July 31, 2018/Cordros Report
Update: NESTLE reported 56.9% y/y EPS growth in Q2-18, driven by strong revenue and margin growth, marginal increase in opex, and a net finance income (vs. loss the previous year). Compared to our estimate, the achieved Q2 EPS was ahead by 8%. Annualized, the H1-18 EPS of NGN27.07 is c.3% ahead of consensus estimate for 2018E.
In-line Q2-18 revenue; 2018E growth estimate unchanged: The reported Q2-18 revenue was ahead of Q2-17 by 11.6% and beat our estimate by a marginal 1%. At current run-rate, we believe NESTLE’s revenue growth (10.97% in H1-8) is in line with our 10% forecast for the year, hence we make no changes. Compared to both Q2-17 and Q1-18, we estimate volume grew at low single-digit during the reference period, supported by both Ramadan-related consumption as well as the recent introduction of new SKUs – Maggi Naija Pot, Golden Morn Puff, and Milo-Ready-to-Drink – for which adverts and promotions have been aggressive thus far this year. Food revenue grew 11% y/y while Beverages grew by 13% y/y in Q2. We are aware of rising competition in the FMCG space with new entrants, but should also note that NESTLE’s RTM is aggressive, hence we expect revenue will maintain the H1 trajectory in the remaining half of the year.
A welcome recovery of margins: From the decline to 38.2% in Q1-18, NESTLE’s gross margin recovered strongly to 43.96% in the review period, exceeding both Q2-17’s 40.9% and our estimate of 41.6%. We revise our gross margin estimate for 2018E slightly higher to 42.5%, and while noting downside risk relating to the rising price of cocoa (+20% YtD), elsewhere, we believe NESTLE’s margin will be supported more by the stable exchange rate, soft sugar (-26%YtD) and dairy prices (-8% YtD), continued sourcing of cheaper local inputs, and importantly, stable selling prices. Our revised forecast brings gross margin closer to the average of 43% achieved between 2012-2014FY (average gross margin was 40% prior), but still below the peak of c.45% achieved in 2015FY.
EBITDA and EBIT grew 28% y/y and 30.7% y/y respectively in Q2-18, with respective 28.4% and 26% margins. Our revised estimates for 2018E produced EBITDA and EBIT growth of 17% and 18% over 2017FY, equating to record-high 27.1% and 24.5% margins respectively.
FX gain offsets interest expense: Net finance income of NGN300 million was recorded in Q2-18. FX gain of NGN590 million more than offset interest expense of NGN550 million, as the balance of borrowings reduced by a further NGN630 million to NGN17.5 billion (vs. NGN24.2 billion in 2017FY and NGN42.99 billion in H1-17). Following the result, and with the risk of FX fluctuation muted, we now model finance cost will be much lower at NGN2.6 billion in 2018E, from. NGN4.6 billion previously (vs. NGN15.1 billion in 2017FY).
High effective tax rate: Recognized effective tax rate was 29.5% in Q2, averaging 32.7% over H1-18. We have consequently adjusted our tax rate assumption higher from 25% to 30%, hence the little impact of the upwardly revised gross margin and reduced finance costs estimates on 2018E EPS estimate.
Estimate and valuation: The net impact of the changes to our model is an increase to our 2018E EPS estimate to NGN60.14 (from NGN58.30 previously) and TP to NGN942.23 (previously NGN851.48), while maintaining SELL rating. NESTLE’s stock has lost 6% since we updated on Q1-18 result, with a SELL rating. On our estimates, the stock is trading at forward (2018E) P/E and EV/EBITDA multiples of 25x and 16.2x, a significant discount to its five-year historical averages of 45x and 21.1x respectively.