Flour Mills’ Rights Issue to the Rescue

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The decision by Flour Mills of Nigeria to undertake a N40 billion rights issue will lead to a reduction in its financing cost and boost the bottom-line for the benefit of shareholders, writes Goddy Egene

Flour Mills of Nigeria (FMN) Plc is among the top food and agro-allied products companies in Nigeria. While the company has leading brands in various market segments, the potential of these products and brands have not fully translated into returns to shareholders in form of dividends.

Although FMN Plc record a robust top-line, the bottom-line, which is what matters most to investors and shareholders, has not been satisfactory enough. The major reason for the low bottom-line is the huge cost of finance the company expends on bank borrowings.

Although FMN has been a regular dividend paying company, it is believed that if the finance cost is reduced through equity capital injection, shareholders will receive more dividends. An analysis of the company’s results in the last two years showed that 53 per cent of its gross profit has gone into finance cost. For instance, while FMN Plc recorded gross profit of N104.313 billion in 2016 and 2017, N54.927 billion went into finance cost, which is 53 per cent. Selling and distribution expenses accounted for 9.9 per cent or N10.344 billion, while administrative expenses accounted for 33 per cent or N34.267 billion.

Even in its half year results ended September 30, released last week, out of the N35.5 billion gross profit, N16.27 billion or 46 per cent went into cost of finance. This implies that if the high cost of finance is reduced, the company will be more profitable going forward.
This is why stakeholders are excited that the company has revived its plan to inject N40billion equity into its operations through Rights Issue.

Half year performance
The company grew its revenue by 17 per cent from N255.30 billion in 2016 to N298.44 billion in 2017. It reduced its administrative and distribution expenses from N2.936billion to N2.766 billion while it posted a net operating gain of N5.076 billion, compared with a loss of N8.082 billion in the corresponding period of 2016.

Finance costs increased from N10.925 billion to N16.267 billion due to high interest rates. FMN Plc ended the half year with a profit before tax of N13.38 billion, up from N8.80 billion in 2016, just as profit after tax improved from N6.46 billion in 2016 to N9.36 billion in 2017.

A further analysis of the performance indicators showed that gross margin reduced from 15.5 per cent in 2016 to 12.2 per cent in 2017. Also, operations expenses (Opex) margin stood at 3.89 per cent compared with 3.79 per cent in 2016.

However, earnings before interest and taxes (EBIT) margin improved from 6.04 per cent to 9.6 per cent in 2017. Similarly, PAT margin grew from 1.5 per cent to 3.2 per cent.
Commenting on the results, the Group Managing Director of the company, Mr. Paul Gbededo, said: “Our half year results show continued growth through most segments of our businesses, especially in the food business, delivering strong top and bottom line financials in line with our objectives. The Group recorded growth from volume and product mix. This growth was despite what continued to be a challenging business environment. Overall, the business shows an impressive performance in the first half of the year. We are positive that we are on track to meet our growth targets for the remaining part of 2017/18 financial year.”

The food business value chain was responsible for an increase of N40 billion of the group’s turnover and the Chief Finance Officer (CFO) of FMN, Mr. Jacques Vauthier, has said that the management of the company was confident that this sector will record even stronger performance as the year progresses.
“To this end, we are enhancing our marketing activities to push the brand’s presence into newer outlets while strengthening present market share,” he said.

The Head, Corporate Business Development, Mr. Sadiq Usman , in the agro-allied division, the group’s focus will remain on developing competences and improving execution capacity to backwardly integrate its core value chains, Sugar sweeteners, edible oils, feeds proteins and Cassava starches.

“The Group will leverage its significant resources and continue to build the capacity of local farmers and farming groups, who are an integral part of our strategy to develop sustainable, locally-focused supply chains,” Usman said.

As part of a strategic measure to consolidate operations, create value for shareholders and enhance administrative and operating efficiencies, the company in Q2 2017, announced the completion of a merger and absorption of Golden Penny Rice Limited, a wholly owned subsidiary, into FMN Plc.
According to the company, it is expected that the restructuring will meaningfully improve the synergies of the Group, reduce costs and improve the competitiveness of the company’s products, with the aim of advancing the profitability of the group.

Analysts’ assessment
Looking at the results, analysts at Cordros Capital Limited, said the primary driver of the profit growth (as was the case in Q1) is a net operating gain of N1.92 billion, against a loss reported in Q2-16. That aside, gross profit was down 14 per cent year-on-year(y/y) while opex and finance costs increased by 13 per cent y/y and 31 per cent y/y respectively.

The explained that net operating gain increased from N3.15 billion in Q1-17/18 to N1.92 billion in the review period, reflecting continued gains from FX hedges, on the backdrop of improved dollar liquidity and consequent strengthening of the naira.

“Coming off 2016/17, management said – in obvious acknowledgement of the little room for price increases – it will leverage on increased sales volumes and marketing activities to boost top-line going forward. While salient, we note that efforts in this regard continue to face challenges associated with both the gridlock in Apapa (which negatively affects both the movement of goods out FMN Plc’s factory and customers’ access to the factory) and the consequent congestion of the seaport. The slower revenue growth also reflects sugar price discounting (we estimate five) initiated by the market leader on the back increased illegal imports following improved access to dollars. All divisions of the business, save for ports operations, reported y/y revenue growth,” the analysts said.

The analysts noted that FMN Plc has reported lower gross margins in each of the two quarters of the current year, thus bringing GM over H1 to 11.9 per cent (vs. 14.3 per cent in H1-16/17).

According to them, given the relative stability of the naira in recent months, they would attribute the lower margins to price discounting (as in the case of sugar above) and unfavourable products mix.
“Operating expenses increased by 12.6 per cent y/y and 9.4 per cent q/q, with the margins also rising by 10 bps and 32 bps respectively. Admin expenses remain the driver of opex growth, although we note the slow growth from Q1’s 52 per cent (which management attributed to one-off charges). Increasing competition and the Apapa traffic situation are yet to reflect in marketing and distribution costs (-14 per cent y/y).

Cordros Capital said finance costs are higher by 31 per cent y/y, but compared to Q1, they are lower by 18 per cent. While the y/y increase in finance costs reflects the still relatively higher gross debt (N188.2 billion vs. N155.4 billion), the continued q/q moderation mirrors the reducing debt balance since March ending 2017 (by N53.4 billion). Improved liquidity in the currency market and reduction in the tenor of CBN’s forward contract to two months (previously five months) have enabled FMN Plc reduce its local currency-induced borrowings.

“Overall, declining revenue growth and weaker gross margin, amidst still high fixed financing and operating costs, in the absence of FX revaluation gains, portend risks to FMN Plc’s earnings. That said, we expect upward revision to 2018F estimates on higher annualised net profit of N17 billion, compared to consensus’ N11.7 billion,” the analysts said.