Outlook for DANGOTE FLOUR tied to Tiger Brands’ restructuring initiatives

Proshare

Tuesday, June 11, 2013 4:30PM / ARM Research

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Dangote Flour Mills Plc “DFM” simultaneously released Q3 12, FY 12 and Q1 13 results. Q3 12 revenues declined 20% YoY to N14.4billion and although Q4 12 revenues rose 4% YoY to N14.7 billion; FY 12 revenues contracted ~11% YoY to N58.7 billion.

•The rather belated release of financials—the first set under Tiger Brands management—was compensated for by disclosure which was significantly more comprehensive than usual in a refreshing departure from past practice, a phenomenon which can only bode well for the company.

•Nevertheless, DFM recorded its first ever FY operating losses in 2012 with pre and post tax losses of N4billion and N2.3billion respectively.

Wheat price inflation erodes Q3 12 earnings
•Q3 has accounted for 26% of DFM’s FY revenues on average over the last three years and is its second largest contributor to revenues after Q2, which likely reflects the seasonal trends in the North where higher prices of out-of-season agricultural products make flour based meals more price competitive. Q3 12 contribution to FY revenues shrank 2pps lower than the preceding 3-year average which we link to the effect of the insecurity in the North (which accounts for ~50% of sales) on distribution networks.  

•Q3 12 gross profits shrank 82% YoY to N412million with margins contracting 10pps YoY to 3% (5pps QoQ). This contraction likely reflects the 23% YoY increment in average wheat prices during the period on the back of weather related shocks to major wheat producing regions. 

•Although, Q3 12 operating expenses contracted 10% YoY to N933million leaving corresponding margins flat YoY at 6% even as other operating income rose 492% YoY to N252million a N269million loss for the quarter was DFM first quarterly operating loss.

•Furthermore, although net finance costs contracted 37% YoY to N564million, an impairment allowance of N1.4billion during the quarter cemented DFM’s third consecutive quarterly net-loss bringing pre and post tax losses to N2.2billion and N1.04billion which compares to PBT and PAT of N2.2billion and N2.1billion respectively in the corresponding period in 2011.

Input price inflation dampens Q4 12 revenue recovery

•Q4 12 accounted for 25% of FY 12 revenues which is 4pps higher than its prior 3-year mean; Q4 is typically the weakest contributor to DFM’s FY revenues. However, the quarter also marks the first full quarter under Tiger Brands (TBL) ownership and TBL adduces the weak growth in top-line (3% rise QoQ) to issues around product quality, stiff industry competition and an inefficient route to market strategy at DFM. Breakdowns provided for its FY report reveal a 24% and 32% YoY contraction to N28.4billion and N8.6billion in Flour and Pasta revenues which accounted for 65% and 16% of revenues on average over the preceding five years respectively. Revenues at its Agro-sacks subsidiary (which accounted for 17% of revenues on average over the last five years) grew 25% YoY to N16.8billion reflecting the 65% increase in capacity to 51million sacks per month during 2012.

•Q4 12 COGS rose 19% YoY to N13.8billion resulting in a 12pps contraction in gross margins to 6% on account of the 35% YoY increment in average wheat prices during the period which led to an 83% YoY contraction in gross profits to N943million. FY 12 gross profits shrank 48% YoY to N5.3billion with gross margins constricting 6pps YoY to 9% on account of wheat price inflation.

• Q4 12 operating expenses rose 35% YoY to N1.3billion--a 2pps expansion in opex-sales ratio to 9%--putting operating loss for that quarter at N152million.

•FY 12 operating profits contracted 89% YoY to N502million with margins shrinking 6pps YoY to record low of 1% (10pps below the trailing five year average).

•Q4 12 Net finance costs rose 176% YoY to N858million tracking an over 300% QoQ rise in LT borrowing to N10.7billion resulting in a full year cycle of negative quarterly earnings with DFM reporting a Q4 12 loss before and after tax of N1.01billion and N408million which compares to PBT and PAT of N2.2billion and PAT of N2.5billion.

•DFM posted its first ever FY loss before and after tax of N4billion and N2.26billion amounting to a loss per share of N0.45 (unadjusted for other comprehensive income).

•In its full year analysis, Tiger Brands alludes to company specific challenges which we long suspected but were never able to verify.  It points to  bloated overheads (citing, among others a—presumably redundant—1000 man workforce)  sub-optimal business processes and weak enterprise planning systems which it hopes to address in the next 18-24months under a ‘fix, optimize and grow strategy’ initiative. 

•Given the company’s spotty corporate governance history, this assessment--and the losses that attend Tiger’s acquisition—hold very little surprise for us. Indeed given DFM’s performance relative to peers, much of our positive theses for the company reflects the significant scope for efficiency gains we anticipate under Tiger’s management.

 Losing streak extends into Q1 13, meanwhile
•Q1 13 revenues rose 2% YoY to N14.1billion (-5% QoQ) implying that DFM is still facing pressures driving volumes on account of the problems cited earlier.

•Although average wheat prices have moderated 5% QoQ in Q1 13, they remain 15% higher YoY and reflect in gross margins that are 9pps lower YoY but 4pps higher QoQ at 10%. Consequently, gross profits are 46% lower YoY at N1.4billion.

•Q1 13 operating expenses rose 7% YoY to N2.2billion with opex-sales ratio flat YoY at 15% resulting in an operating loss of N525million pared by an over 500% rise in other operating income to N232million. This affirms TBL’s assertion that DFM’s high operating leverage triggers EBIT losses on sales declines. 

•Interest income shrank 84% YoY to N6.7million tracking a 71% QoQ decline in cash to N535million while interest expense rose 61% to N1.2billion in line with an increase 14% QoQ increment in long term loans to N12billion.  This resulted in a 70% YoY increase in net finance costs to N1.23billion. DFM reported sharply higher pre and post tax losses of N1.8billion and N2.1billion respectively.

Much to discuss…and learn: Outlook tied to Tiger Brands’ restructuring initiatives
•Despite the recent streak of losses, TBL insists it has the capability to turn things around at its DFM acquisition citing similar success at its UAC Foods and Deli acquisitions.  Management asserts it has commenced the implementation of a ‘fix, optimize and grow’ turnaround plan, which would suggest that the plan has already taken a definite shape and direction.

•Our earlier report on DFM factored the possibility of higher inter-group sales from TBL’s Nigeria acquisitions; however, this does not appear to have played out given the tame growth in Q1 13 revenues. This would suggest that UAC Foods and Deli still maintain arms-length, price competitive, relationships with DFM which would make sense under the current circumstances given reported quality and efficiency lapses at the latter. However, we would expect this to change at some point and the timeline would be a key factor in DFM’s outlook and Tiger’s overall strategy in its portfolio companies,  a point that would require clarification from TBL.

•DFM’s lower mean gross margins (5%) with wheat price inflation over Q3 12 and Q4 12 relative to peers FMNL (10%) and HFM (17%) suggests the absence of a forward bulk buying strategy as with its peers. Significantly, we note that TBL does apply a hedging strategy for wheat purchases for its South African operations which its competitors in the Nigerian market do not. While the dynamics in Nigeria may lead to a different decision, we maintain the view that consolidating its input sourcing as part of its re-organization could deliver substantial cost gains and dampen the effect of input price shocks on gross margins that has continued to hamstring domestic peers. We thus continue to see substantial scope for cost savings.

•We believe DFM’s high operating leverage is on account of fixed costs tied to its underutilized northern mills (at Ilorin and Kano) which industry sources have cited as being responsible its lower utilization rate and whose distance from the Ports creates massive logistics hiccups. Industry operators have highlighted the planned revitalization of the rail link from the ports to this region as a possible tailwind for the industry, which benefits DFM in particular. In addition, TBL’s reference to a bloated workforce would also suggest rationalization of its headcount as part of its restructuring program. A decline in DFM’s 9% average opex to sales ratio since 2007 (vs 8% for competitors FMNL and HFM) from either initiative should also support.

•However financial leverage has surged from 2.4x in FY 11 to 3.1x in FY 12 tracking ~400% YoY increment in LT loans.

•In view of the many issues and variables, the new management clearly has a very busy schedule on its hands over the next few months. However the discussions in its earnings releases do tend to lend some credence to our basic thesis on DFM, where we see substantial value in the huge scope for efficiency gains. The specifics of its reorganization plans feature heavily in our outlook for the company and we leave our ratings on the stock (which has risen 16% since our last update with a BUY recommendation) suspended till we have a chance to review these issues with management.

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