Flour Mills of Nigeria Q2 2020 Results Review: Squeeze in Flour PBT Weighs on Group Earnings

Workers operate a machine at the Dangote flour mill in Apapa district in Nigeria's commercial capital of Lagos November 13, 2010. REUTERS/Akintunde Akinleye (NIGERIA - Tags: EMPLOYMENT BUSINESS) - GM1E6BE0DY301

Slight upward adjustment to average EPS forecasts

On the surface, Flour Mills of Nigeria’s (FMN) Q2 2020 results (end-Sep) appear decent.

PBT for the quarter grew marginally by 1% to N3.1bn and was in line with our forecast of N3.2bn.

That said, a deeper analysis of the numbers suggests that future earnings will come under more pressure relative to previous quarters.

To put this in perspective, the food business (60-65% of group sales) recorded a -94% y/y drop in PBT to N175m, fueled by elevated global wheat prices and cutthroat competition in the domestic flour space.

As a result of these challenges, overall volumes declined by -1% y/y.

The impact of these on group profitability was however lessened by marked improvements in the sugar (+31% Q2 PBT growth y/y) and agro-allied businesses (-N135m vs. -N1.2bn in Q2 2018).

Sugar earnings were boosted by price increases implemented in Q1. PBT for the group ex-flour was also largely underpinned by the government’s border closure.

The ensuing declines in supplies of smuggled sugar and imported rice fed through positively to sugar and pasta (typically seen as a substitute for rice) sales.

However, over the coming quarters, struggles from flour will be the major obstacle to growth. Indeed, BUA Group recently established a 500,000MT flour refining plant.

Further compounding FMN’s woes, food giant Olam’s ramp-up in capacity via its acquisition of Dangote Flour Mills potentially strengthens the former’s competitive edge.

Nevertheless, we have left our 2020E sales forecast unchanged because flour losses will likely be offset by strong growth delivered by the other key segments.

However, there are clear indications that the borders will not remain closed indefinitely. As such, with tailwinds from non-flour segments expected to ease off post-2020E, we have made 7-10% cuts to our 2021-22E sales.

The only positive adjustment we have made is a -13% average cut to our 2020-22E interest expense forecast on the back of an improved debt profile.

Our 2020-22E average EPS forecasts are higher by around 3%, driven by cheaper borrowing costs but our price target is up 10% to N21.0 because we rolled over our valuation to 2021.

Our new price target implies a potential upside of 29%. Despite the upside, we are retaining our Neutral recommendation on the stock given the persistent headwinds in flour.

Earnings lifted by decline in interest expense

PBT for Q2 was driven by a -14% y/y decline in interest charge and 38bp wider gross margin, but weighed down by a 14% y/y increase in opex.

Sequentially, PBT declined by -43% q/q due to a -97bp gross margin and a 24% q/q increase in opex.

Relative to our forecasts, gross margin was 25bps wider, while interest expense surprised positively by -23%.

PBT was still slightly behind our forecast by -2% because opex missed by 15%.

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