Nigeria may have recently pulled out of its first economic recession in 25 years but sustained declines in the profit margins of its biggest corporations flash signs that the economy may be well on its way to another downturn next year if the fundamentals fail to improve in the near term.
Over the last six months, Nigeria’s real economic growth though remaining positive has decelerated for 2 consecutive quarters, posting GDP growth of 2.1 percent in the first quarter (Q1) of 2019, a decline from 2.38 percent recorded in the fourth quarter (Q4) 2018 and growth of 1.9 percent in the second quarter (Q2) 2019, which marked another decline from Q1 levels.
The Nigerian Stock Exchange which gives some representation of the performance of the economy as it houses some of the biggest companies in the country, offers a glance into the weakening economic fundamentals in the country.
Seven (7) of the nine (9) major sectors represented in the Exchange, recorded declines in their profit margins over the last 6 months, enabling economists to trace the potential source of weakening macroeconomic fundamentals.
Healthcare and Consumer Goods sectors on the local bourse felt the greatest hit to their net profit margins. The average net profit margin of companies in the Health sector dipped to 2.88 percent in the first half of 2019 from 5.38 percent at the end of 2018.
The healthcare sector contributes slightly over 6 tenths of a percent to the GDP of the country, so the decline in corporate margins in that sector is not as alarming as what was recorded in the consumer goods sector.
Consumer goods companies are represented by the Manufacturing sector in terms of GDP contribution and the Manufacturing sector is the fourth largest contributor to the Nigerian economy.
Profit margins of companies in the fast-moving consumer goods space are thinning as costs increase and revenues fail to grow as fast. The net profit margin in the FMCG sector on the NSE declined to 3.51 percent in the first six months of 2019 from 5.80 percent at the end of 2018.
The average net profit margin of Industrial goods firms dipped by 137 basis points in the space of six months to close at 13.74 percent, while Construction and Real Estate firms lost 98 basis points from last year’s margins.
The expectation for future profit margins, which may be a better indication of what is to come, is bearish, according to recent surveys conducted by BusinessDay on the Chief Financial Officers (CFOs) of some of the biggest companies in the country.
The CFOs, who were not authorised to share sensitive financial information publicly, hold little optimism for next year, as they analysed the implication of the government’s plan to increase taxes and lower infrastructure spending in 2020.
These factors including the sustained pressure on consumer spending and the indefinite border closure by the President since August 30, will only heap more pressure on company profits, according to Muda Yusuf, the director-general of the Lagos Chamber of Commerce and Industry (LCCI), a private sector advocacy group that draws membership across various sectors of the economy and works with some 2,000 local companies.
The border closure is having a ripple effect across West Africa, with factories and traders struggling to import key raw materials and having to use alternative routes for their exports.
“Declining profit margins is a reflection of the struggling economy, costs are rising and consumer spending is weak and that is bound to affect economic growth and cause another recession,” Yusuf said.
“The government’s nationalistic policies have not helped matters and unless there is a change of direction, it situation will get worse,” Yusuf added.
A real-sector induced economic recession doesn’t only hurt the profit margins of businesses but also crimps the government’s tax revenues in the form of company income tax.
Given that tax is a percentage of profit, lower profits will lead to reduced tax revenues for an already cash-strapped federal government.
The Federal government missed its target for company income tax (CIT) in 2018, after raising N637 billion, 20 percent below the N794 billion budget, according to data by the Budget Office.
The government has not provided details of CIT expectations for 2020 but expects to raise N1.7 trillion from non-oil revenue sources. CIT traditionally accounts for the largest chunk of non-oil revenues, followed by receipts from customs and Value Added Tax (VAT).
Lower profit margins also have an implication for job creation in a country bedevilled by record high unemployment rate. As at the third quarter of 2018, the National Bureau of Statistics reported unemployment rate of 23 percent. But at the current pace, it could climb to as high as 40 percent next year.
Obinna Uzoma, Chief Economist at EUA Intelligence, told BusinessDay that most companies seeking to protect their profit margins will be forced to look at ways to drive cost efficiency in the system which will include retrenching workers in order to reduce personnel cost and boost firm profitability.
“The declining margins mean that corporate organizations would fail to retain enough income to reinvest in the business and employ more workers. Investors also have the option to pull out operations as the operating environment becomes more stringent. “This could lead to higher unemployment and weaker consumer spending which hurts output growth in the economy,” Uzoma said.
“Such corporate strategy could trigger another recession next year, barely 3 years after exiting one. I see a lot of companies relying more on technology than people in the coming years to drive efficiency and this could make massive retrenching a scary reality,” Uzoma added.
The outlook for the global economy over the past months has been gloomy and in line with this, the new Managing Director of the International Monetary Fund, Kristalina Georgieva forecasts a slowdown in global growth.
However, this slowdown might hit the Nigerian economy faster than expected if margins of the companies that contribute the most to the Nigerian economy keep falling.
The split of aggregate demand between the private sector and the public sector is now at 91.5 percent to 8.5 percent, meaning that largest contributor to GDP growth is private sector investments which has consistently lagged since 2012, according to official data.
“The pace of economic recovery remains slow, as depressed private consumption and investors’ wait-and-see attitude kept growth in the first half of the year at 2 percent, a rate significantly below population growth,” the IMF said in a statement last week following a staff visit to Nigeria.
The economy expanded a tepid 2.02 percent in the first half of 2019, below the population growth rate of 2.6 percent. This implies that on per-capita basis the economy contracted and has done so since 2016 when per capita GDP first shrank.
Leading Nigerian economist, Ayo Teriba, said the government must act swiftly to attract huge private investments to avert another recession.
“The liquidity glut has opened a window for Nigeria to attract investments which will serve as a buffer against another recession but the government must go for it,” Teriba said.
LOLADE AKINMURELE & IFEANYI JOHN
