Flour Mills of Nigeria Plc

Transcription

1 Equity Research PZ Cussons Nigeria Flour Mills of Nigeria Plc Finance costs weigh down bottom line Despite a 10.0 y/y increase in revenue, post-tax profit drops 28.82% y/y on higher finance costs. In FY2014, Flour Mills of Nigeria (FMN) reported sales revenue of billion, an improvement of 10.0 y/y compared with billion posted in FY2013. Against the increase recorded in sales revenue, the group recorded post-tax profit of N5.37billion, i.e. a decrease of 28.82% y/y relative to N7.54billion posted in FY2013. The increase in sales revenue was driven by strong volume growth from the group s food and agro-allied business segments, while the slowdown in post-tax profit came on the back of a weak performance recorded in the group s sugar business at bottom line levels. Excluding the sugar business, FMN s post-tax profit was up 22.4 y/y to N9.41billion in the year under review. We believe it was high finance costs that depressed the post-tax profit from the group s sugar business and that a significant portion of the finance costs which depressed the group s post-tax profit y/y resulted from interest on the debt used to finance the expansion of its sugar business. Meanwhile, revenues from the food and agro-allied business segments improved 17.5 and 13.2 y/y to N259.82billion and N57.55billion respectively. The strong growth recorded in the food business segment was driven by the segment s B2B and B2C businesses which include flour, pasta, noodles and sugar, while the agro-allied business experienced growth from fertilizer and animal feeds. In particular, the sugar business was instrumental to FMN s performance at top line levels as without it, the group would have posted revenue growth of 3.3 y/y to N312.04billion. Meanwhile, revenues from packaging, port operations and others were down 39.5, 82.4 and 86.2 y/y to N13.59billion, N619.90million and N552.10million. We are of the view that aggregate revenues would have come in stronger than reported were it not for the underperformance posted in the group s non-food and non-agro allied business segments, especially its packaging business segment which experienced challenges in the year under review. FMN s businesses are diversified and tied to key sectors of Nigeria s economy. We believe the businesses will wax stronger in the years ahead, given their leading positions in their various markets and industries and the strong demand we anticipate from domestic consumers especially as regards Nigeria s robust youthful population and the anticipated increase in domestic propensity to consume partly on the back of recent plans of the monetary arm of government to 1) gradually reduce interest rates, a move which we believe can stimulate aggregate consumption levels; 2) include unemployment rate in monetary policy decisions, a strategy likely to buoy the economy, place a lid on domestic unemployment and possibly enhance income levels, consequences which are again Oyakhilome Ibhagui oibhagui@dunnlorenmerrifield.com Sadiq Modibbo smodibbo@dunnlorenmerrifield.com Price: - Current N 68.11* - Target N Recommendation: BUY * As at Friday August 22, 2014 Fig. 2: Stock data Full year end March Price Mov t: YtD / 52wk -7.01% /- 6.21% 52-week range N N91.85 Average daily vol./val. 448,418/N35.43m Outstanding Shares ( mn) 2,386 Market Cap. (N mn) 193,266($1, 209m) EPS, N - FY DPS, N - FY FCFPS, N - FY Source: Bloomberg, NSE, DLM Research Fig. 3: Key ratios FY2014 FY2013 Gross margin 13.14% 12.55% Net margin 1.62% 2.5 Equity multiplier 3.56x 3.40x Asset turnover 1.12x 1.08x Source: NSE, DLM Research Fig. 4: Valuations FY2014 FY2015E FY2016F FY2017F P/Sales 0.58x 0.50x 0.44x 0.39x P/E 43.97x 30.63x 25.46x 20.22x PEG N/A EV/EBITDA 11.11x 10.46x 9.63x 8.88x P/B 2.31x 2.09x 2.02x 1.91x ROE 6.42% 6.81% 7.95% 9.45% ROA 1.81% 1.98% 2.31% 2.74% Div. Yield 2.47% 3.71% 4.33% 4.94% Source: NSE, DLM Research Fig. 5: FLOURMILLS vs. NSE, 52-wk movement Fig 1: Quarterly results highlights Q42014 Q32014 Q42013 Q/q Y/y Sales revenue ( millions) 91,954 72,201 96, % -4.64% Operating profit ( millions) 4,621 3,727 1, % % Post-tax profit ( millions) Source: NSE, DLM Research Estimates Source: NSE, DLM Research August 25, 2014 Please read the Important Disclosures at the end of this report.

2 Fig. 6: Revenues ( millions) by segment Fig. 7: Gross profit ( millions) by segment Source: Company Financials, DLM Research Fig. 8: Breakdown of revenues by quarterly contribution Fig. 9: Revenue ( millions) and y/y growth (%), FY2008 FY2017F Source: Company Financials, DLM Research Source: Company Financials, DLM Research Packaging business to wax stronger. We believe the enhanced products consumption will benefit FMN s packaging business as the products which will be consumed will first have to be packaged before they are sold for onward consumption. We are also of the opinion that the doubling of UNICEM s capacity to 5 million tonnes per annum will further be supportive of FMN s packaging business as the cement produced from the newly expanded plant will be packaged before they are sold, and doubling production capacity means an increase in the quantities of cement to be packaged and consequently an increase in demand for packaging materials. Additionally, we expect external demand for the firm s packaging materials to be strong, given the household name of its packaging business BAGCO. Management already hinted that the packaging business is now well positioned for growth, after it experienced a challenging environment in the period under review. August 25,

3 Investment in domestic crop cultivation to drive sales. The group has over the years invested heavily in domestic cultivation and processing of cassava, sugarcane, soybean, maize, rice and oil palm. We believe that, as time progresses, the group would attract the patronage of domestic consumer goods companies that utilize these products as their major raw materials but have not invested in their cultivation and/or do not have intentions of cultivating them domestically. This provides an additional source of revenues for FMN as it would lead, in our view, to a situation in which FMN would generate revenues not only by selling intermediate and finished goods, but also by selling raw products. We believe domestic cultivation would rein in FMN s import activities via enhanced backward integration. In addition to an improved patronage of its domestically cultivated products, anticipated from local consumer goods companies that still import these products as major raw materials, we believe the group s domestic cultivation, if sustained, will contribute to easing import activities in Nigeria. In our view, this will be supportive of margins of participating consumer goods companies, shield their earnings from exchange rate vagaries and, from an external macroeconomic perspective, strengthen Nigeria s current account and currency in the long run. Government s resort to boost local manufacturing of goods is further supportive of our increased revenue thesis for FMN. In particular, the increasingly dynamic private sector, consisting of local and multinational companies, especially those in the consumer goods space, speaks volumes about government s favourable policies towards domestic production and adds colour to our outlook. We believe domestic cultivation would rein in FMN s import activities via enhanced backward integration. Combined with the increased patronage of the group s domestically cultivated products we anticipate from consumer goods companies that still import these products in large quantities as their raw materials, One of our favoured drivers of FMN s revenues is Nigeria s population, with an average growth of c.2.23% in the last 7 years. Majority of the population is within the youthful and working age brackets, as 54% of the population is between the age of 15 and 64 while 46% of the population is below age 14 and above age 65 (Fig. 10 and 11). The youthful and working age brackets are supportive of active consumption, in our view, as they are more inclined to command a higher propensity to consume. Added to this, we have found that with a growth in population comes an increase in revenues of diversified consumer goods companies such as FMN (Fig. 12 and 13). We believe an active consumption age is positive for FMN and bodes well for demand of goods produced in most of its business segments as the group targets to grow revenues sustainably. August 25,

4 Fig. 10: Average proportion of population by age group (AG), Fig. 11: Working versus non working-age population, 2013 data Source: Index Mundi, DLM Research Source: Index Mundi,, DLM Research Fig. 12 Revenue ( millions), FY2008-FY2017F Fig. 13: Population ( 000), F Source: Company Financials, DLM Research Source: Index Mundi, DLM Research Another important consumption and revenue driver is the monetary arm of government, given its plans to gradually ease the relatively tight monetary environment in Nigeria. Using recent past data, we have realized that a tight monetary policy environment, more often than not, does not catalyse revenue growth of consumer goods companies, emphasis of FMN (Fig. 14). Therefore, we believe that the policy of gradual easing has a nontrivial likelihood to be supportive of the growth in revenues of consumer goods companies - such as FMN - with diversified businesses that cut across a wide array of consumer goods. August 25,

5 Fig.14 Average interest rate vs. FMN s revenue growth, F 5 45% 4 35% 3 25% 2 15% 1 5% Average interest rate (%) Revenue growth (%) E 2016F 2017F A rapidly growing economy, improved disposable income and rapid urbanization will also be supportive of enhanced consumption of FMN s products and growth in revenues. In particular, the fiscal arm of government has made, as one of its major objectives, policies aimed at achieving a strong and growing economy. More recently, the monetary arm of government stated plans to include unemployment in its monetary policy decision making process. If implemented well, we believe such objectives and inclusion, amongst other things, have the potential to douse current levels of high unemployment rate in the country. Our expectations are that actions from the fiscal and monetary arms, if successful, will improve the overall economy in general as well as disposal income in particular, combinations of outcomes that have the potential to enhance general consumption levels and, in our view, drive sales volumes of FMN s products. Rapid urbanization is also a key factor for enhanced consumption. Our argument here is that urbanization exposes a population to items that were hitherto unknown and changes the tastes of consumers in such a way that they begin to demand valueadded food and non-food products, especially when disposable income is not on the decrease, all of which are supportive of revenues of consumer goods companies. FMN s Food and Agro-allied business segments remain portfolio leaders. The group s Food and Agro-allied businesses continued their dominance of its business portfolio (Fig.15), contributing 78.24% and 17.32% respectively to FY2014 revenues, up from 66.51% and 15.35% contributed in FY2013. August 25,

6 Fig. 15: Contribution to revenue by business segment % 66.51% 17.32% 15.35% 4.09% 6.62% 0.18% 1.05% 0.17% 1.2 Food Agro-allied Packaging Port operations Others Together, they accounted for 95.56% of consolidated revenues for the period, up from 81.85% in FY2013. The remaining 4.44% was realized from packaging, port operations and other micro-businesses. Contribution of the packaging business, which stood at 4.09% for the period, down from 6.62% in FY2013, would have been higher if not for the production challenges the business experienced in the review period. According to management, the packaging business is now better-positioned for growth and is expected to record a more decent performance, going forward. Update on activities across FMN s business segments. In FY2014, FMN sustained the organic and inorganic growth of its business segments. For organic growth, the group expanded its existing business segments and/or engaged in Greenfield projects; strategic acquisitions of other businesses from their owners constituted its inorganic growth. Food In the past 12 months to FY2014, the group further strengthened the operations of its food business segment by commissioning its Agbara plant for the launching of new, in-demand food products such as snacks, powdered drinks and breakfast cereals. The group also commissioned additional long and short pasta lines to boost pasta production and expanded its Apapa flour milling capacity. It invested in increased flour milling capacity at its Calabar plant and ramped up volumes at its newly commissioned 750,000MT sugar refinery via raising capacity utilization to 48%. The group is desirous of not just producing but also pushing products to customers. In line with this, the group invested in the continuous growth of its customer service centres. We believe the group is positioning its food business segment to deliver long term growth and value. August 25,

7 Agro Allied In the review period, FMN established 10,000 Ha cassava plantations in Kwara State. The group also invested in Thai Farms and developed additional land in Kaboji Farms in order to increase the processing capacity of its cassava tubers and support capacity expansion of its feed mills respectively. The group acquired and rehabilitated 3,000 Ha of Oil Palm plantations in Edo State to support its vegetable oil refineries where capacity was recently quadrupled. The group also acquired 4,500 Ha rice farm on the Niger River, a project aimed at adding to its rice production at Sunti Farm to form the backward integration of its rice milling operations. Further activities in this business segment included investment in integrated animal feed plant in Calabar, signing of joint venture technical support agreement with Adecoagro on Kaboji Farms and expanding its palm kernel and soybean crushing and oil refining operation at its ROM Oil Ltd. Others The group in the review period received ISO 9001 accreditation for Apapa Flour, Iganmu Pasta and BAGCO operations and also officially opened its new corporate headquarters Golden Penny Place in Apapa. Approval to build a second line that will double production capacity to 5MT at its associate cement company, UNICEM, where it has a 3 stake, was also granted in the period. We believe these investing activities will bear positive fruits for FMN, as they are being carried out in areas where we expect an impressive level of outperformance in the years ahead. In particular, given our auspicious outlook for Nigeria s cement industry, We believe these investing activities will bear positive fruits for FMN, as they are being carried out in areas where we expect an impressive level of outperformance in the years ahead. In particular, given our auspicious outlook for Nigeria s cement industry, driven by positive factors such as improving housing mortgage finance, growing population as well as housing and infrastructural deficits amongst others, we expect the expanded UNICEM to be positive on FMN. August 25,

8 Slower growth in cost of sales boosts gross profit. FY2014 was a cost efficient year for FMN just as it was for other listed flour millers in the industry. The group s cost of sales recorded a single-digit growth of 9.26% y/y to billion in FY2014, a growth which came in below the double-digit growth recorded in its sales revenues. Consequently, cost of sales/revenue ratio decreased to 86.86% in FY2014, from 87.45% in the same period of Fig. 16: Cost of sales and cost of sales/revenue ratio, FY2008-FY ,000 Cost of sales ( 'millions) Cost of sales/revenue ratio (%) 9 300, , , , , ,745 84% 87% 198,612 83% 156, ,542 78% 218,560 85% 263, ,485 87% 87% 88% 86% 84% 82% 8 78% 76% 50,000 74% 0 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY % On the back of the slower growth recorded in cost of sales, gross profit expanded by 15.19% y/y to 43.66billion while gross profit margin improved to 13.14% from 12.55% in FY2013. Fig. 17: Gross profit and margin, FY2008-FY2014 Gross profit( 'millions) Gross margin (%) 50,000 45,000 40,000 46,066 22% 40,185 39,709 38,010 43,657 25% 2 35,000 30,000 25,000 20,917 16% 23,075 13% 17% 15% 13% 13% 15% 20, ,000 10,000 5% 5,000 0 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 August 25,

9 Most of the improvement recorded in FMN s gross profit came from its food and agro-allied business segments (Fig.18). Specifically, the food business contributed 78.24% to gross profit, up from 66.51% in FY2013, while agro-allied contributed 17.32%, up from 15.35% in FY2013. However, gross margins were roughly equal across all business segments in the period under review (Fig.19). Fig. 18: Contribution to gross profit by business segment % 64% 17% 15% 4% 6% 1% 1% Food Agro-allied Packaging Port operations Others Fig. 19: Gross margin by business segment 14% 12% 1 8% 6% 4% 2% % 13% 13% 14% 13% 13% 13% 13% 13% 1 Food Agro-allied Packaging Port operations Others August 25,

10 A quick look at each business segment shows that gross profit from FMN s food business recorded the most expansion, increasing 22.1 y/y despite a lower growth of 17.5 y/y in revenues generated from the business segment. Fig. 20: Y/y growth in revenue versus gross profit Revenue growth y/y Gross profit growth y/y 22% 18% 18% 13% Food Agro-allied Packaging Port Operations Others % -37% % -82% -82% -86% Therefore, as flour and other wheat based products make up a substantial portion of FMN s food business, we are inclined to believe that the impressive expansion in gross profit of the business segment was driven in large parts by the moderation in wheat prices recorded in the period. Furthermore, as the food business whose gross profit was supported by moderation in wheat prices contributed the most to FMN s overall gross profit expansion, and the overall gross profit expansion came on the back of a slower growth in cost of sales, we conclude that the lower wheat prices in the period significantly contributed to the lower cost of sales. Operating expenses expands 10.64% y/y on significant increase in selling and distribution expenses. In FY2014, FMN s selling and distribution expenses increased 23.51% y/y to 12.43billion while administrative expenses rose 2.21% y/y to 15.72billion. On the significant increase recorded in selling and distribution expenses, the group s operating expenses expanded 10.64% y/y to 28.16billion. The group was able to contain its administrative expenses in the period; we believe the more significant growth in selling and distribution expenses reflects the funds committed to driving sales volumes, even as the group continues to grow its customer service centres in order to continuously optimize sales volumes. In spite of the double-digit increase in operating expenses, operating expenses/revenue ratio came in at 8.48% compared to 8.43% recorded in FY2013. August 25,

11 Fig. 21: Operating expenses/revenue ratio, FY2008-FY % 1 8% 1 7% 9% 8% 8% 8% 8% 6% 4% 2% FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 Benign cost of sales supports overhead/revenue ratio In FY2014, FMN reported overhead/revenue ratio of 95.33%, compared to 95.78% posted in FY2013. As operating expenses/revenue ratio did not decline in the review period, we believe the benign overhead/revenue ratio resulted from the more favourable cost of sales/revenue ratio recorded in the period. Fig. 22: Cost of sales/revenue and overhead/revenue ratio, FY2008-FY Cost of sales/revenue Overhead/revenue 94% 94% 96% 91% 93% 95% 87% 86% 87% 84% 83% 85% 87% 78% FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 and lifts operating profit and margin. On the back of FMN s benign overhead/revenue ratio, its operating profit expanded 8.5 y/y to 19.38billion in FY2014, from 17.86billion in FY2013. However, the group posted an operating profit margin of 5.83% in FY2014, compared to 5.91% in FY2013. We believe the slight moderation in operating margin, despite the growth recorded in operating profit, is reflective of the increase in FMN s operating expenses and operating expenses/ revenue ratio. August 25,

12 Fig. 23: Operating profit and margins, FY2008-FY ,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Operating profit ( 'millions) Operating profit margin (%) 29,469 14% 24,923 20,791 9% 1 19,375 18,146 8% 11,346 13,0967% 6% 6% FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY % 14% 12% 1 8% 6% 4% 2% Finance costs weigh down bottom line and margins. In FY2014, FMN s finance costs expanded 41.15% y/y to 16.10billion. We believe a significant portion of the finance costs represents interest on the debt used to finance the expansion of the group s sugar business Golden Sugar Limited. The increase in finance costs led to an accelerated decline in post-tax profit and margins. In particular, FMN s FY2014 post-tax profit declined 28.82% y/y to 5.40billion from 7.54billion in FY2013 and its net margin also followed the same trend, declining to 1.62% from 2.5 recorded in FY2013. Fig. 24a: Post-tax profit and margins, FY2008-FY ,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Post-tax profit ( 'millions) Net margin (%) 16,518 8% 5% 8,487 7,197 7,540 6,340 4% 5,368 3,815 3% 2% 2% 2% FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 9% 8% 7% 6% 5% 4% 3% 2% 1% However, excluding Golden Sugar Limited, FMN would have recorded an increase of 22.4 y/y to 9.41billion in FY2014. We therefore conclude that the sugar business actually made a loss of c. 4.01billion which considerably depressed FMN s overall post-tax profit. The loss was driven, in significant parts, by the high finance costs attributable to the business. Going forward, our view is that post-tax profit and margin declines from high finance costs is temporary as we note that FMN has the capacity to significantly reduce current debt levels given its established ability to generate strong and positive operating cash flows. August 25,

13 Fig. 24b: Net cash flows from operations ( million), FY2008-FY ,000 25,000 20,000 15,000 10,000 5,000 0 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 Average Once the debt levels and finance costs are reduced, and given the gradual ramp up of capacity utilization (currently at 48%, up from initial levels of 4) in the sugar business in response to demand, we believe the business is likely to experience a positive turnaround, which will be supportive of the overall profits and margins of FMN, especially as we are of the opinion that the major factor stifling the bottom line of the sugar business and, by extension, the group performance, is high finance costs. FMN proposes per share cash dividend of 2.10, an increase of 5% from last year s levels. Motivated by improved results, and barring the dismal performance of its sugar business at bottom line levels, FMN proposed a cash dividend of 2.10/share for FY2014. This equates to a dividend yield of 2.94%, a pay-out of % based on the group s reported diluted earnings per share of 1.84 and a dividend increase of 5% y/y from last year s dividend levels. In the years beginning from FY2008, FMN s dividend pay-out has averaged 49.03% versus an average retention ratio of 50.97%. Fig. 25: Dividend payment policy, FY2008-FY Dividend payout (%) Retention (%) % 78% 79% 56% 52% 31% 114% % 44% 48% 25% 22% 21% FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY % August 25,

14 The high dividend pay-out, which exceeds the 10 bound, implies the group has decided to pay as dividend an amount greater than what it earned in the year under review, a move which, in our view, is hardly sustainable if continued as it means the group may have to deplete its retained earnings or cash flows or borrow in order to cover this dividend. Going forward, we do not expect FMN to maintain such a dividend pay-out trajectory, not even in the short term. Valuation shows FMN still trades at a discount to target. At a current market price of 68.11, FMN shares are undervalued and, in our estimation, trade at a riskadjusted discount of 29.13% relative to its target price of We have therefore maintained our BUY recommendation on the stock. In arriving at our estimate of FMN s target price, we have taken into cognizance previously articulated forward prospects. Our valuation incorporated target prices from absolute valuation methodology - mostly driven by our sum-of-the-parts and aggregated DDM and DCF models - and relative valuation methodology, with emphasis on P/E and EV/EBITDA multiples. Our final target price is the minimum-variance unbiased estimator of the different target prices obtained from the aforementioned techniques. Fig. 26: Share price Our recommendation history At a current market price of 68.11, FMN shares are undervalued and, in our estimation, trade at a risk-adjusted discount of 29.13% relative to its target price of We have therefore maintained our BUY recommendation on the stock BUY BUY BUY Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Source: Bloomberg, DLM Research.. August 25,

15 Investigating value and wealth creation in Nigeria s flour milling industry In making key investment decisions, our view is that answers to pertinent questions usually informs the choice of whether or not to invest in the shares of certain companies listed in certain industries. In our opinion, investors would often want to ascertain whether companies whose shares they own, or intend to own, have an established and/or a clear potential to create value and wealth for shareholders. As the emphasis of this report is on flour millers - FMN in particular - investors are not unlikely to ask questions such as: Has Nigeria s listed flour millers created wealth and value for investors? What position does FMN occupy in the hierarchy of wealth and value creation? And what is the firm s potential to create value and wealth going forward? In this section, we provide answers to these questions as we seek to understand how FMN has fared relative to select peers in creating value and wealth for shareholders over the last few years, beginning from We have taken 2008 as the earliest date in our analysis because that year coincides with the earliest time that the millers we have considered together had available all the data we require for this analysis. Has Nigeria s listed flour millers created wealth and value for investors? What position does FMN occupy in the hierarchy of wealth and value creation? And what is the firm s potential to create value and wealth going forward? For the purpose of comparing firms with the same financial year end within the industry, we have decided to perform our wealth and value creation analysis on FMN, its listed subsidiary Northern Nigeria Flour Mills (NNFM) and Honeywell Flour Mills. These millers all have March 31 as their financial year end. The background to our analysis is as detailed on the next page. August 25,

16 Background Although assumed equivalent, value creation and wealth creation are not the same. Value creation is specific to a company s operations; wealth creation is dictated by the performance of a company s shares in the market. A company is said to create value if, in addition to being profitable, it provides returns on capital in excess of the cost of capital. On the other hand, a company is said to create wealth for shareholders if its shares record a positive capital appreciation in the market, and/or its dividend yield is non-zero and its total returns, which are the sum of its capital appreciation and dividend yield, are more than zero. Thus, value creation is endogenous because it is internal and company-specific and depends more on the company s business model and strategy. In contrast, wealth creation is exogenous since it is external and depends on investor and market sentiments towards the fundamentals and value creation potential of a company. It is this extrinsic sentiment - driven in part by an anticipation of value creation and benign fundamentals - that drive the performance of a company s shares in the market. A value creating company is intuitively not unlikely to create wealth for shareholders; however, that a company creates wealth for shareholders does not necessarily mean it would also create value for shareholders, especially if such company runs a suboptimal business model, as there is often a disconnect between performance of a company s operations and performance of its shares in the market. A company is said to create value if, in addition to being profitable, it provides returns on capital in excess of the cost of capital. On the other hand, a company is said to create wealth for shareholders if its shares record a positive capital appreciation Value creation can and does equate wealth creation; in fact, a necessary and sufficient condition for value creation to equate wealth creation is that the market is efficient and all information on a company is contained in its share price as it trades in the market. However, as this is rarely the case, we conclude that value creation rarely equates wealth creation. Estimating value creation and wealth creation in Nigeria s flour milling industry To quantify value, one would have to employ a metric for estimating value creation. In this report, we favour equity spread as the metric to estimate value creation due to its simplicity and desirability which includes linking returns to cost of invested capital, with emphasis on equity. Total shareholder return (TSR), on the other hand, is favoured as the appropriate metric to estimate shareholder wealth creation. Computationally, equity spread is the difference between returns on equity (ROE) and cost of equity (COE), while TSR is the sum of share price capital appreciation/capital gain and dividend yield. August 25,

17 Which listed flour millers created the most value in FY2014? To answer this question, we completed an equity spread analysis of 3 listed firms in Nigeria s flour milling industry, based on their FY2014 audited results. Using equity spread as the basis of our analysis, we say value is created for equity holders if a company generates ROE in excess/surplus of its COE, otherwise the company is either not creating value or, in the worst case scenario, is destroying value. In determining the COE used in our analysis, we employed the average yield of 12.5 on FGN 10-year bond as a proxy for risk free rate. We also employed the 1- year beta of each stock, alongside an equity market risk premium of 5%. Fig. 27: Beta - sensitivity to market movement - and required rate of return - COE Beta COE (%) % 17% 16% 14% 0.31 NNFM FMN Honeywell NSEASI 2 18% 16% 14% 12% 1 8% 6% 4% 2% Source: Bloomberg, DLM Research In addition to equity spread, we determined the Naira value or magnitude of value created or destroyed by each firm. Results of our value creation analysis are summarised in Fig.28 below. Fig. 28: Nigeria s cement industry Value creation in FY2014 ROE FMN NNFM Honeywell Average 6.42% 13.16% 16.27% 11.95% COE 15.96% 14.02% 16.79% 15.59% Equity Spread -9.54% -0.86% -0.52% -3.64% Shareholders' Equity ( 'millions) 83,559 1,774 20,605 35,313 Value Created ( 'millions) (7,972) (15) (107) (2,698) DuPont Analysis Asset turnover 1.12x 3.53x 0.86x 1.84x Net profit margin 1.62% 2.05% 6.08% 3.25% Equity multiplier 3.56x 1.82x 3.10x 2.82x ROE 6.42% 13.13% 16.27% 11.95% August 25,

18 In our estimation, all flour millers considered in this analysis destroyed value for shareholders in FY2014. Honeywell destroyed the least value amongst the listed millers as it recorded the highest equity spread/excess return of -0.52% in that year. This was followed by NNFM, FMN s subsidiary, whose excess return came in at -0.86%. On the other hand, FMN was profitable in FY2014, but destroyed value for shareholders in that financial year. In particular, the group recorded the least excess return of -9.54%, in our estimation, and destroyed the most value. Given the nearness of each COE to average COE, we note that the major factor that determined the extent of value creation or destruction in the industry in FY2014 was the strength of the ROEs of the listed flour millers. This explains why Honeywell and NNFM, both having the highest and next highest ROE in the industry in FY2014, destroyed the least value in that year. In particular, Honeywell s robust ROE was driven by a combination of a high net margin, i.e. c.4x and c.3x the net margins of FMN and NNFM respectively, and a high financial leverage, c.2x that of NNFM. On the other hand, NNFM s ROE was driven largely by its extremely high operating efficiency, i.e. c.3x that of FMN and c.4x that of Honeywell, as a significant portion of its assets already contributes to its revenues. The major factor that impeded the strengthening of FMN s ROE in FY2014 was its weak net margin and relatively suboptimal operating efficiency as most of its recent investments in assets are yet to begin contributing to revenues. We nonetheless expect the situation to improve as the group ramps up utilization of its newly acquired assets in order to meet demand for products. Put differently, we expect operating efficiency to improve with improving asset capacity utilization and believe this to be positive on FMN s revenues, margins and also ROE, going forward. In terms of actual Naira value destroyed in the industry, once again, FMN fared worse as it destroyed the most Naira value in FY2014. In our estimation, the group destroyed 7.97billion of shareholder value in FY2014. Meanwhile, NNFM and Honeywell switched positions in terms of actual Naira value destroyed. Whilst relative to Honeywell, NNFM destroyed more value in percentage terms, it destroyed the least value in actual Naira terms (Fig.30). Specifically, Honeywell destroyed 107million of value in FY2014 while NNFM destroyed 15million of value in the same financial year. August 25,

19 Our analysis reveals that the low Naira value destroyed by Honeywell and NNFM reflects their smaller net asset base, relative to FMN. Therefore, a firm as big and diversified as FMN would only need to record an equity spread slightly more than zero, at the minimum, in order to create a relatively substantial Naira value, while smaller and less diversified firms such as Honeywell and NNFM would have to provide an excess return that is significantly greater than zero, in order to create the same Naira value. However, in FY2014, FMN did not take advantage of the increasing returns to Naira value creation provided by its robust net asset base. Fig. 29: Shareholders Equity and Equity Spread, FY ,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Shareholders' Equity ( 'millions) Equity Spread (%) FMN NNFM Honeywell Average -2% -4% -6% -8% -1-12% Fig. 30 Naira Value Created ( millions), FY (1,000) FMN NNFM Honeywell Average (2,000) (3,000) (4,000) (5,000) (6,000) (7,000) (8,000) (9,000) August 25,

20 Which listed flour millers have - more often than not - created value for shareholders since FY2008? To answer this question, we performed an equity spread analysis on the flour millers audited financial results from FY2008 to FY2014. The graph below provides a summary of our 4-year equity spread analysis. Fig 31: Value creation, FY2008-FY2014 FMN NNFM Honeywell Average 2 13% 15% 15% 9% 5% 2% 0.23% 1% -1% -0.32% -0.96% -1.46% -0.52% -1% FY2008 FY2009-2% FY2010 FY2011 FY2012 FY2013-3% FY2014-4% -5% -6% -8.09% -7% -8% -8% % -16% Among the flour millers considered in the last financial years beginning from FY2008, FMN and its subsidiary, NNFM, have recorded the highest frequency of value creation for shareholders. Fig. 32 Naira Value Created ( millions), FY2008-FY ,000 8,000 FMN NNFM Honeywell Average 8,017 6,000 4,000 2,000 - (2,000) (4,000) 2, (36) (691) (48) (211) 0 (272) (15)(108) FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 (909) (1,093) (163) (2,152) (2,073) (2,243) (2,697) (6,000) (8,000) (10,000) (5,845) (6,457) (7,968) Contrary to their outing in FY2014, Nigeria s listed flour millers, on average, have not always destroyed value for shareholders. Among the flour millers considered in the last financial years beginning from FY2008, FMN and its subsidiary, NNFM, have recorded the highest frequency of value creation for shareholders. Honeywell has recorded the least frequency of value creation for shareholders and the most frequency of value destruction. August 25,

21 Specifically, FMN created value for shareholders thrice out of the seven financial years considered as it recorded an equity spread of 2.13%, 15.05% and 1.02% in FY2008, FY2010 and FY2011 respectively. This was tracked by NNFM s consecutive value creation of 13.29%, 19.72% and 15.32% in FY2009, FY2010 and FY2011 respectively. In FY2013, NNFM neither created nor destroyed value as it recorded a positive but very negligible equity spread, in our estimation. Honeywell has been the industry laggard on value creation, recording a positive equity spread of 0.23% only in FY2008. From this analysis, we conclude that over the past years, FMN and its NNFM subsidiary have dominated Honeywell on value creation for shareholders. FMN recorded its best and worst performances on value creation in FY2010 and FY2014 respectively, while NNFM recorded its best and worst performances on value creation in FY2010 and FY2012 respectively (Fig.31). In the last 7 years, Honeywell has recorded the highest number of value destructions and have destroyed value in 6 out of the 7 financial years under consideration, according to our estimation. On a cumulative basis, NNFM has been the clear leader among the listed flour millers we have considered, despite being the smallest among them. The firm has been outperforming on value creation since FY2009. While other flour millers considered recorded a negative cumulative yearly excess return by FY2014, an indication that they have destroyed value cumulatively by FY2014, NNFM recorded a positive double-digit cumulative excess return (Fig. 33). To be clear, cumulatively from FY2008 to FY2014, FMN and Honeywell recorded cumulative yearly excess returns of % and respectively, while NNFM recorded a cumulative excess return of 26.47% in our estimation. This shows that NNFM and its parent, FMN, dominate on cumulative value creation, in relation to Honeywell. Further analysis reveals that NNFM s strong cumulative value creation reflects its consecutive value creation in FY2009, FY2010 and FY2011 at a time when some other peers were destroying value. In terms of cumulative yearly Naira value created, NNFM again has the highest frequency of cumulative value creation. In addition to generating the highest cumulative yearly excess returns amongst peers from FY2008 to FY2014, the firm also created the highest cumulative yearly Naira value of million from FY2008 to FY2014. This contrasts more favourably with the cumulative yearly Naira value of 9.98billion and 4.92billion destroyed by FMN and Honeywell respectively (Fig.34). August 25,

22 We are of the view that the higher cumulative yearly Naira value destroyed by FMN compared to Honeywell, despite its lower equity spread, relative to Honeywell, is reflective of its significantly higher shareholders equity which magnifies Naira value destruction even if equity spread is relatively less negative or just slightly below zero. Fig. 33: Cumulative yearly value creation, FY2008-FY FMN NNFM Honeywell Average FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY Fig. 34: Cumulative Naira value created ( millions), FY2008-FY2014 8,000 6,000 4,000 2,000 - (2,000) (4,000) (6,000) (8,000) (10,000) (12,000) FMN NNFM Honeywell Average FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 Has wealth been created by Nigeria s flour millers since FY2008? Who created it? Investors might, however, argue that cumulative value creation does not mean actual wealth creation and that one would have to check whether the flours millers who created value also created wealth in the years value was created. In line with this argument, we performed a total shareholder return analysis (TSR) from FY2008 and FY2014 to see whether the flour millers have created wealth for shareholders in each year and cumulatively over the years considered (Fig. 35 and 36). August 25,

23 Fig. 35: Total shareholder return, FY2014 Capital Appreciation Dividend Yield Total Shareholder Return (TSR) FMN % 3.39% -9.6 NNFM -7.52% 1.82% -5.7 Honeywell 30.74% % Average 3.41% % Source: Bloomberg, DLM Research Fig. 36: Wealth creation, FY % 3 25% 2 15% 1 5% -5% -1-15% 35% 7% FMN NNFM -6% Honeywell Average -1 Source: Bloomberg, DLM Research Honeywell and FMN created the highest and least wealth for shareholders in FY2014. We note that, in FY2014, Honeywell dominated in value creation, as measured by equity spread, and also created the most wealth for shareholders. NNFM s value destruction was less pronounced than that of FMN; accordingly, its wealth destruction was also less than that of FMN. These seem to suggest that the millers that destroyed the most value in FY2014 also destroyed the most wealth in in the review year. To put the wealth created in perspective, investors that had invested 100million in the shares of each of the flour millers at the start of April 2013, and did not reallocate their investment, would have earned the highest total return of c.35.15% from Honeywell via creation of an additional wealth of c million, bringing gross wealth to c million by March Fig. 37: Wealth creation, single capital scenario analysis Invested capital ( 'millions) TSR Wealth created( 'millions) FMN NNFM Honeywell % Average % Source: Bloomberg, DLM Research August 25,

24 Fig. 38: Wealth creation from 100million hypothetical investment Invested capital ( 'millions) Wealth created ( 'millions) TSR(%) % % % % % 5% % -5% FMN-1 NNFM Honeywell Average % In the last 7 years from FY2008 to FY2014 and cumulatively, Honeywell has not always outperformed listed peers on wealth creation. In fact, Honeywell only outperformed NNFM and FMN on wealth creation in FY2014, a year when its ROE and equity spread dominated in the industry. In other years, it destroyed wealth for shareholders. In terms of wealth creation, FMN and NNFM have been relatively more consistent. FMN destroyed wealth in FY2012 and FY2014 while NNFM destroyed wealth in FY2009, FY2012 and FY2014. FMN has been relatively more consistent in the creation of wealth. The group destroyed visible wealth in FY2012 and FY2014 alone, and created wealth in the remaining years, with unrivalled wealth created in FY2011 and FY2013 (Fig.39). Thus, historically, FMN has been the dominant wealth creator among the listed peers we have considered as it has the highest frequency of wealth creation since FY2008, suggesting that it has created more wealth for shareholders than most of its peers. Fig. 39: Yearly total shareholder returns, FY2008-FY FMN NNFM Honeywell Average FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY August 25,

25 On a cumulative wealth creation basis, FMN also leads the pack, creating the highest cumulative yearly total shareholder returns of % from FY2008 to FY2014, followed by its subsidiary NNFM that created cumulative yearly total shareholder returns of % within the same horizons. Meanwhile, Honeywell destroyed wealth for shareholders within the same horizons as it recorded cumulative yearly total shareholder returns of Therefore, an investor who allocated an equal amount to the shares of these millers at the start of FY2008 would have created the most cumulative yearly wealth from FMN by the end of FY2014. Fig. 40: Cumulative yearly total shareholder returns, FY2008 FY FMN NNFM Honeywell Average FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY On the whole, our value-wealth creation analysis suggests that FMN has an established ability to create value and wealth for shareholders. To further harness its future potential to continually create value and wealth for shareholders, the group still has plenty to do as regards strengthening its value creation strategies to better create a substantial Naira value from its well-diversified business. Based on our cumulative analysis, FMN and its subsidiary NNFM have created the most wealth and value for shareholders since FY2008 at the minimum and only underperformed Honeywell on value creation in FY2014 on the back of a much weaker ROE. On the whole, our value-wealth creation analysis suggests that FMN has an established ability to create value and wealth for shareholders. To further harness its future potential to continually create value and wealth for shareholders, the group still has plenty to do as regards strengthening its value creation strategies to better create a substantial Naira value from its welldiversified business. Our analysis strengthens our view that FMN has had a robust business model. We believe the group s optimal business performance of previous years can still be replicated as the it has now evolved to become much bigger, well-diversified and, in our view, better over the years and have invested in areas we expect to outperform on the back of previously highlighted drivers. We expect its diversification strategy which has thus far been positive for cash generating ability to also be positive for earnings, going forward. For truly long-term investors that have investment horizons of more than one year, a healthy risk appetite and a desire to maximize value and create wealth from Nigeria s flour milling industry, we conclude that FMN offers ample opportunities. August 25,

26 Fig. 41: Statement of Profit and loss, N mn FY2014 FY2015E FY2016F FY2017F Revenue 332, , , ,706 change % 12.37% 12.37% Cost of sales 288, , , ,323 change 9.26% 15.55% 12.88% 11.98% Gross Profit 43,657 53,725 58,663 67,383 change 15.19% 23.06% 9.19% 14.86% Operating Expense 28,155 32,901 35,664 41,540 change 10.77% 16.86% % Operating profit 19,375 20,824 22,999 25,843 change % 10.44% 12.36% Interest Expense 16,101 17,035 18,316 19,510 change 41.15% % 6.52% Profit before tax 8,228 8,968 10,328 12,051 change % 8.99% 15.16% 16.68% Income Tax Expense 2,860 2,666 2,746 2,506 change % -6.77% % Profit after tax 5,367 6,302 7,581 9,545 change % 17.41% 20.31% 25.9 Basic EPS Fig. 42: Statement of Profit and loss, N mn Assets Source: Company s annual reports, DLM Research FY2014 FY2015E FY2016F FY2017F Propetry, plant & equipment 169, , , ,232 Cash & Near Cash Items 16,825 18,844 19,786 20,776 Trade Receivables 14,647 15,672 16,769 17,943 Inventories 63,685 67,506 71,556 75,850 Total Current Assets 100, , , ,569 Total Noncurrent Assets 196, , , ,813 Total Assets 297, , , ,382 Liabilities & Shareholders' Equity Trade Payables 45,454 47,837 49,312 52,257 Short-Term Borrowings 86,867 92,485 95, ,031 Total Current Liabilities 128, , , ,804 Long-Term Borrowings 65,098 66,972 69,037 73,160 Total Liabilities 213, , , ,351 Total Equity 83,560 92,485 95, ,031 Fig. 43: Profitability FY2014 FY2015E FY2016F FY2017F Margins Gross margin 13.14% 13.88% 13.49% 13.79% Operating margin 5.83% 5.38% 5.29% 5.29% Net margin 1.62% 1.63% 1.74% 1.95% Returns ROE 6.42% 6.81% 7.95% 9.45% ROA 1.81% 1.98% 2.31% 2.74% ROCE 11.49% 11.46% 12.27% 13.01% Fig. 44: Activity Ratio FY2014 FY2015E FY2016F FY2017F Inventory turnover (x) Receivables turnover (x) Payables turnover (x) Days inventory outstanding Days sales outstanding Days payables outstanding Cash conversion cycle Fig. 45: DuPont Analysis FY2014 FY2015E FY2016F FY2017F Total assets turnover(x) Net margin 1.62% 1.63% 1.74% 1.95% Equity multiplier (x) ROE 6.42% 6.81% 7.95% 9.45% Fig. 46: Efficiency Ratio FY2014 FY2015E FY2016F FY2017F Fixed assets turnover (x) Current assets turnover (x) Equity turnover (x) Total assets turnover (x) Fig. 47: Liquidity Ratio FY2014 FY2015E FY2016F FY2017F Working capital (N'millions) -27,815-32,255-33,250-35,236 Current ratio (x) Quick ratio (x) Cash ratio (x) Fig. 48: Leverage and solvency Ratio FY2014 FY2015E FY2016F FY2017F Equity multipler(x) Debt-to-equity (x) Total debt-to-assets (x) Total assets-to-liabilities (x) Interest coverage (x) Cash coverage (x) August 25,