July 12, 2013 / DLM Research
Dangote Flour Mills Plc, Nigeria’s second largest flour miller, is a firm whose financial performance in recent times is yet to justify its position in the industry. The firm is debt burdened, yet its interest coverage ratio keeps falling over the years due to its inability to optimally utilize the debt in its book to grow its earnings. Currently, the firm has a very low interest coverage ratio of c.0.18x which, according to our estimation, is well below the minimum threshold of 1x. This suggests that it is highly risky for the firm to continue amassing debt as such continuity could result in a situation in which the firm would be incapable to service its outstanding debt with earnings from its core operations. A proof of the firm’s suboptimal debt utilization is evidenced by the fact that its performance reached a peak level in 2009, a year when its debt was at the lowest level. Subsequently, margin and profitability levels have been on the decline while the debt level has been growing.
In our view, the aggregate challenges facing the firm mirror four very important concerns. The first is its weak sales revenue in an industry where performance is essentially driven not just by installed capacity, but also by the ability to consistently grow sales revenue. The second is the depletive consequences of high interest expense on its bottom line and margins on the back of its high debt levels. The third is its inability to use the resources within its control to substantially stimulate positive inflows from its operating activities. The fourth is its Noodles subsidiary which has consistently underperformed and negatively impacted group profits and margins.
• Wheat cereal grain—originally from the Levant region of the Near East and Ethiopian Highlands but now cultivated worldwide in varying quantities—is among the oldest and most widely used staple food crops in the world; it provides c.20% of food calories for the world’s population.
• There are about 30 different species of wheat cultivated around the world. However, in general, wheat is either hard or soft and can be broadly categorized into spring wheat and winter wheat. Hard wheat contains a higher amount of protein, between 11%-18% protein content, than soft wheat which has 8%-11% protein content.
• Wheat is a major raw material used by flour millers. It makes up more than 90% of the total raw material input for the production of flour and flour-based products.
• Hard Red Winter (HRW) wheat and other hard wheat variants such as durum are the species of wheat used as raw materials by many flour millers around the globe because of their desirable properties which include adequate protein content and or substantial gluten deposits.
• In particular, bread flour is made mainly from hard wheat; confectionary flour for cakes and biscuits is made from soft wheat; pasta (macaroni and spaghetti) and breakfast cereals are made from semolina, a product of durum wheat; noodles are made from wheat flour while bran, a substance high in fibre content, is a by-product of milled wheat.
• Wheat is United States’ (US) leading export crop and the fourth leading field crop. HRW wheat is the most common class of wheat produced in the US and c.50% of the total wheat production in the US is exported, while c.33% of the HRW wheat produced is exported.
• A significant portion of US HRW wheat is exported to Nigeria as the climate in Nigeria is unfavourable for large scale wheat production. Currently, wheat production in Nigeria is negligible at c.100,000 tonnes per annum while local demand, as estimated by wheat imports into Nigeria, stands at c.4.50million tones per annum. Thus, Nigeria is among the highest importers of US HRW wheat, with c.75% of the country’s HRW wheat imports coming from the US.
• Flour Millers in Nigeria have a preference for HRW wheat (No.2 variety) as the major raw material for flour production—despite the unstable price of the commodity in the international market and the attendant exchange rate uncertainty—because they believe it is more suitable for flour production due to its high protein and gluten content and its low glycemic index. A low glycemic index is associated with a low risk of developing type-2 diabetes and coronary diseases.
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