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Flour Mills Plc: Good results, bad fundamentals

*Investment analysts cautious on 2016/17 outlook

Against the prevailing economic headwinds Flour Mills of Nigeria Plc, FMN, appears to have found a way round the odds, following the stella results of its first quarter 2017 (Q1’17) ended June, which opened its 2016/17 financial year.

FMN’s Q1 ‘17 results showed marked growth on all key headline items with sales up by 45%   year-on-year (y/y) to N119.2 billion, and Profit Before Tax, PBT, up by a huge 394% y/y to N5.9 billion.

The growth in PBT was driven by a combination of factors including: slower growth (+6% y/y) in operating expenses (OPEX) relative to the double-digit (+45% y/y) growth on the top-line, a 14% y/y decline in interest expense.

To underscore the quality of the results, the books show all business segments in double digit growth except packaging segment that went down 6.0 per cent. Moreover, the growth was coming against price increases in prices of its products which could have led to volume decline but instead sales volume also increased. Sales increased by 51% q/q.

The stellar growth in FMN’s top-line was mainly due  to a  strong performance in the foods and agro-allied business,  both of which grew by 43% y/y and 61% y/y respectively to N90.6 billion and N25.2 billion respectively.

Operating Efficiency

Financial analysts observed that FMN had intensified its cost cutting measures over the period. In a bid to offset rising raw material costs (+49% YoY), FMN cutback on its direct labour costs (-3.7% YoY) with its cost optimization strategy also evident in the subdued movement in other input costs.

In the absence of substantial weakness in foreign exchange rate (mean rates QoQ: interbank: -6.1%, parallel: -7.4%) FMN’s cost control initiatives resulted in a slower rise in cost of goods sold, COGS,   (+44% YoY) relative to revenue (+45% YoY). Consequently, gross margin expanded 80bps YoY to 12.8%. Further cost savings in OPEX and interest expense helped drive FMN’s normalized earnings to its highest level in 21 quarters.

But impact of 6.0 per cent spike in administrative and distribution costs appeared diminished when compared to the 489 bps YoY rise in Earnings Before Interest and Tax (EBIT) to 9.0 per cent. This appeared to have been helped by a 14 per cent YoY reduction in its net interest expense, which also presents a bit of surprise as FMN still remains highly geared with a huge bank debt which has plunged its debt-to-equity ratio at 69 per cent as at end March 2016.

Perhaps the company is on its way to resolving this challenge with plans to raise equity by N40 billion but this may be coming in long term, rather than an immediate solution to a present problem.

Investment analysts’ verdict, forecasts

Despite the seeming stella performance of FMN in Q1’16/17 investment analysts were generally conservative regarding the present profile and future outlook of investments in the company.

We expect further payoffs – Vetiva Capital

Reacting to the results analysts at Vetiva Capital Limited stated: “Whilst we note the impressive growth recorded in Q1’17, we do not expect growth in the next quarter to be as strong given that the July – Sept period usually sees slower growth for most consumer companies.

“Just as we have expressed in previous reports, we expect further payoffs from Flour Mill’s improved product mix and backward integration plans (this includes mid-term expansion plans for the sugar milling business). Also we have adjusted our operating expenses assumption as we expect the synergy will help contain costs going forward.

“That said, we have revised our FY’17 revenue and Earning Per Share, EPS, estimates to N410 billion (Previous: N372 billion) and N3.03 (Previous: N1.15 loss) respectively.

“Major downside risk to our outlook remains currency volatility given the exposure to raw material inputs. Consequently, our 12 month target price (TP) is raised to N31.42 (Previous:N23.41)”.

We project significant downturn in earnings – ARM

According to analysts at ARM Investment Limited, the solid earnings largely reflect impact of stronger than projected revenue growth and cost control.

They however stated: “Going forward, management guides to further price increases over the rest of FY 17 which portends upside to FY 17 sales and informs upward revision in our forecasts on the line item (+31% YoY to  N449billion).

“Over the rest of the financial year, we project a significant downturn in earnings as impact of Naira weakness fully reflects in the company’s input cost. Overlaying current FX rate of  N315/$ with FMN’s mean rate of  N245/$ over FY 16 points to currency weakness of about 29%.

“FMN trades at a current P/E of 3.0x (excluding the gains from UNICEM disposal, P/E would have been negative) vs. 15.3x for its Bloomberg Middle East & Africa peers. Last trading price of  N20.43 is at a 2.3% discount to our FVE  (N19.94), which leaves our  “SELL”  rating on the stock intact”.

We are cautiously optimistic for FMN – CardinalStone

For analysts at CardinalStone Partners Limited, huge debt position poses a challenge to future earnings

They noted that in full year 2016 results FMN’s 70.2% YoY growth in earnings was largely from the disposal of its stake in United Cement, UNICEM. They therefore stated: “We, however, do not anticipate a recurrence of this one-off gain FY’17. Excluding the impact of the gain, the company would have reported a loss after tax of N9.3 billion.

“We are cautiously optimistic for FMN going into 2017 as its huge debt position (N148 billion   as at FY’16) remains a hindrance to future profitability growth.

On earnings outlook, they noted that “FMN relies on imported wheat and raw sugar for its milling requirements hence, we envisage production costs to remain under pressure given the devaluation in the currency and the continued depreciation at the parallel market.

“We anticipate some moderation in finance costs as Flourmills uses proceeds from the sale of UNICEM (N23.7 billion) to reduce its debt position.

“Given the high base of FY’16, we project a 79.2% decline in after-tax earnings to N3.0 billion in FY’17. Valuation We cut our one year target price for Flourmill to N20.10 (previous: N66.08) and downgrade the rating on the stock to “SELL”.

FMN has shown fairly good traction –   Cordros Capital

Analysts at Cordros Capital Limited also noted that FMN’s earnings contracted consistently between 2012 and 2014, and grew in 2015 on the backdrop of profit realized from the divestment of a long held investment. They stated that if not for income from the divestment, the Company would have reported a loss after tax of N6.4 billion.

According to them, the primary drivers of the stress on company’s earnings are: the dominance of low margin products in the group’s product portfolio; foreign exchange losses booked from Naira devaluation and; the escalation of finance charges.

They also noted that 2016 is not any different. According to them “the N19 billion PAT recorded as at nine months ended December was boosted by the final leg of the income from the divestment mentioned above. Once again, excluding this one-off item, bottom-line should have been in negative of about N4.7 billion.

“For 2016, we forecast loss before tax of N3.3 billion excluding the gain from divestment.

“For 2017, earnings face risk from higher raw materials and energy input costs (from the recent floating of the Naira) and still elevated finance charges. We forecast loss after tax of N1.2 billion.

“On the positive, FLOURMILL has shown fairly good traction with sales (9% average growth in five years). As at nine months 2015/16, revenue has grown by 8% and could reach 12% in 2017, given the price increment recently effected across some SKUs and, the introduction of new products.

“Risk, however, is that report from our market search shows that a number of FLOURMILL’s products have been scarce for months” .

We rate FMN shares Neutral – FBN Capital

At the backdrop of Flour Mills’ good Q1’16/17 results analysts at FBN Capital, and arm of First Bank of Nigeria, stated: “Given the historical lackluster results by FMN in recent times, we would be watching closely to see the sustainability of the solid growth posted in Q1 going forward.

“In terms of outlook Bloomberg consensus wheat forecasts  indicate that wheat prices are expected to rise by around 12% between 2016 and Q1 2017 (end-March). As such, the company still faces downside risks arising from an uptick in wheat prices and volatility of the Naira exchange rate on the interbank market.                             “Given the stellar results, we expect to see marked upward revisions to consensus 2017E (end-Mar) PBT forecast and a positive reaction from the market over the next few days. We rate FMN shares Neutral. Our estimates are under review”.


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