Proposed VAT hike from 5.0% to 10.0%

Proposed VAT hike from 5.0% to 10.0%

·         Food Manufacturers – neutral to negative

·         Consumer Goods – negative

·         Brewers – neutral, though with negative implications for excise duty

·         Cement – neutral

·         Negative cost implications for all companies

On Friday afternoon the Acting Executive Chairman of the Federal Inland Revenue Service (FIRS), Sunday Ogungbesan, told reporters that VAT could rise from 5.0% to 10.0%. Although he is only the Acting Executive Chairman, and as yet there is no Minister of Finance to propose this, and any change would have to be approved by parliament, we believe this is quite likely to happen under this government.

The reason is that, under tax law, 85% of VAT revenues go to state governments, the very public entities that are showing the most financial distress at the moment.  The former (until May) Coordinating Minister of the Economy Ngozi Okonjo-Iweala was in favour of raising VAT in her December 2014 budget review, arguing that raising VAT by 5 percentage points would raise N614.0bn (US$3.1bn) in extra government revenues.

Nigeria’s government revenues are c.70% derived from oil, with direct taxation, VAT and excise duties currently making up a small part. Clearly, with oil revenues down, there is pressure to improve the total tax take.

Schedule of VAT

The schedule of VAT is given in a 1997 document which is still in force.  Generally, basic materials (though not cement) are exempt, as are basic foods, though most prepared foods and consumer products attract VAT. Professional services also attract VAT, which has negative cost implications for most companies. A criticism of the current VAT regime is that it functions more like a Sales Tax than VAT as understood in other jurisdictions, and therefore the re-claiming element is not well developed.

Impact on sectors and companies

Food Manufacturers

Food manufacturers are likely to suffer the rise in VAT on some or most of their products. Although some basic products (like frozen meat) and infant food (we assume, for example, Nestle Nigeria’s Celerac) are exempt, a number of different prepared foods attract VAT which would rise from 5.0% to 10.0%.

Companies affected would be Nestle Nigeria (Hold, target price: N777.6/s, current price: N850.0/s), UACN (Buy, target price: N72.6/s, current price: N37.0/s) and GlaxoSmithkline Consumer Nigeria (Buy, target price: N78.6/s, current price: N40.0/s), we believe. The Nigerian consumer is under pressure generally, and a 4.8% (ie 110/105) price increase would be difficult to pass through, we believe, without some loss of volumes.

Consumer Goods

Consumer goods generally attract VAT, and since there are few exemptions in this sector we assume that most consumer products will have to be re-priced to reflect a rise in VAT from 5.0% to 10.0%. The impact on consumer goods companies would therefore be greater than on food manufacturers.

Companies affected would be PZ Cussons (Hold, target price: N29.7/s, current price: N34.5/s) and Unilever Nigeria (Sell, target price: N24.3/s, current price: N37.8/s).

Brewers

For brewers the issue, we believe, is not so much VAT as excise duty, and although excise duty has not been mentioned it would not be surprising to see increases in excise duty on beer and spirits in the context of a rise in VAT, we believe.

Companies affected would be Nigerian Breweries (Sell, target price: N127.7/s, current price: N135.0/s), Guinness Nigeria (Sell, target price: N111.0/s, current price: N131.0/s), and International Breweries (Hold, target price: N24.5/s, current price: N18.2/s).

Cement

Cement prices already include 5% VAT, (the ex-factory prices cited by the manufacturers are ex-VAT, but they do charge it to customers) and therefore it is likely that cement prices would suffer from any increase in VAT rates to 10.0%. However, there is very little price elasticity in cement demand.

For example, Dangote Cement’s (Buy, target price: N198.4/s, current price: N181.0/s) 9% cut in price from N1,460 (US$7.30) per 50 kg bag to N1,335 per 50 kg bag in September 2014, and then a further 14% cut to N1,150 in November, did not create any increase in demand, in our view. The company put its price up 36% in December to N1,567 per 50kg bag, and put it up a further 4% to N1,630/bag in March 2015. 

Dangote Cement’s volume sales in H1 2015 were down 7.5% y/y but its naira sales were up 2.7% y/y. We would attribute the weakness in volume sales to strong marketing and service delivery by its competitor Lafarge Africa (Under Review, current price N103.3/s), whose pricing is similar (if less volatile) and whose Nigerian sales grew 9% y/y in Q2 2015 with a volume increase of 3% y/y.

Costs to all companies

Many professional services used by companies attract VAT, so an increase in VAT rates could mildly inflate costs.  As noted above, one comment about Nigerian VAT is that it functions more as a Sales Tax than VAT as understood in other jurisdictions, which has some bearing on the ability to re-claim VAT.