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Flour Mills Plc: Expansion and Debt, To Swim or To Sink

Proshare

Monday 21st August 2017 11.50AM/ GTI Research

Q1- 2017; Revenue up by 25%, net income by 3%.
Flour Mills (‘The Company or FMN’) Nig. Plc., a forefront player of wheat milling in Nigeria and one of the largest single site mills in the world released its unaudited financial statement for the three months ended June 30th 2017 on 31st July 2017. The Company reported a 25% growth in revenue generated from the sale of goods and services to 148.9bn ($40.2million) from 119.2bn ($32.7million) y/y.  

The rise in revenue was driven by strong growth in packaging (+74%y/y) and food (+28% y/y) as a result of both increases in volume sold and price. The 27% increase in cost of sales from 103.9bn ($28.5million) to 131.7bn ($36.1million) y/y was triggered by 28% rise in cost of raw materials (wheat, rice and cassava flour). However, there is the need for raw materials to be sorted locally which will help cut input cost.  

Administrative expenses rose by 52% while marketing and distribution expenses used to promote sales dipped by 4% y/y. The drop in marketing cost translated to the 33% rise in operating profit from 10.9bn ($3.0million) to 15.1bn ($4.1million) y/y. The Company has a huge debt overhang which had been the case in previous years, despite the recent relative stability in the foreign exchange, finance cost was up by 67% from 5.3bn to 8.9bn y/y.  

Effective Tax Rate (ETR) for Q1 2017 was 27% as against 25% for Q1 2016. Regardless of the 84% contraction in interest income, bottom line was marginally up by 3% from a 4.4bn ($1.21million) to 4.53bn ($1.24mllion) y/y. EPS came to 154kobo from 159kobo. Shareholders’ equity was slightly up by 3%. FMN share price rose by 19% which equates to 27 ($7.0) in Q1 2017 when compared to 22.61 ($6.2) recorded in the same period in the prior year.  

The Company’s result was quite impressive given the difficulties and challenges experienced with the huge interest expenses on debts and challenges associated with the current business environment, especially the gridlock in Apapa, which negatively affected operations and subsequently net income in the review period.  

Performance Ratio
Debt The current debt profile of Flour Mills constrained its performance ratios as could be seen here. Return on Equity (ROE) which measures returns on fund provided by shareholders returned 4%, same posted in Q1 2016 while Return on Asset (ROA) stood at 1%, same as in 2016.  

Current ratio improved to 1.31x compared to 1.2x posted in Q1 2016. Debt to equity ratio increased to 3.2x against 2.9x y/y. The Company needs to work round the clock to soften the existing debt profile. Flour Mills comprises of 16 integrated mills situated in Lagos, with its flagship mill located in Apapa.  

The principal activities of the company includes flour milling, farming and other agro-allied activities, distribution, importation, sales of fertilizer, manufacturing and marketing of laminated woven polypropylene sacks, operation of Terminals A and B at Apapa Ports, real estate etc.  

In 2016 the company merged with five wholly owned subsidiaries, this was effected at the beginning of the financial year. The merger was expected to increase the company’s capacity, however in our opinion, we think the desired impact of the consolidation is yet to be achieved especially in relation to the Company’s bottom-line performance.  

Valuation Analysis
Based on our analysis, the stock is currently trading at a 30.94% discount to our estimated fair value of 37.33, with a 12 month investment horizon. We focused on the historical financial performance of the stock and our expectation for FY 2018 to arrive at our fair value for the stock.  

Our fair value for the shares of Flour Mill Nigeria Plc was calculated using the Dividend Discount Model comprising our expected dividend estimate for the company and GTI Securities customized tweak to adjust for the risk of investing in the Nigerian consumer goods sector. Our Required Rate of Return (RROR) factors in a risk premium of 11.15% and the yield for the most recently issued 20-Year FGN Bond was applied as the risk free rate of return.  

We have placed a BUY rating on the stock of Flour Mill Nigeria Plc because the stock is underpriced based on our analysis.  

Forecasts
Our FY 2018 revenue estimate for Flour Mills Nigeria Plc is 587.40bn ($160.9million) representing a 12% increase relative to FY 2017, while our net income estimate for FY 2018 is 9.98bn ($2.7million) which is a 2% increase from FY 2017.  

This yields an improved EPS of 3.81. Our estimates were driven majorly by the company’s steady revenue growth trend along with its strong hold on the Nigerian milling market which possess one of the most extensive portfolio of food products in the consumer goods sector.  

Recent Investment
FMN recently embarked on some strategic business acquisition which is aimed at positioning the company for accelerated growth. The recent acquisition of 95% equity stake in ROM Oil Mills Limited (ROM), a 350,000 metric tons per annum edible oil processing company in Ibadan, and also acquisition of 100% stake of Thai farm international Limited, Ososa, Ogun State a foremost high quality cassava flour processing company, would help strengthen net earnings.  


However, we think its increasing exposure to interest charges remains a major challenge and this had retarded growth as recorded in previous years. In spite of the debt burden, we are still positive that the Company will record an improvement in its performance on FY 2017.  

Also in other to conserve earnings due to high exposure to debt, the Company should look at the option of coming to the market to restructure their debt and ease interest burden. Again, assets that are not contributing to the bottom line should be disposed in order to reduce debt profile.  

Investment Conclusion/Outlook for Flour Mills
The shares of Flour Mills is undervalued with a focus on our FY 2018 estimates. The stock is currently trading at a 30.94% discount to our fair value estimate of N37.33 and a P.E of 11.56x. Notwithstanding, the company still remains strong in the consumer goods sector as sales revenue remains strong and also with the improving macroeconomic environment, we remain optimistic about revenue growth.  

However the company critically needs to draw up strategies to significantly reduce its debt profile which will ultimately form the basis of an improved bottom-line in the succeeding years. In addition, the company needs to significantly reduce its dependency on imported raw materials, diverting its attention to local sources.  

We have a BUY recommendation on the shares of Flour Mills Nigeria Plc because it is trading at a considerable discount to our target price with focus on FY 2018 estimates. The strong dividend antecedence of the company and its revenue growth are added incentives for any investor acquiring the share of Flour mills at this time. 


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