It’s been a wonderful year for Consumer Goods Businesses in Nigeria.
Flashback three years ago it was all hell raising for the Consumer Goods Sector. The sector was in a downward spiral and no company was spared, not a single one. Margins grew so thin there was nothing left of profits. Those that could squeeze out profits did so only by a whisker and they were very few of them.
Fortunately for Unilever, it was one of the few companies that managed to eke some profits in 2015. With household essentials like Blue Band, Omo, Knorr, Geisha, it had the brand names that somehow found its way to dinner tables, cooking pots and bathrooms. The signs were clear and they knew the recession was upon us. They took action.
Mid into the second quarter of 2016 the National Bureau of Statistics reported that the Manufacturing sector pumped out a GDP of –7%. The food and beverage sector, where most consumer goods companies play, bled 11% in negative GDP. However, Unilever reported a strong revenue growth of 17.7% closing the year at N59.2 billion and adding over N10 billion in revenue year on year. Profits also soared 170%, a more appreciative effect of the action taken earlier in the year. To take action the company did what any business with a strong moat can do in situations like this, increase prices.
Unilever resorted to price increases to augment drop in volumes as Nigerians cut their disposable income in response to the crushing recession. The strategy worked as it meant increasing revenue without having to increase cost. The momentum has continued all through to 2017 with another 30% increase in revenue and 143% increase in profits. Margins improved all round in testament to this strategy. It also had a strategy for another clog in its turnaround wheel, debt.
A recently concluded rights issue saw the company raise about N57 billion, which it quickly deployed into paying down some of its debts. The result is a stronger balance sheet, impressive earnings, and dividend to shareholders.
Equity is expensive and explains why it is less preferred to debt if you are a company like Unilever. Despite the lure of higher returns on equity that cheap debts provide, it made no sense sacrificing all this for profits and to a large extension cash. It’s a sacrifice they had to make to ensure this company keeps its competitive advantage.
As a consolation, the upside of new equity begins with a 97% reduction in external debts as well as the savings they will get from interest payments which they no longer need to pay. There is also the benefit that interest-free cash provides. They already spent some of the cash in capacity expansion and perhaps no longer need to use debt to pay dividends.
The share price has gained 34% (currently priced N55) in the first quarter of 2018 despite falling from its year high of N64. But it’s not time to celebrate.
For all these benefits that its new strategy portends it is hard to ignore one crucial fact. The share price is overvalued and it is increasingly hard to justify this valuation for a number of reasons. Firstly, Unilever shareholders should be worried about the level of returns they are left to salvage. Returns on Equity for the current year is 17% down from 31% in 2016 and from its 5-year average of 37%. The N57 billion in new equity means shareholders now get the claim N17 for every N100 of equity injected in the business, from N31 for every N100 in the last 5 years.
Also, the fundamentals just don’t justify its recent valuations. Unilever trades at a price to earnings multiple of has been overvalued for years trading at an average multiple of 33 times to earnings. In fact, its traded at an average multiple of 30 over the last 5 years. It’s share also trades at a multiple of 535 to free cash flow just a few months ago. Despite this, earnings per share growth remained unimpressive at a compounded annual growth rate of 9% between 2013 and 2018.
What about dividends? The company proposed a paltry 50kobo per share in dividends from the profits of 2017. This provides a dividend yield of 0.17%, one of the lowest in the stock market. By the way, the 5 year average of 1.4% while dividend growth is negative 56.9%.
Long-term outlook for the sector also indicates stiffer competition down the road as Nigerians adjust to cheaper alternatives to the everyday consumables. Revenues came lower in the final quarter of 2017 despite higher prices. Thus the profitability surge we have seen in 2017 might not be matched in 2018.
The move to reduce debt in exchange for equity is strategic to the competitiveness of the company. However, it is not a guarantee that returns on equity will continue to be higher. Unilever Plc is a great company and one of the most reliable stocks on the Nigerian Stock Exchange. It has enjoyed a Foreign Investor Premium for years now and that is understandable. However, its share price of N55 is grossly overvalued when compared to other alternatives in the market.