As Nestle Encounters New Challenges

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After an impressive first quarter, Nestle Nigeria posted a 94 per cent fall in profit after tax for half-year 2016 on foreign exchange losses and rising costs of inputs due to the devaluation of the naira. Goddy Egene reports

The hopes of shareholders of Nestle Nigeria Plc receiving a higher dividend at the end of 2016 are seriously becoming dimmer following the weak performance of the company for the half year ended June 30, 2016. Nestle Nigeria Plc had surprised many stakeholders with better-than-expected results in first quarter (Q1) ended March 31, 2016, growing its profit before tax (PBT) by 150 per cent to N8.725billion, while PAT rose by 126 per cent to N6.681billion.

Given the cost saving strategy that influenced the Q1 performance, stakeholders had expected the positive trend to continue into the H1. However, going by the results made available last week, factors beyond the control of Nestle Nigeria made the company to record 94 per cent fall in PAT.

Corporate background
Nestle made the first sale of its products in Nigeria date back to the beginning of the 20th century. This was done through local importers who placed their orders directly with British trading companies active in the country. The importation of Nestle products became regular from the 1920s when Nestlé decided to formally organise the importation and distribution of products.

But in 1961, one year after Nigerian independence, Nestlé Products (Nigeria) Limited was officially created. This signaled the start of the Nestlé operations in Nigeria as a locally based subsidiary of Nestlé.
Nestle S.A, Switzerland owns 63.5 per cent of the company’s shares, while the remaining 36.5 per cent shares are held by Nigerian shareholders.

The company has two major two business units including food products and beverages. This strategic business units offer different products and are managed separately because they require different technology and marketing strategies. The food products segment contributed 59.75 per cent to the company’s revenue in FY 2015, compared with the contribution of 40.25 per cent by the beverages range.

Half year results
The Nestle reported a revenue of N80.4billion for the H1 end June 30, 2016, showing an increase of 22 per cent above the N65.9 billion posted in the corresponding period of 2015.
Unlike Q1 when the company witnessed a decline in cost of sales and finance, H1 witnessed increases in those expenses. Cost of sale rose by 28 per cent from N37.3 billion to N47.7 billion, while gross profit grew by 14 per cent to N32.7 billion, from 28.6 billion in 2015.

Marketing and distribution expenses rose by 18 per cent from N10.8 billion to N12.8 billion. However, finance cost soared by 376 per cent from N2.958 billion in 2015 to N14.1 billion in 2016.
Hence, PBT fell by 92 per cent from N10.6 billion in 2015 to N896 million in 2016. Despite a reduction in tax expenses by 79 per cent, PAT fell by 94 per cent to N535 million in2016 from N8.887 billion in 2015.

Commenting on the results, the company said: “We are pleased that our revenue increased by 22 per cent in the first half of 2016 despite the tough economic environment. In both the first and second quarters of 2016, our revenue grew by double digits, thereby confirming the great value that our brands provide consumers. The increase in the cost of sales was mainly due to higher material costs resulting from currency devaluation. Operating Profit for the period has increased by 10 per cent despite pressure on input costs. Net profit has been negatively impacted by the revaluation of the foreign loans due to Naira devaluation.”

The company assured stakeholders that it would continue to implement necessary measures and cost saving initiatives to address the macroeconomic challenges and remain fully committed to the long term potential of the business in Nigeria.

Analysts’ comments
Looking at the performance, analysts at FBN Quest, said the two factors that affected the results are systemic in nature and would further impact performance going forward.
“The key drivers were elevated cost pressure and foreign exchange losses. These two factors are systemic in nature and will further impact performance, albeit to a lesser extent, in the remaining half of 2016 full year. Consequently, we look for 2016FY earnings before interest tax depreciation and amortisation (EBITDA) and PAT declining by 14 per cent and 72 per cent respectively,” they said.

According to them, firstly on cost, subsequent depreciations in the Naira exchange rate against the Dollar portend downside risk for margins.
“Reference here is to the potential impact on: input cost of raw sugar and milk which are still wholly imported and import duties which has a direct link with the official local currency (LCY) exchange rate. Secondly, we would expect the pass through impact of the hike in petrol price on transportation cost — which management also attributed to the cost inflation experienced in Q2-16 — to linger for the rest of the year. Broadly, Nestle is at about the limit of domestic raw materials input substitution, and short of further, sizeable price increases across principal products, the cost cutting measures being considered by the management will be of less impact on margins,” they added.

FBN Quest noted that the scope for further forex losses has widened following the full floating of the LCY. With the Nigerian Naira having already lost over 14 per cent from end June level, amid further declines, saying it is not unlikely that Nestle’s net forex losses will reach (or breach) their target N18 billion for 2016FY.

“On revenue, the selective price increases effected year-to-date (YTD) (Milo 15 per cent average, Golden Morn seven per cent average and Maggi 15 per cent average) have been the major driver of growth. Whilst noting the tendency of management adjusting prices to fairly reflect costs in H2-16, the decision should be tough, considering the risk of losing grounds to competitors (as in the experience of Maggi in Ghana). Price increases in 2017 are more realistic, and we expect some recovery in margins accordingly,” they said.

Earlier projections
Making future projections for Nestle after assessing the Q1 performance, analysts FSDH had cited some factors that would influence company’s performance. The positive factors include: focus strategy on food segment of the Nigerian economy; cost management initiatives; growing demand for food and beverages in Nigeria; focus on investment in key brands; investment and innovation in plants, which should improve efficiency; technical partnership with the parent and related companies; large market size in Nigeria and stable growing population; strong demand for product at all levels; existing taste and preference for products by consumers.

On the other hand, the negative factors are: the prevailing stiff competition in the industry, the current weak consumer spending power, security challenges in some parts of Nigeria, and expected further depreciation in the naira.

“Looking at the medium to long-term outlook of the company and the impact of the aforementioned factors, we are of the opinion that the impact of the positive factors would be higher on both the revenue and the profitability of the company than the negative factors. We therefore estimate a turnover of N176.64 billion, N208.90 billion, N253.33 billion, N305.18 billion, and N358.49 billion for the periods ending December 2016, 2017, 2018, 2019 and 2020. Our PBT forecasts for the periods are: N45.58 billion, N57.63 billion, N71.20bn, N86.43bn and N102.47bn. Adjusting for tax, our PAT forecasts are N31.90bn, N40.34bn, N49.84 billion, N60.50 billion, and N71.73 billion, PAT Margin for the period are 18.06 per cent, 19.31 per cent, 19.67 per cent, 19.82 per cent and 20.01 per cent. Our forecast final dividend for the FY 2016 is N36.36 per share,” FSDH had said.