Transcript
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Initiating Coverage

Nigeria | Equity | FMCG | April 2014

www.gtlgroup.com

Good Food, Good Life

Strengthened to ride through the bumps

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CONTENTS

INVESTMENT SUMMARY .......................................................................................... 2

THE NIGERIAN CONSUMER GOODS SECTOR .................................................................. 3

COMPANY PROFILE ............................................................................................... 7

KEY GROWTH DRIVERS ..................................................................................... 10

REVIEW OF NESTLE FULL YEAR 2013 RESULTS ........................................................... 16

OUTLOOK FOR EARNINGS – 2014 AND BEYOND ........................................................... 18

VALUATION ..................................................................................................... 21

DISCLAIMER AND IMPORTANT DISCLOSURES ............................................................... 24

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Nestlé Nigeria Plc

The Nigerian consumer market is poised to continue to

expand and a rapidly growing population as well as

rising income levels will be key drivers of consumption

growth, in our view. We believe that evolving consumer

themes will play to Nestlé’s strengths - robust capacity

(on the back of high capex investment), unique

approach to distribution channels and product

innovation.

Nestlé has recorded double-digit revenue growth over

the last decade, despite challenges within the Fast

moving consumer goods (FMCG) sector. We hold a long

term positive outlook for the sector and we believe the

company has capabilities to sustain momentum, as

pressure points in its FY-13 numbers are mostly

transient.

Over the past four years, the company has invested

heavily in capacity expansion in its Nigerian business.

We believe increased volumes from on-going expansion

will be a key driver of future revenue. This has driven

our expectations for double digit revenue and after-tax

profits growth over our forecast horizon.

While market sentiments on the counter over a five year

period reveal a price uptrend of ~83% CAGR, suggesting

the stock has been modestly over-bought, we still see

some upside as we believe the stock is current trading at

close to its intrinsic value, at current levels. At

N1215.67, our 12 month Price target is ~9% above

Nestlé’s current trading price of N1111.00. We rate

Nestle HOLD.

Nestle Nigeria

RECOMMENDATION

Current Price, NGN 1,111.00

Target Price, NGN 1210.92

Rating HOLD

Potential upside 9%

FINANCIALS

2013 2014e 2015F

Sales 133.1 165.3 203.3

EBIT 27.8 38.5 47.8

PBT 26.0 37.2 60.8

PAT 22.3 30.9 38.4

EPS 28.1 39.0 48.5

Div. Yield % 2.5 2.6 3.4

SHARE SUMMARY

Bloomberg Nestle NL

Reuters Nestle LG

Free float 36%

Market Cap, (N’mn) 911,475

Year Low (N) 958.80

Year High (N) 1,195.00

52 – Week Low (N) 879.50

52 – Week High (N) 1,249.50

RETURNS

Year to Date -4.18%

52 – Week 27.40%

Usoro Essien

[email protected]

Ade Alabi

[email protected]

Oluwaseun Dosunmu

[email protected]

Nelson Iziogba

[email protected]

INVESTMENT SUMMARY

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THE NIGERIAN CONSUMER GOODS SECTOR

The consumer goods sector can be broadly grouped into the following

sub-sectors; white goods, brewers and bottlers, pharmaceuticals, household

and personal care, beauty as well as food & nutrition. Although dominated by

global brands such as Reckitt Benckiser, Procter and Gamble, Unilever, PZ

Cussons, Cadbury and Nestle, which are active in the Nigerian market

through their local subsidiaries, the sector remains fragmented. Other key

players within the space include Kneipe, Promasidor and United African

Company of Nigeria (UACN). Of the major players, only Unilever, Cadbury,

PZ Cussons, Nestle, Nigerian Breweries, Guinness and UACN are listed on the

Nigerian bourse.

Strong macro-fundamentals underpin positive outlook....

A review of our basket of companies in the Nigerian consumer goods space

show that revenues have grown by 15% over the past three years, while the

Nigerian food market is estimated to be growing at an average of ~9% per

annum. Major drivers include a positive shift in consumption patterns, the

emergence of a significant middle class in a sizeable population of

~167million, growth in the non-oil sector of the Nigerian economy and

annual per capita GDP growth of 3-5% for the past five years (which is

comparable to the growth seen in other emerging markets over the same

period).

Furthermore, data from the National Bureau of Statistics (NBS) show that

since 2006, the sector is the third largest recipient of foreign direct

investment (FDI), behind the oil & gas and telecoms sectors.

Our outlook for the sector is positive, underpinned by expected secular

growth in consumer demand in the near to medium term. Sub-Saharan

Africa (SSA) is now nearly as urbanized as China and also has a similar

population to urban city ratio with Europe. In addition, Mckinsey estimates

that Lagos, (together with Johannesburg and Cape Town) will generate

~$25bn in consumer spending annually by 2020, a figure comparable to its

forecast for key cities in other emerging markets such as Delhi and Mumbai.

The consumer goods

sector is poised to

continue to expand, to

be driven by continued

secular growth in

consumer demand.

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Mckinsey also expects Ibadan, located only some 150km from Lagos, will

generate over $10bn within the same period.

Key players within the consumer goods space such as Nestle, Unilever, UACN

and PZ Cussons seem aware of these projections, and continue to invest

heavily in capacity expansion. We view this as a significant initiative, and

envisage that growth within the sector will likely be driven by these leading

brands, despite competition from smaller domestic companies whose

products have gained some prominence as cheaper substitutes, on the back

of the domestic impact of events that stemmed from the 2008 global

financial crisis. We hinge our perspective on three lines of reasoning:

First, we consider Nigeria’s most developed cities - where the leading brands

already have a strong hold - central to the growth of the fast moving

consumer goods sector, given the growth of the middle class as well as rising

urbanization.

Furthermore, rapidly expanding distribution networks as well as innovation

and versatility of the products offered by the leading FMCG companies,

suggest that the rural communities across the country will likely see

increased penetration from the leading brands in the near to medium term. A

good example is Nigerian Breweries’ acquisition of five small brewers in

October 2011, a move that has seen its mass market brands

(Maltagold, Life, Climax and Goldberg) gain traction in the second and third

tier states across Nigeria.

45% 30% 40%

73% 79% 82%

55%

70% 60% 27%

21%

18%

0

200

400

600

800

1000

1200

1400

1600

China India Africa Europe Latin

America

North

America

To

tal

Po

pu

lati

on

Urban Rural

Growth within the FMCG

sector will likely be

driven by leading

brands, despite

competition from

smaller domestic

companies.

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Finally, we see a major advantage of scale for the leading players, especially

those with foreign parentage. These can benefit from access to cheap

financing from their parent companies, through which they can better fund

operations whilst also improving efficiency.

Thus, despite some challenge from the less popular section of the FMCG

segment, we view the leading brands as the prime beneficiaries of the

expected growth in the Nigerian FMCG sector in the foreseeable future.

Defensive players to remain strong, despite potential headwinds…

Despite a positive long term Outlook for the Nigerian consumer goods sector,

we are conscious of potential headwinds that may arise from upcoming

events in the next 24 months; notably the change in the central bank

leadership and its potential impact on monetary policies, political events in

the run-up to the 2015 elections, and plausible re-emergence of socio-

political unrest in the Northern part of the country.

Nevertheless, we expect companies in the consumer goods space with

defensive characteristics (from exposure to non-cyclical goods, especially

food) to outperform companies more involved in the production of cyclical

goods, irrespective of the occurrence or otherwise of these risk factors. We

believe that this view is corroborated by recent trends.

During the last three years, the consumer goods sector has experienced a

challenging environment due to a squeeze on consumer disposable income,

stemming from the global financial crisis, as well as structural adjustments in

the domestic economy.

As we would expect, the impact of these events was less evident on the

earnings of companies within the consumer goods space with exposure to

non-discretionary goods, as demand for these classes of products remained

relatively strong. For instance, while both Unilever and PZ Cussons, which

are major players in the non-food segment, easily delivered high teen sales

growth prior to 2009, both companies have endured single digit growth in

revenue over the past three years.

We favor companies in

the non-discretionary

FMCG segment as these

have a track record of

resilience in a

challenging business

environment.

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On the other hand, Nestle, which is a major player in the food segment,

constantly delivered double digit growth prior to and over the corresponding

period (average of ~20% per annum).

With the ability to benefit from long-term growth in consumer demand while

also demonstrating resilience in the face of a more challenging environment,

we are naturally inclined to favor companies in the non-discretionary section

of the market, such as Nestle and UACN.

0

5000

10000

15000

20000

25000

30000

35000

40000

Q1 - 12 Q2 - 12 Q3 - 12 Q4 - 12 Q1 - 13 Q2 - 13 Q3 - 13 Q4 - 13

Trend in Revenue Growth (Q1-12) - (Q4-13)

Unilever Cadbury Nestle RHS

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COMPANY PROFILE

Nestle Nigeria, a member of the Switzerland based multinational Nestle

Group, began trading operations in Nigeria in 1961 and was listed on the

Nigerian Stock Exchange (NSE) in 1979. The company is presently the

largest food and beverage company in Nigeria (ex-brewers), both in terms of

sales and market capitalization. Nestle Nigeria is part of the Central and

West Africa division of the Nestle Group, managed by Nestle Central & West

Africa based in Accra, Ghana. This entity is also the largest shareholder in

the Nigerian subsidiary.

The company has two manufacturing plants in Ogun state; the Agbara and

Flowergate plants. With an initial outlay of ~N30 million, the Agbara factory

came into existence ~30 years ago, and remains one of Nestlé’s largest

factories in Asia and Africa. The factory has been subject to extensive

capital expenditure over the years, as Nestle grew volumes and increased its

product portfolio in response to evolving consumer demand.

The Flowergate plant was commissioned in 2011 at an estimated cost of

~N12 billion, and has since been dedicated solely to the manufacture of

popularly positioned products (such as the Maggi brand) in order to ease

Part of the Central and

West Africa division of

Nestle Group

Two Manufacturing

plants in Ogun

state - Flower gate and

Agbara.

59.59%

3.89%

36.52%

Nestle Nigeria - Shareholer Structure

Nestle CWA Ghana

Nestle SA Switzerland

Others

Source: Company Filings, Greenwich Research

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pressure and free up space at the Agbara plant for other product lines.

The company has also revealed plans to build a third factory in Abuja in the

near term, as it seeks to grow its presence in the Northern region.

Nestle operates a centralized distribution system with its distribution centre

in Ota, in Ogun state. The centralized distribution centre supplies a total of

74 distributors (as at Q3-13), spread across key regions in Nigeria.

Brands manufactured by Nestle Nigeria fall under eight categories as shown

below:

Table 1: Nestle Nigeria – Major Product Lines

Product Line Products

Infant Cereals Nestle Nutrient, Cerelac, Lactogen

Family Cereals Golden Morn

Beverages Milo

Confectionary Chocomilo

Bouillon Maggi - Cube/Chicken/Crayfish/Mixpy

Table Water Nestle Pure Life

Coffee Nestle Classic/3-in-1/Nescafe Breakfast

Milk Nido

The products are produced by two main strategic business units (SBUs),

namely Food and Beverages, which are defined by differing marketing

strategies and technology requirements.

Food •Maggi, Cerelac, Nutrend, Lactogen

and Golden Morn.

Beverages •Milo, Milo ready to drink, Chocomilo, Nido, Nescafe and Nestle Pure Life.

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Over the last five years, revenues for the two strategic business units have

grown in double digits, with the Food SBU – accounting for ~61% of sales.

Nido , 3%

Nescafe , 4%

Pure Life, 9%

Golden Morn, 12%

Baby Food, 14%

Milo, 22%

Maggi, 36%

2013 - Product Contribution to Revenue

Revenues from Nestle

Nigeria’s 2SBUs - Food

and Beverages - have

grown double digits in

the past five years.

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KEY GROWTH DRIVERS

Over the last five years, Nestle has consistently recorded double digit growth

in profitability, with revenue and net income growing at an average of ~23%

and ~26% y/y respectively. At 21%, growth in EPS lagged the bottom line

rate, owing to adjustments made to outstanding shares in FY-10,

when a bonus of one share was issued for every five held.

Portion sizes expand mass market appeal: Nestlé’s production of key

products such as Milo, Nescafe and Golden Morn in small single-use sachets

has been a major driver of volumes and market share in the last 3-4 years.

These products are designed for and appeal to low-income consumers who

constitute a large proportion of the Nigerian population, and in our view, play

a significant role in the overall consumption value chain. We observe this

strategy is being adopted industry wide, with products from Procter &

Gamble, Cadbury, Unilever and Promasidor providing competition.

Exports gaining traction: The Company commenced exporting some of its

products to neighbouring African countries such as Ghana, Togo, Mali and

Benin in 2011. We believe the move was designed to improve capacity

utilisation following the recent significant investment in capex. Although the

contribution of export sales to revenue is still minimal (two year average of

~1.5%), we envisage a steady improvement in the near term, as further

expansion plans are completed (mainly the construction of the Abuja

factory). The company’s export strategy also benefits from the Federal

Government’s favourable stance to exports in the form of subsidies.

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Efficiency gains from improved distribution network: In our view, the

company has benefitted from changes to its distribution process that saw it

shift from wholesale to a “retail” driven distribution model. The retail model

relies heavily on secondary sales forces to push products through distribution

channels, resulting in a rationalization of the company’s distributors from a

total of about 170 to 74. This rationalization coincided with the company’s

move to a more centralized warehouse in Agbara, Ogun State.

.

As a result, Nestle now has a more structured distribution network, which

has given the company more grip over its distribution chain, while giving its

distributors more responsibility and ensuring deeper penetration across

different regions of the country.

We observe that Nestlé’s footprint continues to grow across secondary and

tertiary cities, especially locations within the northern region not rocked by

socio-political unrest, as it seeks to diversify away from those areas where

the local economy has been hit.

0

5

10

15

20

25

30

35

40

45

50

2008 2009 2010 2011 2012 9M - 13

Percen

t

Source: Company Filings, Greenwich Research

Nestle - Gross margin vs. competitors

Nestle Unilever Cadbury

Nestlé’s footprint

continues to grow in

secondary and tertiary

cities, especially areas

in the northern region

not rocked by

socio-political unrest.

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0%

10%

20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013

Cost to Sales Opex to Sales

Change in dynamics for raw material procurement: The company has

vastly improved its ability to manage typically volatile raw material costs

(which are affected by global commodity prices and exchange rates) by

ensuring a large proportion of its agricultural raw materials and packaging

materials are sourced from the domestic market. Figures from the FY-12

annual report show that ~75% of agricultural raw materials, which constitute

~60% of COGS by our estimates, are sourced locally. Key raw materials

obtained locally include cocoa, sorghum, cassava, maize and soybeans.

Furthermore, for imported raw materials, the company operates three levels

of procurement to drive supply chain efficiency: Nestle SA (at the global

level), Nestle Central and West Africa (at the regional level) and Nestle

Nigeria (at the local level). Thus, while the company is now exposed to

volatilities in domestic agricultural production, its exposure to exchange rate

volatility, which we consider the greater risk, has been significantly reduced.

We expect the trend to persist in the near term, with favourable Government

policies towards the agriculture sector providing support. Overall, this has

helped to moderate the rise in COGS and SDA expense over the last five

years, both of which have grown at a lower rate than revenues.

-5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

2008

2009

2010

2011

2012

9M - 13

Cadbury Unilever Nestle

Opex to Cost of Sales & EBIT Margins vs. Peers

~75% of agricultural

raw materials, which

constitute ~60% of

COGS by our estimates,

are sourced locally, thus

reducing significantly

exposure to exchange

rate risk.

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0

5,000

10,000

15,000

20,000

2008 2009 2010 2011 2012 2013

Mil

lio

n ₦

Source: Company Filings, Greenwich Trust

CAPEX Investment - Nestle Vs Peers

NESTLE CADBURY UNILEVER

Tax incentives: As a result of the pioneer tax status granted by the Federal

Government’s Nigerian Investment Promotion Council (NIPC), Nestle has

enjoyed a significant moderation in its tax rate, which has fallen to ~13% in

the last two years (vs. an average of ~30% prior to 2011). This follows the

expansion and completion of the company’s Agbara and Flowergate factories

in FY 2011. The lower tax rate has boosted net margin within the period.

Trend in Net Margin and Effective Tax rate

Investment in capacity expansion: In the last decade, Nestle has

invested over N100 billion in capacity expansion, well ahead of peers, in its

bid to meet growing demand. Major completed investments include new

production lines (to increase capacity across the company’s flagship

products), the commissioning of the Flowergate factory, the completion of a

malt plant as well as an independent tri-generation power plant in the

company’s Agbara factory, which cost N3.6 billion.

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

2008 2009 2010 2011 2012 2013

Net Margin Effective Tax rate (RHS)

In the last decade,

Nestle has invested

over N100 billion in

capacity expansion,

well ahead of peers

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In our view, investment in the new power plant is especially important as it

reduced the company’s dependence on energy from the national grid,

thereby increasing overall energy efficiency and reliability. The recent surge

in capital expenditure commenced in 2009 (with a total investment spend

~3x that of 2008) and increased further over the following two years.

Consequently, operating free cash flow (OFCF) was negative in 2009 and

2010. However, operating cash-flows remained strong, leading to a reversal

in OFCF in 2011 and 2012, despite an additional total capex outflow of ~N30

billion in both years. We expect OFCF to remain strong going forward.

We believe that the company will be close to the end of its major spending

programme, once the Abuja factory is completed. Nevertheless, we do not

expect capex to fall to pre-2009 levels (of ~N4 billion annually) as we

believe that management will continue to invest in strategic ventures to keep

the business at the forefront in the sector.

94,300

-1,120

1,721 2,101

19,047 28,186

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

-30,000

-10,000

10,000

30,000

50,000

70,000

90,000

110,000

2008 2009 2010 2011 2012 2013

Th

ou

san

ds

Trend in OFCF and CAPEX

OFCF CAPEX (RHS)

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100% 93%

102%

67%

85%

66%

50% 47%

85%

0%

20%

40%

60%

80%

100%

120%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Company Filings, Greenwich Research

Trend in Dividend Payout Ratio

Net Income Dividend Pay Out Ratio

Expansion plans drive debt and lower dividends…

Nestlé's balance sheet shows that, prior to 2008, the company was fully

equity financed. Since then, Nestlé’s debt to total capital has hovered

between 40% - 60%, with bulk of the debt financing (> 75%) obtained from

the parent – Nestle SA.

Nestle maintained close to 100% dividend pay-out policy until 2008, where a

change in strategy engendered investments in capacity expansion. Over the

last four years, the dividend pay-out ratio has averaged 62%. We expect the

company to increase pay-out in the near term, as the construction of Abuja

factory nears its completion.

0

20

40

60

80

100

120

140

160

180

200

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2008 2009 2010 2011 2012 2013

Source: Company Filings, Greenwich Research

Nestle - Debt Coverage

Interest Cover (x) RHS Interest Expense

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REVIEW OF NESTLE FULL YEAR 2013 RESULTS

Revenue growth slows…

Nestle Nigeria recently released its FY-13 results, reporting revenue and net

profit of N133.1 billion and N22.3 billion respectively, representing a 14.0%

and 5.3% rise from the comparable period in 2012. Q4-13 revenue rose by

~14% q/q (19% y/y) to N37.7 billion. Management proposed a final dividend

of N24.00, which brings the total dividend for FY-13 to N25.50, a rise of

~28% from the prior year.

Further analysis revealed that input cost pressures weighed on the Q4-13

cost of sales, which surged 32% y/y (24% q/q) to N22.6billion. The impact

was however lower on the full year figures with the FY-13 COGS rising 15%

y/y to N76.3 billion, ~300 bps below the 3-year trailing average.

At 42.7%, the FY-13 gross margin was 30 bps lower than the previous year

and 200 bps below Nestlé’s five year historical average. In our view, this was

partly due to the slower than expected top-line growth, which expanded at

its weakest pace in four years. We believe the slow growth in top-line was

due to negative consumer reaction to a price increase in Nestlé’s Maggi line

in H1-13.

Nevertheless, top-line performance improved somewhat in H2-13, as the

company rolled back some of its pricing decisions and also benefited from

stronger volume sales in its Milo line, following more aggressive pricing of its

main rival Bournvita by Cadbury during the same period.

As Higher Operating Expenses Crimp FY-13 Earnings…

Higher operating expenses y/y (admin costs up 13% to N6 billion, selling and

distribution costs up ~22% to N19 billion), were driven by an increase in

staff wages, a trend seen industry-wide in FY-13, as well as higher

distribution spending stemming from the company’s expansion into 2nd and

3rd tier states under its new retail distributorship model (designed to protect

market share, especially in the north).

FY-13 and Q4-13

revenues both rose

~14% to N133.1 billion

and N37.7 billion

respectively.

Net profit for FY-13 was

N22.3 billion, equating

to a 5.3% increase y/y

and resulting in an EPS

of N28.10k

(vs. N26.7 in FY-12).

Slower than expected

top-line growth and

input cost pressures in

Q4-13 drove FY-13

gross margin to 47.2%,

30bps lower than FY-12

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As a result, the opex to sales ratio rose 100pbs to 21.8% (vs. 20.7% in

FY-12) with the EBIT margin falling by a similar proportion to 20.9%. FY-13

profit before tax came in at N26.0 billion, up ~4% y/y. For Q4-13 PBT

declined 16% y/y (21% q/q) to N5.7 billion, despite a steep ~71% fall in

finance costs to N185.5 million. Net profit for the year was N22.3 billion,

equating to a 5.3% y/y increase and resulting in FY-13 EPS of N28.10k (vs.

N26.7 in FY-12).

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OUTLOOK FOR EARNINGS – 2014 AND BEYOND

Nestle Global has made a firm commitment to expansion in emerging

markets which has been reflected in its Nigerian operations. Approximately

20% revenue CAGR over the past six years, effectively doubling revenues

once every three years, has been driven by continued investment in capacity

expansion. Based on the high capex outlay in the last 3-4 years, together

with the strengthening of the company’s distribution network (designed to

cater for increased market penetration), we believe the company still sees

opportunities for volume expansion in Nigeria in the near to medium term, to

be driven by expected strong consumer demand and favorable

demographics.

Nevertheless, as seen in the recent results, some pressure points have

emerged. These include a slowdown in revenue growth, a sharp rise in

operating expenses (driven predominantly by a rise in distribution spending),

as well as the impact of a weakening domestic currency on input costs and

interest payments on the company’s long-term borrowings, a significant

portion of which are dollar denominated.

While we anticipate stiffer competition across our forecast horizon, on the

back of a growing influx of packaged food manufacturers such as Tiger

Brands and forward integration of existing food businesses by companies

such as Flour Mills of Nigeria (all of which we expect to wield the same

supply chain control that has proven an effective competitive advantage for

Nestle) we believe that Nestlé’s scale, pricing power and its better

understanding of the domestic terrain will ensure that it maintains a leading

market position.

Based on the negative consumer reaction to product price increases by FMCG

players in H1-13, which adversely impacted Nestlé’s FY-13 revenues, our

view is that the players that will deliver the most impressive top-line

performance in the near to medium term are those able to adopt innovative

strategies that will ensure higher volumes sales with minimal price

increments.

~20% revenue CAGR

over the past six years,

effectively doubling

revenues once every

three years, has been

driven by continued

investment in capacity

expansion.

Slowdown in revenue

growth, sharp rise in

opex and impact of

weakening currency on

input costs are key

pressure points from

FY-13 results

Despite stiffer

competition on the

horizon, we believe

Nestlé’s scale, pricing

power and its better

understanding of the

domestic terrain will

ensure it maintains a

leading market position

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We believe the ability to push volumes and achieve scale is strongly

dependent on three main factors, namely; available capacity, depth and

efficiency of distribution and appeal to diverse consumer classes.

In our view, the themes that will likely unfold in the medium-term play to

Nestlé’s strengths, and drive our expectation of strong top-line growth across

our forecast horizon. Furthermore, we expect recent pressure on consumer

spending to ease after Nigeria’s 2015 elections, with the expected

subsequent pick-up in spending supporting growth in Nestlé’s top line. On

this basis, we expect only a mild recovery in 2014 and expect revenues to

grow ~15% (similar to FY-13 run rate), we however forecast 18% growth in

revenue (CAGR) through to 2016, largely in line the company’s five-year

trailing average (pre – FY-13).

On the cost side, we expect to still see higher distribution spending, albeit at

a lower rate than the FY-13 level. We therefore anticipate a mild progressive

uptrend in operating expenses of ~100bps annually over the next 3-5 years,

as a rise in administration and marketing expenses will mask savings from

lower distribution spending relative to FY-13.

We see scope for pressure on the domestic currency to persist in the near

term. Nevertheless, barring domestic shocks to agricultural outputs relevant

to Nestlé’s business, we do not foresee that volatility in global commodity

prices and the value of the domestic currency will materially affect the

company’s input costs going forward, as Nestle now sources ~75% of its

input requirements locally.

In addition, while a significant portion of Nestlé's long-term debt is dollar

denominated, we expect to see a reduction in the face value of its total long-

term exposure over the next 2-3 years, as the company enters the final

phase of its capacity expansion programme which – in our opinion - is the

reason for the inclusion of debt in its capital structure. Overall, the impact of

a depreciating naira on Nestlé’s numbers will likely not be as severe as it has

been in the past and interest expense will likely continue to decline across

our forecast horizon.

The themes that will

likely unfold in the

medium-term play to

Nestlé’s strengths, and

drive our expectation of

strong top-line growth

across our forecast

horizon.

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We expect operating free cashflow to increase significantly going forward, as

the company’s capex spend declines from the levels seen over the last four

years. We deem it unlikely that a large and growing cash position will be left

sitting on the company’s books, and expect any surplus will be put to use by

means of one or both of the following means:

Repayment of long-term debt, ~75% of which was obtained from Nestle SA

for the latest capacity expansion. Although significantly below domestic

rates, we believe this borrowing exposes the company to a depreciating

naira.

The dividend payout ratio (currently at ~90% in FY-13) may also increase as

it benefits from the increase in OFCF mostly from decline in capex.

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VALUATION

In valuing Nestle, we have employed a combination of discounted cash flow

(DCF), dividend discount model (DDM) and relative valuation methodology

(P/E).

Table 3:DDM Summary 2014e 2015F 2016F 2017F

Dividend Per Share 29.28 38.76 44.68 55.42

Terminal Value 1455.51

Present Value 29.28 38.76 44.68 55.42

Implied Value per Share 939.83

Table 2: DCF – Valuation Parameters

Risk Free Rate 13.8%

Return on the Market 14.0%

Beta 0.6

Average Tax Rate 16%

Terminal Growth Rate 10.3%

Cost of Equity 14.52%

Table 4: Peer Comparables

Domestic Market Emerging Market

2013 EPS FWRD EPS TRLN PE(x) FWRD PE(x) 2013 EPS FWRD EPS TRLN PE(x) FWRD PE(x)

Nestle 28.10 30.96 36.70 33.60 Nestle 28.10 30.96 36.70 33.60

Unilever 1.48 1.54 42.10 39.70 T.Brands 16.24 17.59 16.83 15.66

Cadbury 1.10 1.58 36.50 36.00 Spar 6.97 7.17 16.73 15.86

PZ 1.23 1.23 21.40 32.10 Savola 3.37 3.68 19.86 18.22

Guinness 9.95 6.76 28.20 36.40 AVI 3.41 3.67 15.55 15.45

NB 5.03 5.81 26.40 29.60 Almarai 2.50 2.94 25.06 21.33

Flour mills 2.91 6.09 28.80 13.70

Peer AVG. 30.57 31.25 Peer AVG. 30.57 31.25

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For the DCF and DDM valuation methodologies, details of the relevant

parameters are given in Tables 2 and 3 above, which results in a 12 month

target (TP) of N1,355.45 and N1272.40 per share respectively. Our DDM

assumptions factor in expectations of dividend payout from 2014 forward.

While the payout has declined from historical levels, especially during a

period of high capex outlays (FY-09 till FY-12), we anticipate dividend payout

will return to near historical levels as the company is set to complete its

capex investment cycle in the near term.

The average trailing and forward P/E for local food producers (excluding

Nestle) is 30.6x and 31.3x respectively. At 36.7x, Nestle currently trades at

a premium to its local peers, a premium we however believe is justified. Our

P/E relative valuation (based on a domestic peer simple average) implies a

12 month TP of N822.68 per share for Nestle.

A blend of our three valuation methodologies result in a final 12 month TP of

N1,215.67, just ~9% above the current trading price of N1,111.00.

Consequently, we place a HOLD rating on Nestle Nigeria.

Conclusion

In our view, Nestlé’s valuation reflects its commitment to product quality and

innovation, the benefits from recent capacity expansion and deeper country

coverage through its powerful distribution, our expectations of a rise in

consumer disposable income post 2015 elections and Nestlé’s marketing

capabilities. While competition will likely be more intense going forward, we

believe the company is well positioned to take advantage of growth

opportunities that will emerge in the near to medium term, as the Nigerian

growth story continues to unfold.

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P&L (Mn) ₦ 2013 2014e 2015F 2016F

Turnover 133,084 151,716 179,025 211,249

COGS (76,298) (83,444) (98,464) (116,187)

Gross Profit 56,786 68,272 80,561 110,737

Operating Costs (28,953) (32,138) (35,673) (39,597)

Operating Profit 27,833 36,134 44,888 71,140

Profit Before Taxation 26,048 34,016 42,303 68,080

Taxation (3,789) (6,293) (7,811) (13,667)

Profit After Taxation 22,259 27,723 34,492 54,413

Bal Sheet(Mn) ₦

Fixed Assets 70,621 78,227 84,344 92,807

Stocks 9,854 11,319 13,922 15,403

Trade Debtors 17,885 18,110 22,276 24,528

Total Assets 108,207 122,852 142,337 177,579

Trade Creditors 16,256 13,863 17,174 20,907

Total Liabilities 67,613 138,306 144,900 144,067

Net Assets 40,595 51,133 58,815 72,817

Key Ratios

Gross Margin 42.67% 45.00% 45.00% 52.42%

Operating Margin 20.91% 23.82% 23.07% 33.68%

Net Margin 16.73% 18.27% 19.27% 25.76%

Return on Assets 13.62% 14.02% 15.13% 13.99%

Return on Equity 33.53% 33.69% 36.61% 36.13%

Capex/depreciation (x) 0.83 0.98 1.18 1.03

Current ratio (x) 1.44 1.68 1.81 1.85

Quick ratio (x) 1.14 1.37 1.50 1.55

Cash Convetrsatino Cycle 31.37 27.79 26.98 26.52

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DISCLAIMER AND IMPORTANT DISCLOSURES

This publication is for general information only and is not intended to be relied upon as a forecast, research or

investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed in this article represent the current views of the analyst(s) based on good faith, at the time of publication. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Greenwich Trust Limited to be reliable, but are not necessarily all-inclusive and do not guarantee accuracy, completeness or otherwise. Opinions expressed are our own unless otherwise stated.

Past performance is no guarantee of future results. The inclusion of past performance figures is for illustrative purposes only. There is no guarantee that any forecasts made will come to pass. Reliance upon the information in this material is at the sole discretion of the reader. This is not in any sense a solicitation or offer of the purchase or sale of securities. Neither Greenwich Trust Limited nor any of its officers or employees accept any liability

whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. Investments in securities in general and, equities, in particular, involve numerous risks, including,

among others, market risk, counterparty default risk and liquidity risk. The ratings and company profile assessments reflect the opinion of the individual analyst and are subject to change at any time, without any prior consent of the reader. This material has been issued by Greenwich Trust Limited, which is regulated by the Nigerian Securities and

Exchange Commission. Further information on any security mentioned herein may be obtained by emailing: [email protected] Ratings Definition: Ratings may be defined by the following standard: BUY (OVERWEIGHT): Target Price of the stock is above the current market price by at

least 20 percent;

HOLD (NEUTRAL): Target Price of the stock ranges between < -10 percent and < +20 percent from the current market price and; SELL (UNDERWEIGHT): Target Price of the stock is more than 10 percent below the current market price.

Contact Address:

Greenwich Trust Limited

Plot 1698A, Oyin Jolayemi

Victoria Island, Lagos.

Nigeria

Telephone: +234(1)4619261-2

Email: [email protected]

Visit us at: www.gtlgroup.com


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