Event

Following the successful acquisition of Honeywell Flour Mills (‘HFM’ or ‘Honeywell’), Flour Mills of Nigeria (FMN) incorporated the combined results of the two entities in its Q1 2023 results.

Revenue grew by 45% YoY to N339.60bn in Q1 2023, with the Group’s entire business segments recording strong growth. Revenue growth in the Food segment was 45% YoY to N213.17bn and this accounted for 63% of the total revenue growth. In the Agro Allied segment and Sugar segment, revenue grew by 38% YoY to N65.65bn and 64% YoY to N55.02bn, respectively.

Across the segments, the growth drivers in Q1 2023 include increased market penetration, particularly into new markets through deployment of containers, tricycles, POS, and other digital channels. There were also new SKUs launches in the starch and fertiliser product segments. In summary, enhanced distribution via deepened route to market and higher pricing accounted for the Group’s total revenue growth in Q1 2023.

Higher Input Costs Pressure Margins

The Group contended with higher raw material costs during the quarter, as cost of sales rose by 47% YoY to N306.35bn. This resulted in a 100 basis points cost margin expansion to 90% in Q1 2023. The impact of the geopolitical conflict between Russia and Ukraine, relating to prices in the global commodities market, took a heavy toll on the Group’s cost profile. The negative impact also reflected in the Group’s cash position, given the significant inventory ramp-up (+97% YoY to N367bn).

Inflationary Pressures and One-Off Costs Further Depress Margins

Operating expense grew by 52% YoY to N14.68bn. The transitional process of incorporating Honeywell resulted in a N1.10bn loss during the period. Heightened inflationary pressure and higher energy prices also factored in the operating expense increase in Q1 2023.

Buoyed by higher debt levels (majorly from Honeywell), finance cost spiked by 79% YoY to N8.15bn. Beyond the accounting and financial reporting impact of the Honeywell transaction, increased working capital need due to inventory build-up, also led to higher borrowings levels.

The combined impact of higher operating expense and finance costs dampened bottomline, as net profit grew marginally by 1% YoY to N5.49bn. However, if transitional expenses were stripped off, we estimated that net profit could have grown by 16% YoY.

Outlook

We maintain our BUY recommendation for the stock; however, we lower our fair value estimate to N43.46 (previous: N52.77). This is because we lowered our earnings projections across our seven years forecasts due to increased cost pressure and working capital constraints – particularly from the Honeywell business. We also posit that heightened inflationary pressure and what it means for household purchasing power would begin to reflect in the Group’s performance in the form of weak volume sales and downtrading. Increased downtrading by consumers could hurt margins.

Nonetheless, we think that FMN’s investment thesis is strong. Market leadership, product innovation, enhanced distribution network, and sound management are some of the investment considerations of the Group. While we note the historically weak margins of the business, cash flow generation is relatively strong. Over the long term, we see scope for improved margins and return on equity, given the ongoing investments in backward integration.

Please follow the link “Flour Mills of Nigeria Q1 2023 – Higher Cost Profile Dampen Earnings Growth”  to view the whole report.

Thank you.