N10.44bn in 6M’20 from N5.79bn in 6M’19. On the other hand, free cash flow to equity (FCFE) rose by 218% to N13.38bn in 6M’20 N4.20bn in 6M’19. The spike in FCFE was due to a higher net borrowings of N5bn during the period. In our view, we posit that the Company refinanced costly short-term debts (overdrafts), possibly taking advantage of the low-yield environment.
Headwinds
Worsening Margins: Despite revenue growth in Q2’20, the Company recorded higher cost and operating expense margins, thus it could not fully maximise the higher revenue earned. Specifically, the operating expense margin worsened to 22% in Q2’20, from 21% in Q2’19. On a 6M basis, opex margin worsened to 24% in 6M’20 from 23% in 6M’19.
High finance costs: The Company, in 2017, raised equity capital of c.N40bn which was used to pay down outstanding loan obligations. However, resulting from weak revenues and rising costs in the last few quarters, the working capital requirements of the Company necessitated a drawdown of overdraft facilities to support operations. As a result, finance cost grew. However, we noted that the Company possibly made efforts to paydown debts (including overdraft facility), as reflected in the lower finance cost of N626.80mn in Q2’20 from N934.44mn in Q2’19. The Company had earlier recorded a 116% spike in finance cost in Q1’20 to N1.26bn from N593.11mn in Q1’19. The impact of the high finance cost in Q1’19 weighed on the overall finance cost in 6M’20.
Risks
Risks to our estimates include macro-demand slowdown, inconsistent government policies, slower revenue growth, and FX instability.
WSTC Securities Limited (WSTC)
