UAC of Nigeria : UACN H1 2022 Results Conference Call Transcript

UACN H1 2022 Results Conference Call Transcript

NSE Ticker: UACN

UAC of Nigeria PLC: H1 2022 Results Conference Call Transcript

Date: Thursday, 4 August 2022 3:00 PM WAT

Presenters:

• Mr. Fola Aiyesimoju (Group Managing Director, UAC of Nigeria PLC)
• Mrs. Funke Ijaiya-Oladipo (Group Finance Director, UAC of Nigeria PLC)

Moderator:

• Mrs. Chiamaka Uwaegbute (Associate, Investment, UAC of Nigeria PLC)

1. Presentation

Moderator: Good afternoon, ladies and gentlemen. Welcome to UAC of Nigeria PLC's Half Year 2022 Results Conference Call. This conference call will be hosted by Fola Aiyesimoju, Group Managing Director; and Funke Ijaiya-Oladipo, Group Finance Director. Please note that this call is being recorded. Following prepared remarks by UAC's management team, there will be an interactive Q&A session. I will now hand the call over to Fola Aiyesimoju. Please go ahead

Fola Aiyesimoju (UAC Group Managing Director)

Introductory remarks

Thank you for joining our results presentation. Our performance in the first half of the year was poor and largely attributable to operating decisions and execution at our Animal Feeds business- Grand Cereals. Over the course of the discussion today, Funke and I will aim to provide updates on our operating context, performance in the first half of the year, and focus areas for the second-half of the year.

Macroeconomic review

Please turn to slide 5. Macroeconomic conditions in the first half of the year were very difficult, with declining growth rates, rising inflation, Naira devaluation and scarcity of foreign exchange. Unfortunately, we do not anticipate an improvement in conditions in the near term.

On slide 6, we reflect the input cost trajectory for key raw materials across our businesses. The prices of maize and soya beans increased sharply impacting our animal feeds business. As the prices for resins and titanium dioxide, key inputs of our paints business. Milk and sugar, raw materials for our dairy business also recorded sharp increases in price. With the recent devaluation of the Naira, and the imported component of raw materials, we expect further input cost pressure. In addition to rising raw material costs, conversion costs and distribution expenses increased meaningfully as the price per litre for diesel tripled.

Funke will now take us through the financial performance for the first half of the year starting on Slide 8.

Funke Ijaiya-Oladipo (UAC Group Finance Director)

Group financial performance

Good afternoon ladies and gentlemen. Please turn to slide 8 which provides an overview of the Group's financial performance .

Our results for the first half of the year were mixed. In the first three months of the year, we delivered double digit growth in revenue, operating profit and earnings per share across the group.

UAC of Nigeria H1 2022 Results Conference Call

Thursday, 4th August 2022

The second quarter of the year was more challenging, with slower growth, which affected topline performance and accelerating inflation, which impacted operating margins and profitability.

Looking at the entire six month period compared to 2021, the results are disappointing.

We recorded consolidated revenue of N52 billion which is 12% higher than the N46 billion recorded in the first half of 2021.

All of our four operating segments recorded topline growth, which was largely driven by price increases to offset rising raw material costs across each segment.

The Paints segment recorded double digit revenue growth with a 29% increase year on year and this was driven by pricing initiatives across all paint categories as well as expansion of the retail footprint.

The Quick Service Restaurants segment also recorded double digit top line growth at 28% and this was driven by additions to company-owned restaurants. We have opened six new stores across Lagos and Abuja this year and sales from these new stores supported topline growth in the Quick Service Restaurants segment.

The Animal Feeds and Other Edibles segment recorded 9% revenue growth, driven by price increases.

Revenue growth in the Packaged Food and Beverages segment was 6% year on year and it was driven by volume growth in the water category as well as price increases across snacks, water and ice cream. The business also benefited from improved distribution, particularly in the spring water and ice cream category.

Gross profit for the group increased 7% year on year to N9 billion however, gross margin compressed by 73 basis points to 17.2%. This was impacted by input cost escalation, which was not sufficiently offset by price increases across all our businesses apart from the Paints segment, which recorded expansion in gross profit and gross margin.

We recorded operating profit of N1.6 billion, which was 9% lower year on year and the decline was a result of underperformance in our Animal Feeds and Edible Oils business as well as the impact of escalating costs, particularly in energy and distribution. Our businesses with cold and frozen components and their supply chain, which are our ice cream and our restaurant businesses were particularly affected.

As a result of these factors, the operating profit margin of the group compressed by 73 basis points to 3.1%. We recorded a loss per share from continuing operations of 17 Kobo compared to earnings per share of 5 Kobo in 2021. Profitability was impacted by higher finance costs on account of increased short term borrowing in the Animal Feeds segment. Profitability was also impacted by losses recorded by our associate companies.

As a result, we recorded lower return on invested capital at 5.4%. Free cash flow for the period was negative N4.5 billion, driven by working capital and capital expenditure across the group.

Group financial position (Balance sheet and liquidity)

Please turn to page 9, which shows a snapshot of the group's financial position as at 30 June.

The Group has roughly N50 billion net assets and the year on year movement reflects the net increase in inventory and debt across the group since December 2021. The group's net debt is N16.5 billion, which is N8 billion higher than December, and I will touch on that on the next slide.

Our businesses invested just under N3 billion in capital expenditure in the period. 50% of that went towards upgrading our IT infrastructure across the group to SAP S/4 HANA. 40% of this amount was invested in mixers, freezers, trucks and cold chain infrastructure for our ice cream business. 10% of the capital expenditure went towards expanding our corporate store network by UAC restaurants.

Our cash cycle increased by 33 days to 169 days and this is reflective of the excess inventory we are carrying in our Animal Feeds business.

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UAC of Nigeria H1 2022 Results Conference Call

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Key drivers of Group debt

Please turn to page 10, which provides additional context on key drivers of debt.

In summary, the net increase in the group debt is attributable to the additional short term debt to support working capital in our Animal Feeds business. And you will see in the bar chart that the increase in debt is correlated with the increase in inventory and interest expense incurred in the period.

We are conscious of the impact of finance costs on our profitability and we sought out to optimize funding costs and successfully issued UAC's first commercial paper in the Nigerian debt capital markets in May. We issued an N18 billion commercial paper under our N45 billion program. And the issuance by UAC, the holding company, was aimed at reducing finance costs across the group. We were able to refinance the short term debt in our Animal Feeds business and reduce interest rates on that amount by about 210 basis points.

Despite a softening in the price of soya bean and maze in the second quarter of the year, the market value of inventory of the Animal Feeds business exceeds total borrowing. And such, we have comfort that liquidity generated from future sales are sufficient to reduce leverage and inventory.

I will now hand over to Fola to take us through the next section of the presentation. Thank you.

Fola Aiyesimoju (UAC Group Managing Director)

Thank you, Funke.

Animal Feeds Impact on H1 2022 Performance

Slide 12 aims to reflect the outsized impact our Animal Feeds business had on our performance in the first half of the year.

Operational planning for this segment entails procuring raw material inputs at harvest to meet production needs for the subsequent year. This involves forecasting production volumes a year ahead, and we unfortunately got this wrong last year and purchased agricultural inputs in excess of our needs.

Unusually, the prices for these agricultural inputs declined post harvest, putting downward pressure on selling prices and finished goods, and this negatively affected margins. Inventory purchases were financed with debt and as such interest expense depressed profitability further. The movement in inventory and debt, which did not result in proportionate increases in revenue are reflected on slide 13 of this presentation.

As you would see, our inventory days increased sharply as inventory growth was not matched by a commensurate increase in sales.

H2 2022 Focus Areas

Our focus in the second-half of the year is on aggressively reducing inventory and deleveraging the business. To achieve this, we are pursuing a dual strategy of bulk inventory sales and ramping up end products sales. We would also focus on eliminating costs in this segment.

Product sales improvement will benefit from improved formulation for our poultry feed, which has been very well received by the market.

Slide 14 touches on our focus in the Packaged Food segment. Here the goal is to commission a new line for SWAN water business, which has been out of capacity for a while. The line has been purchased and we expect it to be fully operational in the fourth quarter of the year. This would increase capacity threefold and enable us to meet demand. We are however paying very careful attention to distribution costs given the recent escalation in diesel prices.

Finally, on slide 15, we highlight other areas that we are focusing on that we believe will have long term positive impact on our business.

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UAC of Nigeria H1 2022 Results Conference Call

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We have recently transitioned to the SAP S/4 HANA enterprise resource planning system and are at the hypercare stage of this project. We expect this phase to be completed in September, after which we will focus on maximizing value over this long-term investment.

In the Quick Service Restaurants business, we are aggressively rolling out corporate stores. We gave guidance of ending the year with about 22 stores. We have about 18 stores and we fully expect to meet and in all likelihood exceed our targets by the end of the year. These stores continue to perform well and we are planning further expansion next year.

Our Paints business continues to grow and our focus here is on revamping colour centers, rolling out additional points of presence and improving overall customer experience.

Finally, in the dairies segment of our Foods business, we deployed close to a thousand freezers this year and changed packaging for ice cream and our aim is to derive full benefits from these investments.

Overall, our main challenge and as such, our focus will be on reversing recent poor performance in the Animal Feeds segment but we will pay very careful attention on continuing to implement the growth trajectory we are seeing in the rest of our businesses.

Thank you and we will now take questions.

2. Questions and Answers

Adewale Okunrinboye (Sigma Pensions)

Good afternoon and thank you for the presentation. I think H1 looks like it was a very difficult operating environment. For your Animal Feeds business, towards the tail end of last year, I could see a pickup in inventory. It was clear you were trying to buy. I am just trying to understand- you had purchased a bit of inventory, is it that price came down or you struggled with volumes? Which was the issue was it that pricing was infavourable? I suspect you were trying to frontload against maybe inflation and currency devaluation. I am just trying to understand what really happened on that side.

Next question is on your QSR business. We have been seeing a lot of traction on that. However, I think if I look at the notes I see you are still at an operating loss. What is the issue? And what do you think you need to do to move the business to profit? Maybe on a going forward basis, you said your guidance is that you do not see any improvement on the overall picture. Is it a case that maybe you think things will be weak for a while. Or maybe you think with the adjustments you make on your Animal Feeds business, you will be able to turn things around.

Fola Aiyesimoju (UAC Group Managing Director)

Thank you, Adewale. Just to make sure I have the three questions. One was seeking additional clarity on what exactly happened to Animal Feeds. The second was understanding the outlook for the operating loss of the QSR business in spite of traction and getting context on the comment around the continued difficult outlook.

For the Animal Feeds business, I think it was two things really. Yes, you are 100% correct that we significantly ramped up inventory towards the tail end of last year and this peaked in March of this year. We did so in anticipation of growing volumes in that business. So you need the inventory to meet your your monthly production targets. But it is important to note that already by the end of last year, prices for maize and soya had more than doubled and they increased probably another 30% to the peak of the buying season. So the overall market slowed down, the volumes we targeted did not materialize. So regardless of what happened to the commodity prices, we would have had excess inventory and paid for that in leverage.

The unique circumstance this year was that the conventional wisdom is that commodity prices, maize and soya beans are cheapest at harvest and post harvest, the prices typically rise. So it is much easier to course correct. If you overbuy inventory, you simply sell that inventory and frankly can make a profit.

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UAC of Nigeria H1 2022 Results Conference Call

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This year, for some reason, in spite of historical patterns, Russia-Ukraine, inflation, those prices came down in Nigeria. It is important to know that we track the prices globally and in Nigeria they came down which limited our ability to immediately sell down inventory and reduce our borrowing levels. And because the price of those commodities came down, it also affected the end product selling prices. You could not keep on pushing the end product selling prices to drive margins, so it affected margin.

So one was just our planning. We planned for big growth in volumes, bought the inventory and those volumes did not materialize because the industry slowed down. And because the prices came down, it limited our ability to course correct.

On QSR, it is important to note that we were a 100% franchise business and took the decision to massively prioritize corporate stores and aggressively implement our franchise standards. So we will shut down or buy over any franchisee that does not meet our requirements. To achieve this, the company had to invest meaningfully in the capabilities to run a corporate store network. And those investments peaked around April last year. The way it works is that every store we roll out is profitable. The return on invested capital is very high and they operate at north of 20% margins. And you need X number of stores or X revenue from your corporate stores to fully cover your headoffice overhead costs and begin to break even. That business will get to roughly N4 billion business or between N3 and 4 billion business. It requires, in our estimation a run rate. So any month where your run rate is about N10 billion a year, so you are doing N800 to 900 million a month in corporate store sales to break even. And we very much expect this to materialize sometime in the next financial year 2023. So what we focus on is how many corporate stores can we roll out and how well does each corporate store rollout perform. Because the investment in the central platform to support this has peaked.

My comment around the overall environment was more macro. I am not in any way suggesting that UAC's performance would continue in this trajectory. In fact, I expect the absolute opposite. I frame the macro because it guides the things we are going to need to manage, so we are going to need to be very agile in terms of sourcing. And we are going to need to be very attentive in terms of pricing to make sure that we respond to input cost escalation. So the comment was more a macro comment than a company performance-specific comment in terms of outlook.

Adewale Okunriboye (Sigma Pensions)

OK, thank you. Just one follow up. So I think Funke said about leverage- that it is tied basically to the inventory build up. As you wind that down, you will repay and finance cost will not be an issue going forward. Secondly, in your QSR where would you say the margins are- Mr Biggs, the pizza, the express stores. Which has the higher margins?

Fola Aiyesimoju (UAC Group Managing Director)

On a standalone basis, Debonairs Pizza has higher margins than Mr Bigg's. But we roll out Mr Bigg's in clusters, so I am glad you picked up on the express. So every main Mr. Bigg's store you see, there would be three to four express stores attached. And on a cluster basis, Mr Bigg's is more profitable than Debonairs. So Debonairs is profitable on a standalone. Individual Mr Bigg's to Debonairs, Debonairs is more profitable. Mr Biggs cluster is the most profitable in the portfolio.

Moderator: Your next question is from Bernard from Steyn Capital Management. He would like to know if you can give a sense of what state the consumer is in, given the high inflation in the country. Also, are you able to take prices without affecting volumes in your Packaged Food and Beverages business?

He has another question on the Paints business. Can you give us some more colour as to what happened to volumes in that business? Are you taking share from competitors? Do you plan to take more price increases? And lastly, how are you progressing with your store roll-outs to increase your retail presence?

Fola Aiyesimoju (UAC Group Managing Director)

Thank you very much Bernard. If I just recap, the first question was state of the consumer and ability to pass on price in Packaged Foods business without volume impact. Next was the Paints, similar- what

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