Flour Mills: high operating expenses dampen performance
Flour Mills of Nigeria Plc (www.fmnplc.com), like other operators in the Fast moving consumer goods industry, is faced with twin issues that include fast-rising costs and declining revenue.
That says two things. First, cost inflation is eating into operators’ margin. At the same time, buyers’ disposable incomes are weak.
All of these however link to one overriding weaker macroeconomic condition in the nation’s economy. So, Flour Mills of Nigeria is having romance with all these.
In the short term, the company dare not increase prices, because customers don’t have too much to spend. At the same time, its production cost is weighty in relation to its revenue.
Meanwhile, to an extent, border closure is expected to impact results as the millers take hold of the local market squarely.
Then, home rivalry has become so fierce with competitors building strategic edges to protect their market shares, first and then scramble for weak fighters’ market share through strategic encroachment.
LSintelligence Associates said market rivals that lose guard protecting their market shares would be pressured, as it is difficult to raise prices at the moment without letting go of price-sensitive customers.
Year to date, flour mills’ share price that traded at N15.20 currently has lost 31.53% of its opening value. The stock has peaked at N22.20 in the year, and lowest point had been N12.80. The market thinks Flour mills are worth N62.325 billion on 4,100,379,605 shares outstanding.
What is the number saying really?
In the second quarter of the financial year 2020, its revenue declined by 1% year-on-year from N136.67 billion in the comparable period in 2019 to N135.95 billion in the second quarter of 2020.
In the previous quarter, revenue had increased by 1%. The pressure felt in the second quarter of 2020 was owing to a steep decline in its support services business.
Analysts at WSTC Securities said the support services business, which is mainly a packaging business, declined by 46% year-on-year to N3.02 billion in the second quarter of 2020 from N5.61 billion in the first quarter of 2020.
The food business segment was slowed by 2% from N89.80 billion in the second quarter of 2019 to N88.40 billion in the second quarter of 2020.
WSTC’s analysts observed that the 2% revenue decline was a relatively improved performance from the 3% revenue decline in the first quarter of 2020.
According to analysts, the pressure felt in the food business segment was on the back of higher levels of down trading in the bread-flour business, which started in the first quarter of 2020.
Analysts at WSTC clarified that the down trading implied that volumes of lower-priced products grew, thus not resulting in a proportionate growth in food revenue.
Overall in the first half of 2020, revenue from food business segment declined by 2% year-on-year from N173.50 billion in the first half of 2019 to N170.00 billion. READ: Flour Mills of Nigeria CEO Seeks to Rally Shareholders Wealth
On the other hand, the group recorded a 7% growth in its agro-Allied business from N22.30 billion in the second quarter of 2019 to N23.80 billion in the second quarter of 2020.
This came on the back of a strong performance in the animal feed and fertilizer segments amid the success of segment restructuring.
In the first half of 2020, revenue from the agro-allied business segment grew by 5% year-on-year from N47.00 billion in the first half of 2019 to N49.40 billion in the first half of 2020.
Analysts stated that the Group continued to record improved revenue in its sugar business segment, resulting from higher prices and volumes.
Looking at the numbers, show that in the first half of 2020, revenue from the sugar business segment grew by 15% from N39.00 billion in the first half of 2019 to N44.90 billion in the first half of 2020.
However, higher cost caps margin expansion.
Gross profit grew by 3% from N14.47 billion in the second quarter of 2019 to N15.30 billion in the second quarter of 2020.
Connecting dots, it shows that the advancement in gross profit arose from a lower cost of sales which nosedived by 1% from N121.85 billion in the second quarter of 2019 to N120.71 billion in the second quarter 2020 during the period.
Thus, it resulted from a lower material cost in the second quarter of 2019 which was reduced by 3% from N106.76 billion in the second quarter of 2019 to N103.62 billion in the second quarter of 2020.
Despite a 13% increase in direct staff cost from N3.82 billion in the second quarter of 2019 to N4.30 billion in the second quarter of 2020, and an 8% increase in depreciation charge from N3.89 billion to N4.69 billion.
Meanwhile, earlier in the first quarter of 2020, cost of sales had risen by 2% year-on-year to N118.27 billion from N115.77 billion in the first quarter of 2019, on the back of higher material costs and higher direct staff cost.
Material cost surged 1% while direct staff cost expanded 14%.
On an overall basis, cost of sales grew marginally as the company did 1% from N237.62 billion in the first half of 2019 to N238.98 billion a year after.
Management put fingers on cost in the second quarter of 2020, thus helped reduce the increase in the cost of sales in the first half of 2020.
Though, gross profit in declined by 1% to N31.78 billion from N32.12 billion in the first half of 2019.
Analysts at WSTC however summarised that operating efficiency and lower finance costs drive the bottom line in the period.
The numbers show that the company’s operating expenses grew by 7% from N13.97 billion to N15 billion in the first half of 2020.
Rising operating expenses was driven by higher overhead incurred in the second quarter of 2020.
Specifically, in the second quarter of 2020, operating expenses increased by 14% year-on-year to N8.29 billion from N7.27 billion in the comparable period in 2019.
The movement was due to higher expenses incurred on major line items which include salaries and related staff costs that rose+30% from N2.02 billion to N2.45 billion.
Plus, uptick in selling expenses, which grew 18% from N1.11 billion to N1.31 billion, general administrative expenses, increased 32% from N908.25 million to N1.19 billion.
In addition, depreciation jerked up 12% from N393.18 million to N440.62 million, while bank charges sparked 20% from N293.77 million to N351.48 million, and audit fees ballooned by 172% from N112.39 million to N305.31 million.
“The combination of weaker revenues, higher cost of sales, and higher operating expenses resulted in a 13% year-on-year decline in operating profit from N19.24 billion to N16.82 billion in the first half of 2020”, analysts at WSTC stated.
WSTC Securities believes that the management balance sheet optimization continues to bear fruits for Flour Mills.
The firm said in its continued drive to maintain an efficient capital structure, the Group’s total borrowings declined by 14% year-on-year, from N141.79 billion in the first half of 2019 to N122.53 billion a year after.
The implication of this was a decline in finance cost from N11.23 billion to N8.63 billion in period.
WSTC said: “The reduction in finance cost was enough to make the Group rebound to profit growth, as profit before tax grew by 4%, from N8.28 billion in to N8.63 billion in the first half of 2020”.
Other than a lower finance cost, the Group’s borrowing mix now consists of 51% short-term debt and 49% long-term debt.
Pioneer tax status supports profitability
The Group’s effective tax rate in stood at 32% in the first half of 2020, relative to 39% in the comparable year.
The lower effective tax rate in the period was due to the pioneer status of the Group. Consequently, profit after tax spiked by 17% from N5.05 billion in to N5.89 billion in the first half of 2020.
WSTC however said that the performance of FMN was in line with its expectations. Based on the operating performance in the second quarter of 2020, analysts’ assumptions proved accurate.
“However, we noted the change in the cost structure of the Group, following increases in personnel costs and other major expenses.
“In the first quarter of 2019, we did not anticipate these increases. Our analysis revealed that the increases in these costs weakened margins as reflected in 6% operating profit margin in the first half of 2020 as against 7% in the comparable period.
The 1% differential in operating margin was a supposed N2.7 billion that could have added to the bottom-line, WSTC analysts reckoned.
Analysts noted the possible accretion to the top line due to the recent Federal Government directive on border closure.
Yet, they expect the challenging business environment to persist in in the second half of 2020, amid poor macroeconomic outlook, weak consumer demand, and heightened competition.
“Given the increased personnel cost of the Group as evidenced in the numbers, we revised our model and adjusted for expectations of higher operating costs.
“Owing to improved capital structure and borrowing mix, we expect to see increased cash flows generation by the Group and a low use of overdraft facility.
“As a result, we believe that the Group will continue to optimize its balance sheet to lower finance cost and deliver value to shareholders in the form of higher earnings per share (EPS)”, analysts stated.
Analysts at WSTC Securities thus downgrade FMN earnings per share to N2.02 from N2.70 on the back of an expectation of higher operating expenses amid weak revenues.
Just as it downgraded its target price to N18.48 to a share. It had placed a fair value of N24.66 on the share, though maintains BUY recommendation.