Guinness Nigeria Plc (‘Guinness’ or ‘the company’), in its recently released Q1’2021 results, reported a 12% year-on-year revenue growth, from N26.89bn in Q1’2020 to N30.02bn in Q1’2021. We attribute the revenue growth to a higher volume of products sold during the period, as the lockdown directive induced by the outbreak of COVID-19 was relaxed. The lockdown directive by the national authorities had affected sales in previous periods, notably in Q4’2020 when revenue dipped by 72% YoY.
The reopening of the economy, thus, resulted in higher volumes of products sold, given improved supply and distribution chain. From our perspective, the partial reopening of bars, hotels, and major selling points of the company’s products contributed to volume growth.
Also, we believe that there were price increases during the period. We posit that the impact of exchange rate devaluation on costs could have resulted in higher prices to protect margins. However, we think that the price increase was partial, considering the heightened competition in the industry.
Exchange Rate Devaluation Drive Costs
Cost of sales rose by 21% YoY, from N18.95bn in Q1’2020 to N23.01bn in Q1’2021. As suggested above, we opine that the exchange rate devaluation drove the high cost incurred during the period. While we maintain that raw input prices were lower during the period, the higher exchange rate eroded the cost savings, in our view. Consequent to the 21% YoY rise in cost, Guinness’ cost margin increased by 700 basis points from 70% in Q1’2020 to 77% in Q1’2021, which further strengthens our postulation Guinness partially passed the cost burden to consumers. Hence, gross profit declined by 12% YoY from N7.95bn in Q1’2020 to N7.01bn in Q1’2021. As a result, gross margin declined to 23% in Q1’2021 from30% in Q1’2020.
Operating Profit Declines Despite Cost Optimisation
Operating expenses declined by 10% YoY from N7.38bn in Q1’2020 to N6.63bn in Q1’2021, thus implying an operating expense margin of 22% in Q1’2021 (Q1’2020: 27%). The decline in operating expense stemmed from an 11% YoY decline in marketing and distribution expense from N5.20bn in Q1’2020 to N4.63bn in Q1’2021. The lower expenses incurred on marketing expenses came as a positive surprise, considering that the company was the Gold sponsor of the recently concluded ‘Big Brother Naija’ (a TV reality show). We most likely relate the lower marketing and distribution expenses to lower distribution expense (rather than marketing), as many bars and sale outlets were still inactive during the period despite the gradual reopening of the economy.
Despite the lower operating expenses incurred during the period, operating profit dipped by 14% YoY from N681.57mn in Q1’2020 to N586.32mn in Q1’2021. Expressly, the 12% decline in gross profit could not still totally cover incurred expenses during the period. Operating margin lowered from 3% in Q1’2020 to 2% in Q1’2021.
Higher Finance Costs Amid FX Losses
Finance cost grew by 6% YoY from N1.29bn in Q1’2020 to N1.37bn in Q1’2021. The impact of exchange rate devaluation further reflected in the company’s finance cost. Excluding the impact of FX losses, the company’s finance cost could have declined by 19% YoY, mirroring the 48% YoY reduction in total borrowings from an average of N23.53bn in Q1’2020 to an average of N19.07bn in Q1’2021. On the other hand, finance income grew by 97% YoY from N234.79mn in Q1’2020 to N462.25mn in Q1’2021. The company’s cash balance increased by 3% YoY from an average of N11.34bn in Q1’2020 to an average of N15.17bn in Q1’2021.
The growth in the cash balance majorly resulted from working capital efficiency. The company recorded an improved collection of N12.45bn from debtors. On a year-to-date (YTD) basis, the company’s inventory lowered by 22% from N26.43bn as of FY’2020 to N20.68bn as of Q1’2021. Furthermore, the company’s trade and other payables grew by 15% from N31.94bn as of FY’2020 to N36.74bn as of Q1’2021, implying a delayed payment to creditors.
Therefore, the working capital improvements resulted in the higher cash position of the company during the period. We note that as part of the renewed focus and strategy of the company, efforts are put in place to create quality assets and ensure liquidity. The management had earlier guided that the company would embark on a credit tightening policy.
Consecutive Losses On the Back of Macroeconomic Challenges
Owing to higher operating costs (i.e. cost of sales and operating expenses) relative to operating income, the company recorded a loss before tax of N317.48mn in Q1’2021, albeit an improved level from N370.41mn loss before tax in Q1’2020. Loss after tax widened by 119% YoY from N384.11mn in Q1’2020 to N841.65mn in Q1’2021, resulting from a higher income tax of N524.17mn in Q1’2021 (Q1’2020: N13.70mn).
Financial Performance Summary
We expect to see continued recovery in revenue, driven by both volume and prices in FY’2021. However, we maintain that the revenue recovery will be weak in subsequent years due to the competitive industry where the company operates, particularly considering the high elasticity of demand for the company’s products (both price elasticity and income elasticity). The short-to-medium-term strategy of the company, as guided by the management, is to focus more on the spirits business with higher margins pending when
macroeconomic challenges subside for the beer segment to improve. We note that the company had recorded a consistent revenue decline in its Lager beer products.
We revise our estimates to reflect improved revenue growth, due to the expected impact of higher prices on products, as well as expected volume growth. Meanwhile, we believe that the credit tightening policy might not be sustainable due to the anticipated increase in industry competition. Hence, our revenue growth assumptions in subsequent periods remain weak.
We adjust our fair value estimate to N16.71 (previous estimate: N7.23). The rationale for the significant rise in our fair value estimate is analysed below:
• An improved outlook for revenue: we believe that price increases are inevitable due to a surge in costs, induced by exchange rate volatilities and inflation. However, we also note that the expected revenue growth might not suffice for the increase in costs due to competition.
• Focus on higher-margin products: as guided by the management, the focus on spirits business, particularly the premium segment of the brands, is value accretive to the company in terms of cash flow. Therefore, we have a higher cash flow expectation in our revised numbers.
• Expected operating efficiency: we expect to see further improvements in cost optimisation, in efforts to protect margins.
• Lower cost of equity: we revised our cost of equity estimate to reflect lower opportunity costs, given the significant decline in yields in the fixed income markets. By implication, the risk-free rate used as an input to our discount rate was lower. The lower discount rate (cost of equity) used to discount our projected cash flows and dividends resulted in a higher fair value.
• Incorporation of EV/EBITDA valuation methodology: Unlike our previous valuation, we incorporated the EV/EBITDA valuation, together with a Discounted Cash Flow Model, Dividend Discount Model, and Residual Income Model. The capital-intensive nature of the business and the need to capture both the value of operating and non-operating assets were major considerations of incorporating the Enterprise Value method. The incorporation of the Enterprise Value valuation method was the major driver of our increased fair value estimate. The Enterprise Value contributed 69% to our total fair value.
At the current market price of N15.95, the stock trades at a 4% discount to our fair value estimate. Hence, we have a HOLD recommendation