PRESCO PLC – Increased capacity to drive long-term growth

What shaped the past week?

Global:  This week’s global markets trend was positive as investors kept a close eye on the latest earnings reports and central bank decisions. The Federal Reserve, Bank of England, and the European Central Bank all decided to raise their interest rates by 25bps, 50bps, and 50bps respectively, and the market had a mixed reaction as these hikes were in line with expectations. The ongoing earnings season continues to be a hot topic, with investors eagerly analyzing the latest reports, especially from tech companies. One company that stood out was Meta Platforms, whose Q4’22 earnings beat market predictions, causing its shares to soar by 18.5% on a week-over-week basis. Investors also digested the latest macroeconomic data from key economies across the globe. The European Commission reported a rise in consumer confidence in the region. However, Germany’s GDP fell by 0.2% in the fourth quarter of 2022. In the Asian Pacific region, there were varying responses to the latest consumer and manufacturing data from Japan and China. Japanese consumer confidence showed improvement, while China recorded a rise in its manufacturing PMI, although it was lower than expected.

Domestic Economy:   Moody’s downgraded Nigeria’s sovereign bond from B3 to junk status (Caa1) due to concerns about fiscal and debt sustainability. As a result, investors began to dump Nigeria Eurobonds, demanding higher risk premiums to hold Nigerian Eurobonds. Consequently, yields increased at its fastest pace in three months. We expect bearish sentiments to persist in the near term as investors continue to demand higher risk premium, alongside expectations that the US FED will continue to raise rates to tame inflation.

Equities: The past week has been a positive one for the Nigerian equity market, with the benchmark NGXASI returning 2.97% on a weekly basis, elevating its YTD performance to an impressive 5.78%. The interest of investors was widespread, with three out of the four major indices closing in the green for the week. In particular, the Oil and Gas sector emerged as the best performer, soaring 9.16% W/W basis, driven by buying activity in SEPLAT. The Banking sector also had a positive week, as investors absorbed the latest earnings results from industry players. The sector returned 2.49% w/w, with gains recorded in the likes of FCMB, UBA, ACCESSCORP, and FIDELITYBK among others. However, the Consumer Goods sector saw moderate profit-taking action, resulting in a decline of 0.42% for the week. On the other hand, the Industrial Goods sector recorded moderating gains, translating to a 0.17% return for the week.

Fixed Income:  The secondary experienced mixed sentiment during the week. Yields were impacted by investors showing varying degrees of demand and profit-taking behavior. On average, benchmark bond yields increased by 7bps due to profit-taking across the curve but saw significant changes in individual tenors such as the 12.50% FGN-JAN-2026 and 14.80% FGN-APR-2049, which surged by 51bps and 19bps respectively. However, on certain days, such as Wednesday, the bond market saw a strong performance with a decrease in yields due to high demand. The yield on the 13.53% FGN-MAR-2025 and 16.2499% FGN-APR-2037 tenors also fell by 29bps and 21bps. Meanwhile, in the NTB market experienced mixed sentiment throughout the week. Yields for the NTBs were impacted by profit-taking actions at the long-end and increased interest at the short-end of the curve.

Currency: The Naira appreciated N0.25 w/w at the I&E FX Window to N461.50.

What will shape markets in the coming week?

Equity market: The equity market is expected to sustain its bullish momentum with earnings results driving market activity. Mixed sectoral performance is expected, with the banking sector being a strong point. Large-cap counters are expected to elevate activity levels, with positive market breadth expected.

Fixed Income: Next week, we anticipate mixed trading, as investors pursue attractive tenors across the bonds curve, while system liquidity will dictate activity the NTB segment.

PRESCO PLC – Increased capacity to drive long-term growth PRESCO recently released its unaudited FY’22 earnings, reporting a 25% y/y growth in PAT to N21.4 billion, driven by strong earnings performance in H1’22.

Weak quarterly earnings pressure margins

Within the Q4’22 period, PRESCO finalized the acquisition of Siat Nigeria Limited, a subsidiary of its parent company, Siat NV. Following this acquisition, the consolidated company’s milling capacity expanded by 60 tons per hour to 150 tons per hour, which we believe was key to the growth witnessed in the company’s turnover (+75% y/y to N83 billion). However, despite this gain, PRESCO recorded its first quarterly decline (since Q1’20) in the period, which we believe was dragged by lower margins from the new subsidiary. For context, prior to the acquisition, Siat Nigeria had incurred about N8.7 billion in finance cost; consequently, PRESCO’s interest expense for the Q4’22 period increased by 54% y/y to N7.8 billion. We believe this is attributed to the payment of debt incurred by Siat Nigeria Limited as well as the interest payments from its N34.5 billion bond.

Speaking specifically to operating margins, Q4’22 gross margin came in 23ppts weaker y/y (at 44%), constrained by inflationary and currency depreciation cost pressures, as cost of sales jumped 49% y/y to N23.3 billion. Furthermore, although operating expenses for the Q4’22 period declined by 3% y/y to N9.8 billion, EBIT margin contracted by 39ppts to 22% y/y, as EBIT for the period moderated 68% y/y lower to N9.2 billion.

H1 earnings save the day

For the FY’22 period, the knock-on effect of the H1’22 earnings offset the negative quarterly performance seen in Q4. Accordingly, revenue grew by 75% y/y to N83 billion, driven by the more positive commodity pricing from that period. We believe that the topline expansion was largely driven by the passthrough effects from the positive H1’22 performance.

That said, FX concerns remained a headwind as cost of sales increased by 122% y/y to N34.7 billion, taking gross margin lower by 9ppts to 58%.

The strong topline growth was also unable to counterbalance the 83% y/y jump in operating expenses, dragging EBIT margin lower by 18ppts to 43%. Nonetheless, even after accounting for a 204% y/y surge in interest expense to N7.8 billion (due to a 2.4x increase in borrowings), PRESCO’s FY’22 PAT grew by 11% y/y to N21.4 billion.

Cost efficiency to stabilize earnings in 2023

Despite the weak earnings in Q4’22, we expect an uplift in the subsidiary’s performance in the near term through improved operational efficiency, cost optimization strategies and greater economies of scale. Nonetheless, we expect increased volumes from the capacity expansion to fuel topline growth in 2023, amid the expected price increase in the domestic CPO market. As such, we forecast revenue growth of 17% y/y to N96.8 billion and estimate a target price of ₦163.39. Given the 8% upside potential from current market valuation, we rate the stock a HOLD.