February 28, 2017/Cordros Research

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Despite the outperformance on revenue (10% more than Cordros’ estimate), FLOURMILL’s Q3-16/17 PBT came behind our forecast by 83%. The key outliers during the period were other operating losses (+36% ahead) and finance costs (+310% ahead). The former was impacted by foreign exchange loss while finance costs spiked with the increase in outstanding loans. Management attributed the forex loss to both the revaluation — using market rates — of the long standing real estate USD-denominated liability (USD20 million) and the settlement of trade payables (also denominated in USD). The spike in finance costs on the other hand was linked to higher interest borrowings to cater to incremental funding for forwards and deposit for imports.

As FLOURMILL sets to wrap the 2017FY, we see the robust y/y revenue growth experienced thus far extending into the final quarter. Although fourth quarter revenue has trailed the third quarter since 2015, and would likely be the case this year (we project -5%), we think the low base of Q4-15/16 makes another strong y/y revenue growth (we project 62%) very likely come end-March. Overall, we estimate 2017FY revenue growth to be north of 50% at N517.9 billion. Our latest Q4 revenue projection (N127.9 billion) is 4% ahead of the previous estimate.

That said, before the announcement of the Q3-16/17 earnings, we had projected FLOURMILL to report loss before tax (LBT) of N310.3 million in Q4-16/17 (consistent with the trend in the last three years) in recognition of the abnormally higher operating expenses (opex) usually reported in the final quarter. Whilst still expecting a relatively higher opex (although lower than the initial estimate) this year, LBT in Q4 has been revised higher to N2.7 billion on potentially bigger — than previously expected — FX loss (on continued depreciation of the naira exchange rate at autonomous markets) and finance costs (against a bigger gross debt).

Consequent upon the revisions, in addition to the weak performance (relative to our expectation) in the third quarter, we have revised 2017FY PAT lower to N5.7 billion (previously N7.5 billion). Notwithstanding, it bears noting that FLOURMILL impressed in 2017FY, coming from back-to-back losses in 2015FY and 2016FY (excluding one-off gains) and considering the challenging business environment.

Long Term – Reiterating Investment Case

From solely flour milling, FLOURMILL has grown organically and inorganically to become Nigeria’s largest consumer focused company. With strong market positioning in segments (1) having the capacity to adapt relatively to economic cycles and (2) favoured by Nigeria’s demographic potential and spending patterns, we remain constructive on the company over the long term. This, as well as attractive valuation, makes investing in FLOURMILL for the long term compelling. However, it bears noting that FLOURMILL’s share price may take longer to converge to our recommended price (1) as investors look for consistency in earnings recovery and (2) given the broadly subdued Nigerian consumer and equities story. Crucially, greater visibility on management’s effort to significantly deleverage the company while focusing on driving returns from recent backward integration investments will act as a strong catalyst for recovery in the company’s share price which has long been in slumber.

Valuation

In this note, we roll forward our model for FLOURMILL to 2018FY. Notwithstanding, we cut target price to N49.24 (previously N51.71) having revised earnings growth estimates lower. Our new 12-month TP represents upside potential of 176.7% from current levels; consequently, we maintain our BUY recommendation on the stock. Trading on a forward PE of 4.1x and EV/EBITDA of 4.2x, FLOURMILL appears very attractive in our universe of Nigerian consumer companies, trading on 9.5x and 5.2x respectively on average.