Nestle Plc Nigeria Business to Business Loans are a Financial Masterpiece

Consumer goods giant, Nestle Nigeria Plc, reported an after-tax profit of N27.1 billion for the first half of 2022, compared to N21.7 billion in the same period last year.

This represents a 24.8% increase in revenue, suggesting that Nestlé is turning the clock back after the minor Covid-19 setback. Revenue is also up 29% to N222.4 billion while operating profit (a very good measure of a company’s organic performance) is also up 27% to N46.1 billion. naira in the first 6 months of the year. A combination of higher prices and increased volumes helped to cushion the impact of higher direct and indirect costs and expenses, respectively, although operating profit margins are slightly lower.

We have also observed that Nestlé’s financial costs have risen massively in the first half of this year, exceeding N6.9 billion naira twice the cost of the same period in 2021. In fact, if there were no not a 4.5 trillion naira exchange rate gain, the pre-tax benefits may have been lower than last year. Nestlé’s increased financial costs date back to 2019, when it approached its South African-based parent company for funding. The loans obtained have financed around 50 billion naira since 2019 (21 billion naira in 2021 alone) in investments.

According to the company’s 2021 results, total related party loans stood at N76.8 billion, a multiple of 3.6 to its equity. The loans are denominated in US dollars, carry an interest rate of USD Libor plus 11.34% and include a moratorium on interest payments.

It’s the breakdown.

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  • A loan of US$100 million was approved for the Company by Nestlé SA in April 2020, of which US$100 million was drawn as of December 31, 2021.
  • The loan has a term of 7 years (including a 2-year moratorium period on interest only payments) from April 2020.
  • The unsecured facility bears interest at 3 months USD Libor plus a margin of 1134 basis points. There is no fixed payment term agreed in the loan agreement. Payment should be made subject to FX availability.
  • An additional US$100 million was approved for the Company by Nestlé SA in September 2020, of which US$60.5 million was drawn as of December 31, 2021. T
  • The loan has a term of 7 years (including a 2-year moratorium period on payment of interest only) from September 2020.
  • The unsecured facility bears interest at 3 months USD Libor plus a margin of 747 basis points. There is no fixed payment term agreed in the loan agreement. Payment should be made subject to FX availability.

Very few companies have the operational and financial competitiveness of Nestlé, so it’s not hard to see these loans as a financially expedient move on the part of its board. There’s little to worry about, at least for now.

Nestlé has a healthy cash position of N80 billion, large enough to continue paying dividends while meeting other financial obligations. There are also no bank loans to repay since inter-company loans were also used to repay banks. Additionally, Nestlé posted a return on average equity of over 100% in 2021, suggesting that the business model is cheaper to finance with debt than with equity.

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Loans are more than 3 times equity, which means she will be heavily dependent on the company’s organic cash flow to service the loans. That’s also not a problem, at least for now, as the company has continued to generate super profits and has maintained a dividend payout ratio of over 100% since 2019.

The use of business-to-business loans, especially in USD, has also helped the company manage forex-related obligations that have been a major burden for most businesses, especially its competitors. This gives the company a superior competitive edge when it comes to pricing and inventory management.

The loans and related financial costs could help the company meet its huge tax bill which has been stubbornly raised to around 35% over the past three years (despite 3.6x leverage). It is remarkable that Nestlé’s debt is 3.6 times equity, but it pays 100% of profits as dividends and pays 35% of pre-tax profits as taxes. A look into the company’s added value statement also shows an optimal distribution of value. About 28% for employees, 20% for taxes, 7% for financial charges, 8% for Capex and 38% for shareholders, all in addition to its intercompany loans.

The only concern of minority shareholders is the additional control that Nestlé SA exercises over the operations of Nestlé Nigeria. Business-to-business loans essentially give the parent company even more control over what the business can do with its finances.

A potential headwind, however, is the risk of lower dividend payouts if interest charges increase. The 3-month LIBOR is currently around 3.6%, so interest rates on dollar loans are now around 14% per annum. A lower dividend payout ratio will impact the dividend yield, which averages 3-4%. A lower return could slow capital appreciation or erode it during a downturn in financial markets.

That aside, Nestlé Intercompany Loans is a financial masterpiece with a super financial upside for its capital structure, at least for now.

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