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How Africa's poor will drive consumer spending after Covid-19

  • Covid-19 may have blunted the African poor, but they remain the main engine of consumption on in the continent

  • We return to our proprietary metric that rates companies on their ability to target the poor – the PEP factor

  • Nestle Nigeria (NESTLE NL), Unilever Nigeria (UNILEVER NL) and East Africa Breweries (EABL KN) rank high on our metric

How Africa's poor will drive consumer spending after Covid-19
Nirgunan Tiruchelvam
Nirgunan Tiruchelvam

Head of Consumers Equity Research

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Tellimer Research
19 May 2020
Published byTellimer Research

Covid-19 has devastated the lives of Africa's poor. In many countries, the lockdowns have halted the income of day labourers, and curbed their spending. 

Day labourers work primarily in construction, transport and hospitality. They are an engine of consumption, but the World Food Programme (WFP) has warned that a quarter of billion people could face a food crisis if the lockdown eases.

Some countries are beginning to ease lockdowns, and companies across the continent have been proactive in dealing with the new reality. Unilever Nigeria has been packaging hygiene products (Sunlight Soap and Lifebuoy) in small unit sizes to target the bottom of the pyramid. With the easing, the pivotal role that the African poor pays in consumption growth will again be apparent. 

To evaluate consumer companies’ exposure to this growth potential, we introduced a proprietary valuation framework a year ago. This framework rates the degree to which a company targets the bottom of the pyramid (BOP), as well as assessing productivity. 

The framework rates companies based on their cash flow from operations (CFO) volatility, vertical integration and net gearing. We term this metric the Productive Exposure to the Poor (PEP) framework.

How can African companies better target the poor? 

Companies can successfully target the poor by selling products in small units, accepting low margins per unit and targeting high volumes. 

They can achieve superior margins by segmenting their product mix to the poor. Unilever India and Petra Foods have successfully targeted the poor using this strategy.

The management theorist CK Prahalad has argued that the poor occupy a lucrative part of the consumer story in emerging markets. He developed this framework in his book The Fortune at the Bottom of the Pyramid – Eradicating Poverty Through Profits (published 2004).

Three distinct aspects of the thesis about the fortune that exists at the BOP level are:

  1. Consumers who live at the bottom of the income scale collectively represent billions of dollars’ worth of demand.
  2. These consumers will account for much of the growth in global demand in the future.
  3. Companies that target the poor need to frame their business model appropriately. Prahalad summarises his approach as, “if we stop thinking of the poor as victims or as a burden and start recognising them as resilient and creative entrepreneurs and value-conscious consumers, a whole new world of opportunity will open up.”

Targeting the poor can be profitable even in the midst of Covid-19. This economic opportunity is valued globally at US$13tn a year, according to the World Bank.

Three Pillars of the Bottom of the Pyramid

To target the bottom of the pyramid, companies must adopt three strategies. 

1. Small unit packages

Consumer firms must be proactive to target the BOP. The unit price must cater to people whose daily disposable spending is less than US$4. For instance, Unilever Nigeria sells shampoos in single-use sachets that carry less than 25ml of liquid. These are priced at below US¢40. Shampoo in small sachets has proved popular even during the lockdowns. 

There are several examples of small unit sizes providing an avenue to target the poor in developing countries. Sachet marketing is a prominent category:

  1. In Brazil, Unilever produces Ala, a brand detergent. This caters to people who previously washed using detergent in the river water.
  2. In India, Unilever produces Sunsilk shampoo in units of US¢2–4.
  3. In Tanzania, Key soap is sold in tiny units for a couple of US cents.

2. Low margin per unit

Instead of imposing a premium on the poor, targeting the poor requires an expectation and acceptance of low margin. The gross margin per unit of shampoo may be half the margin that can be derived from high-end customers.

3. High volumes

While margins may be lower, the BOP presents scale opportunities. Annual shampoo consumption in Nigeria is just 120ml per capita, which is a fraction of Western levels. But, the country has a population of 195mn, which means that the total shampoo market that Unilever Nigeria can address is already similar to the Belgian shampoo market. 

What is the PEP factor?

Consumer companies have unique challenges in Africa. One is the need to target the BOP through a combination of small unit sizes, high volumes and low margin per unit. The companies that employ these strategies enjoy superior growth to their peers.

We employ a proprietary framework that rates a company’s ability to target poorer customers, as well as the company’s financial health. Our metric is called the Productive Exposure to the Poor (PEP) framework.

The metrics we use in the PEP scorecard are as follows:

  1. Average daily income/APP: The ratio between the average price of a company’s product and the average daily income in Sub-Saharan Africa.
  2. Market share: This is expressed as a percentage of total revenue.
  3. Return on assets: This is a measure of the profitability of a company compared to its total assets. ROA measures the efficiency of management in operating an asset base. It is the company’s annual earnings divided by its total assets.
  4. The inverse of the standard deviation of historical CFO: The variability of a company’s CFO indicates the susceptibility of a company to shocks. This measure rates a company with stable CFO highly. It penalises companies with volatile CFO and rewards companies with resilient cash flows.
  5. The correlation coefficient between operating earnings and the principal raw material: This measures the vertical integration of a company. Operating earnings strip out the cost of financing, tax rate, depreciation and other accounting items. The principal cost element for some companies is quite clear. For instance, barley prices are responsible for half the cost of goods for Nigerian Breweries. For others, such as the diversified food retailers, we use the GSCI Agri Index. The raw material proxy used for convenience stores such as Modern International is the GSCI.
  6. Interest coverage ratio: This is the ratio between the company’s operating earnings and its interest expense.
  7. EBITDA CAGR over 2016–18. 

The PEP assigns a single score for each selected company based on its ranking under the seven criteria.

We add the scores of each company under each criteria to arrive at a score for each of the 44 companies. This method does not favour companies that perform exceptionally well only on a single criterion, as it assigns an equal weight to each criterion.


Table 1: How we calculate the Productive Exposure to the Poor (PEP) score
Source: Tellimer
The fundamental valuation metric for the African consumer sector is the DCF valuation methodology, which discounts the FCF of a company. The valuation is subject to two variables – the discount rate and the perpetuity growth rate. We use our PEP scorecard as a leading indicator while determining the perpetuity growth rate. The PEP scorecard helps us to judge the sustainability of a company’s earnings.


The companies that stand out on our PEP framework

The food segment is the most developed in targeting the poor, and its PEP score is the best. The retail sector has the least exposure to the poor segment and consequently the lowest PEP score. NESTLE NL and UNILEVER NL – which have high PEP scores – are undervalued using traditional metrics, according to our analysis.

The F&B sub-sector continues to trade at a discount to the rest of the consumer sector due to its high PEP score and low conventional valuation metrics. Several F&B companies have created business models that successfully target the poor. 

Nestle Nigeria (NESTLE NL), Unilever Nigeria (UNILEVER NL) and East Africa Breweries (EABL KN) currently rank high on our PEP metric. These companies have mastered the strategy of selling in small unit sizes and in high volumes, and have also segmented their customers in accordance with their income levels and elasticity of demand. These companies rate highly on conventional metrics as well, hence they are among our top picks in the Africa consumer sector.

Two of these three companies have outperformed MSCI Frontier Index since 1 February, when Covid-19 began to have an impact.



Companies with high PEP scores maintain a close connection with their consumers. These companies tend to generate positive cash flow from operations (CFO) – even during the three main crises faced in Africa during the past 15 years. We also stress test African consumer companies on their ability to withstand severe economic difficulties. We find that several of them have durable business models, with a record of generating CFO even when demand and credit have dried up or there was a sudden rise in input costs.

We would avoid names with high raw material exposure as companies that are exposed to raw material price fluctuations are vulnerable to volatility in earnings. Despite its relatively high PEP score and attractive valuations, we find Flour Mills of Nigeria susceptible to raw material price swings. That said, our stress test shows that poorer customers are reliable and durable.
 

Table 2: Productive Exposure to the Poor (PEP) – scorecard
TickerRaw PEPPEP

UCSP KN Equity

-16.1

-2.3

INTBREW NL Equity

-12.8

-0.9

GUINNESS NL Equity

-12.8

-0.9

CADBURY NL Equity

-12.7

-0.9

INN ZH Equity

-12.6

-0.8

UACN NL Equity

-12.6

-0.8

NB NL Equity

-12.3

-0.7

PZ NL Equity

-12.0

-0.6

EFID EY Equity

-12.0

-0.6

CHOPPIES BG Equity

-12.0

-0.6

JUFO EY Equity

-11.9

-0.6

BLR RW Equity

-11.4

-0.3

FLOURMIL NL Equity

-11.4

-0.3

GGBL GN Equity

-11.2

-0.2

SIM ZH Equity

-10.9

-0.1

EABL KN Equity

-9.6

0.4

BATU UG Equity

-9.4

0.5

BAT ZH Equity

-9.4

0.5

NBS NW Equity

-9.2

0.6

FML GN Equity

-9.0

0.6

BATK KN Equity

-9.0

0.7

DLTA ZH Equity

-8.7

0.8

UNILEVER NL Equity

-8.3

0.9

NESTLE NL Equity

-7.8

1.1

DANGSUGAR NL Equity

-5.0

2.3

TBL TZ Equity

-5.0

2.3

Source: Tellimer


Table 3: Productive Exposure to the Poor (PEP) framework – inputs
 TickerMarket shareAvg daily income/ASPEBITDA CAGR 16-18Adjusted ROAInterest coverage ratioCFO Volatility

Raw material price independence

UCSP KN Equity

21

6

3.4

-51.8

-6.6

0.01

-6.39

INTBREW NL Equity

25

2

2.1

-3.2

9.1

0.02

1.54

GUINNESS NL Equity

27

4

-6.0

4.5

5.3

0.02

2.57

CADBURY NL Equity

34

12

-15.6

1.9

2.9

0.02

3.71

INN ZH Equity

23

6

-0.9

1.5

8.1

0.01

3.29

UACN NL Equity

34

11

-7.2

0.2

1.1

0.03

1.65

NB NL Equity

31

9

-5.7

5.0

6.8

0.01

1.60

PZ NL Equity

25

13

3.3

1.3

9.9

0.01

2.29

EFID EY Equity

19

9

9.5

12.1

4.3

0.01

1.55

CHOPPIES BG Equity

27

10

8.8

2.7

2.6

0.02

4.42

JUFO EY Equity

23

8

12.5

8.1

2.5

0.02

1.91

BLR RW Equity

55

5

-1.0

3.9

2.9

0.01

1.07

FLOURMIL NL Equity

38

9

16.7

2.0

1.2

0.02

1.21

GGBL GN Equity

43

5

14.1

5.1

2.7

0.03

1.67

SIM ZH Equity

19

8

13.0

23.7

13.7

0.02

1.30

EABL KN Equity

85

5

0.8

9.1

4.6

0.02

1.62

BATU UG Equity

61

8

6.8

22.0

11.0

0.01

1.10

BAT ZH Equity

71

8

-1.3

30.4

4.1

0.01

-1.10

NBS NW Equity

73

4

5.2

15.3

16.7

0.015

1.60

FML GN Equity

35

9

15.9

11.6

44.4

0.02

2.22

BATK KN Equity

67

9

5.5

18.4

18.4

0.02

1.40

DLTA ZH Equity

90

5

-3.7

14.3

17.8

0.03

2.10

UNILEVER NL Equity

71

14

6.3

9.0

30.4

0.04

2.28

NESTLE NL Equity

62

11

17.2

27.8

24.2

0.02

1.67

DANGSUGAR NL Equity

43

5

16.9

12.0

126.6

0.02

1.04

TBL TZ Equity

60

5

17.4

18.1

103.9

0.02

1.34

Source: Tellimer