Earnings Review: Resilience amidst Macroeconomic Challenges

In line with the challenging macroeconomic landscape in 2016 which weighed on household, government and investment spending as well as operating and financing cost, the operating environment for corporates has remained tight as reflected in the performance of macroeconomic indicators such as GDP, FX rate and inflation. Although the impacts varied across sectors, corporates exposed to the downside risk of macroeconomic headwinds were able to navigate the choppy terrain by leveraging on scale, non-core earnings growth strategy, operating cost optimization, local input sourcing and other accounting ingenuity (usage of deferred tax assets) in order to stay profitable. Thus, financial performance has been largely resilient as indicated by corporate earnings for FY:2016 and the positive performance of the equities market in March 2017.

In the Banking sector, the key risk factor was weak asset quality which drove Non-Performing Loans (NPLs) and provisioning charges higher across industry Tiers, resulting in weaker margins and pressure on Capital Adequacy positions. This factor was also responsible for the reluctance of banks to extend new credit facilities as Industry loan book growth of 22.9% was majorly due to revaluation of FX denominated loans following two rounds of Naira depreciations in the year. Nevertheless, FY:2016 results released so far have been broadly positive on the back of industry-wide growth in non-interest income which was driven by FX trading income, Gains from revaluation of Net FX position and improvement in E-business income. All the Banks that have released results recorded expansion in both Gross Earnings and PAT save for STERLING which grew Gross Earnings marginally by 1.1% while PAT slid 49.5% Y-o-Y. The Banking index has declined 0.5% YTD; nevertheless, we remain optimistic on the prospects of defensive Tier-1 Banks (GUARANTY, ZENITH, UBA and ACCESS) which are our top picks for the sector. Similarly in the Insurance sector, financial performance has been largely positive as all companies that have reported results recorded growth in both Gross Premium Income and post-tax profit save for WAPIC which recorded a 54.8% decline in PAT.

In the Consumer Goods sector, most FMCGs took advantage of the non-discretionary nature of their products to raise prices in order to offset increase in cost of raw materials; hence, revenue grew across board but margins remained weak due to higher operating and finance costs. The biggest players in the sector: NIGERIAN BREWERIES and NESTLE posted rather unimpressive profit numbers though revenues were reasonably positive while players like UNILEVER, DANGSUGAR and CHAMPION BREWERIES outperformed analysts’ estimates. NESTLE and NIGERIAN BREWERIES grew turnover by 20.2% and 6.7% Y-o-Y respectively, Net finance cost surged 276.6% and 71.5% while PAT slid 66.7% and 25.3% in that order. On the flipside, UNILEVER (Turnover up 57.9%, PAT improved 8.6%), DANGSUGAR (Turnover up 57.9%, PAT up 8.6%) and CHAMPION BREWERIES (Turnover up 10.4%, PAT surged 587.6%) impressed within the period.

For Industrial Goods companies, margins were pressured by aggressive price competition in the first 9 months of the year and rising cost of sales which was driven by Gas supply challenges. DANGCEM, the biggest player in the sector sustained a positive performance with Gross revenue increasing 25.1% while PAT rose 2.9%. On the other hand, WAPCO recorded a 17.8% dip in turnover while PAT fell 37.9%. WAPCO’s result however outperformed estimates due to a stronger than expected 4th Quarter operating performance and an unanticipated tax credit of N39.7bn. Accordingly, investor sentiment towards the stock has been broadly positive and this has lifted the Industrial Goods index 7.7% YTD – the only index with positive YTD return.

Performance of companies in the Oil & Gas sector has been mixed as the downstream players have continued to benefit from the reforms in the downstream Oil & Gas space especially with regards to the partial-deregulation of the sector which resulted to a hike in petrol prices in May 2016. Consequently, MOBIL (+46.6%) and TOTAL (+39.9%) recorded the highest Y-o-Y increases in turnover while PAT equally rose 67.3% and 270.0% Y-o-Y respectively. On the flipside, results of the upstream players have been largely unimpressive as disruptions to oil installation in the Niger Delta took a toll on earnings. Consequently, SEPLAT’s turnover declined 43.9% Y-o-Y while a Loss of N45.4bn was recorded for the period.

We are moderately optimistic on corporate earnings in the year although we expect the recent improvement in FX liquidity - which has resulted in the appreciation of parallel market FX rate – to positively impact cost of sales for manufacturers while improvement in fiscal revenue for the Sovereign and Sub-nationals will also be positive for consumer spending and earnings growth. Similarly, we expect reforms in the Oil & Gas sector with regards to curtailing attacks on oil installations to bode well for players in the sector. However, with the likelihood of the CBN maintaining current FX peg, companies which leveraged on FX gains to boost earnings in FY:2016 (particularly banks) could experience a high-base impact driven decline in turnover. Despite our positive view of forward earnings, we expect investors’ appetite for equities to remain soft in the interim due to subsisting fragmentation of the FX market.