Equity Analysis /

National Foods: HY 20: Price adjustments offset volume reduction; upgrade to Buy

  • Upgrade our recommendation to a strong Buy

  • Removal of subsidies and higher selling prices drive the top-line

  • Comparative advantage and inflationary pressure in pricing to drive growth

Delika Rama
Delika Rama

Junior Equities Analyst

IH Securities
14 April 2020
Published byIH Securities

Removal of subsidies and higher selling prices drive the top-line

In addition to the operational and economic impediments, overall volumes for the period under review declined by 32% to 211,381 tonnes, as consumer spend continued to be weighed down by the devaluation of the local currency. Volumes for the flour division declined by 49%, as significant subsidies that were present in the prior year were progressively removed. Maize meal volumes closed flat on last year’s high base as demand remained strong following a relatively poor harvest. The removal of subsidies on the maize component of feed ratios resulted in significant price increases, which consequently led to a 21% dip in stockfeed volumes as diminishing disposable incomes deterred consumer demand. Weighed down by consumer affordability, the groceries division reported a 39% reduction in volumes, whilst the snacks and treats category reported a 42% volume decline as consumers shifted to a basic and essential commodities product mix. 

Complying with IAS 29, National Foods presented inflation adjusted results, however, for the purpose of our analysis historical financials were considered for the period under review. Despite volumes tumbling across most segments, revenue grew by 605% to ZWL$1.46bn, attributed to the removal of subsidies and a shift towards market pricing. The group reported a 1,900% increase in EBITDA from ZWL$23.79mn to ZWL$475.62mn, which resulted in PAT surging 1,983% to ZWL$350.71mn from ZWL$16.84mn in the prior comparable period. Consequently, the group’s headline earnings per share grew by 2,028% to ZWLc512.63 from ZWLc24.09 in 1H19. 

Under the prevailing inflationary environment, the company was focused on balance sheet protection. The constrained ZWL$ liquidity incited several operational changes, including but not limited to the reduction of credit terms and the immediate conversion of available cash to stock. Resultantly, total assets for the period under review improved by 168% to ZWL$1.26bn from ZWL$470.36mn in 1H19, whilst total liabilities grew 199% to ZWL$632.38mn from ZWL$211.58mn in the prior period. Thus, the group’s NAV increased by 1,143% to ZWL$ 628.14mn from ZWL$258.78mn in 1H19. Cash generated from operating activities grew to ZWL$34.03mn, an improvement from a negative $37.82mn in the prior comparable period. Resultantly, cash and cash equivalents ended the period 519% higher at ZWL$119.76mn from ZWL$19.34mn in 1H19. An interim dividend of ZWLc86.47 was declared for the period, payable to shareholders registered on 17 April 2020.

Comparative advantage and inflationary pressure in pricing to drive growth 

H1 20 was characterised by numerous operational and economic challenges, hindering production and pressurising volume performance. We anticipate that the factors weighing down operations in H1 20 will continue into FY 20, with the likelihood of being further exacerbated by the Covid-19 global pandemic. 

The outlook for the 2020/21 agricultural season remains discouraging, with a significant decline in plantings attributed to the challenging environment and prospects of poor weather conditions. Consequently, management have indicated that the group will need to continue importing significant quantities of raw materials up to at least FY 21. We see some comparative advantage as National Foods tends to perform better under such circumstances in which they can leverage their balance sheet to import at scale; however, foreign currency shortages, as well as the current global pandemic, naturally pose a serious threat to the group and country’s capacity to import grain creating some downside risk. 

The company’s business model is anchored in staples which adds a defensive layer to the business during the Covid-19 pandemic in which the market will lean heavily towards essentials. Despite the development which enabled entities with free funds to directly import maize into the country, it is our view that the critical maize situation will worsen if the spread of the virus continues across the globe, as countries from which Zimbabwe imports maize will look to preserve or enhance their reserves to avert food insecurity. However, management remain optimistic about the maize category, anticipating very high demand as the company has embarked on a significant maize importation drive and have reopened both the Mutare and Masvingo maize mills. 

Overall, we anticipate some downside risk to volumes, as consumer incomes continue to be eroded by inflation. The company’s margins have expanded well beyond historical and industry norms, leading to strong bottom-line earnings and a highly attractive valuation on a multiples basis versus comparable businesses. However, we do believe that there will be a correction and realignment in margins going forward, and thus expect some significant softening to begin in FY 21. Going forward, the group have indicated that they will continue with their growth agenda in the snack, biscuits and cereals categories which are logical forward integration opportunities from the basic milling portfolio. Whilst demand in these categories remains subdued, the work on broadening the offering in these segments will continue, developing the company’s repertoire for improved economic circumstances.

Significant uplift in TP driven by attractive valuation on multiples basis

We forecast that inflationary pressures will continue to catalyse revenue from higher product pricing, resulting in growth of 490.3% y/y to ZWL$3.34bn for FY20. The lag between the increase in the group’s cost base a inflation is progressively becoming shorter, therefore we anticipate a 919.3% increase in EBITDA toZWL$835.59mn. We estimate that National Foods trades on a P/E (+1) of 2.9x to 2020E, compared to peers at an average P/E (+1) of 15.2x and EV/EBITDA (+1) of 2.3x, compared to peers at an average EV/EBITDA (+1) of 9.8x. Using a weighted DCF and multiples valuation we have arrived at a target price of $50.92 forNational Foods. This implies upside of 91.4% at current levels. We therefore upgrade our recommendation to a strong Buy.