FDC bi-monthly economic and business update - October 22, 2015

Countercyclical Spending, the Remedy for

Stagflation

The Nigerian economy has witnessed three consecutive quarters

of slowing growth and rising inflation, a situation economists refer

to as stagflation. Second quarter growth slowed to 2.35% while

third quarter growth is estimated at 2%. On the other hand, infla-

tion has increased steadily eight out of the nine months this year

to 9.4% in September.

Global oil prices have fallen sharply by over 58% from 2014’s

peak of $116pb to $48pb in October 2015. On a marginal cost/

marginal revenue basis, margins are down 77%. According to the

CBN’s economic report for the second quarter, gross federally col-

lected revenue declined by 27.7%; attributing the decline to

shortfalls in oil and non-oil revenue. The external reserves level is

also down 12.9% ($4.45bn) to $30.04bn, year to date. The Nige-

rian stock market has not been insulated from the shocks. The

market has lost 13.36% YTD while corporate earnings have been

below par; a reflection of declining disposable income, market and

policy uncertainty.

On the political front, the long awaited ministerial list has been

released and the screening and confirmation of some Ministers

concluded. The first thing the Ministers will do after taking up

their portfolios is to approve long standing contracts. While this

bodes the question- what is the source of funding for this project-

this might actually be the remedy the economy needs for the

state of stagflation it is in.

According to a well renowned economist, John Maynard Keynes,

A Financial Derivatives Company Publication

: 7739831, 7798998, 2715414; Email: [email protected]; Website: www.fdcng.com

FINANCIAL DERIVATIVES COMPANY LIMITED

Bi-monthly Economic

& Business Update

Volume 5, Issue 60

October 22, 2015

INSIDE THIS ISSUE:

Countercyclical Spending, the Remedy for Stagflation

1

The Unintended Conse-quences of the 1Kobo Stock

Rule

3

Global Perspective: Culled from the Economist

Africa’s middle class

9

Global Perspective: Culled from the FT

ECB raises possibility of further

stimulus at December meeting

14

Macroeconomic Indicators 16

Stock Market 19

Corporate Focus - PZ Cusson Nigeria Plc

21

you spend your way out of an austerity. For Nigeria, this may

mean countercyclical spending; government spending on capital

projects and key sectors of growth such as construction, manufac-

turing, agriculture that will yield productivity gains, boost con-

sumer disposable income and ultimately stimulate economic

growth. In addition advocating for a lower interest rate will en-

courage banks to lend more. So back to the question of funding.

Likely sources of funding for the government include borrowing

from the local and international markets, aggressive tax collec-

tion, review of tariffs, etc.

The risk of this is a higher inflation rate. But there is no gain with-

out pain. If the level of economic growth achieved by the counter-

cyclical accommodative policy is significant, the impact of a high

rate of inflation may be muted.

Page 2



The Unintended Consequences of the

1Kobo Stock Rule

The Nigerian Stock Exchange was set to change in August with

the introduction of the 1 kobo stock rule. By removing the 50

kobo price floor, the new rule was supposed to boost liquidity and

investor confidence, as well as bring the Nigerian Stock Exchange

(NSE) more in line with advanced trading markets, which have no

price restrictions. However, on July 21, 2015 the implementation

of the new rule was suspended indefinitely citing fears that it

would further impair an already declining market capitalization.

The cold feet are understandable. The NSE All Shares Index (ASI)

has recorded an 11.31% loss since January amidst political uncer-

tainty, declining oil prices, and delays in policy formulation follow-

ing the election of the new administration. The new rule would

likely cause a further decline resulting in severe consequences for

the broader economy. Companies would likely see their market

values plummet, with declines as high as 50% being a very real

possibility. If market capitalizations fell below the minimum re-

quirement, affected companies would have to seek other means

of raising funds to meet their capital requirements.

Despite the anticipated negative consequences, however, the pol-

icy is an overdue market reform. It would contribute to market

liquidity and also reflect the true value of some dormant stocks

trading at nominal value on the exchange thereby promoting mar-

ket efficiency. This will go a long way in bringing the market to

par with other advanced markets making it more attractive to for-

eign portfolio investors and eventually increasing market size and

liquidity. These benefits outweigh the temporary pain of a reduc-

tion in stock prices and market value, as a strong market is foun-

dational for a strong and growing economy.

However, It is the timing and mode of implementation that will

determine if it will be successful or otherwise. The NSE must work

with the Securities and Exchange Commission SEC to synchronize

the implementation of the policy with a strong market rally. While

some level of pain is inevitable, effective collaboration on imple-

mentation would cushion the negative impact on investors and

the entire market, while achieving the benefits outlined above.

Page 3



Understanding the 50 kobo floor price

The current 50 kobo price floor was introduced following the 2008

market crash. The change was made to minimize the magnitude

of losses and salvage crashing stocks that were headed for 1

kobo. In effect the price floor of 50 kobo reduced the loss expo-

sure of individual investors and the entire stock market.

Following the crash, risk management frameworks for commercial

banks were improved, decreasing the exposure of the financial

system to the banks. As a result, the factors that led to the col-

lapse of the market have been addressed. Yet the 50 kobo price

floor has remained, acting as a support for stocks which otherwise

would have dropped further. It is in this context that the 1 kobo

rule was conceived.

Likely implications of the 1 kobo rule

There is no denying that the negative impacts of the 1 kobo rule

would be far reaching. It would likely impact entire sectors, merg-

ers and acquisitions, bank loans, penny stocks, and IPOs.

Sectors that have seen little movement from the 50 kobo mark

would be the hardest hit. One example would be the insurance

sector. Twenty-two of its stocks have remained at the 50 kobo

floor price since 2008 and the industry has all but lost national

investor confidence as a result. In other sectors, such as industri-

als and ICT the inability for companies to increase their stock

from 50 kobo could result in hostile takeovers and the rise of the

cartel behavior.

On the loans front, there could be a significant increase in margin

calls by commercial banks. Asset quality deterioration by compa-

nies whose stocks have been pledged as collateral would lead to

lenders calling for extra collateral to reduce or avoid credit expo-

sure. If the companies are unable to provide extra collateral, then

we might see an increase in the impairments and non-performing

loans, which will ultimately affect the banks’ profitability.

For individual and portfolio investors who trade primarily in penny

stocks, the danger of portfolio value erosion is even more pro-

nounced. Whilst the 1 kobo rule will give them the opportunity of

Page 4



exiting positions in illiquid stocks, it also exposes them to major

losses as they reassess their value after the selloff.

Companies preparing to embark on initial public offerings (IPOs)

may have to list at a lower price per share. This means they will

have to increase their outstanding shares to meet up with the

capital that they seek to raise. This also means that registrars will

have a lot more shares to reconcile and reconciliation will proba-

bly become more cumbersome.

Concerns about companies being delisted from the exchange have

also been raised from different quarters. When a stock price falls

to 1 kobo with little or no trading activity on the stock, there is a

probability of it being delisted from the exchange. The SEC has

constantly reiterated its commitment to support companies enlist-

ing on the exchange and exploiting the inherent opportunities that

the bourse has to offer. The move to implement the 1 kobo rule

may contradict this effort.

The Way Forward

Without a doubt, the impacts of the 1 kobo rule are severe and

varied. However, the importance of the 1 kobo rule cannot be

downplayed. When implemented, it would bring about the much-

needed liquidity in the stock market. Investors who have invest-

ments trapped in non-performing stocks would be able to sell

them off when the stocks find their true value. This would come at

some cost but would be much more preferable to having assets

that cannot be traded because they are overpriced. Market turn-

over will also increase, as more investors will be willing to trade

knowing that price floors won’t serve as barriers when they desire

to exit the market.

In the short term, the fall in stock prices will bring about in-

creased market activities, as more Nigerians and foreign portfolio

investors will be willing and able to trade on the exchange as

stock prices fall, bringing liquidity, increased trade volumes and

eventually market capitalization. Listed companies will be able to

raise more capital from the exchange stimulating economic activi-

ties.

Page 5



Long-term benefits will include improved market efficiency: in-

creased responsiveness of stock prices to market news and com-

panies periodic results. Companies listed on the exchange will

make every attempt to improve financial performance knowing

fully well that poor results will reflect on their stock prices and

make them susceptible to hostile takeovers and acquisitions.

Furthermore, when the rule is implemented, stocks currently trad-

ing at 50 Kobo will find their true value; more investors will be

able to increase their holdings in firms where the ownership struc-

ture is uneven. This is turn will increase their influence and voting

rights and may bring about increased responsibility by the board

of directors.

Investor confidence will be bolstered on improved market trans-

parency, as will the perception of international market players to

the market. Increased demand for cheap stocks will improve mar-

ket turnover and stock prices will be set by market forces as

against artificial support.

The benefits of the 1 kobo rule cannot be overstated. Overall, ad-

vantages of this rule to the economy, the exchange, listed compa-

nies and investors will outweigh its disadvantages despite initial

pains.

The timing of the implementation however is just as important as

the rule itself. For a while now, the market performance has been

unimpressive which is why the implementation of the rule was

suspended, It is best that the price floors are gradually reduced

from 50 kobo to, say, 30 kobo and that market performance is

carefully watched before the price floor is further reduced or to-

tally removed. A gradual reduction will help to gauge the market

response and allow time to formulate appropriate response meas-

ures to the precise challenges that arise.

Conclusion

Whilst the SEC may have good intentions with the formulation of

this policy, it is in the best interest of the NSE that this policy has

now been suspended. Proper research needs to be carried out and

Page 7



all factors taken into consideration before recommendations are

made as to how the above listed issues can be addressed and the

rule implemented. The net negative effects of this policy could

very well outweigh its positive effects if implemented at the wrong

time and using the wrong approach.

The rule, which has been temporarily suspended due to the de-

pressed nature of the exchange, will become effective at some

time in the future. However, there is no perfect time. Whenever

the NSE does implement the rule, the market will react and the

consequences enumerated above will play out. Whilst not a popu-

list reform, it is one that will bring about the much needed trans-

parency on the exchange and force companies whose stocks are

currently trading at 50k to do more work so that they do not lose

out of the market.



Page 8

Global Perspective: Culled from the Economist

Africa’s middle class

Few and far between

Africans are mainly rich or poor, but not middle class. That

should worry democrats

LOOK out from the cafés of Accra’s financial district and you could

be almost anywhere. In the shadow of glassy skyscrapers, Ameri-

can-accented entrepreneurs order lattes and ponder spread-

sheets. “You couldn’t have imagined this even five years ago,”

Joseph Baffour, a local financier, says of his surroundings.

“There’s been an astronomical change.”

On a continent once synonymous with war, famine and poverty, a

middle class has started to emerge, propelled by growth and ur-

banisation. Its rise has much to do with the spread of democracy

and greater rule of law—countries with such attributes tend to

generate more economic opportunities than those in which a few

rulers line their pockets. In turn, the new middle classes have

raised their voices in demanding clean and accountable govern-

ment and public services. A study by Nic Cheeseman of Oxford

University, found that in Kenya the richer people were the more

likely they were to support democracy (and vote for the opposi-

tion).

Yet step beyond the air-conditioned malls that are popping up like

meerkats across the continent, and it is clear how thin this

emerging middle class is. Just a few miles down the road from

Accra’s coffee -connoisseurs are the columns of smoke that billow

above Agbogbloshie, a digital dumping ground. Here hundreds of

men risk their health burning old electronics for useful parts.

Leave the capital altogether and the celebrated middle class

grows harder still to spot: high-rises give way to huts, suits to

shoelessness.

So too with much of Africa. Good data on the exact size of the

middle class are hard to come by, but it remains small across

most parts of the continent. The Pew Research Centre, an Ameri-

can outfit, reckons that just 6% of Africans qualify as middle

Page 9



class, which it defines as those earning $10-$20 a day. On this

measure the number of middle-income earners in Africa barely

changed in the decade to 2011.

More recent data from EIU Canback, a consultancy (and sister-

company of The Economist), show some growth (see chart) in the

decade to 2014 but it is painfully slow: 90% of Africans still fall

below the threshold of $10 a day and the proportion in the $10-

$20 middle class (excluding very atypical South Africa), rose from

4.4% to only 6.2% between 2004 and 2014; over the same dec-

ade, the proportion defined as “upper middle” ($20 -$50 a day)

went from another 1.4% to 2.3%. Other surveys are also disap-

pointing. Standard Bank, a South African lender, thinks that

though the number has increased, there are still only 15m middle

class households in 11 of sub-Saharan Africa’s bigger economies

(excluding South Africa and using a range of $15-$115 a day).

Page 10



The puzzling question posed by these data is why the middle class

is so small after a decade in which economic growth has averaged

more than 5% a year, about twice as fast as population growth.

One reason is that the proceeds of economic growth are shared

very unequally. In recent years inequality has increased alongside

growth in most parts of Africa.

Another reason is that poverty in many parts of Africa is so deep

that even though incomes may have doubled for millions of peo-

ple, they are now merely poor rather than extremely poor. Laur-

ence Chandy at the Brookings Institution, an American think tank,

points out that the average person in extreme poverty in Africa

lived on just 74 cents a day in 2011, compared with 98 cents in

other parts of the developing world. Ethiopia, which is both one of

Africa’s most populous nations and best developmental perform-

ers, is a good example. Its share of people living on more than

$10 a day has increased more than 10 times in the decade to

2014 to 2% of the population: but that still left close to 98% of

Ethiopians living below this threshold.

A low wage is better than none at all, but those living on $10-$20

a day are hardly sipping sangrias at sunset. For most of them, life

is still tough. “I came from the north because I needed a job,” a

sweating Awal Ibrahim says as he cuts the copper out of old com-

puter wires in Agbogbloshie. Working relentlessly in the baking

heat, he earns about 20 cedis ($5) a day. Does he still feel poor?

He glances with commendable humour at the smouldering Sodom

surrounding him: “If I could find other work I would.”

That is the problem. Unlike Asia, Africa has failed to develop in-

dustries that generate lots of employment and pay good wages.

Only a few countries manufacture very much, largely because na-

tional markets are small and barriers to trading within Africa are

huge. Most people who leave the countryside move into labour-

intensive but not very productive jobs such as trading in markets.

John Page, also of Brookings, reckons that such jobs are on aver-

age only about twice as productive as the ones that many left be-

hind.

For investors who piled in on the promise of a new African bour-

geoisie, this is a worry. The commodities boom has ended and all

but the richest tend to stop spending at the first sign of economic

trouble, as they have done in Nigeria and South Africa, the conti-

Page 12



nent’s two largest economies. Having overestimated the number

of upwardly mobile people, many big firms are expanding far

more slowly than they expected. A few years ago, Shoprite Hold-

ings, South Africa’s largest retailer, envisaged opening 600 -800

stores in Nigeria. It currently has 12. Across the continent in

Kenya, Cadbury and Coca-Cola have closed factories. “We thought

this would be the next Asia”, Nestlé’s chief executive for equato-

rial Africa said earlier this year. “But we have realised the middle

class…is extremely small and it is not really growing.”

Those investors with deep enough pockets can afford to wait. In

the meantime, they are expertly targeting poorer shoppers with

such things as tiny packets of washing powder and water. In Ni-

geria UAC Foods sells cheap sausage rolls through bus windows

rather than in supermarket aisles.

But those concerned about raising economic growth and the

spread of democracy in Africa should be less patient. The middle

class that has emerged, small as it may be, is also vulnerable;

even mild economic shocks may be enough to push households

back below the threshold of poverty. That in turn may slow the

impetus for reform, and perhaps even reverse it.

Page 13



Global Perspective: Culled from the FT

ECB raises possibility of further stimulus at De-

cember meeting

The European Central Bank stands “ready to act when needed” if

the euro zone’s economic recovery disappoints, Mario Draghi has

vowed in comments that raise the spectre of an expansion to the

bank’s €1.1tn asset -purchase programme and a further cut in its

deposit rate.

The comments by the President of the ECB during a press confer-

ence came after the eurozone’s central bankers decided to keep

interest rates on hold at record lows after a meeting of the gov-

erning council in Malta on Thursday.

The euro declined by 1.23 per cent against the dollar to just under

$1.12 as Mr Draghi spoke, while two-year German government

borrowing costs sunk to a record low of -0.293%.

The ECB’s governing council held its benchmark interest rate at

0.05%. The deposit rate charged on bank reserves parked at the

ECB remains minus 0.2% — although Mr Draghi said lowering it

further into negative territory had been discussed. “The degree of

monetary policy accommodation will need to be re-examined at

our December monetary policy meeting,” said Mr Draghi.

December is also when ECB staff roll out their latest projections

for growth and inflation — raising pressure on what is likely to be

seen by market analysts a crunch meeting. Mr Draghi added that

“there were a few on the governing council” who pressed for ac-

tion today.

In September, Mr Draghi indicated that policymakers would roll

out a beefed up version of their quantitative easing package

should the slowdown in emerging markets and financial market

volatility threaten growth and inflation within the single currency

area. Most economists now expect inflation to take longer than

previously thought to return to the ECB’s target of below but close

to 2%. The ECB has been buying €60bn of mostly government

bonds since March. It intends to keep on doing so until September

2016. Many economists think the ECB will announce an extension

of the programme beyond the autumn when they meet in Decem-

ber.



Page 14

http://www.ft.com/topics/organisations/European_Central_Bank

http://www.ft.com/topics/people/Mario_Draghi

http://www.ft.com/cms/s/0/64a8505c-77d3-11e5-933d-efcdc3c11c89.html#axzz3pHOEvqZo

Officials at the central bank have also said they could buy more

assets each month or extend the list of assets eligible for QE — a

list that at the moment is limited to government bonds and cer-

tain packages of bank loans.

While the programme appears to have thawed the region’s credit

markets, growth remains lacklustre and inflation has fallen back

into negative territory.



Page 15

http://www.ft.com/cms/s/0/ed1e12ba-770a-11e5-933d-efcdc3c11c89.html#axzz3p8cMB1BQ

Macroeconomic Indicators

Money Market

Short term interbank rates averaged 6% p.a. from October 2 –

22, 2015, 841bps lower than the corresponding period in Septem-

ber. This was as a result of increased market liquidity as inflows

exceeded outflows during the period under review. The CBN de-

layed in mopping up excess liquidity, possibly as part of its drive

to encourage lending to the real sector and reflate the economy.

As at October 22nd, the OBB and O/N rates were at 5.33% p.a.

and 5.92% p.a., 1,800bps and 2,091bps lower than their respec-

tive figures in the previous month.

Outlook

Money market liquidity is expected to remain at current levels

pending significant outflows. However, an expected disbursement

of FAAC funds estimated at N400bn may further boost liquidity.

Oil Market

Oil Prices

Global oil prices (Brent crude) averaged $49.77pb from October 2

– 21, 2015, 2.2% higher than the average of $48.68pb in the cor-

responding period in September. Although, concerns over Russia’s

involvement in Syria caused a temporary spike in Brent crude to

$50pb during the period under review, slowing Asian economies

and an increase in U.S. crude inventories continued to weigh on

crude prices. In addition, OPEC continued to produce above its

production quota of 30mbpd as they battle for market share with

Non-OPEC members.

Outlook

The outlook on oil prices remains bearish as crude prices are

unlikely to rebound with slowing demand from emerging econo-

Page 16



Source: FMDQ, FDC Research

Chart 1: Average NIBOR (% p.a.)

mies, increased OPEC production and U.S. inventory.

Forex Market

Exchange rate volatility continued in October, as market panic

heightened with the decline in external reserves towards the

$30bn psychological resistance level. As at October 22nd, the

naira traded at N226/$ at the parallel market, a 1.1% deprecia-

tion from N223.5/$ at the end of September. The naira however,

appreciated by 0.16% to N198.77/$ at the Interbank Foreign Ex-

change Market (IFEM) on October 22nd compared to N199.08/$ at

the end of September. The IATA rate of exchange remained flat at

N200/$ during the same period under review.

Outlook

The CBN has reiterated that currency devaluation is unlikely but

the pressure on the naira is expected to continue with no signifi-

cant accretion in external reserves.

External Reserves

Nigeria’s external reserves fell by 0.99% ($300m) to $30.04bn as

at October 21st. Year to date, the reserves level has declined by

12.9% ($4.45bn). The level of import and payments cover is

down to 4.86months from 4.92 months at the end of September.

Page 17



Source: FMDQ, FDC Research

Chart 2: Forex N/$

Source: CBN, FDC Research

Chart 3: External Reserves ($'bn)



Stock Market

The expected release of the ministerial list drove positive market

sentiments as investors expect a mini market rally to follow the

announcement of a cabinet. The market managed to sustain

gains recorded in the first two weeks of the month.

Sentiments were buoyed by the expected release of the ministe-

rial list, and positive reports by the military on containment of the

terrorist group in the North-East.

The NSE ASI gained 2.99% from 30,311.77 to 31,217.77 its high-

est in Seven weeks. Market capitalization also increased by 1.69%

from N10.42trn to N10.59trn. Consequently, the year-to-date

(YTD) return in the market was -9.92%.

All sectors recorded positive performance in the second half of the

month.

The consumer goods sector had the best performance: gaining

4.97% during the period despite rising inflation, Nigerian Brewer-

ies, NASCON and Nestle managed to drag the oil and gas sector

into positive territory with combined gains of 22% during the pe-

riod.

During the period, financial services sector dominated activities on

the exchange accounting for 55.99% of total value traded. Con-

sumer goods sector accounted for 19.40% whilst industrial goods,

conglomerates, oil and gas and accounted for: 10.13%, 7.33%,

5.25% respectively. Total volume of shares traded within the pe-

riod was 3.37bn, while market breadth increased to 1.07x as 44

stocks advanced against 41 stocks that declined. 108 stocks re-

mained unchanged during the period under review.

In line with our expectations, the MPC at its just concluded bi-

monthly meeting, decided to reduce the Cash Reserve Require-

ment (CRR) to 25.0% from 31.0% and maintain the going rate of

13% for the MPR

We expect that this decision would help to ease the liquidity

crunch in the system and have a net positive impact on banking

stocks in Q4.

Page 19



Source: NSE

Chart 4: Sectors in September 2015

Outlook

Positive sentiments may drive the Nigeria equities market in the

first two weeks of the month after the ministerial list is released

and investors play out likely policy scenarios. We expect renewed

interest in the exchange by local investors as market activities

pick up. Long-term investors will likely wait for Q3 results after

which they will take positions in undervalued stocks.

However, poor Q3 results may dampen investor confidence as the

effects of government policies may partially affect Q3 results. Ef-

fects of these policies will be felt the most in Q4 due to policy

lags. Some level of volatility is expected in the first two weeks of

the month, as speculators will attempt to take advantage of mar-

ket sentiments.



Page 20

Corporate Focus - PZ Cusson Nigeria Plc

Sector : Fast Moving Consumer Goods

Ticker Symbols:NSE Bloomberg: PZ:NL Reuters: PZ:LG

FT: PZ:LAG

Shares Outstanding: 4.2b TP Downside: 12.91%

Target Price: N22.97 Market Cap: N86.99b 2015

Annual Dividend: N0.61 2015 Annual Dividend Yield: 2.53

Price:N25.39

PZ CUSSON NIGERIA PLC: Old assumptions not necessary

for new economic normalcy

Analysts Recommendation: SELL

Recommendation Period: 9 months

Analysts Note: Current economic conditions likely to

constrain top-line and bottom-line growth

The manufacturing sector has been resilient despite facing turbu-

lence. The current economic conditions; naira devaluation, tight

monetary and fiscal policy/directives, lower oil prices, low external

reserves and security challenges in the North-East region have all

contributed to stifling the country’s business environment. PZ

Cussons Plc has not been isolated from the impact of these

trends. It reported first quarter revenue (Q1’15) of N14.95 billion

representing a 0.44% decline from the previous year. On a 5-year

trend, decreasing revenue has been observed which can be tied to

the economic conditions. Its cost of sales for Q1’15 stood at

N10.82bn representing 72.4% of Sales. This represents a mar-

ginal reduction in cost of sales when compared to Q1’14 ratio of

73.09% thus attesting to the company’s ongoing cost reduction

programme. As a result, the stock is overvalued and we are rec-

ommending to SELL.

Profile

PZ Cussons Nigeria dates back to December 4, 1948 under the

name PB Nicholas & Company Limited. It became Alagbon Indus-



Page 21

tries Limited in 1960 and in 1972 it was listed on the Nigerian

Stock Exchange (NSE). In 1976, it changed its name to Paterson

Zochonis Industries Limited and later adopted PZ Cussons Nigeria

Plc in 2007, which is its current name. Over the years, PZ Cus-

sons has evolved to become one of the leading brands in the

country by gaining deep insight into the Nigerian market, its con-

sumers and general landscape. The company has collaborated

with strategic companies such as Wilmar International and Glanbi-

ato successfully provide products that meet consumers’ needs. It

focuses on the manufacturing, distribution and sale of a number

of consumer products including: detergents, soaps, cosmetics,

medications, confectionery, refrigerators, freezers, air condition-

ers and home appliances. The company remains the market

leader in the toilet soap and baby soap segment.

Page 22



Business Segment Brands

Home Care Elephant, Zip, Jet, Tempo, Rex, Morning Fresh

Soaps

Medicaments

Hair Care

Baby Care

Skin Care

Perfumes

Household Appliances

Consumer Electronics

Electrical retail

Nutrition

Palm Oil

Premier, Imperial Leather, Joy, Duck, Canoe, Drum

Robb, Heatol, Super Robb, Medicated Dusting

Powder

Venus, Joy

Nigerian Baby Care, Cussons Baby Range

Venus, Stella Pomade, Joy, Carex

Dan Duala, Venus Gold, Joy Cologne

Haier Thermocool

Haier Thermocool

Cool World

Coast; Yo; Nunu; Bliss

Mamador; Kings Refined Palm Olein

At its core, PZ Cussons Plc is rivalled by Nestle, Cadbury, GlaxoS-

mithKline (GSK) and Unilever. However, its unique selling point is

its broad distribution network, which spans 25 channels across the

country. It's strategic investment in distribution centres ensure

that PZ Cussons can reduce cost and reach remote markets of Ni-

geria. The challenge with a wide network is that PZ Cussons's po-

tential for geographical expansion is limited. Increased pressure

on disposable income will continue to present PZ Cussons with

some challenges, its revenue will brace the impact.

Aware of these limitations, the company has embarked on a cost

reduction programme and has initiated a brand renovation pro-

gramme in its value add portfolio such as Premier soap. In addi-

tion, it is increasing capacity utilization of its palm oil joint venture

with Wilmar Nigeria Limited.

Page 23



PZ CUSSON NIG. PLC

2011 2012 2013 2014 2015 CAGR

N'000 N'000 N'000 N'000 N'000 %

Non-Current Assets 25,034,942

24,360,347

24,370,445

24,485,136

25,217,847 0.15%

Current Assets 43,891,587

40,046,450

47,925,975

46,480,599

42,170,067

-0.80%

Total Non-Current Liabilities 3,670,536

4,426,382

4,462,476

4,475,105

4,152,489 2.50%

Total Current Liabilities 22,087,259

17,112,373

21,397,087

23,952,048

19,562,981

-2.40%

Net Assets 43,168,734

42,868,042

46,436,857

42,538,582

43,672,444 0.23%

CAPITAL AND RESERVES

Share Capital

1,588,191

1,985,238

1,985,238

1,985,238

1,985,238 4.56%

Share Premium

6,878,269

6,878,269

6,878,269

6,878,269

6,878,269 0.00%

Other Reserves

32,726,881

32,065,610

35,252,554

31,711,254

32,573,287

-0.09%

Non-Controlling Interest

1,975,393

1,938,925

2,320,796

1,963,821

2,235,650 2.51%

Total Equity

43,168,734

42,868,042

46,436,857

42,538,582

43,672,444 0.23%

COMPREHENSIVE INCOME

Revenue 65,877,984

72,154,601

71,343,088

72,905,679

73,126,070 2.11%

Profit Before Tax 8,025,266

4,306,863

7,650,265

6,949,985

6,556,814

-3.96%

Taxation 2,328,200

1,768,017

2,329,078

1,867,238

1,986,027

-3.13%

Profit After Tax 5,697,066

2,538,846

5,321,187

5,082,747

4,570,787

-4.31%

Management

At the helm of PZ Cussons Plc is Chief Executive Officer Mr. Chris-

tos Giannopoulos who joined the group in July 1988 and the Nige-

rian subsidiary in 2002. He has been the CEO since 2009 and pre-

viously served in several managerial roles including Managing Di-

rector of Soap & Detergent, Managing Director of PZ Cussons

Kenya Plc, Managing Director of Supply Chain, and Chief Operat-

ing Officer of PZ Cussons Nigeria Plc. The company’s executive

management team comprises of respected and experienced mem-

bers who have worked in PZ Cussons for a considerable time in

various capacities. They include: Mr. David Petzer, Chief Financial

Officer; Ms Joyce Folake-Coke, Human Resource Executive Direc-

tor; and Mrs. Yomi Ifaturotin, Corporate Affairs Director among

others.

What the Bulls and Bears Say

The Bulls Say:

PZ Cussons Plc's extensive distribution network cuts across

the country and would prove costly and difficult for a new

entrant to replicate.

The company’s revenues are relatively diversified and thus

resilient in the present economic downturn.

Effective marketing and an adaptive product portfolio has

served as an economic moat in periods of shifting consumer

tastes and increased pressure on disposable income.

The buy-out stake of Glanbia Limited presents an opportu-

nity for further investment thus ensures control of its sup-

ply chain.

With the company’s access to cheap funds from its parent

company, its finance war-chest can be called to bear to re-

duce its cost of funding.

The company’s loans are primarily in US dollar but its ex-

posure is limited (approximately 5% debt to equity)



Page 25

The Bears Say:

Despite the company’s product popularity; the drive for in-

creased market share from competitors will intensify from

rival companies such as Unilever, Cadbury and Nestle

Its product price increase may weigh on demand of its prod-

ucts thus affecting revenue growth

Exchange rate depreciation and the inflation rate upswing

will pressure the pricing of most PZ Cussons’s products

The current economic climate and outlook, generally weighs

on the sector and market.

– Dampens the purchasing power of many Nigerians

– Insecurity in the northern region of the country

Investment Thesis

FDC’s SELL recommendation on PZ Cussons Plc stock for a period of

nine months is based on a discounted cash flow valuation, earnings

growth and prevailing macroeconomic conditions. Over the past five

years, the company’s earnings growth has shown a downward trend

and thus is likely to translate to a lower share price in the near fu-

ture. The company’s stock is currently over -valued by 12.96%

based on its October 2, 2015 trading share price.

First quarter results for 2015 saw revenue decline by 0.44% versus

a 0.31% decline in the prior year. For the rest of the year, revenue

is expected to grow by 1.5% as against 0.3% recorded. The com-

pany’s profit after tax (PAT) fell by 33.33% from N641.69million

recorded in Q1’14. In addition, distribution, administrative and

other expenses as a percentage of sales increased from 21.59% in

Q1’14 to 23.3% in Q1’15. Factors such as the naira devaluation,

lower consumer disposable income, and higher inflationary pres-

sures are to blame for the weak earnings and net income, despite

PZ Cussons’s limited exposure to the naira. On the brighter side,

the company has maintained a consistent paying policy for over 10

years. We feel this will continue, but we expect a downward review

in dividend payout.

Page 26



Overall, we believe efficiency gains from current innovation, the

growing demand for both consumer products and white goods are a

plus. However, the unfavorable macroeconomic conditions will be

its encumbrance in growing its revenues. Consequently, the com-

pany is overvalued.

PZ Cussons Plc Valuation using DCF/FCFE:

Our intrinsic value for PZ Cussons Plc was arrived at by using a Dis-

counted Cash Flow (DCF) valuation method. Key assumptions in-

clude:

The DCF valuation method is based on a four (4) year fore-

casted financial statement.

We assumed a terminal growth rate of 4.5% in estimating

the company’s future cash flows’.

The target price of PZ Cussons Plc is N22.11, which is a

12.96% discount to the current price of N25.39 as at Octo-

ber 2, 2015.

A cost of equity of 10%. Beta of 0.6234

Capital expenditure over the foreseeable future of four years

is projected to grow at 0.4%.

Over the past five years, PZ Cussons Plc's cost of sales, dis-

tribution administrative and marketing expenses have aver-

aged 73.8% and 17.1% respectively.



Page 27

4 Year Free CashFlow to Equity Projections

PZ CUSSON NIG. PLC 2016 2017 2018 2019

N'000 N'000 N'000 N'000

Turnover/Revenue

74,222,961

75,633,197

77,297,128

79,074,962

EBITDA

19,158,695

19,522,710

19,952,210

20,411,111

EBIT

6,763,460

6,891,966

7,043,589

7,205,592

Less: Cash Taxes @ 32%

(2,132,691)

(2,173,213)

(2,221,023)

(2,272,107)

Tax-effected EBIT (NOPAT)

4,630,769

4,718,754

4,822,566

4,933,485

Plus: Depreciation & Amortization

12,395,234

12,630,744

12,908,620

13,205,519

Capital Expenditures

(610,694)

(490,742)

(579,024)

(618,661)

Change in Net Working Capital

(1,700,706)

(461,848)

(544,932)

(582,235)

Unlevered Free CashFlow

14,714,604

16,396,907

16,607,230

16,938,107

WACC @ 10% 10%

NPV of Unlevered Free Cash Flow

50,882,990

Perpetuity Growth Rate

Undiscounted Discounted EBITDA Multiple

Perpetuity Growth Rate 4.5% 92,376,005 62,908,587 4.53

Discounted Cash Flow 113,791,577

Equity Value 93,321,218

Implied Price Per Share 22.11

Risk

The country’s prevailing macroeconomic conditions and negative

sentiment; the expulsion of Nigeria from the JP Morgan index; the

slowdown in foreign portfolio investments; and the Central bank

of Nigeria (CBN) ban on foreign currency deposits and forty-one

(41) items forex ban all have the potential to impact PZ Cussons

Plc in the form of market risks, security risks and economic uncer-

tainty.

Page 28



Important Notice

This document is issued by Financial Derivatives Company. It is for information purposes only. It does not constitute any offer, recommendation or solicitation to any person to enter into

any transaction or adopt any hedging, trading or investment strategy, nor does it constitute any prediction of likely future movements in rates or prices or any representation that any such

future movements will not exceed those shown in any illustration. All rates and figures appearing are for illustrative purposes. You are advised to make your own independent judgment with

respect to any matter contained herein.

PZ Cussons’s financials could be affected by commodity price fluc-

tuations, particularly for raw material such as Crude Palm Oil (CPO),

tallow, sodium lauryl esther sulfate (SLES), and linear alkylbenzene

(LAB). The company is also, exposed to currency risks on foreign

denominated borrowings from PZ Cussons' Treasury Centre-Middle

East & Africa Limited. Exposure though insignificant, could reduce

profit accruable to equity holders in terms of high finance costs.

Nevertheless, given the macroeconomic conditions, interest rate

hikes are unlikely due to an already tightened monetary policy.

Finally, the security issues have persisted for quite a while in the

North-East region, disrupting major economic activities, restricting

geographical distribution and the sale of PZ Cussons’s products. The

presence of an experienced and quality management team have

consistently managed the macroeconomic challenges and will con-

tinue to be called upon to affect innovation, exploit success, and

ensure continuous productivity improvement and organized aban-

donment in order to navigate this turbulent period.



Page 29

Economy & Finance

FDC bi-monthly economic and business update - October 22, 2015