Nestle Nigeria Plc Q2 16 - FX Loss on Dollar Debt Swings Earnings Negative

Nestlé Nigeria Plc (Nestlé) released unaudited results for 6 months ended 30th June 2016 wherein revenue rose 22% YoY to N80.4 billion; however PBT and PAT plunged 92% and 94% YoY to N896 million and N535 million respectively.

FX losses on dollar debt underpin negative Q2 16 earnings

The sharp contraction in earnings stems from FX losses on Nestlé’s dollar loans (FY 15: $120million) following the 43% NGN depreciation in June 2016. The FX translation loss offset strong sales growth during the period and largely accounts for the company’s underperformance over the period.

Nestle grapples with rising costs on several fronts

Domestic input prices tracked higher during the period (sorghum: +66% YoY, Maize: +70% YoY), pushing production costs on Nestle’s food products higher. Secondly, following several disruptions to gas pipelines, Nestle may have relied more on expensive LPFO. Though Nestle tried to pass on these inflationary pressures by raising prices on some products during the period, we believe constrained consumer purchasing power provided limited scale of price hikes leading to gross margin contraction (-9pps YoY)

Input cost pressures and weak consumer purchasing power dim earnings outlook

In the aftermath of electricity and tariff hikes, we expect weak consumer purchasing power and input cost pressures should constrain scope for complete pass-through in addition to some volume weakness. Overall, the outlook speaks to subdued revenue growth and sustained gross margin contraction over the rest of 2016.

Given Nestlé’s net short FCY positions on dollar-denominated loans (FY 15: $120 million) and maturity of $94 million loan principal payable to related parties in 2016, the company remains susceptible to sizable foreign currency losses in the near term which should impact negatively on earnings.

In addition, recent monetary policy tightening should drive higher interest expense on LCY loans (19% of total loans). Cumulative impact of the elevated finance expense and input cost pressures drive moderation in our 2016E earnings outlook and lower our FVE to N618.73.

Largely reflecting the loss in Q2 16, Nestle now trades at a current P/E of 43.8x relative to 24.6x for Bloomberg Middle East & Africa peers. Given the increased prospects for earnings deterioration and 35% premium implied in last trading price to our FVE we retain our SELL rating on Nestle.

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