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Nestle Nigeria Plc: Stronger profitability growth impeded by rising operating costs

Renowned for quality nutrition, health and wellness products around the world, Nestle Plc maintains a substantial share of the market despite being impacted by stiff competition and declining consumer expenditure. The first sales of Nestle products in Nigeria date back to the beginning of the 20th century. This was through local importers who placed their orders directly with British trading companies who were active in the country at that time. Imports were sporadic and at fiat, but became regular from the 1920s when Nestle decided to set up office in Nigeria to organize the importation and distribution of products.

Nestlé Nigeria Plc was listed on the Nigerian Stock Exchange on April 20, 1979 and is currently the third most capitalized stock on the exchange. The sustained popularity of the Company’s brands, such as Milo, Maggi cube, and Cerelac, as well as their superior quality, continues to drive consumer demand.
The Company recently published its first quarter accounts for the period ended March 2014, reporting a gain of 8.89% in turnover to N33.43 billion. However, net income and pre-tax earnings stayed flat at N7.07 billion and N6.00 billion respectively.

SUPERIOR QUALITY BRANDS DRIVE REVENUE
For the first quarter period ended March 2014, the Company grew revenue by 8.89% from N30.69 billion to N33.42 billion, thanks to the company’s quality and household brands such as Milo, Maggi cube and Cerelac, which has helped the Company sustain its market share amid stiff competition and declining consumer expenditure. Further insight into the Company’s financials revealed that the Food segment with brands such as Maggi, Nan, Golden Morn and Nutrend contributed 56.99% of total revenue which stood at N19.05 billion while the remaining 43.01% (14.37 billion), was from  the Beverages segment with brands such as Milo, Chocomilo, Nido, Nescafe and Pure Life.

Cost of sales also went up by 6.30% to N15.56 billion in March 2014 from N17.45 billion in the corresponding period of 2013 due to increase in the cost of raw materials used during the production process. Nevertheless, gross profit increase by 12.29% to N14.86 billion from N13.23 billion, due to the higher increase in revenue, in comparison with the increase in cost of sales recorded over the period.

GROWTH IN OPERATING PROFIT HAMPERED BY RISING EXPENSE
Operating profit in the first quarter of 2014 increased marginally to N7.72 billion from N7.51 billion, representing a 2.76% change. The primary reason for the meagre growth in operating income can be traced to higher increase in operational expenses which the Company incurred during the financial period that prevented a stronger growth in profit. The Company’s distribution expenses grew by 30.58% to N5.64 billion from N4.32 billion due to higher cost of transportation of products and promotional expenses in keeping the Company’s product brands in consumers’ minds while administrative expenses grew by 5.09 to N1.49 billion from N1.39 billion, due to upgrades and renovations of various production facilities and storage barns expansion through the country.

DECLINE IN INVESTMENT INCOME IN ADDITION TO INCREASED FINANCE COST ERODES PROFITABILITY
Income from investment activities declined significantly by 44.82% to N217.42m in the first quarter of 2014 from N394.03m recorded in the corresponding period of 2013. This was as a result of a decrease of 54.01% in interest income on bank deposits to N132.86m from N288.93m and 19.54% decrease in interest income on loan re measurement to N84.56m from N105.10m over the period.
On the other hand, finance cost grew by 1.58% to N872.90m in March 2014 from N859.31m in March 2013 due to a slight increase in borrowings by the Company. The combination of the decline in finance income and increase in finance cost therefore impacted the Company’s profitability negatively as pre-tax earnings only grew slightly by 0.28% to N7.07 billion in 2014 from N7.05 billion in 2013. Net income also grew by 0.15% at N6.01 billion from N6.00 billion over the period.

CREATING SUSTAINABLE BUSINESS THROUGH LOCAL SOURCING OF RAW MATERIALS
To stimulate industrial growth, the Company has long term sustainable business practices. Almost all of the Company’s key ingredients are sourced locally through farmers and suppliers where available. In addition to its commitment to local sourcing of raw agricultural materials, the Company is involved in two major initiatives in the agricultural sector.

In 2011, Nestle Nigeria commenced a new project to help farmers increase output and quality of cassava starch production in collaboration with the International Institute of Tropical Agriculture (IITA) in Ibadan. The project is aimed at increasing productivity per hectare in cassava through multiplication and dissemination of high yielding varieties and ensuring smallholder farmers’ benefit from improved cassava management practices.

The project will enable sustainable supply of cassava roots (with high starch content) to local processors. The Company has committed over N120million on this project for over two years. The second project, Grains Quality Improvement initiative is aimed at ensuring high quality grains by reducing Mycotoxin contamination in grains through good agricultural and storage practices. This project has significantly reduced the nutritional and economic losses in grains and legumes and ensures high quality raw materials for our factory.

WE MAINTAIN OUR HOLD RECOMMENDATION
The first quarter results for Nestle Nigeria Plc puts the Company in the path of achieving our earlier projections for the full year. Despite this greener outlook, we are conservative in our approach. With respect to operating expenses, we believe that the significant growth in distribution, sales and marketing costs was part of a business strategy geared towards increasing product penetration and sustaining market leadership in a matured sector.
Taking into account external business cons

traints in the current operating climate such as flooding due to the heavy downpours, disruptive effects of unrest in the North-Eastern region of the country, and a persistent high interest rate environment, we project revenue of N157.61 billion and net income of N25.61 billion for the full year ended December 2014, leading to a 9-month forward EPS of N32.32. Using the justified PE method of valuation, we arrived at a 12-month average value of N1,297. Since our target price represents a 12.85% upside on the current stock price, we place a HOLD recommendation on Nestle Nigeria Plc.

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