July 19, 2019
By FBNQuest Research
Material cuts to our 2020-22E EPS forecasts and price target
We have cut our earnings forecasts for Flour Mills of Nigeria (FMN) following its disappointing Q4 2019 results. FMN reported a loss of –N1.1bn in Q4 versus our PBT forecast of N144m, and missed our FY 2019 forecast by 11%. The chief driver behind its underperformance was a rise in production costs which could not be passed on. Indeed, management highlighted during its conference call that it discounted prices across its flour business (c.50-60% of group sales) to protect market share.
Competitive pressures in the animal feeds and edible oil markets also suggest that FMN absorbed cost inflation in its agro-allied business. As such, FY and Q4 gross margins were -115bps and -464bps narrower than our forecasts respectively. Despite FMN’s competitive pricing, overall volumes for the fiscal year were up by just 2% y/y. Over forecast years, we continue to see a tough competitive landscape for FMN’s core businesses.
We therefore expect bottom line to be squeezed by input cost pressures over the 2020-22E forecast period. Our upward adjustment in COGS translates to a decline in our 2020-21E gross margin forecasts by an average of -239bps. For other line items, we see borrowing costs remaining at manageable levels on the back of FMN’s debt restructuring, but expect a ramp up in advertising spend amid competitive headwinds. Effectively, our 2020-21E EPS forecasts are now lower by around -27% on average, while our price target has decreased by -21%.
Year to date, FMN shares have shed –39%, underperforming the broad market index by –29%. The shares are currently trading on a P/E of 10.7x for an average EPS growth of 19% in 2020-22E. Our new price target of N18.4 implies a potential upside of 31% from current levels. We are however retaining our Neutral recommendation on the stock given the weak earnings outlook across core businesses in the near term.
PBT dragged down by tight squeeze on gross margin
FMN declared a pre-tax loss of –N1.1bn in Q4 2019 (end-Mar), though this was an improvement from the –N3.0bn pre-tax loss reported in Q4 2018. The loss was driven by a gross margin contraction of -573bps y/y to 5.3%. This negative completely offset -25% and -16% y/y declines in opex and interest charge respectively, and an 11x increase in other operating income.
Sequentially, all line items worsened q/q except for other operating income which showed an 11x increase q/q. Q4 pretax loss compares with Q3 2019 PBT of N3.0bn. Relative to our forecasts, sales were ahead by 12%, but PBT was well behind our forecast of N144m.