Honeywell Flour Mills Plc

Honeywell Flour Mills Plc Additional Milling Capacity supports revenue growth Honeywell Flour Mills Plc ( HFM or the company ) recently released its 9M results to December 2013. The unaudited 9M results show an increase in revenues to ~N41.03billion, up by 24.19%, compared with ~N33.04billion recorded in the corresponding period of 2012. We are of the view that the improvement in revenues could be attributed to a combination of increased sales volume on the back of the expansion in capacity to 2,610MT per day, from 1,610MT per day, which was completed in Q1 2013 and the investment in aggressive marketing employed by the company which continues to drive sales. Lower commodity prices restrain cost of sales Despite the marked increase in revenues, cost of sales rose by 20.71% y/y, compared with 20.06% in the 9M to December 2012. This can be attributed to lower input costs given that prices for Hard Red Winter (HRW) wheat averaged US$309.16/metric ton (MT) during the period, compared with $311.44/MT and $324.72/MT recorded in previous comparable periods of 2011 and 2012. and boost profits. Consequently, gross profit improved by 41.65% to N7.76billion from N5.48billion in the 9M to December 2012. Similarly, operating profit for the period was 43.27% higher than the N2.54billion posted in the 9M to December 2013. However, we note that the increase in operating profit was supported by the 100% y/y increase in other income, which rose to N204million from N102million. Consequently, tax provision, which decreased by 18.35%, resulted in a post-tax profit of N2.03billion, up by 17.92% from the N1.72billion recorded in 9M2013. (fig.1) Kate Isabota kisabota@dunnlorenmerrifield.com Price: - Current N 3.70* - Target N 4.79 Recommendation: BUY * As at Thursday February 20, 2014 Fig. 2: Stock data FYE March Price Mov t: YtD / 52wk -1.36%/17.53% 52-week range N 2.61 - N 4.11 Average daily vol./val. Outstanding Shares Market Cap. (N million) EPS, N, Trailing 0.31 DPS, N, FY2013 0.16 FCFPS, N, 9M2014 0.42 Source: Bloomberg, NSE, DLM Research Fig. 3: Key ratios 9M2014 2,647,013/ N7.90million 7,930million 28,707.3($184.32million) 9M2013 Gross profit margin 18.91% 16.58% Net profit margin 4.94% 5.20% Equity multiplier 3.43x 3.26x Asset turnover 0.62x 0.55x Fig. 4: Valuations P/Sales 0.54x 0.49x 0.45x 0.43x P/E 8.70x 7.33x 5.25x 4.02x P/ B 1.33x 1.19x 1.09x 1.01x PEG 1.57 0.39 0.13 0.13 EV/Sales 0.54 0.49 0.45 0.43 ROE 15.99% 17.13% 21.69% 26.13% ROA 5.50% 5.92% 7.83% 9.78% Div. Yield 5.13% 5.79% 6.09% 6.41% Source: Bloomberg, DLM Research Fig. 5: HONYFLOUR vs. NSE, 52-wk movement Fig 1: Results highlight 9M2014 9M2013 y/y Δ Revenue (N.billion) 41.03 33.04 24.19% Operating profit (N.billion) 3.64 2.54 43.27% Post-tax profit (N.billion) 2.03 1.72 17.92% Please read the Important Disclosures at the end of this report. www.dunnlorenmerrifield.com

Fig. 6: Revenue and cost of sales, N billion Revenue Cost of sales 41.03 33.04 33.27 27.94 27.56 22.96 Estimates Fig. 7: Cost ratios cos/revenue opex/revenue We observed that the significant increase in operating expenses by N1.29billion to N4.33billion in 9M2014 was insufficient to negatively impact on operating profit margin as it improved to 8.87% in 9M2014. 82.15% 83.42% 81.09% Estimates 9.29% 9.20% 10.54% Net margin declines on the back of higher finance cost recorded during the period. The company achieved a gross profit margin of 18.91% in 9M2014 due to improvement in revenues recorded during the period. We observed that the significant increase in operating expenses by N1.29billion to N4.33billion in 9M2014 was insufficient to negatively impact on operating profit margin as it improved to 8.87% in 9M2014. However, post-tax profit margin declined further to 4.94% during the period, from 6.13% and 5.20% in 9M2012 and 9M2013 respectively. We believe that the decline in post-tax margins is largely attributable to the increase in finance costs - up by 184.87% y/y in 9M2014. (fig.8) February 20, 2014 2 www.dunnlorenmerrifield.com

Fig. 8: Profit Margins Gross margin Operating margin Post-tax margin 17.85% 18.91% 16.58% 8.75% 7.69% 8.87% 6.13% 5.20% 4.94% Estimates We highlight that the increase recorded in finance cost is the result of an increase in non-current financial liabilities which stood at ~N10.81billion in 9M2014, up from ~N5.57billion in 9M2013; we believe the funds were used to finance the additional capacity expansion which was completed in the first quarter of 2013. Consequently, the increase of 4.39% recorded in finance income to N547million during the period was insufficient to minimize the effect of interest expense on earnings. (fig.9) We highlight that the increase recorded in finance cost is the result of an increase in noncurrent financial liabilities which stood at ~N10.81billion in 9M2014, up from ~N5.57billion in 9M2013. Fig. 9: Finance cost and finance income, N billion Finance income Finance costs 1.487 0.501 0.524 0.522 0.547 0.427 Higher operating expenses recorded during the period reflect the management s continued marketing efforts to boost sales. In 9M2014, selling and administrative expenses increased by 42.26% to ~N4.33billion from ~N3.04billion in the corresponding period of the previous year. The increase in distribution expenses was largely due to the increased use of strategic sales and marketing through various advertising mediums. We believe that the aggressive marketing strategy employed by the company is a significant revenue driver through creating awareness in the minds of consumers, invariably leading to greater patronage. February 20, 2014 3 www.dunnlorenmerrifield.com

Operating expenses as a percentage of total cost rose to ~11.51% from ~9.94% in 9M2013 whilst cost of sales declined to 88.49% in 9M2014 from 90.06% in 9M2013. (fig.10) Fig. 10: Cost of sales & operating expenses as a % of total cost, 9M2014 11.51% Cost of sales Operating expenses 88.49% A review of the company s statement of financial position as at 9M2014 reveals an increase of c.9.39% in non-current assets to N36.21billion from N33.10billion in 9M2013. A review of the company s statement of financial position as at 9M2014 reveals an increase of c.9.39% in non-current assets to N36.21billion from N33.10billion in 9M2013. This was principally driven by 12.52% increase in property, plant and equipment (PPE) to ~N36.19billion from N32.17billion in FY2012 as intangible assets reduced by 60.00% during the period. Current assets also recorded an increase of ~11.69% during the period. Overall, total assets rose by 10.42% in 9M2014 to N66.20billion from N59.96billion. (fig.11) Fig. 11: Non-current, current and total assets, N billion Total non-current assets Total current assets Total assets 59.95 66.20 46.18 29.90 33.10 26.85 36.21 30.00 16.28 The fixed-asset turnover ratio which measures the company's ability to generate sales from fixed-asset investments improved at 1.13x in 9M2014 whilst current asset turnover ratio increased to 1.37x during the review period from 1.23x in 9M2013. Overall, total-asset turnover ratio improved to 0.62x in 9M2014 from 0.55x in 9M2013. (fig.12) February 20, 2014 4 www.dunnlorenmerrifield.com

Fig. 12: Asset turnover: non-current, current and total assets Fixed assets turnover Current assets turnover Total assets turnover 1.72 1.37 1.23 1.13 0.93 1.00 0.61 0.55 0.62 Total non-current liabilities rose by 38.80% in 9M2014 from N10.57billion in 9M2013. Current liabilities also recorded a marginal increase of ~3.86% during the period. Overall, total liabilities rose by 12.75% in 9M2014 to N46.89billion from N41.59billion in 9M2013 (fig.13). Whilst we observe the negative working capital recorded during the period, we note the improvement to a negative of N2.22billion compared to the negative working capital of N4.16billion recorded in 9M2013. The impact of the additional 1000MT/day milling capacity through the addition of mills E and F is expected to fully reflect by FY2014 particularly in the Honeywell Wheat Meal and Honeywell Semolina category. Fig. 13: Non-current, current and total liabilities, N billion Total current liabilities Total non-current liabilities Total liabilities 41.59 46.89 28.34 31.01 32.21 19.27 9.07 10.58 14.68 The impact of the additional 1000MT/day milling capacity through the addition of mills E and F is expected to fully reflect by FY2014 particularly in the Honeywell Wheat Meal and Honeywell Semolina category. Overall, we maintain our forecast for a year-on-year increase in turnover of c.23.50% from N45.71billion to N56.45billion in FY 2014, with a post-tax profit of N3.00billion; an improvement of 5.35% y/y in the same period. February 20, 2014 5 www.dunnlorenmerrifield.com

Our Valuation Valuation shows that Honeywell Flour Mills Plc is undervalued at its current market price of N3.70. We employed multiples of price/earnings, price/sales, price/book and the DDM Methodology consequently arriving at a target price of N4.79. We are mindful of the inherent risk that is associated with the Flour milling industry, particularly the foreign exchange risk associated with the importation of wheat and the price of wheat in the international market given that price is subject to forces beyond the control of the company. However, we remain positive on the outlook of the country s flour milling industry, and particularly on HFM. From the foregoing, we place a BUY recommendation on the stock of HFM in the short term investment horizon. Our valuation and forecast took into consideration the challenging operating environment in the country, demographic structure of the nation s population, the level of consumer spending, and the intensity of competition in the market. From the foregoing, we place a BUY recommendation on the stock of HFM in the short term investment horizon. February 20, 2014 6 www.dunnlorenmerrifield.com

Fig. 14: Statement of Profit or Loss, N million Sales revenue 45,709 56,451 60,685 63,841 Change 20.12% 23.50% 7.50% 5.20% Cost of sales 37,788 46,480 49,996 52,714 Change 19.74% 23.00% 7.50% 5.50% Gross profit 7,921 9,971 10,719 11,127 Change 21.99% 25.89% 7.50% 3.80% Operating expenses 4,345 5,003 5,436 5,771 Change 39.59% 15.15% 8.67% 6.16% Other operating income 144.066 223.302 234.467 247.363 Change 28.54% 55.00% 5.00% 5.50% Operating profit 3,720 5,192 5,517 5,603 Change 6.52% 39.55% 6.27% 1.55% Finance income 622.534 632.246 638.567 641.761 Change -10.46% 1.56% 1.00% 0.50% Interest expenses 528.340 1,849 1,942 1,960 Change 1.00% 250.00% 5.00% 0.95% Profit before tax 3,815 3,975 4,214 4,285 Change 4.08% 4.20% 6.02% 1.67% Income tax 971.079 979.333 982.271 983.253 Change 0.01% 0.85% 0.30% 0.10% Profit for the year 2,844 2,996 3,232 3,301 Change 5.55% 5.35% 7.89% 2.15% Fig. 15: Statement of Financial Position, N million Non-Current Assets Property, plant & equipment 34,969 38,431 41,603 43,854 Intangible assets 15.904 16.222 16.514 16.762 Goodwill - - - - Total non-current assets 34,985 38,447 41,620 43,871 Current Assets Inventories 10,009 10,059 10,210 10,226 Trade & other receivables 6,869 6,535 6,339 6,326 Cash & cash equivalents 3,574 3,583 3,601 3,655 Total Current assets 20,452 20,177 20,150 20,208 Total assets 55,437 58,624 61,770 64,078 Equity 18,553 20,828 22,649 24,482 Non-Current Liabilities Deferred taxation 2,935 3,224 3,402 3,436 Financial liabilities 5,573 5,773 5,865 5,880 Total non-current fin. liab. 9,381 9,969 10,314 10,423 Current Liabilities Trade & other payables 1,263 667.597 448.109 286.207 Current tax liabilities 712.342 737.274 748.333 752.075 Current fin. Liabilities 25,528 26,422 27,611 28,135 Total current liabilities 27,503 27,826 28,807 29,173 Total liabilities 36,884 37,796 39,121 39,597 Total equity and liabilities 55,437 58,624 61,770 64,078 Fig. 17: DuPont Analysis Total assets turnover 0.82x 0.96x 0.98x 1.00x Operating profit margin 8.14% 9.20% 9.09% 8.78% Equity multiplier 2.99x 2.81x 2.73x 2.62x ROCE 15.55% 18.91% 18.68% 17.89% Fig. 18: Efficiency ratios Fixed assets turnover 1.31x 1.47x 1.46x 1.46x Current assets turnover 2.23x 2.80x 3.01x 3.16x Total assets turnover 0.82x 0.96x 0.98x 1.00x Inventory turnover 5.06x 4.63x 4.93x 5.16x Receivables turnover 5.38x 8.42x 9.43x 10.08x Payables turnover 10.20x 48.16x 89.57x 143.57x Days inventory outstanding 72 78 74 70 Days payables outstanding 35 8 4 2 Days receivables outstanding 67 43 39 36 Cash conversion cycle (days) 104 115 109 104 Fig. 19: Liquidity ratios Working capital (N millions) -7,051-7,649-8,657-8,966 Current ratio 0.74 0.73 0.70 0.69 Quick ratio 0.38 0.36 0.35 0.34 Cash ratio 0.13 0.13 0.13 0.13 Fig. 20: Long-term solvency & stability ratios Gearing 23.10% 21.70% 20.57% 19.37% Equity multiplier 2.99x 2.81x 2.73x 2.62x Total debt-to-equity 1.99x 1.81x 1.73x 1.62x Total debt-to-assets 66.53% 64.47% 63.33% 61.79% Proprietary 53.06% 54.20% 54.44% 55.83% Interest coverage 8.22x 3.15x 3.17x 3.19x Cash coverage -3.40x -0.59x 0.60x 0.78x Fig. 21: Shareholders investment ratios EPS, N 0.36 0.38 0.41 0.42 DPS, N 0.16 0.18 0.19 0.20 Payout 45% 47% 47% 48% FCFPS, N 0.68 0.77 1.06 1.10 Source: Company s annual reports, DLM Research Fig. 16: Profitability & return Gross profit margin 17.33% 17.66% 17.66% 17.43% Operating profit margin 8.14% 9.20% 9.09% 8.78% Net profit margin 6.22% 5.31% 5.33% 5.17% ROCE 15.55% 18.91% 18.68% 17.89% ROE 15.99% 15.21% 14.87% 14.01% ROA 5.50% 5.25% 5.37% 5.25% Source: Company s annual reports, DLM Research February 20, 2014 7 www.dunnlorenmerrifield.com

Equity research methodology employed in this report Views documented in this equity research report stem from conclusions reached through the use of multiple valuation methodologies, industry-wide knowledge, company specific information and our near to medium term expectations of industry and company performance, as well as market outlook. Our forecasts are based on a combination of top down and bottom up analysis, alongside historical trends in industry and company financials. Where appropriate, we factored in available forecasts and business direction provided by company management. This equity research report qualifies as an initiation research report on the company whose stock has been analysed, hence the level and depth of details documented herein. Further updates on this company, or its stock, or both, will be communicated to investors via brief research notes or earnings-flash emails, as occasion demands. Our recommendation is slightly biased towards value investing. Therefore, our investment rank gauge a customized scale we use to judge how well a firm under coverage has performed is determined using major value parameters as well as relevant ratios and multiples computed with figures from the company s most recent financials. The investment rank or grade given to a company is an alphabet which falls in the set {A+, A, B, C+, C, D, E, F}, where Grade A+ means the company has done excellently well on all fronts that form the basis of our consideration, and has a strongly positive performance outlook. Grade A means the company s performance is of high quality, but can be made better. Outlook for the company is positive. Grade B means the company performed marginally above average, at least relative to its peers, but faltered on some fronts. Outlook is weakly positive. Grade C+ means the company s performance is exactly average; outlook is neither positive nor negative. Grades C and D indicate that dwindling performance is the company s fate at the current time. Outlook for the company is mildly negative. Grades E and F mean the company is headed for towards jeopardy, which might impair its ability to continue as a going concern. Outlook for the company in this case is alarmingly negative. The variables used to arrive at the company s investment rank cover a wide range of measures which characterize liquidity, operational efficiency, profitability, profitability margins, growth, economic profitability, gearing, relative valuation ratios, capital structure and management performance. Our investment recommendation is underpinned by the upside or downside potential of a stock under coverage. This potential is estimated by comparing the stock s current market price to its price target and fair value, on a percentage increase or decrease basis as summarized below: Deviation from current price Recommendation >30% STRONG BUY 10% to < 30% BUY -10% to < 10% HOLD <-10% SELL Source: Company Financials, DLM Research In our analysis, we distinguish between fair value and price target. Fair value is our opinion of the actual fundamental worth of a stock, irrespective of what the market thinks of the stock or what investors are willing to pay for it. Value investors purchase stocks way below their fair values, while income investors might purchase stocks at their fair values at the very maximum. Price target, on the other hand, is the estimated price we opine the stock will trade in the near to medium term. It is the price that, if realized, could result in the best investment returns, given prevailing market conditions. It gives an idea of the price other investors might be willing to pay for a stock regardless of its actual worth. We employ fair value, price target or both to determine a stock s upside or downside potential. A BUY recommendation directly means what it says; purchase the stock according to your wallet and appetite for risk. A SELL recommendation prompts investors to exit their positions in the stock, as the analyst believes the stock is not worth investors time and capital commitment. A HOLD recommendation generally tells investors to do nothing; if you have not bought the stock, do not buy it and if you have bought it, do not sell it. February 20, 2014 8 www.dunnlorenmerrifield.com

IMPORTANT DISCLOSURES. This research report has been prepared by the analyst(s), whose name(s) appear on the front page of this document, to provide background information about the issues which are the subject matter of this report. It is given for informational purposes only. Each analyst hereby certifies that with respect to the issues discussed herein, all the views expressed in this document are his or her own and reflect his or her personal views about any and all of such matters. These views are not necessarily held or shared by Dunn Loren Merrifield Limited or any of its affiliate companies ( DL Merrifield ). The analyst(s) views herein are expressed in good faith and every effort has been made to use reliable comprehensive information but no representation is made as to its accuracy or completeness. The opinions and information contained in this report are subject to change and neither the analysts nor DL Merrifield is under any obligation to notify you or make public any announcement with respect to such change. This report is produced independently of DL Merrifield and the recommendations (if any), forecasts, opinions, estimates, expectations and views contained herein are entirely those of the analysts. While all reasonable care has been taken to ensure that the facts stated herein are accurate and that the recommendations, forecasts, opinions, estimates, expectations and views contained herein are fair and reasonable, none of the analysts, DL Merrifield nor any of its directors, officers or employees has verified the contents hereof and accordingly, none of the analysts, DL Merrifield nor any of its respective directors, officers or employees, shall be in any way responsible for the contents hereof. With the exception of information regarding DL Merrifield, reports prepared by DL Merrifield analysts are based on public information. Facts and views presented in this report have not been reviewed and may not reflect information known to professionals on other DL Merrifield business areas including investment banking. This report does not provide individually tailored investment advice. Reports are prepared without regard to individual financial circumstances and objectives of persons who receive it. The securities discussed in this report may not be suitable for all investors. It is recommended that investors independently evaluate particular investments and strategies. The appropriateness of a particular investment or strategy will depend on an investor s individual circumstances or objectives. Neither the analyst(s), DL Merrifield, any of its respective directors, officers nor employees accepts any liability whatsoever for any loss howsoever arising from any use of this report or its contents or otherwise arising in connection therewith. Each analyst and/or any person connected with any analyst may have acted upon or used the information herein contained, or the research or analysis on which it is based prior to its publication date. This document may not be relied upon by any of its recipients or any other person in making investment decisions. Each research analyst certifies that no part of his or her compensation was, or will be directly or indirectly related to the specific recommendations (if any), opinions, forecasts, estimates or views in this report. Analysts compensation is based upon activities and services intended to benefit clients of DL Merrifield. As with other employees of DL Merrifield, analysts compensation is impacted by the overall profitability of DL Merrifield, which includes revenues from all business areas of DL Merrifield. DL Merrifield does and seeks to do business with companies/governments covered in its research reports including market making, trading, risk arbitrage and investment banking. As result, investors should be aware that DL Merrifield may have a conflict of interest that could affect the objectivity of this report. Elephant House 214 Broad Street, February 20, 2014 9 Lagos, Nigeria www.dunnlorenmerrifield.com Tel: 234 1 462 2683-4 www.dunnlorenmerrifield.com