STOCKS: Poor operating performance downgrades Guinness Nigeria to Sell
In its lately released 9M 2020 results, Guinness Nigeria Plc (Guinness) recorded a 5.3% y/y decline in Income to N96.0bn from N101.4bn in 9M 2019. On q/q basis, revenue decreased 33.2% to N27.7bn in Q3 2020 (Jan – Mar 2020) from N41.4bn in Q2 2020. Pressured by higher excise as well as the closure of on-trade channels in the final week of the quarter, the company’s performance in Q3 2020 (historically one of the best quarters for Guinness) was weak with Q3 2020 Revenue and Net Income declining 17.6% and 97.2% respectively when compared with Q3 2019.
We chopped our Revenue forecast for the rest of the year as on-trade channels remained shut for the first 5 weeks of Q4 2020 (Apr-Jun 2020) while ceremonial activities remain banned in many states in the country. Furthermore, while we expect lower barley prices would provide some support to Gross Profit, we expect Opex and Finance cost to remain significant pressure points in Q4. We forecast a loss in the final quarter of the year which would pressure FY 2020e Net Income lower.
We cut our target price for Guinness Nigeria to N15.08/s from N32.12/s previously which implies a 21.5% downside to Wednesday’s closing price of N19.20/s. Thus, we downgrade our recommendation to a SELL from HOLD. We have revised down our profit lines steeply and lower pricing multiples in our relative valuation models given the company’s poor operating performance relative to peers. We arrive at our target price using a combination of the single-stage FCFF model and Relative valuation in the ratio 60:40 with the greater weighting on the FCFF methodology.
Confluence of headwinds pressure Revenue
In its recently released 9M 2020 results, Guinness reported a 5.3% y/y decline in Revenue to N96.0bn from N101.4bn in 9M 2019. On q/q basis, revenue declined 33.2% to N27.7bn in Q3 2020 (Jan – Mar 2020) from N41.4bn in Q2 2020. Revenue performance was unusually weak in Q3 2020 given it is historically one of the best quarters for Guinness. To give perspective, on a y/y basis, Q3 2020 Revenue declined 17.6% y/y.
The decline in revenue was driven by a confluence of several factors. First, we note that Guinness remains the most affected brewer from the change in excise duty calculation. The company’s portfolio consists of both beer (Excise: Q3 2019–N3,000/hl Q3 2020 – N3,500/h) and spirits (Excise: Q3 2019 – N15,000/hl Q3 2020 – N17,500/hl) making it more exposed to the excise changes. In addition, on-trade channels were shut for the final week of the quarter due to lockdown measures to control coronavirus spread, thus, affecting volume growth. These headwinds combined to mute the impact of price increases earlier implemented by the company.
Lower volume and input cost underpin COGS decline
The company recorded a 1.9ppts expansion in gross margin to 38.3% in Q3 2020 due to a faster decline in Cost of Sales relative to Revenue. Cost of Sales declined 8.1% y/y to N59.3bn in 9M 2020. We were particularly impressed by the faster decline in Q3 2020, as Cost of Sales declined 46.5% q/q (vs. Q2 2020) and 29.4%y/y (vs. Q3 2019). While we note that a decline in volume sold contributed to the dip in Cost of Sales, lower Barley prices (down 3.9% y/y in Q3 2020) also contributed to the decline. Nevertheless, Gross Profit was relatively flat in 9M 2020, down 0.5% y/y to N36.7bn. In addition, Gross Profit was considerably weaker in Q3 2020, down 6.7% q/q due to lower revenue.
Operating performance deteriorates on Opex & Depreciation increase Operating Expenses (adjusted for depreciation) increased by 4.6% y/y to N23.8bn in 9M 2020 from N22.7bn in 9M 2019. The increase was driven by pressure across Marketing & Distribution Expenses (adjusted for depreciation) and Administrative Expenses (adjusted for depreciation) with both increasing by 3.6% y/y and 7.1% y/y respectively to N16.7bn and N7.1bn in 9M 2020. Consequently, EBITDA was down 8.6% y/y to N13.0bn in 9M 2020 from N14.1bn in 9M 2019. The 9.3% increase in Depreciation & Amortisation cost placed further pressure on operating performance as EBIT dipped 28.8% y/y to N5.2bn in 9M 2020. Q3 2020 operating performance was particularly weak, with EBIT down 38.4% y/y.
Finance cost spikes due to jump in FX losses
Guinness reported a 197.5% spike in Net Finance cost on the back of higher Finance cost (+97.1% y/y) and lower Finance Income (-49.8% y/y) in 9M 2020. The jump in Finance cost was primarily driven by 506.7% spike in FX losses to N1.4bn. We also saw an Increase in Interest on Loans & Borrowings (+26.2% to N1.5bn) and Interest on Overdrafts (+129.0% to N0.5bn) as total Loans & Borrowings increased by 74.0% to N20.7bn as at 9M 2020 from N11.9bn in 9M 2019. The spike in Net Finance cost pressured Pre-Tax profits lower by 67.9% y/y to N2.0bn in 9M 2020 from N6.3bn in 9M 2019. Net profits were also down 68.0% y/y to N1.4bn in 9M 2020 from N4.3bn in 9M 2019. Q3 2020 Net Income declined significantly, down 97.2% y/y to N0.05bn in Q3 2020 from N1.7bn in Q3 2019. Earnings per Share for 9M 2020 was N0.62/s (9M 2019 – N1.94/s).
Outlook & Forecasts
Pressure on “on-trade” channels threatens Revenue We lower our Revenue forecast for Guinness given expectations of an unusually poor Q4. We forecast revenue of N27.8bn (2.6% lower than our previous forecast) for Q4 2020 (Apr – Jun 2020) which brings our FY 2020e (Jul 2019 – Jun 2020) to N123.8bn. We lower our Revenue forecast due to on-trade channels remaining shut for the first 5 weeks of the quarter while ceremonial gatherings remained banned. Furthermore, the final phase of the new excise regime will be implemented for spirits in June (the last month of the financial year) which would see it move to N20,000/hl from N17,500/hl previously. However, the impact would be minimal considering it would only impact one month in the whole year. The full impact will be felt in FY 2021.
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Favourable commodity price to support Cost of Sales
International commodity prices have remained low relative to last year although signs of recovery are beginning to show. Thus, with Barley prices expected to remain low in Q4 2020, we lower our modeled cost margin by 3.0ppts to 62.0% for FY2020e. Consequently, our new Cost of Sales forecast of N76.8bn implies a decline of 8.7% from FY 2019. We forecast a Gross Profit of N47.1bn. We highlight possible devaluation as a risk to our forecasts over the medium to long term. With Guinness’ financial year ending in June, we do not expect the devaluation risks to crystallise so soon.
Growth in Depreciation & Opex to dampen performance
We forecast sustained pressure on Operating Expenses which we expect to impact on the company’s operating performance for the rest of the financial year. We forecast operating expenses will grow 7.4% to N31.0bn thus placing pressure on EBITDA which we forecast will be down 11.9% y/y to N16.1bn (Prior forecast – N16.6bn). Pressure on operating performance will be further aggravated by high fixed depreciation costs, thus, dragging EBIT lower by 38.6% y/y.
Finance cost pressures to weigh further on Net Income
With Guinness Nigeria booking unexpected FX losses in Q3 2020, we expect Finance cost to remain a key pressure point for the rest of the financial year with the company carrying some dollar-denominated debt and payables. We raise our forecast for finance cost to N4.4bn and consequently, Net Finance cost to N3.9bn. The resulting impact of this is a dip in Pre-Tax profit which we revise lower to N1.6bn for FY 2020e. We also revise our Net Income forecast to N1.1bn for FY 2020e from N2.7bn. Our new Net Income forecast implies a 79.6% y/y decline from FY 2019.
Valuation: Downward revisions to estimate informs downgrade
We cut our target price for Guinness Nigeria lower to N15.08/s from N32.12/s previously. Our new target price represents a 21.5% downside from Wednesday’s closing price of N19.20/s, thus we downgrade the stock to a SELL. The steep cut in our target price is due to downward revisions on our profit lines and lower pricing multiples in our relative valuation models given sub-optimal performance relative to EM peers. Our valuation methodology uses a combination of the single-stage FCFF model and relative valuation in the ratio 60:40 with the greater weighting on the FCFF methodology.
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