Nigeria Capital Structure and Profitability Report 2018

NIGERIAN CAPITAL STRUCTURE & PROFITABILITY REPORT

2018

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NIGERIAN CAPITAL STRUCTURE & PROFITABILITY REPORT

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2018

BUSINESSDAY RESEARCH & INTELLIGENCE UNIT

NIGERIAN CAPITAL STRUCTURE & PROFITABILITY REPORT

2018

BusinessDay Research & Intelligence Unit (BRIU) is a Strategic Business Unit (SBU) within the BusinessDay Group, publishers of Nigeria’s leading business & financial newspaper. BRIU operates as an independent department within the organisation. The Unit’s products and services comprise: • Cutting-edge business intelligence and market research studies; • Industry analysis & reports; • Feasibility studies & business plans; • Client-specific research projects and strategic planning; and • Polling and surveys covering industries and business segments.

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Our clientele comprise state governments and federal government agencies, as well as private sector businesses. BRIU has consulted for across banking, insurance, financial services, manufacturing, healthcare, ICT, etc.

Our team of research analysts also contribute business intelligence and economic research articles to the BusinessDay newspaper. We are committed to providing you with the latest insights and perceptions, as well as current trends and developments on business and sectorwide issues within our economy and nation space.

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Contents Page Executive Summary 8 Introduction 6 Capital Structure Analysis Debt to Equity Ratio 7 Debt to Asset Ratio 8 Firms’ Profitability Return on Capital 8 Returns on Assets 9 Pertinent Information on the NSE-30Firms 10 Market Capitalisation of the NSE-30 Key Findings 12 Conclusion 13 Appendices 14 Methodology 14

Results 15 Descriptive Statistics 15 Correlation Analysis 16 Regression Analysis 16

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Capital Structure and Profitability in Nigeria • A look at the NSE- 30 companies Executive Summary The capital structure decision is important for firms as they strive to eke out maximum returns to stakeholders, because it affects the firms’ competitive abilities in a variety of ways. Finance managers of firms are therefore often faced with the task of determining the level of debt and equity mix to use in their operations to reduce cost of capital and increase shareholders value.

Our study of the link between the level of debt finance employed by Nigerian firms and their profitability revealed an inverse relationship. Analyses of the financial statements of the companies in the NSE-30 index of The Nigerian Stock Exchange showed that the companies with high level of debt in their capital structure performed poorer than companies that otherwise have low debt in their capital structure.

This observation is supported by statistical analyses of the financial data of the companies. We used correlation and the panel regression model to examine the relationship between capital structure of the firms and their profitability. Results of the various analyses we did show that profitability levels of the firms bear inverse relationship with leverage.

Firms1 in the agricultural sector, which had the lowest average debt-to-asset ratio of 9.27 in 2016 generated the highest profit from their assets than any other sector in the NSE-30 in 2016, having recorded a return on assets (ROA) of 26.71%. Conversely, companies in the conglomerates sector had the highest average debt-to-assets ratio of 42.45; these companies posted negative average ROA (-0.43).

Therefore, it is imperative that financial managers of Nigerian firms re-examine their current debt-equity mix in order to find ways of reorganising it to deliver optimum value to shareholders.

1In this brief, firms and companies are used interchangeably in the same sense to mean a commercial business enterprise.

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Introduction The capital structure decision is important for firms as they strive to eke out maximum returns to stakeholders, because it affects the firms’ competitive abilities in a number of ways. Firms finance their operations and growth by using a combination of debt and equity financing. While the debt financing can be short-term or long-term, equity (whether common or preferred) is usually relatively permanent.

Managers often adopt a strategy of mixing debt and equity in their capital structure in a bid to reduce their firms’ cost of capital and increase the value to shareholders. It is an accepted convention in finance that higher debt should lead to increased firm value because of tax benefits2. Sometimes, the expected value from adding debt to a firm’s capital mix does not accrue to firms for a number of reasons outside the scope of this brief.

In this brief, we have tried to appraise the nexus between Nigerian firm’s capital structure and their profitability, by analysing the companies on The Nigerian Stock Exchange index of the 30 most capitalised and most liquid stocks in the different sectors of the Exchange (NSE-30 Index), a modified market capitalization index with the number of stocks fixed at 30. The shares of these companies are usually considered blue chip stocks, which have traded for at least 70 per cent of the number of times the market (i.e. The NSE) opened for business3.

• Debt to Equity • Debt to Assets Capital Structure

Profitability • Return on Capital • Return on Assets

Source: BRIU’s Analysis

2Interest on corporate debt is tax deductible (see Modigliani and Miller’s Capital Structure Theory, 1963) 3See http://www.nse.com.ng/mediacenter/pressreleases/Pages/2017-Reviews-Composition-of-Market-Indices.aspx

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Capital Structure Analysis Debt to Equity Ratio The debt to equity ratio (D/E) gauges the extent to which a company has used borrowed money to fund its projects. Our analysis revealed that between 2015 and 20164, the construction sector recorded the highest average D/E of 102.12 and 131.03, respectively. This implies that for every N1 invested by the shareholders of the companies in this sector, the companies borrowed N102.12 in 2015 and N131 in 2016.

The high value of debt can be attributed to the nature of the sector as it requires huge investment in property, plants and equipment. A low D/E should be preferred since investors’ interests will better be protected if the fortunes of the businesses decline.

The Agricultural sector recorded the lowest debt to equity ratio of 25 and 13.9 in 2015 and 2016 respectively. In this context however, it may not be best practice to compare the D/E ratios of different sectors as a D/E ratio that is optimal for a particular sector may be sub-optimal for another sector.

Average Debt to Equity Composition of NSE-30 Sectors (%) 103 58.03 51.78

Oil & Gas

61.91

48.99

86.24

Industrial Goods Financial Services

98.81

64.57

Consumer Goods

131.03

113.99 24.96

102.23

88.23 13.91

Construction

Conglomerates Agriculture

Debt to Equity (2016)

Debt to Equity (2015)

Source: Bloomberg, BRIU’s Analysis

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Debt-to-Assets-Ratio The debt-to-assets-ratio (D/A) is employed to examine the proportion of a company’s assets that have been financed with either debt or equity. An analysis of the financials of the NSE-30 companies revealed that a substantial portion of their assets is financed by shareholders’ equity, as the D/A is less than one. The conglomerates sector had the highest D/A in both 2015 and 2016, while the construction sector had the lowest D/A of 10.12 in 2015. Agriculture had the lowest D/A of 9.27 in 2016.

Sectoral Analysis of Average Debt to Asset Ratio of the NSE-30 (%) 42.45 27.92 20.26 18.09

Oil & Gas

24.38 15.79

24.89 13.52

12.80 21.78

14.75

38.06

10.12

Industrial Goods Financial Services Consumer Goods Construction

9.27

Conglomerates

Debt to Asset (2016)

Agriculture

Debt to Asset (2015)

Source: Bloomberg, BRIU’s Analysis

Firms’ Profitability Return on Capital As a measure of profitability, return on capital (ROC) indicates the effectiveness of the firms’ management in transforming their capital into profits. In 2016, the agricultural sector had the highest return on capital of 37.73 per cent, while the construction/real estate sector had the lowest ROC of one per cent in the same year.

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Average Return on Capital of the NSE-30 Sectors (%)

23.73

16.68

Oil & Gas

37.73 18.14 14.47

15.78 5.66 5.63

13.07

Industrial Goods Financial Services Consumer Goods

7.97

Construction

4.11 2.68

Conglomerates ROC (2016)

11.26

Agriculture ROC (2015)

Source: Bloomberg, BRIU’s Analysis

Returns on Assets Our review showed that the agricultural sector generated the most profit from its assets than any other sector in the NSE-30 in 2016, as it recorded a return on assets (ROA) of 26.71 per cent, 17.65 per cent higher than the ROA of the industrial goods sector, which generated the next highest ROA of 9.06 per cent.

The construction and conglomerates sectors recorded negative returns (-1.19 per cent and -0.43 per cent respectively) in 2016. In 2015, the industrial goods sector had the highest ROA of 12.15 per cent, followed by the agricultural sector with a ROA of 7.40 per cent.

Sectoral Analysis of the Average Return on Assets of the NSE-30 (%) 26.71 12.15 5.75 5.23

Oil & Gas

9.06

1.91 1.73

5.95 5.00

0.70

0.21

-1.19

-0.43

Industrial Goods Financial Services Consumer Goods Construction

Conglomerates ROC (2016)

7.40

Agriculture ROC (2015)

Source: Bloomberg, BRIU’s Analysis

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Pertinent Information on the NSE-30Firms

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S/N

Firms

Sector

Sub-sector

Date of Incorporation

Market Cap. (N’bn)5

1

Access Bank Plc

Financial Services

Banking

February 8th, 1989

345.7

2

Dangote Flour Mills Plc

Consumer Goods

Food Products

January 1st, 2006

79.8

3

Dangote Cement Plc

Industrial Goods

Building Materials

February 17th, 2010

4,544.7

4

Dangote Sugar Refinery Plc

Consumer Goods

Food Products

January 4th, 2005

261

5

Diamond Bank Plc

Financial Services

Banking

December 20th, 1990

68.1

6

Ecobank Transnational Incorporated

Financial Services

Banking

October 3rd, 1985

360.6

7

Fidelity Bank PLC

Financial Services

Banking

November 19th, 1987

94.5

8

Flour Mills Nig. PLC

Consumer Goods

Food Products

September 29th, 1960

85.6

9

Forte Oil PLC

Oil and Gas

Petroleum and Petroleum Products

November 12th, 1964

62.8

10

Guaranty Trust Bank PLC

Financial Services

Banking

July 20th, 1990

1,412.7

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Guinness Nigeria PLC

Consumer Goods

Beverages – Brewers/Distillers

April 29th, 1950

240.9

12

International Breweries PLC

Consumer Goods

Beverages – Brewers/Distillers

December 22nd, 1971

507.2

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Julius Berger Nig. PLC

February 18th, 1970

36

14

Lafarge Africa PLC (WAPCO)

Industrial Goods

Building Materials

February 24th, 1959

289.9

15

FBN Holdings PLC

Financial Services

Other Financial Institutions

August 13th, 2012

430.7

16

11 PLC (MOBIL)

Oil and Gas

Petroleum and Petroleum Products

December 31st, 1951

71.9

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NASCON Allied Industries PLC

Consumer Goods

Food Products

April 30th, 1973

55.6

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Nigerian Breweries PLC

Consumer Goods

Beverages – Brewers/Distillers

November 16th, 1946

1,094.8

19

Nestle Nigeria PLC

Consumer Goods

Food Products – Diversified

September 25th, 1969

1,078

Construction/Real Infrastructure/ Estate Heavy Construction

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Okomu Oil Palm Plc Presco Plc

Agriculture

Crop Production

December 3rd, 1979

69.2

Agriculture

Crop Production

70

22

PZ Cussons Nigeria Plc

Consumer Goods

95.3

23

Seplat Petroleum Development Company Ltd. Stanbic IBTC Holdings Plc Total Nigeria Plc

Oil and Gas

Personal/ Household Products Exploration and Production

September 24th, 1991 April 12th, 1948

June 17th, 2009

403.1

March 14th, 2012

462.3

January 6th, 1956

78.1

Transnational Corporation of Nigeria Plc United Bank for Africa Plc Union Bank Nigeria Plc Unilever

Conglomerates

November 16th, 2004

87

February 23rd, 1961

410.4

Zenith International Bank Plc

Financial Services

21

24 25

26

27 28 29

30

Financial Services Oil and Gas

Financial Services Financial Services Consumer Goods

Other Financial Institutions Petroleum and Petroleum Products Diversified Industries Banking Banking Personal/ Household Products Banking

240.2

November 4th, 1923

284.1

May 30th, 1990

970.2

Source: NSE, BRIU’s Analysis

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Market Capitalisation of the NSE-30 Market capitalisation of the NSE-30: Replace the fourth sentence with this: The consumer goods sector accounted for 26.47 per cent of the NSE-30, with Nigerian Breweries Plc and Nestle Nigeria Plc the top players in terms of market capitalisation. The industrial goods sector, with a market capitalisation of N4.8 trillion, accounts for close to 34 per cent of the NSE 30 market capitalisation; Dangote Cement Plc in turn accounts for 94 per cent of the industrial goods market capitalisation. Similarly, 34 per cent of the total NSE-30 market capitalissation is attributable to the financial services sector. Nestle Nigeria PLC and Nigerian Breweries PLC also contributed greatly to the consumers’ goods market capitalisation. The sector with the lowest market capitalization is the Conglomerates Sector of N36 billion among the stocks in the NSE-30 is the construction sector, which comprised just 0.3 per cent of the index.

Sectoral Composition of the NSE-30 (%)

0.97

0.25

0.61

Agriculture

Conglomerates

Construction

26.47

33.56

33.83

Consumer Goods Financial Services Industrial Goods

4.31

Oil & Gas

Source: Bloomberg, BRIU’s Analysis

Key Findings The analysis of the schedule of profitability and capital debt-equity composition of the firms in the NSE-30 showed a negative relationship between high level of debt and the profitability of the companies. This is in line with the result of statistical analysis performed given that the sectors with higher D/E in the NSE-30 have lower ROC. ROC measures the profitability of firms and their ability to create value from the resources deployed in their operations.

Across all the sectors, the median ROC was 14.47 per cent in 2016, with agriculture and oil & gas sectors posting greater-than-median ROC of 37.73 per cent and 23.73 per cent respectively. The median D/E of the companies stood at 98.91 as the conglomerates sector (with D/E of 113.99), the construction sector (with D/E of 131.03), and financial services sector (with D/E of 103.00) all leveraged their balance sheets above the median levels.

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The ideal debt to equity ratio is that which maximizes the value and minimizes the cost of capital of the firm. Hence, the negative relationship between the firms’ leverage levels and their profitability indicates the firms may have exceeded the optimum debt levels, thereby losing the potential benefits accruing from debt financing (i.e. low cost of capital due to tax deductibility of interest on debt capital).

We note that the optimal D/E ratio varies from one industry to another, as certain sectors are inclined to deploy more debt financing than others. The financial services sector, for instance, borrows money in order to grant credit to customers; a high debt-to-equity ratio is to be expected as a result. Similarly, the construction/real estate and the conglomerates sectors borrow huge funds to power their capital-intensive operations.

Conclusion The capital structure decision is a critical aspect of a company’s competitive strategies as it affects its ability to generate profits and deliver returns to stakeholders. On the average, 15.17 per cent of the assets of companies in the NSE-30 are financed by debt within the ten-year period we reviewed (2007-2016).

We used correlation and the panel regression model to examine the relationship between capital structure of the firms and their profitability. Results of the various analyses showed that the profitability of the firms was inversely related to their leverage (i.e. their D/E ratio).

This means that increasing leverage adversely affects the profitability of firms.

This negative relationship may be as a result of the high cost of borrowing in Nigeria, which may have eroded any benefits that should have accrued from the use of debt financing. As at September 2017, the average lending rate in Nigeria stood at 17.88 per cent as against single digit rates in most developed and emerging economies.

The debt-equity mix that guarantees the maximization of firms’ profitability and value is desired by companies. Hence, it is imperative that financial managers of Nigerian firms should re-examine their current debt-equity mix in order to find ways of reorganising it to deliver optimum value to shareholders.

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Appendices Methodology We used the companies on the NSE-30 in our study Sample and the data were collected from the financial statements of the firms, Bloomberg and The Nigerian Stock Exchange for a period of ten years (2007-2016). The return on capital and return on assets are used as proxies for firms’ profitability while total debt to total equity and total debt to total asset ratios are proxies of capital structure of the firms.

To examine the relationship between capital structure and the return on capital, we specify the following model: ROCit = αit + β1 TDTEit + β2TDTAit + β3 Growthit + μit Where ROC represents returns on capital, TDTE represents debt to equity ratio, TDTA stands for debt to asset ratio and Growth is the growth rate of the firms’ total assets. i represents the individual firm, t stands for the sample period and the error, μit cater for other factors that affects returns on capital.

To examine the nexus between capital structure and the return on capital, the model is specified as: ROAit = αit + β1 TDTEit + β2TDTAit + β3 Growthit + μit Where ROA represents returns on assets; TDTE represents debt to equity ratio; TDTA stands for debt to asset ratio; Growth is the growth rate of the firms’ total assets. i represents the individual firm, t stands for the sample period and the error, and μit represents other factors that affects returns on assets.

We used the growth rate of the total assets as a control variable to avoid endogeneity problem, as it affects the profitability ratio and is also correlated with the capital structure measures.

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Results 1.

Descriptive Statistics TDTA

TDTE

ROA

ROC

GROWTH

Mean

15.17

65.66

7.41

18.08

32.49

Median

11.45

51.89

3.71

12.92

14.44

Maximum

61.51

350.85

49.62

91.52

2379.21

Minimum

0.00

-32.06

-34.20

-65.20

-69.35

Std. Dev.

13.41

61.09

9.27

17.96

155.40

Skewness

1.10

0.96

0.65

14.19

Kurtosis

0.95 3.33

4.39

6.53

6.68

214.08

Jarque-Bera

38.26

69.42

164.71

155.30

463065.50

Probability

0.0000

0.0000

0.0000

0.0000

0.0000

245

245

245

245

245

Observations Source: BRIU’s Analysis

The descriptive statistics revealed that over the ten-year period, that is 2007 to 2016, the D/E ranged from 0 per cent to 61.5 per cent, with an average value of 15.2 per cent and a standard deviation of 13.4 per cent, indicating the level of variations in the ratio. The mean value of the D/E implies that about 15.2 per cent of the assets of the NSE-30 Companies are financed by debts. The control variable, growth has the highest number of variability with a standard deviation of 155.4 per cent while return on asset’s standard deviation of 9.27 per cent is the variable with the lowest dispersion.

To establish the relationship between these variables, we used the correlation matrix as shown below.

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Correlation Analysis TDTA

TDTE

ROA

ROC

GROWTH

TDTA

1.00

0.71

-0.11

-0.22

-0.07

TDTE

0.71

1.00

-0.35

-0.31

-0.05

ROA

-0.11

-0.35

1.00

0.85

0.27

ROC

-0.22

-0.31

0.85

1.00

0.23

GROWTH

-0.07

-0.05

0.27

0.23

1.00

Variables

Source: BRIU’s Analysis

The value of 1.0 on the diagonal axis indicates that each variable is perfectly correlated with itself. From the correlation matrix, it can be observed that there is a negative relationship between D/E and ROA, ROC, and growth of assets. The implication of this is that as the debt to equity ratio of the NSE-30 companies increase, the returns on their assets and capital, as well as the growth of their assets decline.

3.

Regression Analysis Capital Structure and Firms’ Profitability (Returns on Capital)

Variables

Pooled

Fixed

Random

Constant

22.840*

25.827*

25.161*

TDTA

0.024

-0.463*

-0.322**

TDTE

-0.090*

-0.020

-0.037

GROWTH

0.025*

0.019*

0.020*

R-squared

0.139

0.647

0.148

12.98 (0.000)

12.14 (0.000)

13.97 (0.000)

F-statistic (P-value) Hausman Test

4.49 (0.213)

* Significant at 1%; ** significant at 5% Source: BRIU’s Analysis

With reference to the result above, the F-Statistics of 12.98, 12.14 and 13.97 with a similar probability value of 0.000 illustrates joint statistical significance of the total debt to total assets, total debt to total equity and total assets growth in the pooled, fixed and random estimates. The R-squared statistics of these variables jointly account for about 13.9%, 64.7% and 14.8% variation on the profitability of the firms in the pooled, fixed and random effects estimates respectively. Since the probability value of the Hausman test statistics is greater than 5 per cent, the null hypothesis that differences in coefficient of the fixed and random estimates

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are not systematic should not be rejected, therefore the random effect model is accepted and interpreted. Going by the random effect estimates, there is a negative relationship between returns on capital and total debt to total assets and total debt to total equity. Hence, we conclude that high debt levels impact the firms’ profitability negatively (note the coefficient value of -0.113). This means that one percentage increase in the total debt to asset will decrease the return on capital by 11.3 per cent. The growth of total assets positively impacted the returns on capital over the sample period: the total assets growth of one per cent led to 2 per cent growth in returns on capital.

Capital Structure and Firms’ Profitability (Returns on Assets) Variables

Pooled

Fixed

Random

Constant

8.520*

9.623*

9.346*

TDTA

0.102

-0.199*

-0.113*

TDTE

-0.048*

0.005

-0.006

GROWTH

0.014*

0.009*

0.010*

R-squared

0.146

0.651

0.097

15.21(0.000)

13.85 (0.000)

9.56 (0.000)

F-statistic (P-value) Hausman Test

20.39 (0.000)

* Significant at 1%; ** significant at 5% Source: BRIU’s Analysis

Looking at the impact of capital structure of the NSE-30 companies on their profitability as measured as returns on assets, the F-Statistics shows that the debt to total assets, total debt to total equity and total assets growth in the pooled, fixed and random estimates are jointly statistically significant. The R-squared statistics of these variables jointly account for about 14.6%, 65.1% and 9.7% variation on the profitability of the firms in the pooled, fixed and random effects estimates respectively. The Hausman test probability value of zero is less than 5 per cent, thus we can reject null hypothesis that differences in coefficient of the fixed and random estimates are systematic.

As a metric of firms’ profitability, the returns on assets is significantly negatively correlated with to total debt to total asset and positively related to debt to equity and the growth of total assets. From the estimates, one per cent increase in the total debt to total assets will decrease the returns on assets by 19.9 per cent. The positive relationship between ROA and the total assets growth is also significant, and it shows that as the growth rate of total assets increases by one per cent, the returns on asset increase by 0.9 per cent.

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List of Acronyms NSE – Nigerian Stock Exchange D/E – Debt to Equity D/A – Debt to Asset TDTE – Total Debt to Total Equity TDTA – Total Debt to Total Asset ROC – Return on Capital ROA - Return on Assets

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Disclaimer This document has been prepared in good faith on the basis of information available at the date of publication.

BusinessDay Research & Intelligence Unit (BRIU) does not warrant the accuracy, reliability or completeness of the information in this report for the purpose of making any investment decision. Readers are advised to assess the relevance and accuracy of the content of this publication against the limitations noted herein.

BRIU will not be liable for any loss, damage, cost or expense incurred or arising by reason of any person using or relying on information in this publication.

The opinions/conclusions and suggestions in this report do not represent investment or other advice and should therefore not be construed as such.

This publication is a copyright. Apart from any use as permitted under Copyright Act 1968, Nigeria, no part contained herein may be reproduced, copied or duplicated in any form without prior written consent of BRIU.

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