EUR 3.58 For Business Accounts Only

Flour Mills of Nigeria-Core momentum inspires fresh upside

• The stone the builders rejected…: Prior to the FX-induced equity rally in Nigeria, the food sub-sector bore the brunt of a challenging macro-economic environment as investors priced in effects of constrained consumer income, naira depreciation and high interest rate on the performance of food producers. The scale of aversion was however not equal across sector names with the shares of Flour Mills of Nigeria (FMN), Honey Well Flour Mills and Cadbury taking a greater beating. Investors’ aversion to FMN’s stock was underpinned by the negative core earnings declared in the two financial years ending March 2016. Precisely, the combination of higher input cost, sizable FX losses as well as upsurge in finance charges deprived the otherwise low margin business of profitability. The latter drag was consequent on an upsurge in debt levels which pushed the company’s net gearing ratio^[2] to a then record high of 164% at the end FY 15 (Bloomberg EMEA average: 56%) despite receiving an N2 billion in cash for the sale of UNICEM.
• has become the pillar stone : However, FMN’s operating performance turned the corner in the financial year ending March 2017 with the company posting its highest operating profit^[3] on record at N9 billion (+156% YoY) while profit from core operations (PAT less profit from sale of associate) printed at  a six year high of N8.8 billion (FY 16: N9.3 billion loss). The improved performance largely stemmed from its robust turnover^[4], which printed at a historical high of N524.5 billion (+53.1% YoY) as well as an 81% YoY cutback in other operating loss to N1.5 billion, with the combined effect offsetting subsisting FX pressures.
• Earnings surge as FX pressures subside: In more recent releases, some of these FX pressures however dissipated following CBN’s liberalization of the FX market which helped underpin strong naira gains at the non-interbank FX windows. Particularly, over FQ1 18, FMN reported FX-induced other operating income of N2 billion on revaluation of outstanding FX liability at cheaper FX rate even as inventories (-6% QoQ to N109.7 billion) and prepayments (-48% QoQ to N36.6 billion) declined. FMN’s management attributed contraction in the latter to improved liquidity in the currency market and reduction in the tenor of CBN’s forward contract to 2 months (five months previously) which enabled the company to meet its outstanding letter of credit obligation (N26.2 billion) and lower its deposit for FX relating to forward and futures contracts (-58% QoQ to N13.0 billion) respectively. Against this backdrop, FMN cutback its borrowings (-21.4% QoQ to N190 billion) which in turn applied downward pressure on interest charges (-39.8%QoQ to N8.9 billion). Thus, aided by a double-digit revenue growth (+25% YoY to N1499 billion, QoQ: +10.7%) which was sustained for the sixth consecutive quarter in FQ1 18, FMN reported its highest core earnings in 21 quarters (N4.5 billion) in the period.
• Naira gains and cutback in debt underpin bullish outlook: In projecting our outlook for the company over the rest of the financial year, we begin by estimating the company’s debt levels. On long term debt, management’s guidance of limited capital outlay over the near term underpins our view for sustained stability of the company’s largely concessionary borrowings from the CBN. However, on short term borrowings, we project a modest rise (+7%) from current levels to N169 billion. Our prognosis for higher leverage largely stems from expected rise in prepayments. In our view, whilst sustained FX liquidity and unchanged 2 months tenor on CBN’s forward contract should keep deposits for forward contract largely in check, we believe the nil reading of “letters of credit” is unsustainable given the company’s huge dependence on imports. Against this backdrop, aided by comparison with the relatively stable FY 16 reading, we estimate a N2 billion deposits for imports over the year. Overlaying the increase in debt with the company’s current effective interest rate of 16.5%, we forecast a tepid rise (+3.4% YoY) in finance charges to N34 billion over FY 18. Nonetheless, a projected rise in EBIT (+10% YoY to N47.2 and a N4.2 billion other income (FY 17 other operating loss: N1.5 billion) largely driven by FX-induced gains reported in FQ1 18 should drive FY 18 core profit (PAT less profit from sale of associate) to an eight year high of N13.1 billion (+48% YoY).
• FMN trades at discount to peers, both on a current (P/E: FMN: 8.5x, Bloomberg EMEA: 11.8x) and forward basis (P/E: FMN: 5.7x, Bloomberg EMEA: 10.2x). The company’s attractive P/E, robust core performance and cutback in debt levels underpin our BUY rating on the stock with a FVE of N35.07 

See attached for full report 

[2] Net debt less cash

[3] We placed the line item “other operating income” below the line due to the volatility of the nature of the components (FX loss, impairment, insurance claims etc.)

[4] Prices were also raised by between 30% and 40% across other operating segments of the business