Smart Investor: a frothy punt on African demand

FTSE 250-listed PZ Cussons (PZC.L) provides personal care, home care, food and nutrition, and electrical products to consumers in Africa, Asia and Europe.

Some of its well-known brands include Original Source, St. Tropez, Imperial Leather and Fudge, although its biggest brands are found in its biggest market: Africa. PZ Cussons began life in West Africa when George Paterson and George Zochonis (the ‘P’ and the ‘Z’ in PZ Cussons) set up a trading post in 1879.

Twenty years later, the company opened up its first branch in Nigeria, and over the past 113 years it has acquired a large number of businesses, including Cussons in 1975, gradually increasing its geographical scope to include Asia (18.5% of 2012 revenue) and Europe (39.3% of 2012 revenue) as well as Africa (42.2% of 2012 revenue).

Today, it employs 7,000 people and, with a market capitalisation of £1.5 billion, is the 164^th-biggest UK-listed company.

Performance review

Over the past five years, PZ Cussons has been able to turn a net profit each year. However, after profits rose from £47 million in 2008 to £70 million in 2011, they fell to £34 million in 2012. This was mainly due to economic and social difficulties in its biggest single market, Nigeria, although the company still managed to deliver an average return on equity (ROE) over the period of 12.5%. This is impressive, although it was substantially less than this last year at 7.5%.

In spite of a fall of 51.4% in net profit, PZ Cussons increased its dividend to 6.72p per share in 2012, meaning the shares currently yield 1.9%. Although last year’s earnings-per-share (EPS) figure was affected by highly challenging trading conditions in Nigeria, the company’s payout ratio prior to 2012 has been rather mean, with it averaging 42% in the four years to 2011.

Perhaps management were being cautious, but it does appear to be low. Moreover, the yield of 1.9% is well below the FTSE 250 average yield of around 3.6%.

As for financial soundness, PZ Cussons has very low financial gearing of 19.8% using the debt-to-equity ratio. This means interest cover is very high at 13.8. However, while on the topic of viability, the company’s significant exposure to one market, Nigeria, must be viewed as a major risk for investors in the company.

Country risk

Nigeria has been a highly profitable market for the company in the past and it has huge potential for growth in future. On the one hand, such vast exposure could be a major boon for the company, should Nigeria’s economy perform well.

However, the flip side is that if the country experiences economic problems (as it has done during 2012, which coincided with the removal of the fuel duty subsidy) then PZ Cussons will struggle to turn a substantial profit – as has been the case this year.

So, although putting many of your eggs in one basket has the potential to pay off generously, it also includes great risk.

My verdict

With shares currently priced at £3.50, PZ Cussons trades on a price-to-earnings (P/E) ratio of 43.8 and a price-to-book ratio of 3.3. Although the price-to-book ratio is not catastrophically high, the P/E ratio is. Of course, supporters of the company will argue that I am using (unadjusted) earnings per share from what was a very difficult year for the company, but even using the previous year’s EPS figure (when the company made a record profit) still gives a P/E of 21.5.

Although PZ Cussons has performed well over the past five years in spite of challenging trading conditions, and although it has an impressive return on equity (especially when low financial gearing levels are taken into account) and is financially sound, its price is simply too high to merit investment.

Moreover, the company’s reliance on one market for much of its revenue creates a significant amount of risk for which investors are not being compensated.

Of course, Nigeria’s economy may have a brighter 2013, and I sincerely hope it does. But the current share price assumes this to be the case when, in reality, it is not a foregone conclusion.