NESTLE NIGERIA PLC. Vetiva Research 26 October Q3 10 Earnings Release. Organic Growth on Track. Fair Value Range N N426.

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1 Vetiva Research 26 October 2010 Q3 10 Earnings Release Organic Growth on Track We retain our Neutral rating on Nestle Nigeria Plc s (Nestlé), premised largely on recent price appreciation, although we note that increased capacity from its soon to be completed Sagamu plant is expected to come on stream in the first quarter of Nestlé s share price rallied earlier in the year, gaining 67.01% YTD, compared to the NSE YTD of 20.02%. Our fair Value range is between N N426.52, implying a midpoint of N and a potential upside of 5.55%. We reiterate our positive outlook for Nestlé Nigeria Plc (Nestlé) primarily in anticipation of a spike in Sales in FY 11. Ramping-Up Capacity According to the management of Nestlé, the company has made massive investment in the construction of a new plant at Sagamu in order to increase its capacity and meet the surging demand especially in new markets and regions that were erstwhile unreached by the company s distributors. The new plant is the biggest investment Nestle has embarked upon in Africa; the plant is also expected to be twice the size of the Company s Agbara (current) plant, presently the company s only production site. In 2009, Nestle spent over N16billion in capital expenditure and 2010 CAPEX is expected to exceed this amount. The construction of the Sagamu plant is expected to be completed in the first quarter Locally sourced raw-materials boosts profits resilience. Nestle remains relatively insulated from external shocks that could be an offshoot of world commodity prices, which have spiked. Nestle makes use of agricultural produce such as Cocoa, Soya bean, maize e.t.c in its production process and according to the company over 75% of its raw material inputs is sourced domestically. This in our opinion significantly reduces the cost associated with production, especially as Nestle has adopted a more active approach by collaborating with agricultural research instituitons such as University of Agriculture, Abeokuta (UNAAB) and some local farmers, in a bid to increase output levels and crop yields. Strong Outlook and Prospects for the Confectionery maker. Our outlook for Nestle remains positive for reasons outlined above; we expect a strong increase in revenue growth over the next two years. In addition, earnings and margins are expected to improve significantly on the back of increased processes and efficiencies. Furthermore, the company has consistently delivered on earnings and paid both dividends for over the past 7 years. We would definitely be buyers of Nestle at a lower price, and recommend a hold where investors are already holding the stock. Key Headlines Q3'10 Q3'09 Chg 2010F Q3 as % NGNbn % NGNbn of 2010F Turnover % % PBT % % Tax % % PAT % % Source: Company fillings, Vetiva Research Analyst Adedoyin Adelakun a.adelakun@vetiva.com Stock Data Symbol: NSE Bloomberg Reuters: NESTLE VS F&B SECTOR VS NSE ALSI (YTD) Rebased 14/10/ Fair Value Range N N NESTLE F&B SECTOR NSE ALSI Oct-09 Dec-09 Feb-10 Apr-10 Vetiva Capital Management Limited Plot 266B Kofo Abayomi Street Victoria Island Lagos, Nigeria Tel: Fax: research@vetiva.com NESTLE NESTLE.NL NESTLE.LG Current Price (NGN): Trailing EPS (NGN): Trailing P/E (x): P/E (x): Shares Outstanding (mn): Market Cap (NGNbn): Year High (NGN): Year Low (NGN): Share Price Performance 30 Days (%): Days (%): weeks (%): Ownership Structure: Nestle CWA Ltd Ghana: Nestle SA (%): 3.17 Others (%): Source: NSE; Vetiva Research 1

2 Key Headlines Q2'10 Q2'09 Chg 2010F Q2 as % NGNbn % NGNbn of 2010F Turnover % % PBT % % Tax % % PAT % % Source: Company fillings, Vetiva Research Highlights of Q3 & Q2 Performance Notable Sales Growth YoY - Nestle has been exhibiting impressive growth in sales volumes majorly buoyed by its increased market penetration and expansion on the part of the company within the period. Nestle aggressively executes its advertising and marketing strategies, enabling it to discover and harness opportunities in new and potential markets. Nestle has been recording impressive growth in Turnover in the past 1 year and we are much more optimistic about its growth prospects in 2011/2012. We expect that Nestle would surpass these growth levels 2011/12 given the expected completion of its new plant in From the graph below the company expects a 17.45% growth in FY 2010 to N21.20 billion; we also note that Nestle has consistently surpassed its forecast for each of the quarters both in top and bottom lines. We note that Sales growth dipped by 8.58% to N19.86 billion in Q3 10 relative to sales of N21.56 billion as at Q2 10. TURNOVER GROWTH (Q1 Q3 ACTUAL; FY 10 FORECAST) Billion Naira % % % % 10 0 Q1 10 Q2 10 Q3 10 FY 10F Source: Vetiva Research; NSE 2

3 Profitability Margins Improve YoY - In Q3 10, the Company s profitability margins increased to 22.50% (PBT) and 15.42% (PAT) from 20.12% and 14.47% as at Q3 09 respectively. QoQ, PBT margin slowed down to 20.69%, while PAT margin rose to 15.46% from 15.18% as at Q2 10 respectively. In Q2 10, profitability margins also increased YoY to 23.41% (PBT) and 15.41% (PAT) from 19.98% and 13.25% as at Q2 09 respectively. However on a quarterly basis, margins slowed down marginally to 23.18% and 15.18% from 23.70% and 15.68% as at Q1 10 respectively. We partly attribute this to the volatility in food commodity in the course of the year, although Nestle sources the bulk of its input locally, the company still remains c.25% exposed to volatility in global commodity prices. We observe that Nestlé s profit margins dropped YoY in 2009 majorly due to loss incurred on its foreign currency denominated loans. According to the Company, we do not expect this to reoccur, hence we expect higher profit margin in FY Earnings Continue to Improve - Nestle s earnings has been improving both YoY and QoQ, the company has surpassed its Sales and Earnings forecast of N18.44 billion and N2.05 billion; N17.56 billion and N2.27; N19.50 billion and N1.86 billion respectively for the first three consecutive quarters of After Tax Margins also increased relative to Nestle s forecast, inspite of higher tax rates in Q1 and Q2. The company expected PAT margins to dip to 11.12% (Q1), 14.30% (Q2) and 9.52% (Q3), its effective tax rate was an average of 34.17% in Q1 and Q2 quarters but fell to 25% in Q3 10. Metrics Dangflr DSR Nestle NBC FMN Current Price (N) Trailing EPS (N) PE (x) DPS (N) DY (%) 5.00% 5.95% 3.23% 1.61% 2.85% Payout Ratio (%) 71.93% 91.01% 84.73% 8.26% 20.16% ROAE (%) 12.78% 35.52% 99.96% 30.66% 38.76% ROAA (%) 4.71% 19.27% 26.65% 13.39% 11.40% Outstanding Shares(mn) , ,708 Source: Vetiva Research & NSE Forecast (N'mn) 2008A 2009A 2010E 2011E 2012E Turnover 51,742 68,317 83, , ,368 PBT 11,862 13,783 18,435 27,184 38,374 Tax (3,531) (4,000) (5,899) (8,971) (12,663) PAT 8,332 9,784 12,536 18,214 25,710 Absolute Dividend 8,289 8,289 10,655 16,939 24,425 Earnings per share (N) Dividend per share (N) Net Assets per share (N) P/E (x) Source: Vetiva Research & NSE 3

4 Nestle remains unaffected by the prevailing slower consumer spending - In our opinion, the company s Sales and Earnings remain intact in spite of the slower consumer spending; this could be attributable to its effective market penetration and market discovery efforts; locating new markets and ensuring smooth and seamless distributions to both old and new markets. Following from above, Nestle has retained its position of having one of the highest margins in the Food and Beverage sector over the years, after NASCON and Dangote Sugar. HIGHEST PROFIT MARGINS (Q1 10 Q4 09) Percent (%) Q1'10 Q4'09 DSR s profit margin was impacted by higher input prices in Nascon DSR Nestle Source: Vetiva Research; NSE 4

5 Outlook and forecast Our short to long-term growth prospect still on course: As earlier stated, majority of the growth Nestle is currently experiencing is organic. Nestle embarked on generating demand for its product especially Maggi which contributes the highest to the overall turnover of the company. Based on a market survey carried out by the company to discover new markets for its products, Nestle is currently undergoing expansion of its production capacity, the result of which is expected to double current production capacity, in order to satisfy the demand in newly discovered markets thereby further penetrating the Nigerian market and expanding its market share. In our opinion, Nestle s growth will likely be both volume and price driven in the coming years. Value Proposition for Consumer Goods remains strong: The investment case for the Fast Moving Consumer Goods (FMCGs) sector are :- o Favorable demographics provide a sustainable demand for products of FMCGs. The increasing population in the country signals a robust market for consumer goods coupled with increasing adoption of the western diet especially amongst the younger population which make up a major part of the Nigerian population structure. o Defensive Nature of Products is also one of the key drivers of demand for Consumer Goods. In our opinion, the necessity nature of consumable products further strengthens the investment case for these companies. Nestle has carved a niche for itself especially in the baby food, beverage and seasoning product segments. o Aggregate Demand also seems to be picking up, relative to the previous year (aggregate demand declined in 2009). This majorly on the back of a recovering economy, increasing disposable income and moderate inflation levels which has the ability to increase the real wage of consumers. We therefore expect demand to pick up gradually in the coming months and to continue to impact positively on consumer spending. 5

6 Valuation In valuing Nestle, we applied the Discounted Cash Flow Method; we have assumed a WACC of 15.05% which is composed of Cost of Equity of 14.50%, Cost of Debt of 7.53%, Beta of 0.51, and Equity Risk Premium of 6% and a Terminal Growth Rate of 4.50%. Using Sensitivity Analysis to vary the discount factor and growth rate, we derived a Fair Value range of N N Nestlé Nigeria Plc is currently trading at a PE multiple of 21.96x and a forward P/E multiple of 20.44x, relative to a sector and market average of 11.65x and 16.15x. Our FY 11 forecast for Turnover and PAT stands at N83.69 billion and N12.54 billion respectively; our FY 10 EPS and DPS estimate stands at N18.71 and N15.90 respectively. Valuation and Market pricing Further to the release of Nestle s Q results and indicative timelines for the coming on stream of its near completed Sagamu Plant, we had forecast an increase in product volumes of about 50% on its 2010 figures, and further to this we had revised our valuations upwards placing an Accumulate weighting on the stock. However, further to the release of our report, Nestle has rallied 67% YTD, with the market pricing in the ramp up in production capacity, sales and profits, expected to accrue next year. Risks to Our Valuation The major risks to our valuation for Nestle could be the following: 1) Rising input costs, which could be higher than we have modeled into our forecast 2) Fall in disposable income resulting in lower demand for company s products 3) Adverse movement in exchange rate leading to losses on foreign currency denominated loans. Interest payment on its US$94 million loan (the inter-company has a moratorium of 2 years which expires in 2010) commences in March 2010 and January This could impact negatively on the company s profitability margins. 6

7 Appendix: Nestle Nigeria Plc Financial Model INCOME STATEMENT (N'Mn) F 2011F 2012F Income Turnover 44,027 51,742 68,317 83, , ,368 Cost of Sales (27,805) (31,301) (39,957) (45,950) (55,140) (65,066) Gross Profit 16,222 20,442 28,360 37,738 55,328 72,468 Distribution & Admin Expenses (7,826) (6,059) (9,389) (10,879) (22,419) (27,523) Management Fees (2,479) (3,239) (4,211) (6,371) (9,179) Core operating profit 8,396 11,904 15,732 22,648 43,276 63,600 EBIT ,032 30,532 42,471 Finance Cost (67) (2,046) (2,597) (3,347) (4,097) Interest Income Profit from operations ,435 27,184 38,374 Profit before taxation 8,463 11,862 13,783 18,435 27,184 38,374 Taxation (3,021) (3,531) (4,000) (5,899) (8,971) (12,663) PAT 5,442 8,332 9,784 12,536 18,214 25,710 BALANCE SHEET (N'Mn) F 2011F 2012F Assets Employed Fixed Assets 10,436 13,817 25,405 33,026 41,283 49,539 Current Assets Stocks 5,226 6,415 10,698 11,981 14,378 16,103 Debtors & Prepayments 2,299 4,304 3,403 4,151 5,064 6,178 Due from related companies Foreign currencies purchased , ,049 Cash and bank balances 2,336 3,643 1,764 3,898 4,873 6,091 Advance payment to contractors 2, ,392 Total Assets 21,252 29,159 44,250 54,214 66,705 82,494 Due within one year 8,237 11,094 19,011 26,981 37,420 50,892 Due After one year 6,779 9,035 14,695 14,801 15,577 16,609 Net Assets 6,237 9,030 10,544 12,432 13,707 14,993 Capital and Reserves Share capital Share premium Revaluation Reserves Retained Earnings 5,687 8,482 9,995 11,875 13,150 14,436 Shareholders' Equity 6,237 9,030 10,544 12,432 13,707 14,993 7

8 Key financial ratios and forecasts RATIOS F 2011F 2012F GROWTH RATES F 2011F 2012F Turnover growth 15% 18% 164% 23% 52% 30% Growth in Core Operating profit 7% 42% 32% 44% 91% 47% Growth in PBT 3% 40% 203% 34% 47% 41% Growth in PAT -4% 53% 226% 28% 45% 41% PROFITABILITY F 2011F 2012F Return on Equity 86% 109% 100% 109% 139% 179% Return on Assets 27% 33% 27% 25% 30% 34% Return on Invested Capital 30% 35% 28% 31% 36% 41% Growth rate (g) 0% 1% 15% 16% 10% 9% MARGINS F 2011F 2012F EBIT/Sales 19% 23% 23% 25% 24% 26% Gross Profit Margin 37% 40% 42% 45% 57% 61% Pretax Income/Sales 19% 23% 20% 22% 21% 23% Net Profit Margin 12% 16% 14% 15% 14% 16% 8

9 INVESTMENT RECOMMENDATIONS Vetiva uses a 5-tier recommendation system for stocks under coverage: Buy, Accumulate, Neutral, Reduce and Sell. Buy/Overweight +25% expected absolute price performance Accumulate +10% to +25% expected absolute price performance Neutral/Hold +/-10% range expected absolute price performance Reduce -10% to -20% expected absolute price performance Sell/Underweight -20% expected absolute price performance Definition of Ratings Buy/Overweight recommendation refers to stocks that are highly undervalued but with strong fundamentals and where potential return in excess of or equal to 20% is expected to be realized between the current price and analysts target price. Accumulate recommendation refers to stocks that are undervalued but with good fundamentals and where potential return of between 10% and 20% is expected to be realized between the current price and analysts target price. Neutral/Hold recommendation refers to stocks that are correctly valued with little upside or downside where potential return of between +/- 10% is expected to be realized between current price and analysts target price. Reduce recommendation refers to stocks that are overvalued but with good or weakening fundamentals and where potential return of between -10% and - 20% is expected to be realized between current price and analysts target price. Sell/Underweight recommendation refers to stocks that are highly overvalued but with weak fundamentals and where potential return in excess of or equal to -20% is expected to be realized between current price and analysts target price. 9

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