Nigerian Breweries Plc: Haemorrhaging Margins Amid Challenging Operating Environment

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Nigerian Breweries Plc recently released its Q1’20 interim report for the first quarter ended March 31, 2020. According to the report, revenue stood flat at N86.20bn in Q1’20 (Q1’19: N83.28bn). Operating profit declined by 22% year-on-year, while profit before tax declined by 28% year-on-year. Profit after tax also dipped by 31% year-on-year.

Muted Revenue Amid Sustained Demand Pressure

Revenue growth was muted, following the relatively unchanged revenue position from N83.28bn in Q1’19 to N83.20bn in Q1’19. We note that there was no increase in excise duty recorded in Q1’20, as the final round of increase took place in Q1’19. Hence, we attribute the unchanged demand to pressured demand and low volumes, especially as there were price increases in Q4’19. We think that the impact of price increases in the Q4’19 was already reflecting in lower volume sales.

Cost of sales was also relatively unchanged at N48.34bn in Q1’20 (Q1’19: N48.22bn). Cost margin in Q1’20 remained at 58% (Q1’19: 58%), However, gross profit declined marginally by 1% year-on-year, from N35.05bn in Q1’19 to N34.87bn in Q1’20.

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High Operating Expenses Dampen Bottomline

Operating expenses rose by 14% year-on-year, from N21.15bn in Q1’19 to N24.14bn in Q1’20. Within the operating expenses, marketing and distribution expenses recorded double-digit growth of 14%, from N16.56bn in Q1’19 to N18.79bn in Q1’20. Administration expenses, on the other hand, grew by 16% year-on-year, from N4.60bn in Q1’19 to N5.34bn in Q1’20. In our view, the significant increases recorded in operating expenses, particularly on marketing and distribution, without a corresponding impact on topline growth reflects the impact of intense competition in the industry, amid weakened consumer demand and the battle for a share of consumers’ wallet by the players in the brewing industry.

Consequent to the higher operating expenses during the period, operating profit nosedived by 22% year-on-year, from N14.06bn in Q1’19 to N10.92bn in Q1’20. Finance cost grew by 2% year-on-year, from N2.59bn in Q1’19 to N2.64bn in Q1’20. The higher finance cost incurred during the period, despite a low yield environment, resulted from a 76% year-on-year surge in total borrowings of the Group from an average of N43.71bn in Q1’19 to an average of N77.10bn in Q1’20. In Q1’20, the Group obtained a net borrowing of N30.25bn (new borrowing: N61.23bn, repayment of borrowing: N30.95bn) to finance its capital expenditure and other operational activities in Q1’20. Cash flows from operations dipped by 62% year-on-year, from N11.75bn in Q1’19 to N4.43bn in Q1’20.

Resulting from a higher VAT rate that became effective in February 2020, the Group recorded a 24% increase in VAT paid from N3.98bn in Q1’19 to N4.94bn in Q1’20. Hence, net cash flows from operations was a negative of N1.17bn in Q1’20 (Q1’19: positive of N7.33bn). Cash flows used in investing activities increased by 19% year-on-year, from N7.46bn in Q1’19 to N8.91bn in Q1’20. The net borrowings of N30.25bn, representing a 954% year-on-year increase from an N3.17bn net borrowings in Q1’19, helped the Group to finance its operations. We note the significant increase in net borrowings in Q1’19, and we attribute the sharp rise to the need to stay liquid amid potential financial imbalances that the COVID-19 (coronavirus) pandemic could bring in subsequent periods of the year.

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Therefore, the higher finance cost in Q1’20 worsened the bottom line, as reflected by the 28% year-on-year decline in profit before tax from N11.46bn in Q1’19 to N8.28bn in Q1’20. Profit after tax also dipped by 31% year-on-year, from N8.03bn in Q1’19 to N5.51bn in Q1’20.

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Outlook

The brewing industry is expected to be severely impacted by the outbreak of the coronavirus pandemic in the Nigerian economy. We note that the pandemic has its effects on both the demand and supply side. On the demand side, the lockdown/stay-at-home directive of the government, social distancing directive, as well as possible job losses (thereby lower household income) are the major issues. The major issues on the supply side have to do with the disruptions in the supply chain and closure of hotels and bars. The double-whammy of demand and supply disruptions to take its toll on the financial performance of Nigerian Breweries.

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We expect to see continued pressures on the Group’s top line and bottom line in the subsequent periods of the year (till at least Q3’20), and we believe that the survival of the players in the brewing industry will be largely dependent on the liquidity and capitalization of brewing companies, and we think that NB is well-positioned to weather the storm, at least relative to its peers. We also link the level of the increased borrowing of the Group to the preparation of the Group ahead of the uncertainties ahead.

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Valuation

In our previous report (FY’19), we projected a 2% revenue growth, on the back of increased volume and normalisation of the excise duty in FY’20. We also projected a 6% year-on-year profit before tax growth in FY’20, on the back of lower finance cost and debt levels. However, the economic realities have changed resulting from the black swan event caused by the outbreak of the coronavirus. On the potential impact of naira devaluation, we do not expect to see any significant pressures on the Group’s performance. We, therefore, revised our estimates and outlook for the Group.

We now project revenue and profit after tax decline of 5% and 33%, respectively, in FY’20. The projected steep decline in the bottom line reflects expected stable or higher operating expenses, relative to revenue. Therefore, our earnings per share (EPS) estimate for FY’20 is N1.35 (previous: N2.21, FY’19 actual: N2.01). We further expect the Group to maintain its historical 100% dividend payout for the year. In addition, we expect to see pressured cash flows in FY’20. In Q1’20, inventories grew by 6% from N38.52bn in FY’19 to N40.86bn in Q1’20. Trade receivables spiked by 34% from N21.31bn in FY’19 to N28.61bn in Q1’20. From our perspective, these strengthen our argument on the demand and supply issues faced by the Group. We believe that there will be more relaxed credit decisions by the Group to spur demand.

Our revised fair value for the Group is N28.66 (previous: N47.04). At the current market price of N30.00, the stock’s earnings and dividend yields stand at 4% and 4% respectively. Meanwhile, we expect the Group’s return on equity (ROE) to lower to 7% in FY’20 (FY’19: 10%, FY’18: 11%). Based on our valuation, the price return of the stock stands at -4% while its dividend yield stands at 4% as well. The stock’s total return of 0%, therefore, underpins our HOLD recommendation

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