Operating profit rose by 177% YoY from N103.93mn in Q3’19 to N288.32mn in Q3’20 while profit before tax grew by 269% YoY from N50.63mn in Q3’19 to N187.03mn in Q3’20.
We attribute the significant earnings growth to a possible effective implementation of the Company’s strategies towards value creation. The management of the Company earlier guided on the business objective of a gradual expansion of its operations.
The Company articulated strategies to re-enter the Animal Health business and planned to regain a controlling market share in a few years. In our view, the strategies being put in place appears to be effective, as reflective in the material increase in revenue from the Animal Health business segment.
Revenue from the Animal Health business segment rose from N18.34mn in 9M’19 to N317.19mn in 9M’20, thus increasing its contribution to total revenue from 2% in 9M’19 to 16% in 9M’20.
We also believe that the efforts of the Company to aggressively raise the market share of its flagship disinfectant – NCP yielded results during the period. In a separate development, the enhanced operating efficiency further strengthened bottom-line growth.
Cost of sales margin stood at 45% in 9M’19 relative to 54% in 9M’20. In our view, the improvement in cost margin stemmed from increased productivity. The Company earlier announced its plan to grow production output by upgrading the existing facility and improving production planning and inventory control. We believe that the strategies resulted in the cost efficiency recorded in 9M’20.
Operating expenses were managed effectively in 9M’20, as reflected in the lower operating expense of 34% relative to 37% in 9M’19. The lower operating expense margin was on the back of an 82% reduction in impairment allowance from N50.00mn in 9M’19 to N9.00mn in 9M’20.
Consequent to the enhanced efficiencies recorded on its various cost items, the Company’s operating profit grew by 247% YoY from N117.06mn in 9M’19 to N406.38mn in 9M’20. Finance cost spiked by 96% YoY from N85.99mn in 9M’19 to N168.75mn in 9M’20. In Q3’19, the Company obtained debt financing from the Central Bank of Nigeria.
Total borrowings increased year-to-date (YTD) by 325% from N1.00bn as of FY’19 to N4.25bn as of 9M’20. On a YoY basis, total borrowings grew by 206% from an average of N857.26mn as of 9M’19 to an average of N2.63bn as of 9M’20.
Nonetheless, the material increase in finance cost, profit before tax grew by 665% YoY from N31.07mn in 9M’19 to N237.63mn in 9M’20.
Outlook and Valuation
We revise our projections upwards to reflect increased prospects for growth. We see further improvements in its pharmaceutical business segment. We also see room for increased market share in the Animal Health business.
In Q3’20, the Company obtained a CBN long-term financing of N3.15bn. The higher debt taking significantly increased the financial leverage of the Company from 2.57x as of FY’19 to 4.76x as of 9M’20. In our view, we think that debt financing will be value accretive to the Company, as it focuses on capacity expansion and other investments.
However, while we note that increased leverage has the potential to drive a higher return on equity, we also note the increased financial risk that comes with higher debt levels.
On the back of the coronavirus pandemic that crippled many economies of the world, we expect to see increased attention and favourable government policies towards the health sector, and by extension, drive overall increased growth in the health industry.
Our FY’20 EPS estimate was reviewed and adjusted upwards to N0.20 (previous: N0.13). We also adjusted our cost of equity estimate from 23% to 18%. The downward revision resulted from a lower risk-free rate (from 11% to 9%). We also lowered our extra risk premium (from 6% to 3%) to reflect the improved stock liquidity.
Overall, we arrived at a fair value of N1.26 which implies a justified P/E of 6.17x. The stock currently trades at a P/E of 9.04x. Owing to the 31% premium the stock trades to our fair value estimate, we maintain our SELL recommendation.
While we remain optimistic about the growth prospects of the Company, we also think that the expected value of the Company has been priced-in already.
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