- 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
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.
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
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.
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)