FLOUR MILLS OF NIGERIA PLC

Transcription

1 CSL Stockbrokers LTD NIGERIA Equity Research NSE ASI: 47, % YTD April 30, 2007 Price: NGN74.00 Fair Value: NGN66.29 Rating: Perform Recommendation: HOLD (ST); BUY (LT) FLOUR MILLS OF NIGERIA PLC Financial Summary Revenue: NGN86.57B, $676.33M E 2008E 5-year EPS CAGR: 9.2% ROE: 30.68% EPS Current BVPS: NGN13.06 Current CFPS: NGN5.83 P/E Market Data Credit Rating: N/A Industry Rating: BBB, Agusto Bloomberg: FMN NL FYE: March Outstanding Shares: 1.553B Free Float: 48% Dividend Yield: 1.13% 52 week high/low: NGN84.00/NGN30.61 Lifetime High: NGN84.00 Investment Grade: C- Daily avg. Volume/Value: 691,104 shares/ NGN52.23M, $408,082 (90-day moving average) Mkt.Cap:NGN116.5B; $109.9M N/share Flour Mills price mov't Daily price mov't 30-day mov'g av. 60-day mov'g av. 26-Apr Jul Oct Jan Apr-07 Jude Fejokwu Tola Odukoya Debt to Capital (%): 31.1% Fiscal Year-End: March EBITDA: NGN10.04B, $78.44M Sustainable growth rate: 24.17% INVESTMENT SUMMARY & HIGHLIGHTS Q3 06 result: Net Profit rises 92.11% and revenue grows by 21.4% (year on year) Flour Mills Nigeria Plc recently released its Q3 (nine months) result which showed an increase in the pre-tax profit margin by 3.5% from 6.0% in Q to 9.5% in Q Gross revenue rose to N58.90 billion compared to N48.5 billion in the corresponding period in Profit after tax rose to N3.90 billion compared to N2.03 billion in the corresponding period in EPS for the nine-month period is N2.51 compared to N1.30 in the corresponding period in 2005 utilizing the current outstanding shares of about billion. Flour Mills venturing into new territory: cement production Flour Mills is currently building a cement factory in Calabar; the factory is strategically located where limestone deposits are readily found within Nigeria. This is one of the few industries in Nigeria where demand for the product currently exceeds the capacity of the cement factories on ground unlike the exact opposite for the flour industry. Add to this the steep rise in cement prices in recent months and a new cash cow for Flour Mills is about to be born. Valuation shows that Flour Mills is currently overvalued despite bright prospects The firm is overvalued at the present time; this will likely change once the full-year results are released and taken into cognisance going forward. Flour Mills fair value presently is N66.29.

2 INVESTMENT THESIS In reaction to the government s policy initiative with respect to cement manufacturing in Nigeria, Flour Mills has refocused its cement operations from importation and distribution to manufacturing. Hence, the company has entered into a technical partnership agreement with Holcim of Spain and Orascom of Egypt to manufacture cement at Mfamosing, Cross River State by building a cement factory. Significant progress has been made in the construction of this greenfield cement factory with an annual production capacity of 2.5million tonnes at a cost of US$450million. The start-up date scheduled for the new plant has been fixed somewhere between October to December, This will further strengthen Flour Mills position within the rapidly evolving and expanding cement industry. Good growth stock; great value in the long term Dividend per share is expected to increase by about 50% over last year to about N1.30 per share from N0.85 per share. Nigerian investors love income stocks, especially those that grow their dividends regularly which is a positive sign of the financial health of the company. Diversified business lines all generating revenue. Flour mills is not a monoproduct firm like the name implies. Exponential growth in profits over the past three quarters and the last fiscal year. Revenues are secondary; what matters is the bottom-line: profits. Following a successful bid in FY05, Apapa Bulk Terminal Limited a fully owned subsidiary of Flour Mills was granted two concessions to operate Terminals A and B of the lucrative Apapa Ports Complex, Lagos, for duration of twenty-five years under a lease agreement with the Nigerian Ports Authority and Bureau for Public Enterprises. There is a strong potential revenue stream from the leasing of these two terminals at the Apapa ports complex. These terminals will also reduce importation of cement cost and demurrage. Flour Mills revenue outpaces that of its peers under the Foods/Beverages sector of the NSE. However, it should be noted that these companies operate diverse businesses and work under different structures and business models. 2 CSL Stockbrokers

3 Revenues, N'million Flour Mills NBC Nestle Cadbury 7Up 0 20,000 40,000 60,000 80, ,000 In the FY to March 06, Flour Mills more than doubled its return on shareholders equity (ROE) to about 31%. Also, high retention of profits has led to a significant rise in sustainable growth rate to 24 percent from 6 percent in FY05. We project the company s ROE and growth rate for FY07 to be about 40 percent and 31 percent respectively. % 40.0 Return on equity UAC Flour Mills Year 1 Year 2 Year 3 Year 4E BUSINESS STRATEGY Golden Penny Flour: Flour Mills continues to invest in the upgrading and renewal of its production facilities. To this end, there have been significant investments in new mills and state-of-the-art equipment to improve quality and drive costs down. During the last five years, the company has replaced or renewed six (6) of its mills with total daily grinding capacity of over 3,500 metric tons of wheat. The replacement and modernization process will continue in the next two years. In addition, there are plans to renovate the packing and loading plants, wheat handling storage silos, wheat discharge equipment and ancillary facilities. 3 CSL Stockbrokers

4 From FY07 there will be increased emphasis on marketing activities in order to sustain the growth momentum and preserve the firm s leadership position in its lines of business. During FY07, the shareholding of United Cement Company of Nigeria Limited (Unicem), which was founded on a joint venture between Flour Mills of Nigeria Plc and Holcim Trading S.A. of Spain, will be restructured and strengthened in view of the huge capital outlay required for the successful execution of the new cement plant. The new shareholding structure will allow Egyptian Cement Company (ECC), an associated company of Orascom Industries of Egypt to participate in the equity of Unicem. Unicem s new shareholding structure will reflect a unique combination of international strength. Flour Mills intends to leverage on the global industrial experience and technical expertise of its partners to produce cement of international standard. Nigerian Bag Manufacturing Company Limited (BAGCO): The Lagos factory refurbishment and modernization programme has been completed with all the machines installed and fully in operation. The initial production target of 15 million sacks per month has been achieved. The building extensions and factory refurbishment programme at the Kano factory are well underway. Capital investments at BAGCO amounted to N3.4billion. These covered production equipment, utility services and buildings. Golden Fertilizer Company Limited (GFC): The proposed scheme to absorb GFC, currently a wholly owned subsidiary company into a Division of Flour Mills has reached its final stage. Already, fertilizer bagging operations have been mechanized as part of the measures being embarked upon to reposition GFC for improved performance in blending, bagging, loading and delivery operations and to reduce handling to a barest minimum. Niger Mills Company Limited (NMCL): In FY06, Flour Mills took a strategic decision to increase its stake in the equity of NMCL, a flour milling company, from 51 percent to 84.6 percent. The hub of the company s market is concentrated in the South-Eastern and South-Southern axis of the national market. The proposed expansion of the milling capacity would enable NMCL penetrate deep into the Northern market particularly the North Eastern and North Central markets. 4 CSL Stockbrokers

5 Kaboji Farms: In partnership with Northern Nigerian Flour Mills Plc, a farm of 10,000 hectares of land at Kaboji, Niger State has recently been reactivated. Management of the two companies have decided to step up the level of investment and commitment at Kaboji Farms because they seriously believe that agriculture, which is the mainstay of the Nigerian economy, has a great future. Presently, about half of the area has been cultivated with maize, millet, soya beans, cassava and other products. Management believes this project will pay off in the long run. This is a great idea given the government s non-oil export drive. The firm definitely feels that variety is the spice of life and as can be seen below in the diversification of their revenue sources. This ensures that the firm can still remain as a going concern even if the demand for flour dips significantly. Their revenue from cement is expected to rise after the completion of their cement factory being built in Calabar. Contribution from various revenue lines Bags 9% Fertilizers 11% Pasta 5% Cement 30% Wheat Products 45% Wheat Products Cement Pasta Fertilizers Bags INDUSTRY OVERVIEW There are about twenty-two flour mills in Nigeria. Most of the firms are in the mature stage of their life cycle. The capacity of the industry far exceeds current flour demand in Nigeria. Capacity utilization is currently at about 40%. There is overcapacity in the industry as capacity far outweighs the demand for flour. The industry is highly competitive; this has led to price cutting, customized bread shapes for aesthetic appeal and increase in bread sizes to attract the consumer who has a wide variety of bread to choose from. This industry is definitely a buyers market. Every flour miller is trying to produce more to sell more to break even or eek out a profit. The number of millers exceeds the demand within the country. This had to lower returns on average per miller. 5 CSL Stockbrokers

6 The major players in the industry are Flour Mills and Honeywell Flour. They make up about 50% of the market leaving the other 20 flour mills to battle for about 50% of the market share. Most of the flour mills operating in the country are localized in nature which enables them to remain afloat because majority of their customer base are within the neighbourhood. The industry greatly benefits from the ban on importation of flour. Competition is therefore local in nature which allows competition to evolve naturally on a fairly level playing field. The industry is grappling with rising production costs mainly due to inadequate or in some places non-existent power supply. Diesel costs are spiralling and coupled with the low level of power supply, are putting a financial burden on flour mills countrywide. Another industry issue is the regulation by the government that wheat flour must be fortified with 10% cassava flour. Bakers have been complaining about less yield and shorter life span for bread made from wheat flour mixed with 10% cassava flour. This has reduced demand for flour from bakers that are already complying with the government directive thereby bringing some flour mills to the brink of folding up. Flour mills will require 300,000 tonnes of cassava annually to fortify their produce. Government says it will establish 500 cassava processing centres to help improve cassava quality and ensure that the cassava flour produced meets the requirements of the flour millers. Private investors are currently being encouraged by the government to invest in cassava production plants to process cassava flour. The realization of this objective will likely lead to a reduction in the number of flour mills operating in the country. A member of staff of Flour Mills recently said that only 50 out of 150 cassava producers met the company standard for cassava flour. Quality of flour produced is instrumental to maintaining and increasing customer base in this competitive industry. It is imperative that the flour millers produce high quality flour to ensure that their average demand per miller (which is quite low) does not decrease further than the low levels it is already at. There is a flight to quality in the industry; bakers and flour millers can not risk alienating their customer base. The deadline for implementation is July 1 st, though the National Union of Food, Beverages & Tobacco employees union has appealed to the government to grant flour mills a grace of two years to comply with the directive. The government is yet to issue a categorical statement at the time of writing this report. 6 CSL Stockbrokers

7 COMPANY SYNOPSIS Flour Mills was incorporated in The firm is a conglomerate with a focus on food and cement products. Plc s activities span flour milling, pasta manufacturing, port operations, cement trade & manufacturing, fertilizer blending, bags & other packaging materials manufacturing and agricultural business. At present, the Flour Mills group employs approximately 5,200 staff. Flour Mills subsidiaries include: Nigerian Bag Manufacturing Company Limited (BAGCO); Northern Nigeria Bag Manufacturing Company, Northern Nigeria Flour Mills Plc; Southern Star Shipping Company (Nigeria) Limited; Golden Shipping Company Nigeria Limited (GSC);Golden Pasta Company Limited; Apapa Bulk Terminal Limited; Golden Fertilizer, Niger Mills Company Limited, United Cement Company of Nigeria and Kaboji Farms Limited. Plc also holds interest in Maiduguri Flour Mills Limited (manages the mill) and Flour Mills Registrar Limited. The firm possesses one of the largest flour mills in the world. Flour Mills makes twenty-four products in five categories: wheat (5), pasta (7), fertilizer (5), packaging (5), and cement (2). Flour Mills was listed on the Nigerian Stock Exchange on August 14, N'million Revenue from component parts 40,000 30,000 20, ,000 0 Wheat Products Cement Pasta Fertilizers Bags FINANCIAL RESULTS Results for the third quarter October 06 to December 06 shows a 21.4% (yearon-year) increase in sales to N18.9billion while post-tax profit increased by 154% to N1.6billion. Earnings per share for the quarter equally increased by 112% to N1.03 while net profit margin improved to 8% form 4% in December 05. The firm has a great knack for converting revenue to profit. Over the past three quarters of FY 2006/2007, the percentage increase in profit has exceeded the percentage increase in revenue by 200%. The firm is doing a great job in managing its costs and this is likely attributable to the use of natural gas in fuelling its eight generating sets instead of diesel and its ownership of a port which should reduce its port charges, demurrage and distribution costs. 7 CSL Stockbrokers

8 Cumulatively, Flour Mills 9-month sales increased by 21% to N58.9 billion post tax profits increased by 92% to N3.9 billion. Flour Mills net margin for the period improved to 6.62% while EPS for the period increased to N2.51 from N1.31 in 05. CONTRIBUTION OF 9 MONTHS FIGURES TO FULL YEAR RESULTS Average SALES 56% 56% 52% 55% PAT 43% 56% 32% 44% Flour Mills impressive run in FY06 saw the company s profits increasing by percent to N4.7billion and net margin improving to 5.4% ( 05: 2.2%) while EPS increased to N4.01 ( 05: N1.26) As a result, the company recorded a growth rate of 24.2% ( 05: 5.6%), which can be directly traced to the increase in return on equity and rate of retention to 30.7% ( 05:12.5%) and 78% ( 05: 44%) respectively. Despite the huge investment in assets during the year - especially the upgrade and renewal of production facilities return on assets increased to 9.1% ( 05: 3.7%) while assets turnover improved marginally to 1.70% ( 05: 1.67%). Although Flour Mills remains exposed to financial risks, a reduction in its interest expense to N1.3bn ( 05: N1.5bn) and an increase in profit before interest and tax saw its interest cover ratio improving to 5.2x ( 05: 2.1x) while enhanced productivity was underscored by the increase in productivity ratio to N23.2million/staff ( 05: N15.0million/staff). On the other hand, we are concerned about Flour Mills rising debt profile as bank overdrafts and term loans increased by 14.5% to N14.7bn, which pushed debt equity ratio to 96.3% ( 05: 84.2%). Flour Mills term loans of about N11.7bn are subject to interest at prevailing market rates, repayable in various instalments between April 2006 and December 2011 and secured by negative pledge. Despite the N5.0bn rights issue proceeds and N5.9bn term loans injected into the company s operations in FY 05 and 06 respectively, free cashflow remains at nil as investment in fixed assets remained ahead of cashflow from operations. Also, the company s working capital remains under pressure as current liabilities continue to outstrip current assets by N1.6bn ( 05: N2.5bn) 8 CSL Stockbrokers

9 N'm illion A naly s is of c as hflow, c apex & debt 16,000 14,655 12,000 8,000 11,213 9,806 9,286 8,384 7,567 7,726 4,000 3,899 3, O p. c as hflow Capex Loans & o/d VALUATION Using a five-year discounted cash-flow valuation approach: the intrinsic value of Flour Mills at this time is N6.54. The WACC utilized is 44.77% (the beta of 1.69 is calculated using a four-year calendar period, the risk-free rate is 10.75%, the cost of debt is 14.75%). The dividend discount model generated an intrinsic value of N78.31 while our relative valuation technique generated an intrinsic value of N95.97, Our forward P/E to forward EPS (extrapolation) generated an intrinsic value of N64.50, while a fifth approach called forward P/E to forward EPS (growth) generated an intrinsic value of N Our EV/EBITDA approach generated an intrinsic value of N Using an equal-weighted average of these six prices yields a final price of N66.29 which is our final fair value estimate for Flour Mills at this time. The use of multiple approaches to generate our fair value estimate helps us to avoid model bias and maintenance research which becomes more likely when one valuation approach is used to determine the fair value of a firm. We project FY2006/2007 revenue for Flour Mills to be N104B and PAT to be N8.9B. This was projected purely based on our extrapolation valuation approach factoring in quarterly trends. We believe this is realistic and likely, barring the unforeseen. This yields a forward EPS for FY2006/2007 of N5.73 which can be found in the table on the first page of this report. 9 CSL Stockbrokers

10 INVESTMENT RISKS Economic Factors: The purchasing power of the average Nigerian is quite low and this is worsened daily by rising inflation, unemployment and underemployment. This reduces the demand for flour products, the most staple of them being bread. This will reduce demand for flour with the attendant effect on revenues and profits. The way the economy goes, the way demand for flour products by the populace goes. Regulatory Risk: A ban has been in place for a number of years on the importation of flour into the country. The government has over the years banned and lifted the ban on importation of different items at their discretion. As much as there may be no reason to lift the ban on importation of flour, nothing stops the government from doing so even it s to the detriment of local brands. The government s actions are largely unpredictable. Currency Risk: Flour Mills currently imports cement and is therefore exposed to currency risks. Unless the firm buys currency futures and/or options to hedge its exposure, significant losses are plausible due to depreciation of the Naira against the major currencies. Competition (Internal & External): Flour Mills (a conglomerate) has other subsidiaries which we believe will compete with each other for funds and attention. The Bag Manufacturing Co. (BAGCO) produces bags for flour products and cement produced by Flour Mills and also supplies bags to external clients. With the coming on line of the cement factory, we believe that BAGCO will find it difficult in the early going to meet external and internal demand. This may lead to loss of market share externally. Flour can be customized to the needs of the niche market; Flour Mills will not be able to satisfy the varying needs of its customers as this will not be cost-beneficial; this will likely lead to loss of market share by Flour Mills. Industry Risk: The barriers to entry are quite low in the industry leading to the number of players increasing steadily. Unless there is a new found use of flour currently not known to us, the market share for the big players in the market like Flour Mills and Honeywell will gradually dwindle. This might explain Flour Mills head-on entry into the cement manufacturing business with the building of a cement factory in Calabar. Political Risk: The expected change of government early this summer will bring its own share of uncertainty to the industry. The government has given flour mills across the country up till July 1 st to comply with its directive that there be 10% injection of cassava into flour production. Bakers (major users of flour) have been kicking against it due to the negative effects of the cassava injection into the flour they use for baking bread coupled with the inability of cassava growers to meet the current demand of various users of cassava. This will likely have an effect on the profitability of flour mills unless a moratorium is placed on the directive. 10 CSL Stockbrokers

11 IMPORTANT DISCLOSURES Financial models and/or methodology used in this report Recommendations and opinions in this research report are formed based on a combination of discounted cash flow analysis, industry knowledge, relative valuation techniques, logical extrapolations, peer group analysis, and company specific and market technical elements (events affecting both the financial and operational profile of the company). Forecasting of company sales and earnings is based on segmented bottom up models using subjective views of relevant future market developments. The output is aggregated into models for group profit and loss, balance sheets and cash flow estimates where available all taking into account the recent development in historical reports. In addition, company guidance and financial guidance is taken into account. The assigned Investment Grade is made up of twenty variables analyzing a firm s profitability, efficiency, liquidity, growth, relative valuation ratios, capital structure, market value and management performance. Each variable is assigned a maximum score of five totalling one hundred points. A grade of A B- means the firm has a positive performance outlook A grade of C+ to C- means the firm has a fair performance outlook A grade of D F means the firm has a negative performance outlook We are recommending a HOLD in the short-term for those investors seeking to generate returns exceeding 10% within the next one month. We are recommending a BUY in the long-term for those investors who are willing to wait for about months to generate returns in excess of 15%. The firm is currently overvalued and we expect this to change once the full-year results are factored into future valuations. A HOLD means if you have not bought, do not buy yet and if you have bought, do not sell yet. Risk warning Major risks connected with recommendations or opinions in this report, including a sensitivity analysis of relevant assumptions have been taken into consideration in developing this report. Any particular risk to the company that we are aware of has been discussed in the body of this report. Expected updates This research product will be updated on a quarterly basis or as material information becomes available. This research report is on a stock under active coverage. Please see the front page of this research report for the first date of publication. Price-related data is calculated using the closing price of Flour Mills on April 27 th, CSL Stockbrokers

12 Hedge Clause This report has been prepared by the Investment Research Department of CSL Stockbrokers. The author of this report is Jude Fejokwu, Head, Investment Research & Strategy and a team of analysts. CSL Stockbrokers has established procedures to prevent conflicts of interest and to ensure the provision of high quality research based on research objectivity and independence. These procedures are documented in the CSL Stockbrokers Standards of Professional Conduct. CSL Stockbrokers Investment Research department is organized independently from and does not report to other business areas of the First City Group. CSL Stockbrokers has made no agreement with Plc to write this report. CSL Stockbrokers research reports are prepared in accordance with the CFA Institute s Ethical rules on Research Reports writing. This research report has been developed utilizing multiple sources: CSL data and estimates, Flour Mills website, annual reports and press releases. We believe the above sources are reliable though we take no responsibility or liability for errors based on stated facts or opinion expressed herein. This document is produced for informational purposes only. An investor should be aware that the financial markets are risky and past positive performance and accurate forecasts are not guarantees of future positive performance and accurate forecasts. We do not accept any liability whatsoever for any loss based on the use of information in this report. CSLS Limited may effect transactions in securities of companies mentioned herein and may also perform or seek to perform investmentbanking services for the companies mentioned herein. This report may not be reproduced, distributed or published by any recipient without the written prior consent of CSL Investment Research. Copyright 2007 Equities Research Unit, CSL Stockbrokers Limited, Lagos Nigeria. For further enquiries, please contact the Investment Research Dept. (cslresearchandstrategy@firstcitygroup.com) 12 CSL Stockbrokers

13 Abridged Financials (2-year projections and 3-year actual results) Cash Flow from operations (Nm) 2008E 2007E 2006A 2005A 2004A Cash Receipts 135, ,220 85,065 69,502 53,542 Cash Payments 118,728 95,824 77,338 61,935 50,377 Net cash from Operations 18,864 12,073 7,727 7,567 3,165 CAPEX 22,115 14,330 9,286 8,384 3,899 Profit & Loss (Nm) 2008E 2007E 2006A 2005A 2004A Gross Earnings 130, ,000 86,571 66,805 53,563 Interest Paid 1,111 1,203 1,304 1,518 1,531 Gross Profit 30,518 21,516 15,153 9,308 7,517 Overhead Expenses 15,892 12,439 9,735 7,711 5,964 Profit Before Tax 21,083 11,533 6,308 2,025 1,887 Taxation 5,186 2,918 1, Profit After Tax 15,897 8,614 4,667 1, Dividend Paid 1,924 1, Retained Earnings 13,973 7,234 3, Balance Sheet (Nm) Fixed Assets 54,474 37,893 26,359 19,791 12,755 Total Assets 88,395 67,167 51,037 39,929 29,467 Current Liabilities 32,488 28,367 24,771 21,472 18,888 Total Liabilities 68,012 52,149 39,986 33,095 23,509 Share Capital Shareholders Fund 38,987 24,354 15,214 11,651 5,937 Key Ratios and Variables Gross earnings growth (%) Net Margin (%) Asset Turnover (times) Liquidity Ratio (times) Return on Asset (%) Return on Equity (%) Earnings per Share (N) Price Earnings (times) Dividend per Share (N) Dividend Yield PEG ratio Cash Flow/Total Assets Financial Year End Price (N) CSL Stockbrokers