Unilever Nigeria Plc: Weak Industry Fundamentals Weigh on Earnings

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Unilever Nigeria Plc (‘Unilever’ or ‘the Group’) recently released its Q3’2020 financial results. The Group recorded a significant recovery on its top line, as revenue grew by 94% year-on-year (YoY), from N8.97bn in Q3’2019 to N17.39bn in Q3’2020. Gross profit rebounded from a loss of N1.71bn in Q3’2019 to a profit of N3.73bn in Q3’2020.

Operating expenses grew by 68% YoY from N2.82bn in Q3’2019 to N4.74bn in Q3’2020. Consequent to the increase in operating expenses relative to operating income, the Group recorded another operating loss on a YoY basis. Loss before tax stood at N2.03bn in Q3’2020 (Q3’2019: Loss of N4.64bn), while loss after tax stood at N1.54bn in Q3’2020 (Q3’2019: N3.00bn).

Quarter-on-Quarter Revenue Growth Underscores Earnings Recovery

On a YoY basis, Unilever Nigeria’s revenue surged by 94%, attributed to a low base effect. Unileverrecorded a low revenue of N8.97bn in Q3’2019 resulting from weakened sales as a change of strategy took place during the period. The management tightened credit terms to customers in efforts to maintain quality assets and remain efficient in its working capital management. In Q3’2020, revenue grew to normalised levels, hence, catalysing the spike in revenue growth.

However, beyond the base effect, we believe that Unilever Nigeria’s revenue did improve, as reflected in the double-digit QoQ revenue growth. The Food Products business segment grew by 25% QoQ, from N7.86bn in Q2’2020 to N9.83bn in Q3’2020, On the other hand, the Household and Personal Care business segment grew by 23% QoQ, from N6.15bn in Q2’2020 to N7.57bn in Q3’2020. Overall, the total revenue QoQ growth stood at 24% from N14.01bn in Q2’2020 to N17.39bn in Q3’2020.

From our perspective, improved demand for products as the economy gradually reopened, was a factor that possibly impacted positively on Q3’2020 revenue. We also think that there was an improved distribution, given the supply chain improvement that followed the lockdown relaxation. Furthermore, we believe that there were slight price increases during the period to contain elevated costs.

Gross Margins Improve Year-on-Year, But Below Historical Levels

The Group achieved a lower cost margin on a YoY basis from 119% in Q3’2019 to 79% in Q3’2020. However, the cost margin in Q3’2020 was above the 4-year average (excluding Q3’2019 outlier) cost margin of 69%. In our view, the higher-than-average cost margin in Q3’2020 suggests that there were cost pressures during the period, in which the Group was unable to pass on to consumers.

The major cost driver, in our view, was most likely the impact of the exchange rate devaluation on imported inputs. Consequent to the higher-than-average cost margin of 79% in Q3’2020, gross margin dipped to 21%.

Sticky Expenses Push Earnings to Negative Territory

Despite a 315% YoY growth in operating income to N3.72bn in Q3’2020 (Q3’2019: loss of N1.73bn), the Group still incurred losses. Operating loss stood at N1.45bn in Q3’2020 (Q3’2019: loss of N4.64bn), driven by higher operating expenses relative to operating income.

Operating income margin in Q3’2020 stood at 21% while operating expense margin stood at 27%. The inability for operating income to cover operating expenses resulted in the operating loss incurred in Q3’2020. Specifically, selling and distribution expense rose by 27% YoY from N644.57mn in Q3’2019 to N821.64mn in Q3’2020. On the other hand, marketing and administrative expenses grew by 80% YoY from N2.17bn in Q3’2019 to N3.91bn in Q3’2020.
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In addition to the higher operating expenses incurred, the Group recorded a 334% YoY increase in impairment loss on trade receivables, from N99.01mn in Q3’2019 to N429.39mn in Q3’2020.

Another Loss-Making Quarter

Loss before tax stood at N2.03bn in Q3’2020, from a loss before tax of N4.08bn in Q3’2019. Loss after tax improved to N1.54bn from a loss after tax of N3.00bn in Q3’2019.

The overall loss-making position, as analysed above, was driven by relatively high-operating costs relative to revenue. On a broad basis, the weak macroeconomic fundamentals (i.e. high-cost business environment and price-sensitive consumers whose purchasing power are shrinking, heightened competition, foreign exchange volatilities, among others) took a toll on the Group’s performance.

Outlook

We expect to see another material revenue growth in Q4’2020 due to a low base effect. However, we think that margins will mirror Q3’2020 performance. In our view, the impact of exchange rate on costs and the weak pass-through effect on consumers is a major challenge faced by the Group. Therefore, we expect to further see weak margins in the near-to-medium term.

Our long-term fundamental outlook for the Group is relatively weak, given the macroeconomic vulnerabilities and weakened household income. Furthermore, the impact of increased competition in the industry with low switching cost is negative for the Group. We note that the Group relatively benefits from the border closure policy, as it tends to gain some market share given the lower influx of cheaper smuggled products, we posit that the border closure policy is not sustainable in the long run.

We think that unless there are major macroeconomic reforms aimed at lowering inflation and boosting household income and consumption, the Group might struggle in the near-to-medium term. On a positive note, we recognise the cash balance of N40.12bn on the Group’s balance sheet, and the flexibility it offers the Group to invest in growth opportunities. We yet believe that cash is a non-operating asset unless put into use.

Valuation

We revise our earnings projections downwards to reflect a weaker outlook, given our expected higher operating costs relative to operating income. Our assumptions were based on macroeconomic and fundamental analysis. However, our cash flow projections were revised upwards majorly due to our expectation of lower capital expenditure going forward. In our view, we do not expect to see significant capital expenditure when growth opportunities are limited.

Our cost of equity (discount rate) was revised downward, reflective of a lower risk-free rate and by implication, a lower opportunity cost. We note the significant decline of yields in the fixed income market between the date of our previous earnings report and as of the writing of this report. Overall, we arrived at a fair value of N4.16 (previous: N2.91). At the current market price, the stock trades at a 68% premium to our fair value estimate. Hence, we maintain our SELL rating.

Financial Projections
Unilever Nigeria Plc: Weak Industry Fundamentals Weigh on Earnings
Source: Company Accounts, WSTC Research 

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