International Breweries: Cost inefficiences weigh on operating performance as financial leverage improves

In its recently released Q1 2020 results, International Breweries’ revenue increased 0.7% y/y to N35.3 billion in Q1 2020 from N35.1 billion in Q1 2019. On a q/q basis, revenue growth was flattish at 0.7% q/q growth from N35.1 billion in Q4 2019. The flattish revenue performance in Q1 2020 signifies slowing momentum of its growth-oriented strategy built on undercutting competitors’ market share through penetration pricing. Thus, we think the company may consider rethinking its discount strategy by implementing some price hikes in line with what other market players have done. We note that Q1 2020 performance does not reflect volume weakness caused by the COVID-19 lockdown measures, thus we anticipate weaker Revenue in Q2.

Cost of Sales (adjusted for depreciation) grew 13.2% y/y to N24.5 billion in Q1 2020 from N21.6 billion in Q1 2019. The growth in Cost of Sales was driven by double-digit growth in raw material cost (+12.6% y/y to N22.6 billion) which was faster than the growth in revenue, thereby implying increasing cost per unit.

The faster growth in raw material cost negates industry trends, where raw material costs have benefitted from weaker barley prices, thus suggesting production inefficiencies. Consequently, the Gross margin declined 7.7ppts y/y to 30.8%. In addition, Gross profit followed a similar trend, declining 19.3% y/y to N10.9bn in Q1 2020 from N13.5 billion in Q1 2019.

Operating Expenses (adjusted for depreciation) declined by 3.9% y/y to N7.1 billion in Q1 2020 from N7.4 billion in Q1 2019. The decline in OPEX was driven by lower marketing & distribution expenses (-3.3% to N3.8 billion) and administrative Expenses (-4.6% to N3.3bn). While the modest decline in Opex may signify the company is cutting back on its aggressive brand building, we think the magnitude of the cut must be significant to restore operations back to profitability considering its huge operating leverage.

Despite the modest decline in OPEX, weak Gross profit saw EBITDA decline by 38.1% y/y to N3.8 billion in Q1 2020 from N6.1 billion in Q1 2019 while EBITDA margin was down 6.7ppts to 10.7% in Q1 2020. Against this backdrop, IntBrew recorded an Operating loss of N2.4 billion in Q1 2020 compared with a profit of N0.1 billion in Q1 2019.

On the positive, the successful completion of the company’s right issue provided the company the opportunity to significantly deleverage its books in Q1 2020. The company received Net proceeds of N162.8 billion from the right issue and subsequently paid down N164.5 billion out of its debt balance. This resulted in a 59.3% YTD decline in total loans and borrowing and its solvency position.

Consequently, the company recorded Net Finance Income of N345.9m in Q1 2020 as against Net Finance Expense of N5.0 billion in Q1 2019. However, the company recorded a huge foreign exchange loss of N9.9 billion in Q1 2020 due to its foreign loan exposure. As a result, the gain from improved solvency position was eroded, thus Pre-tax loss and net loss climbed faster at 44.7% and 41.6% respectively to N7.7 billion and N5.6 billion in Q1 2020.

In its recently released Q1 2020 results, International Breweries’ revenue increased 0.7% y/y to N35.3 billion in Q1 2020 from N35.1 billion in Q1 2019. On a q/q basis, revenue growth was flattish at 0.7% q/q growth from N35.1 billion in Q4 2019. The flattish revenue performance in Q1 2020 signifies slowing momentum of its growth-oriented strategy built on undercutting competitors’ market share through penetration pricing.

Thus, we think the company may consider rethinking its discount strategy by implementing some price hikes in line with what other market players have done. We note that Q1 2020 performance does not reflect volume weakness caused by the COVID-19 lockdown measures, thus we anticipate weaker Revenue in Q2.

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