Flour Mills of Nigeria Plc 9M’20 – Favorable Economic Policy Provides Support as Earnings rise on the back of border closure

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Flour Milling Association Plans To Open Procurement Centers In 15 States
Flour Milling Association Plans To Open Procurement Centers In 15 States

Major Highlights

  • Volume grew by 8% in Q3’20
  • Solid growth in the agro-allied, food and sugar business segments
  • Deleveraging efforts continue to provide accretion to bottom-line

In  its  recently  released  9M’20 financial results, Flour Mills of Nigeria (‘FMN’ or ‘The Group’) reported a relatively strong top-line growth. Revenue grew by 6% year-on-year to N423.48bn in  9M’20  from  N400.64bn  in  9M’19.  Operating profit declined by 10%  year-on-year to N24.68bn in 9M’20 from N27.29bn in 9M’19. However,   profit before tax (PBT) rose by 9% to N12.29bn, while profit after tax grew by 3% year-on-year.

Border Closure Delivers for FMN

Following the border closure policy by the Federal Government in October 2019, just at the start of the third quarter of FMN’s financial year, smuggling activities and the influx of imported goods subsided significantly;  thus creating an  increased  market  share.  Resulting  from  the supply gap induced by the border closure, FMN was able to push more goods in the market. Consequently,  revenue  grew  by  17%  in  Q3’19,  as  volumes  grew  by  8%. The food business segment, which had hitherto reported  revenue decline in the last two quarters, Q1’20  (-3%) and  Q2’20  (-2%),  bounced back  to  growth  as  the  business  segment  grew  by  14%  in  Q3’20. The sugar and agro-allied business segments also grew by a  double-digit  of  20%  and  52% respectively. However, the upside recorded in the three business segments mentioned above was partially offset by the support services business  segment,  which  declined  by    27%  to N6.10bn  in  Q3’20  from  N8.30bn  in  Q3’19.  In summary,  for the food,  agro-allied and sugar business segments,  the revenue growth reported majorly resulted from improved sales during the period as the Group took advantage of the border closure in terms of increased market share.

Quarterly Breakdown of Business Segments

Flour Mills of Nigeria Plc 9M'20 - Favorable Economic Policy Provides Support as Earnings rise on the back of border closure - Brand Spur

Cost of Sales Rise with Revenue Growth

The cost of sales rose by 17% in Q3’20 to N136.66bn from N116.43bn in Q3’19. The increase in the cost of sales in Q3’20 (+17%) was the highest compared to Q2’20 (-1%) and Q1’20 (+2%). The sharp increase in the cost of sales in Q3’20  is attributed to raw material cost (which increased by 19%)  and direct staff cost  (which grew by  11%).  Other line items that recorded major increases in the cost of sales were depreciation  (+11%) and maintenance cost (+17%). The 17% increase in the cost of sales in Q3’20 was the major driver of the 6% growth in the cost of sales in 9M’20. As of 6M’20, the cost of sales growth was flat. Nonetheless, gross profit grew by 3% in Q3’20 to N47.83bn from N46.59bn in Q3’19.

Spike in Operating Expense Hits Profits

Operating profit declined by 10% year-on-year to N24.68bn in 9M’20 from N27.92bn in 9M’19. The factor that drove operating profit to a decline despite growth in gross profit was higher operating expenses during the period.  Operating expenses increased by  13%  in  9M’20.  The increase in majorly resulted from higher personnel expenses and general expenses.

Read Also:  We have lost $2m already to Border closure - Ghanaian Alomo Bitters manufacturer laments

Effective Balance Sheet Optimisation Delivers Value

FMN,  however,  returned to the path of profit growth in the period,  as  PBT  grew by  9%  to N12.29bn in 9M’20 from N11.28bn in 9M’19. The higher profit recorded during the period was owing to lower finance costs incurred during the period. Finance cost declined by 21% year-on-year, saving the Group as much as N3.00bn. The lower finance cost reported was a manifestation of the deleveraging efforts by the management of the  Group.  Specifically,  total borrowings declined by  21%  to  N112.56bn  in 9M’20  from  N141.86bn  in 9M’19.  In addition, the portion of short-term debt to total borrowings reduced significantly from 51% in 9M’19 to 37% in 9M’20.

Profit after tax grew by 3% year-on-year. The slow growth in PAT (relative to the higher growth in PBT) was due to a higher effective tax rate during the period. According to the management, prudent steps were taken in estimating the tax bill due to uncertainties regarding the recently implemented Finance Bill. An effective tax rate of 34% was reported in 9M’20 (9M’19: 30%).

Summary of Income Statement

Flour Mills of Nigeria Plc 9M'20 - Favorable Economic Policy Provides Support as Earnings rise on the back of border closure - Brand Spur

Flour Mills of Nigeria Plc 9M'20 - Favorable Economic Policy Provides Support as Earnings rise on the back of border closure - Brand Spur

In our Q3’20 forecast, we underestimated the positive impact of the border closure on the revenues of the  Group due to our thought that increased competition in the industry, weak consumer demand, and an overall challenging business environment would limit the upsides associated with the border closure.  However,  it appeared that the  Group,  in the absence of cheaper smuggled products, was able to establish its leadership status in the market.

Outlook

We note the solid performance of the  Group in  Q3’19.  We also note that the solid performance resulted from the border closure policy by the  Federal  Government.  In the near term and till the end of the Group’s financial year, we expect the Group to continue benefitting from the favourable government policies.  However,  in the medium to long- term,  we believe that the border closure is not sustainable and that earnings growth might be under pressure again.

Generally, we revise our EPS estimate upwards to N2.50 (previous: N2.02). Our basis for an upward revision includes expected revenue growth across major business segments, operating efficiency (as the Group embarks on rightsizing), and lower finance costs. Using a  market-based valuation,  we have a  higher fair value estimate of  N22.88  (previous: N18.48).  Since the beginning of the  Group’s financial year,  our fair value estimates have oscillated between N18.48 to N24.66. We expect the Group to pay a dividend of N1.20 for the FY’20 financial year.

Between our last earnings report (November 13, 2019) and this report (February 5, 2020), the  Group’s share price had rallied from  N15.20  to  N22.00.  We believe that the stock is currently trading at its fair value. Hence, we recommend a HOLD.

 

WSTC Securities Limited (WSTC)