The Company

 Nestlé Nigeria is a subsidiary of Nestlé Group, one of the world’s largest food and beverage companies, which established a presence in Nigeria in 1961 and was listed on the Nigerian Stock Exchange in 1978. The company is 63.75% owned by Ghanabased Nestlé Central & West Africa. Since entering Nigeria, Nestlé has grown to become one of the country’s leading brands in food and beverages. In the marketplace, its products include infant cereals (Nutrend, Cerelac, Nan), family cereals (Golden Morn), beverage drinks (Milo, Nescafé, Nido), confectionary ( Chocomilo), bouillon (Maggi) and table water (Pure Life).

Financial Performance

 In Q2 2014, Nestlé Nigeria’s revenue rose 6.4% year-on-year (y-o-y) and 1.04% quarter-on-quarter (q-o-q) to N33.8bn ($206.2m). With 8.9% y-o-y growth posted in Q1 2014, Nestlé’s H1 2014 top line came in at N67.2bn ($43.9m), 7.6% higher than same period in 2013 but less than the 19% four-year average H1 growth rate. We had expected a drag in Nigeria’s consumer environment coming into the year, and are not surprised by this modest revenue increase despite the many promotional activities deployed by the management in the first half: Milo Back to School, Ramadan Bundle, Milo Reload and various price cuts. We believe 8% revenue growth is more realistic for Nestlé Nigeria in 2014 considering tight competition, prolonged muted consumer demand, conservative promotional spending and sales disruptions in the upper north in the heat of 2015 election campaigns from Q4 2014. In the last four years, Nestlé Nigeria’s revenue has grown by an average 7% q-o-q and 18% y-o-y in the second half and is unlikely to outperform this sequence in H2 2014. Compared to about 0.2% y-o-y in Q1 2014, profit after tax grew by 16.9% y-o-y in Q2 2014 to N6.1bn ($37.2m). Though earnings were flat on a q-o-q basis, we note that the bigger growth relative to 2013 was inspired by lower growth in operating expenses, at 10.9% vs 24.8% y-o-y in Q1 2014. After a 21.8% q-o-q decline in Q1 2014, operating expenses grew by just 2.9% q-o-q in Q2 2014 and these are lower than the 15.7% and 13.1% upsides posted in 2013 respectively. This tapering growth in operating expenses follows a period of huge spending on promotional activities (such as recruiting field sales managers and analysts, and deploying tricycles and distribution vans) to increase the visibility of its products across Nigeria. In H1 2014, company profit before and after tax grew at 5.4% y-o-y to N13.9bn ($84.8m) and 6% y-o-y to N11.8bn ($72m), respectively. Save for the massive decline in finance costs in Q2 2014 (leading to a 33.1% fall in the first half) H1 earnings would have come in much lower given that earnings before tax and interest grew by only 1.9%. Finance costs fell despite an expansion in short-term debt from N900m ($5.5m) to N8.2bn ($50m) in Q1 2014 and fiscal year 2013. The short-term debt was probably taken on to plug working capital (which was strained following payment of a final 2013 dividend) at the end of Q2 2014, and we expect this to affect finance costs in Q3 2014.

Development Strategy

Nestlé Nigeria’s management has hinted that instead of pursuing margin growth Nestlé’s traditional strategy globally, it will be aiming for growth in earnings per share going forward. For this reason, we surmise that henceforth emphasis will be on driving sales volume (using soft prices, product launches and incentives to distributors as major tools) and that stringent measures will be taken for an acceptable limit on costs and operating expenses (we estimate about 57% and 23%, respectively). By virtue of its strategy of sourcing over 75% of its raw materials locally, the company has maintained an average cost of sales margin of 57.3% in the last five years, and since the prices of its products are likely to remain soft in the near term, there may be no need for aggressive spending on promotions to drive sales (except for with newly launched products). Finally, following the normalisation of capital expenditure investment, increased earnings per share will support improved growth in absolute dividend (dividend payout ratio returned to 90% in 2013 after four years) but with a minute yield.