Meristem Investment Guide: Unimpressive earnings dragging equities

The negative sentiment that has marred the Nigerian equities market in 2014, returned this week as the NSE ASI lost in all but one of the trading days of the week with WtD and overall YtD returns of -0.82 percent and -6.65 percent, respectively.

In the four weeks preceding the Easter break, investors took position ahead of Q1 numbers. However, a mixed bag of Q1 results increased the activities of profit-takers and the previously seen positive momentum has taken the backseat and brought the market return negative for the second consecutive week.

In this report, we take a look at the effect of QE further tapering on the Nigerian market and shed more light on the recent appreciating trend of the nation’s currency. Furthermore, we give our opinion on the effect of insurgency in the Northern part of the country as it relates to the affected companies and also on the Q1 results of the companies that have released so far.

Federal Open Market Committee (FOMC) Tapers by another $10bsn: Implications for Nigerian markets

The US Fed decided to further reduce the pace of its monthly asset purchases by an additional $10 billion to $45 billion in May, with hints that the reduction will continue at subsequent meetings except economic data dictates otherwise. This was after the committee considered major US macro-economic indicators such as economic growth (which picked up after initial slowdown caused by adverse weather), labour market indices (which showed improvements on a balance) as well as household spending (which is rising faster than expected). This has implications for emerging and frontier markets that have so far seen an outflow of foreign funds and local currency volatility since the QE tapering began.

 Naira remains strong despite QE fears

The local currency has appreciated by 0.87 percent Ytd despite the pressures exerted on developing economies currencies by QE tapering of the US. The relative respite can be attributed to several factors including the abatement of fears that the FOMC would further retrench the programme due to weaker US data and efforts by the CBN to combat round-tripping (RDAS auctions). Data for March 2014, shows that inflows from foreign sources into equities increased by 54 percent month-on-month to $879 million (from $572m), while fixed income market inflows declined slightly by 6 percent to $103 million (from $110m) although inflows into money market instruments increased by 630 percent to $40 million (from $6m).

A total of $12.006 billion has been sold by the CBN in 2014, in support of the local currency. Given the reduction of capital flight, increase in funds inflow as well as sale of US dollars by IOCs in Nigeria, the need for CBN to resolve to sell dollars from the reserves has declined significantly. As a result of this, amount offered reduced from $3 billion, $3.4 billion and $3.6 billion in January, February and March to $2.8 billion in April. This has seen the foreign reserves increase from its year low of $37.803 billion on March 28, to its current level of $38.149 billion.

Banking

First Bank: Impairment charges pressure earnings

Gross earnings grew by 7 percent (N396bn) driven by interest income (+10%, N324bn). This was possible as the bank’s 22 percent growth in deposits in spite of headwinds allowed it to create risk assets, thus growing its loan book by 15 percent. The reduction in COT and eradication of ATM charges pulled down the non-interest income (NII) bringing it down by 9 percent (N67bn). Cost of Risk (1.2%; 0.9% FY2012) rose on the spike in impairment charges for the bank (62%; N20.3bn) pushing down earnings below our expectations by 7 percent.

 Brewery sector

In the brewing space, Nigerian Breweries reported a c.7 percent revenue and profit growth. Guinness on the contrary posted yet another disappointing result, (-11% top-line and -22% bottom-line growth) dragged not only by the obvious challenges in the sector, but also the keen competition in the beer market. Champion Breweries is yet to translate its c.1 percent Q1 sales growth to profitability. PAT declined 43.34 percent. Though cost to sale ratio is improving (70.62% vs. 88.92% in prior period), Earnings remains pressured by 94.05 percent expansion in OPEX.

Overall, though we acknowledge the fact that internal operational itches among some of these companies account for these poor numbers, we also believe this dragging performance remains pressured by weakening discretionary spending and the sustained insecurity in the north.

Food and Beverages sector: Northern insecurity threats notwithstanding, growth remains feasible

The Food and Beverage sector (FBS) has been somewhat affected by the insecurity challenges in the Northern part of the country. Companies within the sector have had their top line affected (depending on their level of exposure) in the last one year. Nestle for instance announced in H1:2013 that the insecurity concerns was affecting their Northern operation; the aftermath of which brought about a slower 2013FY turnover growth of 14.03% (lowest in 6 years) relative to 5-year average growth of 20.95 percent, while 2014Q1 turnover also grew only by 8.89 percent.

It is our opinion that while the northern insurgence is a drag on some Food and Beverage companies, the degree of exposure to a large extent and the strategic ingenuity of some of the companies have a major connection to driving revenue growth.

For instance, we reason that the decline in Cadbury’s numbers cannot absolutely be attributed to northern crisis but also inadequate internal route to market strategy considering that Nestle (a major competitor) grew its revenue by c.10 percent in the same quarter.

In the medium- to long-term investment horizon, the FBS still portends attractive investment case given the growing population, increasing per capita income and consumer spending as well as supply expansion drive by most of the players.

Industrial Goods sector: Cost curtailment drives profit growth

Cement Company of Northern Nigeria plc (CCNN) whose market area covers six states in the North Western region recorded 2.7 percent decline in Q1:2014 revenues. While the unrest in the North may have affected construction activity, we also see increased competitive activity by peers or possibly lower volumes/prices as factors that could have been responsible for the decline. Asides, the insecurity crises being a downside risk to the Northern player, its small size relative to peers (500,000 metric tons, <2% of industry’s installed capacity as against c.70% for Dangote Cement) will limit dispatch to capture farther markets.

In addition, increased distribution expenses to serve other regions may deter expanding its market reach. However, 47.02 percent reduction in operating expenses and 39.48 percent drop in finance expenses contributed to the 85.6 percent boost in after-tax profits in Q1:2014. We see efforts at further cutting down on cost of sales (which grew 0.34% in Q1:2014) via reduction in the use of Low Pour Fuel Oil for fuelling its plant as well as pursuance of capacity expansion plans will help support sustenance of profit growth over the near to medium term.

Insurance sector

Custody Insurance continues to ride on synergies from merger

Inorganic growth in operations has made the underwriter a pacesetter in the insurance space as the company posted fantastic 2013FY and Q1:2014 results. In Q1:2014, Custody Insurance recorded c.73 percent and c.91 percent surge in its top-line and bottom-line, respectively. The growth in top-line was driven by the company’s strive to penetrate and exploit opportunities in the retail market while also increasing its market share in the underwriting of “big ticket” insurance contracts (majorly oil and gas insurance, in which it operates as one of the industry leaders).

The growth in bottom-line was driven by efficiency in cost management as net claims incurred and underwriting expenses declined by 26 percent and 11 percent, respectively. We remain optimistic on the company’s performance for the year and in the near term as it continue to stretch its strength in underwriting general insurance while its life, trustee and pensions businesses will also augment its bottom-line going forward. However, a business model that currently tilts more to underwriting “big ticket” insurance which comes with high re-insurance costs (169% increase in Q1:2014) remains a concern for the underwriter.

Mobil post impressive Q1

Mobil plc was able to manage the effect of delayed import license in the first quarter of the year as the company grew its top and bottom line by 17 percent and 519 percent Y-o-Y, respectively, although the massive growth in earnings was as a result of a N2.78 billion gain which the company reported as other expenses.

Also, Eterna also released its first quarter result which showed a 62 percent Y-o-Y decline in revenue as the company vulnerability to the current tough operational environment. Despite the unimpressive top line performance earnings declined by only 9 percent primarily due to better cost management (cost to sales 92.92% vs. 97.17% corresponding period in 2013), coupled with a 33 percent decline in finance charges. On the back of the attractive numbers by Mobil we anticipate a positive investor’s sentiment and maintain a positive outlook for the counter.

Conclusion

As H1:2014 gradually winds up, we expect investors to continue re-appraising their holdings in the equities market, taking position and profit ahead of potential opportunities and headwinds. Our outlook for the Naira remains positive primarily due to the apex bank’s resolve to maintain the current band at N155+/-3 percent, also, Nigeria’s relative attractiveness to peer emerging economies augurs well for continued capital inflows which we believe will impact positively on the volume and value of transactions on the exchange.