UAC – Tactical Play Possible Despite New Fundamental Worries

UACN’s Earnings Could Materially Deteriorate on Naira Weakness
Deterioration across key macro indices is likely to affect consumption dynamics in Nigeria and cascade to an 11.2% YoY decline in revenue from continuing operations to N70.3 billion for UACN in 2020.

The cost implication of naira depreciation, supply chain disruptions, and double-digit inflation is also likely to drive EBITDA margin 3.7ppts lower YoY to 6.6% in the current year (vs. 10.2% in the previous forecast and 9.1% in Q1’20). Ultimately, we expect earnings to contract by 38.9% YoY to N3.3 billion in FY’20.

Consistent with projected P&L weakness, UACN’s cash flow position is likely to remain weak in 2020 despite expectations of lower inventory purchases in animal feeds & other edibles segment in coming quarters. We also revise our target price lower to N8.26 (vs. N13.66 previously) to reflect the impact of potential macro-induced top-line weakness in the current year and a naira repricing that significantly alters margin expectations across our forecast horizon.

Restructuring could support tactical positioning, but risks abound
Following the conclusion of UPDC rights issue programme, which UACN utilised to increase its equity stake in the subject to 93.9% (vs. 64.2% previously), attention now shifts to obtaining approvals for the UPDC and UPDC REITS unbundling projects. If approved, the programmes will see:

• UACN divest its entire stake in UPDC to its shareholders. UACN shareholders would now directly own shares in UPDC
• UPDC divest its entire stake in UPDC REITs to its shareholders, who will now own direct shares in the REITS and receive dividends directly from the REITS
• UACN shareholders will thus own shares directly in UACN, UPDC and UPDC REITS because of the unbundling exercise.

According to management, barring any delay, the unbundling exercise is likely to be concluded by July 2020. To our minds, tactical investors could take advantage of market reactions to the confirmation of distribution before the release of Q2'20 results, which we expect to be negatively affected by the current coronavirus setback and naira adjustment. Specifically, Pension Fund Administrators (PFAs) that have been restricted from increasing their stake in UPDC REITS (in order grow real estate exposure) due to its illiquidity, could purchase UACN at depressed prices to gain greater access to the sector. 

From our scenario analysis, which holds share prices of UACPROP and UPDC REITS constant at worse case positions of 20k and N2 respectively (vs. current prices of 83K and N3.40 apiece), only a share price decline in excess of 30.0% (from our reference price) would be damaging to the net worth of a shareholder who seeks to take advantage of the current transaction by investing in UACN. 

We, however, note the following risks: 

• Illiquidity of UPDC REITS and UACPROP may make potential exits/profit taking difficult
• Greater than anticipated market sell-offs due to weak UACN financial performance and absence of dividend could damage shareholders net worth
• The unbundling project may take longer than planned due to COVID-19 crisis

May 19, 2020