Ideas & Debate

What you should consider in EABL bond investment

eabl

The EABL Ruaraka factory. The firm is seeking to raise Sh6 billion through medium term note programme. FILE PHOTO | NMG

East African Breweries Limited (EABL) launched the second tranche of a Sh11 billion medium term note (MTN) programme this week. In the first tranche, which opened for sale in mid-March 2015, strong demand enabled the company raise the entire Sh5 billion.

Its fine pricing at the time partly contributed to the success. This time, EABL wants to raise the programme’s balance of Sh6 billion. I’m calling on due caution with this issue. A few issues about the company have unnerved me since the last issue.

Specifically, I’m worried about the company’s failure to build free cash. In June 2010, EABL was debt-free and super liquid—closing the year with a cash of Sh8 billion.

Now they barely generate any free cash flow. And for a cash-intensive business, this should unnerve you.

Four quick issues on this one: first, the product mix, in my assessment, isn’t optimal—as there is still a strong emphasis towards low-margin products.

Second, they are giving too much concession to Ugandan distributors: discounted prices together with longer credit days: and this is a ruinous combination.

The Uganda issue, to me, is so serious that it has significantly contributed to the widening of working capital gap (hence EABL’s penchant for overdraft financing). 

Finally, South Sudan is bleeding money. I’m not comfortable with the manner in which they are managing these issues.

I also find EABL’s balance sheet a little bit congested: elevated debt financing and payables. This congestion has ensured that cash generated from operations remains encumbered.

This means they have to continue borrowing to finance capital expenditure (Capex). At some point, they even had to resort to a commercial paper programme. I don’t even know how they have continued to pay dividends.

Additionally, Diageo’s continued strangling of EABL still remains a big concern for me. I wrote about this three years ago. Sometimes I find Diageo’s relationship with EABL a little bit predatory.

A while back, they wanted EABL to acquire their majority stake in United Distillers Vintners (UDV) at a time when the former was in the middle of a cash-crunch.

I found this insensitive. The transaction could have involved cash offer or a share swap or even both. I’m not sure about the exact nature of the transaction’s consummation.

Secondly, Diageo pushed forward the supposed refinancing of the Sh4.9 billion cash EABL used to buy a 51 per cent stake in Tanzania’s Serengeti Breweries from 2014 to 2018.

Diageo was to exercise the option between February and July 2014 for a maximum value of $600 million. It was all based on the performance of Serengeti Breweries.

Of course Serengeti is yet to start making money. It reported a loss of Sh1.5 billion for the full year period ended June 2016. It looks like Diageo might further push forward exercising the option.

Well, to a certain extent, I can’t blame them on this. Then there is this expensive shareholder loan—which was predatorily priced. Essentially, minority shareholders in EABL should be concerned.

Finally, EABL has not finely priced the issue. I have come across an indicative pricing floor of 14.17 per cent. This is not inviting.

Remember after the regulatory seizure of Chase Bank and Imperial Bank, both of which had issued senior unsecured debt, the corporate debt market is still under water.

Additionally, the issue has not sufficiently premiumised risk-free pricings. Government’s last issue of a five-year bond was priced at 14.334 percent. 

The market has since moved downwards a bit—and the paper last traded at 13.4234 per cent. However, the market is now nose-up, with bids hovering between 14-14.30 per cent.

Are we saying that EABL can only premiumise risk-free assets by fewer than 100 basis points? Not forgetting that this is an unsecured note.

Look, I’m just trying to lay out an investment/divestment case by asking the tough questions. 

I have long held the belief that in fast moving consumer goods (FMCG), free cash is king. I get a bit uneasy when a business of the stature of EABL is not incubating enough free cash. And so should you, as the potential debt investor.