Nestle Nigeria Plc may not have the room to borrow more as there are more debts in its capital structure, rising bond yields and sporadic devaluation means dollar denominated obligations to creditors could sour.
The largest consumer goods giant by market capitalization in Africa’s largest economy has a debt to equity ratio of 222.98 percent in June 2021, and that compares with 140.0 percent the previous year, according to MoneyCentral calculations.
The debt-to-equity (D/E) ratio is used to evaluate a company’s financial leverage and is calculated by dividing a company’s total liabilities by its shareholder equity.
The D/E ratio is an important metric used in corporate finance. It is a measure of the degree to which a company is financing its operations through debt versus wholly owned funds. More specifically, it reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn.
During the period of economic downturn, companies scale back on business expansion, and that crimps earnings that are used to service interest expenses.
That exposes the firms to liquidation, and their assets will be sold and proceeds shared among creditors starting with bondholders, but equity holders will be settled last as they are risk takers.
A quick look at the books of Nestle Nigeria shows debt to equity and borrowing were very low at 13.83 percent 13.98 percent in 2018 and 2019 respectively as it raised capital through rights issues in those periods.
Perhaps more worrisome is that equity (equity plus retained earnings) is shrinking, while debt is rising.
And the reasons are not too far fetched as weak consumer purchasing power brought on by inflationary pressure and high transportation cost/utility bills, and rising cost of production due to devaluation and decrepit infrastructure are responsible for deteriorating profit margins.
The yield on Nigeria 10 government bond price has weakened, sending yields rising, which makes it more expensive for companies to borrow and service existing debt.
The Nigeria 10 years government bond has a 12.546% yield as at July 29, and a minimum yield of 4.048 percent as at November 3, 2020.
There is light at the end of the tunnel because Nestle’s operating income is strong enough to cover interest expenses as it has an interest coverage of 10.71 times; this means operating income is 10.17 times finance cost.
But currency volatility is another headwind that is spooking investors at the moment because the debt of companies that borrow in foreign currencies will spike, which undermines cash flows.