Nestle: Foreign loan eats up profit

Nestle Nigeria made a good first quarter starting this year but its growth momentum has been broken by an upsurge in dollar denominated loans. This is to the extent that the company had to use almost all its operating profit to settle finance charges at the end of the second quarter. A jump of 376% in net finance costs ate up profit, showing a clear example of the risk of unstable exchange value of the local currency in company operations.

The food & beverages company was headed for another year of stable growth in profit as at the end of the first quarter when it reported an after tax profit of N6.68 billion. The company’s fortunes however changed drastically in the second quarter when after tax profit fell 94% year-on-year and the company closed the first half with just a small fraction of the first quarter profit.

The company achieved a strong growth in sales revenue, which grew by 22% to N80.44 billion, indicating an accelerated growth from the turnover figure of N36.13 billion it posted at the end of the first quarter. The company’s management was excited to see sales push up that much in a tight consumer spending environment. It could however not prevent costs from surging ahead in two major fronts that affirm that the company still maintains a high level of external dependence.

The company grew sales revenue by 5.5% to N151.27 billion at the end of 2015, which was a slowdown from the increase of 7.7% in turnover in the preceding year. Based on the growth rate at the end of the first half, turnover is expected to amount to about N162 billion at the end of the year, which will be an increase of 7%. Without the exchange rate depreciation this would have been good enough to permit stable growth in profit, as all other costs are under a tight control.

Cost saving initiatives paid off for the company last year when cost of sales increased marginally at 2.2%, less than half as fast as sales revenue. That enabled the company to raise gross profit nearly twice as fast as sales revenue at almost 10%. With a tight rein on operating cost, Nestle closed last year with one of the most successful cost saving initiatives in recent times.

This year, the story has changed. Cost of sales rose by over 20% year-on-year at the end of the second quarter to N47.71 billion and claimed more than 59% of turnover compared to 56.5% in the same period last year. The company’s management blamed this on increased materials costs resulting from naira depreciation. Increased materials cost is a major cause for concern among companies heavily dependent on imported materials.

At the end of last year, net finance charges declined by about 7% to N4.42 billion. At the end of the first half of the current year, finance charges amounted to over N14.89 billion – a year-on-year growth of 361% over the period. This claimed almost the company’s operating profit of N14.97 billion. The tripling of finance income to N817 million enabled the company to show a modest profit of N536 million at the end of the second quarter.

The exchange value of the naira is still going down and it is likely that a further revaluation of the company’s foreign loans would be made. The indication is that the ability of the company to improve the profit capacity seen in the first half of the year is doubtful. The company’s profit outlook for the year is therefore clouded by further rapid increases expected in cost of sales and finance expenses in the second half of the year.

The company improved after tax profit by 6.7% to N23.74 billion in 2015, which is a new profit high for the company after a slight decline in 2014. The company faces high prospects for a sharp drop from the new profit high in 2015 to a new profit low in several years.

Nestle improved net profit margin slightly from 15.5% in 2014 to 15.7% in 2015. At the end of its half year operations in June, net profit margin crashed to 0.7%. It earned 67 kobo per share at the end of the second quarter compared to N11.20 in the same period last year. The company earned N29.95 per share in 2015 and improved its dividend from N27.50 for 2014 to N29 for 2015.