04 July 2018 ( Lagos )

HIGHLIGHTS:

• Weak Q4’18 performance drives FY earnings underperformance 

• 5% revenue growth expected for FY’19 amidst muted price increases 

• Lower debt balance to support moderation in interest costs 

• Operating margin estimate reduced, BUY rating maintained 

Weak Q4 performance dampens earlier gains from FY’18 

FLOURMILL recently released its FY’18 financial results showing a 3% y/y rise in revenue to N 542.7 billion and a notable 54% y/y jump in PAT to  N 13.6 billion. The impressive y/y performance was however weaker than the analysts at Vetiva Capital Management Limited had expected. Particularly, profit before tax came in 39% lower than their  N 18.3 billion estimate following a markedly weak performance in Q4 (Jan-Mar 2018 period). 

With Q4 revenue printing 13% lower than analysts had expected and gross profit down to N 12.7 billion vs. their N20.5 billion forecast (Q3’18: N19 billion), gross margin weakened to 11.1% in the quarter (Vetiva: 14.5%, 9M’18: 13.1%). Given that wheat (predominantly imported) is FLOURMILL’s major agricultural input, analysts believe input costs must have been bloated by the sharp rise in global wheat prices so far this year – up c.15% ytd. 

Furthermore, an unusual spike in Operating expenses as well as higher than expected debt servicing figure culminated in a N3.0 billion loss before tax in Q4. The weak Q4’18 performance reminds us of an equally weak Q4’17. Hence, analysts look forward to Management’s clarity and guidance at the FY’18 Conference Call scheduled for July 5 2018. 

However, supported by stronger performances recorded in earlier quarters, profit before tax registered at a 7-year high of N16.5 billion, outpacing the N10.5 billion recorded in FY’17. 

Top line growth of 3% fell short of the company’s 5-year CAGR of 10% and below their 7% estimate. Analysts attribute this to a weaker Q4’18 performance as well as the high base from FY’17 where revenue surged 53% supported by both price increases and volume growth. 

Whilst the Food segment (largest contributor, 80%) managed a 2% y/y growth amidst limited changes in pricing and a flat volume base, the Agro-Allied businesses recorded a 13% y/y rise in turnover. Despite the modest growth in Agro-Allied, analysts note that performance within the sub-sector has been mixed – with revenue moderating successively in every quarter – amidst the tough operating landscape for edible oils, animal feeds and sugar businesses. 

Deleveraging to improve capital structure, reduce interest burden

In a bid to deleverage its business, FLOURMILL raised c.N40 billion through a Rights Issue that was finalized earlier this year. Analysts expect this to impact earnings in FY’19. Notably, short term liabilities (including bank overdrafts) moderated 35% y/y in FY’18 as the company dedicated 75% of its rights proceeds to repayments of these facilities. 

Supported by this, and a stable interest rate environment, analysts expect net interest expense to moderate 38% y/y in FY’19, with debt-to-equity ratio improving to 0.9x (FY’18: 1.0x, FY’17: 2.4x). They are optimistic for even further improvement in FLOUMILL’s debt mix, given plans to refinance expensive short-term debt with N70 billion in medium term notes and also to sell off some of its real estate assets to further reduce financial leverage. Given the still opaque timelines and details for these plans however, they are yet to factor this into their model.

FY’18/19 outlook tempered, forecasts revised marginally lower 

Analysts are less optimistic about price increases in FY’19, hence, they have revised their revenue expectation to N571 billion – translating to a 5% y/y growth (Previous: 7%). They expect sustained recovery in demand to support this growth. Furthermore, sales benefits are expected to accrue from the company’s continuous investments and plans to strengthen its Food business value chain with N10 billion raised from the rights issue (25% of rights proceeds to support working capital base). 

Outlook for the Agro-Allied segment remains mixed as livestock feeds business still struggles with tough market realities, whilst capacity in sugar business ramps up. 

Analysts expect gross margin to remain volatile as outlook for wheat prices remains strong. Hence, they revise their gross margin estimate for FY’19 to 12.7% (Previous: 13.1%, FY’18: 12.7%). Whilst the rise in FLOURMILL’s operating expenses appears broad-based and inflation driven, they believe spikes in Q4’18 were one-off and thus maintain their 4.6% OPEX to sales ratio forecast (FY’18: 4.8%), way below pre-2017 levels of c.7.7%. Thus, they forecast an EBIT margin of 8.4% for FY’19 (FY’18: 8.9%). 

Whilst earnings are expected to be supported by moderation in net interest expense, analysts also forecast normalization in the other operating income line, which was primarily bloated by gains on exchange differences and government grants. Supported by the notable moderation in interest expense however, analysts expect PBT margin to expand 190bps y/y to 4.9% (Previous: 5.3%). And with this, they cut their FY’19 PAT forecast for FLOURMILL to N19.8 billion (Previous: N21.8 billion) – representing a 45% y/y bottom line growth. 

However, given the 56% increase in shares outstanding, EPS estimate for the year comes in 7% lower y/y at N4.82. With a constant dividend payout ratio of c.20%, analysts forecast dividend per share of N0.96 (FY’18: N1.00; Dividend yield: 2.8%). Major risks to their outlook include a stronger than expected rise in global wheat prices and adverse exchange rate movements. Their 12-Month Target Price for FLOURMILL is revised to N40.99 (Previous: N45.45).

Business Description 

Flour Mills of Nigeria Plc is primarily engaged in flour milling, production of pasta, noodles, edible oil and livestock feeds, farming and other agro-allied activities, distribution and sales of fertilizer, manufacturing and marketing of laminated woven polypropylene sacks and flexible packaging materials, operating terminals A and B at the Apapa Port, customs clearing, forwarding agents, shipping agents and logistics and management of third party mills. The Group derives over 90% of its sales from its food and agro-allied businesses. 

Reporting for EasyKobo on Tuesday, 3 July 2018 in Lagos, Nigeria

Source: Vetiva Capital Management Limited