The Business
When the global brewer, Anheuser-Busch InBev (ABInBev) considered expanding its business operations in the largest economy and the largest markets in Africa, it possibly assessed the market potentials that the markets hold. Characterised by a rapidly growing population, with a median age of 18, and a very low beer consumption per capita relative to peers; the Nigerian market seemed to present a lot of opportunities for investment.
The assessment presumably resulted in the entry of ABInBev. The entry came in the form of direct and indirect acquisitions of three breweries Pabod Breweries, Intafact Breweries, and International Breweries. Following the Trailing EPS (N) acquisitions, the three brewing companies were merged to one, with International Breweries (‘the Forward EPS (N) Forward PE (X) Company’) as the surviving entity. The successful merger in 2017 marked the beginning of Justified PE Multiple (X) dynamic change in the breweries industry in Nigeria.
Following the successful merger, the Company embarked on a large-scale investment and aggressive growth activities. It commenced the construction of what would be the biggest brewery in West Africa – the Gateway brewery at Sagamu.
The Company gave other big players in the industry a run for their money, especially on its value brand ‘Trophy’. Coincidentally, the entry of ABInbev in the Nigerian market coincided with a period where consumer expenditure was recovering, owing to the economic recession in 2016 which took its toll on household income and consumption. At that point, consumers downloaded and consumed more goods with low pricing points.
We believe that the Company’s products found their way to consumers’ heart through this growth approach. Meanwhile, there were bottlenecks.
The aggressive growth strategy and increased investments by the Company resulted in significantly higher operating expenses, high leverage, and by extension weak margins. The Company, since its merger, has not reported any profit. Losses before tax stood at N3.23bn in FY’17. It worsened in FY’18 to N8.12bn and further worsened in FY’19 to N36.17bn.
The huge losses of majorly resulted from higher operating expenses and higher finance costs. Furthermore, the cash flows generation trend of the Company has been relatively unimpressive, owing to weak operating cash flows and haemorrhaging of margins by The Company.
We also note the persistent working capital deficit of the Company and the significant disparity between its long- term funds and long-term assets. The implication of the disparity is on the solvency and high financial risk of the Company. To this end, the Company’s management resolved to raise equity capital which it recently concluded, to deleverage and improve the capital structure of the Company.
Beyond the internal operations of the company, the potentials of the brewing industries are hampered by external factors in the operating environment and these factors, in our view, could limit the potentials of the industries. Some of the bottlenecks faced by the Company include weak consumer demand due to declining purchasing power, regulatory issues, and high cost of doing business.
Notably, in June 2018, a new policy on excise duty was implemented which saw an average of 34% increase in excise duties between 2018 and 2020.
By default, the impact of higher excise duty should be reflected on the prices of products. However, the brewing industry in Nigeria is characterised by high buyers’ power.
Also, given that brewery products are relatively inelastic and are also discretionary goods, it was a herculean task to pass the cost directly to consumers, especially considering the heightened competition in the industry.
Hence, the margins of the Company took the hit as a result. Although the management of the Company remains bullish about the prospects of the Nigerian markets and asserts that it is in for the long-term play, we are cautious about the uncertainty that the future holds in the brewing industry.
Nonetheless, the Company has been able to significantly grow market share from 7% pre-merger to 24% post-merger.
Financial Performance in Q1’20
Revenue grew by 1% year-on-year, from N35.09bn in Q1’19 to N35.35bn in Q1’20. Cost of sales, however, rose by 12% year-on-year, from N35.09bn in Q1’19 to N35.35bn in Q1’20. As a result, the cost margin rose by 800 basis points from 75% in Q1’19 to 83% in Q1’20. This development reinforces the postulation of the inability of the Company to pass increased costs to consumers. We highlight that raw material costs increased by 13% year-on-year, from N20.09bn in Q1’19 to N22.61bn in Q1’20. Consequent to the higher cost margin in Q1’20, gross profit dipped by 31% year-on-year, from N8.95bn in Q1’19 to N6.17bn in Q1’20.
The Company made a gain of N4.54bn on derivative contracts during the period. Therefore, the Company’s income line was supported by these derivatives gains. However, the Company yet recorded an N9.94bn foreign exchange loss during the period, resulting from the exchange rate devaluation recently implemented by the Central Bank of Nigeria (CBN). The Company had significant FX exposure on its borrowings and payables.
Meanwhile, in a bid to protect margins, the Company incurred a lower operating expense of N8.56bn in Q1’20, representing a 3% year-on-year decline from N8.82bn in Q1’19. However, the significant FX losses put a damper on the bottom line.
Overall, operating losses worsened from N232.85mn in Q1’19 to N8.04bn in Q1’20. To understand what could have been the true earnings position of the Company had it not incurred an FX loss, we discounted the FX losses and the derivatives gains in both comparable years.
By doing so, the Company could have still reported an operating loss of N2.64bn. This is so because of an operating expense of N8.56bn relative to an operating income (gross profit plus adjusted other income) of N5.92bn. Hence, we see another indicator of eroded profits due to higher cost of sales which could not be passed on to consumers.
Capital Raise Reflected, But Unable to Drive Bottomline Growth
Finance cost declined by 81% year-on-year, from N5.09bn in Q1’19 to N984.21mn in Q1’20. This was due to the equity capital raised during the period to pay down debts on its books. On a year-on-year basis, total borrowings declined by 15% from an average of N221.02bn in Q1’19 to
However, the gains of a lower finance cost were not enough to change the narrative due to the higher cost of sales incurred during the period. On the other hand, finance income grew from N511.00mn in Q1’19 to N1.33bn in Q1’20, due to the higher cash position (resulting from its recent equity raise).
Nonetheless, the losses of the Company increased, reflected by the higher losses before tax of N7.69bn in Q1’20, from a loss of N5.32bn in Q1’19. Losses after tax also increased by 42% year-on-year, from a loss of N3.98bn in Q1’19 to a loss of N5.65bn in Q1’20.
Outlook
We have a weak growth outlook for the Company, especially amid the COVID-19 (coronavirus) pandemic in the economy, which resulted in the closure of bars, hotels, and generally a lockdown in the economy. The economic implications are very pronounced for the brewing industry, due to the disruption in the supply chain as well as the potential loss of income by consumers thus, further weakening consumer demand. We, therefore, expect cash flows to be severely under pressure in FY’20. Although given the current state of the pandemic in Nigeria, we believe that the full impact cannot be measured yet, however, we think that economic recovery post- COVID will be very slow.
In our view, the ability of Companies who are directly affected by the pandemic to survive the storm depends on the working capital sufficiency and strong capitalization of companies. While we understand that the recent capital raise of the Company provided buffers in terms of capitalisation, the Company’s working capital is deficient and might have to resort to increased short-term debt financing again to stay afloat.
We expect the Company to report losses in FY’20, The Company’s average five-year ROE is estimated at -36% and we do not expect any dividends in FY’20. We estimate a fair value of N3.56 for the stock, which implies a 29% discount to the current market price of N5.00. We do
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