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Wednesday, April 17, 2024

Flour Mills of Nigeria Rating Upgraded Despite Threat to Profitability


GCR Ratings has upgraded Flour Mills of Nigeria Plc.’s national scale long term Issuer rating to A-(NG) and affirmed the national scale short-term rating of A2(NG), with the outlook accorded as stable despite earnings exposure to foreign exchange movement.

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In a report issued today, the emerging market focused rating firm said the ratings accorded to Flour Mills of Nigeria Plc reflect its dominant position in the Fast Moving Consumer Goods manufacturing subsector.

This also reflects the operators’ significant control of its value chain, underpinning its large market share and sound revenue generation. These are, however, balanced against weak earnings margins due to the rising cost of production amid tight competition and consequently volatile net profit, GCR Rating added.

GCR adopted a group analytical approach to the above ratings, as FMN owns, consolidates, and facilitates credit facilities on behalf of its subsidiaries, which implies the potential for tangible risk transfers, positively or negatively, into the rated entity.

Should there be material changes to this position, GCR will reconsider the approach, it said while also noting that the Group’s strong competitive position is a key rating strength.

This is underpinned by the substantial flour milling capacity – 30% of Nigeria’s installed capacity-, a wide distribution network, a large customer base, as well as a well-diversified and recognised product portfolio.

“This is complemented by the strong integration along the value chain – including agriculture, processing, and logistics- which helps to mitigate foreign exchange exposure somewhat, and enhance operational efficiency”.

In light of its business mix, FMN’s is viewed primarily as a FMCG manufacturer, but GCR has also incorporated the contribution and exposure to the agricultural business.

The resulting blend of agro-FMCG sector scores balances FMCG’s strong sectorial fundamentals of low cyclicality and relatively stable demand against the overall higher risks associated with the agricultural sector due to the inherent cyclicality, volatile earnings and exposure to insecurity.

GCR takes cognisance of the significant revenue growth for the year ended 31 March 2021 (FY21), supported by demand-led volumes growth and inflation-induced price increases across the various product lines amid the COVID-19 pandemic.

However, adverse foreign exchange movements have eroded the reported net profit. That said, GCR analysts express concern over the narrowing earnings before interest tax, depreciation and amortisation (EBITDA) margins, despite an improved operating profit.

Thus, while GCR expects sound revenue generation over the rating horizon, with the EBITDA margin anticipated to remain around the historical average of 10.9%, further earnings pressure could emanate from further imported inflation and forex volatility.

However, GCR said the ratings agency considers FMN to be moderately geared. Despite the spike in gross debt by N26.5 billion to about N150 billion as of financial year 20221, net debt to EBITDA improved to 1.3x as against 1.8x in 2020 on the back of a higher quantum of earnings and substantial cash holding.

The ratings report said GCR anticipates that debt will remain at a moderate level in 2022-23, with further repayments and higher earnings expected to reduce net debt to EBITDA to the 90%-120% band.

It said the company’s net interest coverage also strengthened to 6x in 2021 compared with a review average of 3.1x on the back of improved earnings and a better-priced debt book and is expected to be sustained at the 4x-5x range in the medium term.

While operating cash flow coverage of debt has trended at the intermediate level, this deteriorated to 10% in FY2021 due to high inventory holdings, to mitigate against supply chain disruptions during the pandemic. The company’s cash flow coverage of debt average printed at 36% pre-2020, according to the report.

GCR expects strong cash generation and moderate working capital release, as the substantial inventory holding unwinds, to support OCF coverage of around 40% in 2022-23.

Amidst all the pressures around the company’s operations, it was noted that liquidity is deemed sufficient, as coverage is estimated to be around 1.3x over the next 18-month period.

This is underpinned by the substantial cash holding of N32.7 billion as of FY2021 and the expectation that operating cash flows will remain strong in FY2022, GCR stated. However, it noted that the liquidity assessment is balanced against a high level of short-term debt, capital expenditure spending and dividend payment.

“While there are no committed facilities, GCR positively views the Company’s access to diverse funding sources and the revolving credit facilities”.

Elsewhere, the stable outlook reflects GCR’s view that FMN will maintain a leading market share, which will support stronger revenue and earnings growth, thereby facilitating further moderation in leverage metrics over the medium term.

It however stressed that positive rating action is dependent on significant ramp-up of earnings margins and stable net profits. Operating cash flow coverage of debt improving to above 50% and interest coverage widening to over 10x in the medium term could also bode positively for the ratings.

Conversely, GCR hinted that an escalation in debt, particularly short-term debt, could result in a ratings downgrade, especially if there is no corresponding increase in earnings. Persistent working capital pressures and a spike in interest payments that further weakens the debt service metrics could trigger a negative rating action.