Weaker Macroeconomic Backdrop Weighs on Corporate Earnings

The macroeconomic terrain in Nigeria was choppy all through the first half of 2016 and this is buttressed by persistently weakening macroeconomic indicators. In Q1:2016, Nigeria’s GDP contracted (-0.4%) for the first time in 13 years, as challenges in the economy which are broadly tied to lower oil prices and foreign exchange liquidity as well as delayed fiscal stimulus depressed economic activity in the period. In addition to this, GDP has been projected to further contract in Q2:2016 – signifying a recession- as threats to growth arising from external sector imbalance and belated macro policy responses subsist.

A fall out of the challenges is seen in the recently released Q2:2016 corporate scorecards which were largely weak especially across companies in the Banking and Manufacturing sectors while downstream Oil & Gas companies moved against the economic cycle, thanks to policy reforms made in May 2016 which partially deregulated the sector. Consequent on the soft earnings releases, investor sentiment on the Bourse has waned, reversing gains recorded in June that followed FX policy implementation which drove NSE ASI to a positive YTD return (+3.3%) in H1:2016.

In the Banking sector, the tougher operating environment is reflected in industry levels of profitability and asset quality. We observed spikes in Non-Performing Loans (NPLs) and impairment charges which weighed on profitability of banks, albeit with an outsized impact in the Tier-2 segment. From the list of banks that have released H1:2016 results, FCMB (+259.9%), UBN (+195.3%) and ETI (+84.8%) recorded the largest spikes in impairment charges. Also in relation to Profit after Tax (PAT), UNITY (-70.2%), STERLING (-25.9%) and DIAMOND (-25.5%) recorded the largest Y-o-Y declines.

For a few banks including FBN Holdings (NII was up 52.0% Y-o-Y), profitability was buffered by higher Non-Interest Income (NII) which partially offset higher impairment provisions. Although most of the recently released results in the sector outperformed broader analysts’ conservative estimates, short term outlook on assets quality, capital adequacy and core earnings remain soft due to exposure of Nigerian banks to the Oil & Gas sector – still pressured by lower oil prices and disruption of production in the Niger Delta – and significant depreciation of the naira. Yet, the banking index has outperformed the market and remains the only index with a positive YTD return (+6.4%). We expect the sector to continue to outperform, driven by defensive Tier-1 (most especially GUARANTY, ACCESS and UBA) counters which we are long on.

The earnings scorecards of companies in the Consumer Goods segment of the market are also indicative of the tougher operating environment which is stifling consumer spending and increasing operating and finance costs. Two of the largest players in the sector, NIGERIAN BREWERIES and NESTLE posted rather unimpressive H1:2016 results in which revenue grew for both companies while PAT declined, a trend noticed almost across the sector. NIGERIAN BREWERIES recorded a 3.8% Y-o-Y growth in revenue while NESTLE’s improved 22.0% Y-o-Y. However, both suffered 11.2% and 94.0% Y-o-Y plunge in PAT respectively. We observed the massive jump in finance cost across the sector, broadly tied to weaker exchange rate within the period which has weighed heavily on servicing obligations on foreign currency liabilities. Specifically, NESTLE recorded a 361.5% surge in finance cost owing to the large volume of foreign currency loans, likewise NIGERIAN BREWERIES  (+151.5%). Cement companies have seen operating margins drop against the backdrop of an industry-specific pricing pressure and higher operating cost attributable to gas supply shortages. Weaker currency has also translated to bigger liability size for major industry players though with a net positive impact on DANGCEM - due to higher foreign currency assets and cash flow – but decidedly negative on WAPCO with less.

The earnings results of companies in the downstream Oil & Gas sector have shown some massive improvement in performance from the poor outing in the prior year, especially for TOTAL and MOBIL. The improvement in the performance was broadly driven by recent reforms in the downstream Oil & Gas space especially with the deregulation of the sector and the removal of petroleum subsidies. Consequently, MOBIL (+57.9%), FORTE (+38.0%) and TOTAL (+29.9%) recorded the highest Y-o-Y increases in turnover. In terms of PAT, TOTAL (+270.6%) and MOBIL (+51.7%) posted the best Y-o-Y returns.

Although fiscal stimulus and FX reforms are expected to support economic performance in H2:2016, corporate earnings will likely remain depressed in the interim as producers adjust to weaker exchange rate. Investor sentiment for equities is also expected to stay soft, regardless of attractive valuation in some sectors and expectation of positive development in macroeconomic policies. There are short term consequences of weaker exchange rate on sovereign and corporate balance sheets thus investors will continue to weigh the implications of these on short to medium term profitability, dividend-payment and financial strength of corporates.