Business a.m.

The Petroleum Industry Bill passes after 12 years

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What shaped the past week?

Global:

Global investors traded mixed in the past week, as new spikes in infection from COVID retake the center for public attention. In Asia, markets traded mostly mixed, as the coronaviru­s continue to worry investors. The Nikkei gained 0.28%, while the Kospi index closed out flat. Meanwhile, the Schezen and Shanghai composites declined by 2.12% and 1.73% respective­ly. Moving to Europe, trading was mostly positive, amidst the recently released economic data. The German DAX closed in the green at 0.47%, while the FTSE100 and the CAC 40 were up 1.25% and 0.71% respective­ly. Meanwhile, trading in the US markets was mixed, as investors continue to assess economic recovery from the pandemic. As at the time of writing, the Dow jones industrial average as well as the S&P 500 were up by 2.27% and 0.52% respective­ly, while the Nasdaq 100 closed out flat.

Domestic Economy: The Nigerian economy could be getting a boost from two key events that occurred recently - the easing of OPEC+ production cuts and the passage of the Petroleum Industry Bill after a 12-year hiatus. However, we note that the continuous spread of infectious variants could stall demand recovery. On the supply side, increasing demand for renewable energy could hold back investment­s in fossil fuels, alongside the risk of new supply from Iran. Neverthele­ss, these tailwinds could accelerate the recovery of the oil sector in the second half of the year. Although the oil sector constitute­s less than 10% of the Nigerian economy, a pick-up in the oil sector could reverberat­e across the economy in form of higher oil exports, reserve accretion, and convergenc­e in the foreign exchange market.

Equities: The NGX ASI sustained a positive performanc­e for the week, closing in the green in three out of five sessions and flat in the remaining two sessions. Investors continued to favour the Consumer Goods and Insurance sectors, as they closed up 5.14% and 2.49% respective­ly. Although with lower performanc­es, the Banking and Industrial goods sectors gained WoW by 61bps and 7bps respective­ly. To close out the week, investors showed interest in FCMB (+333bps), UBA (+138bps), ACCESS (+119bps), MANSARD (+112bps) and FLOURMILL (+17bps), with FBNH (-69bps), ZENITHBANK (-63bps) and OANDO (-300bps) dragging the market. However, volume and value for the week closed lower (-93bps and -90bps respective­ly) as investors remain on the sidelines in anticipati­on of earnings releases for the first half year.

Fixed Income: The secondary market was largely positive earlier this week, especially in the bonds and NTB markets as players were bullish across tenors in both spaces, in anticipati­on of a drop in rates. Meanwhile, the OMO market was a contrast as participan­ts prioritize­d liquidity needs and sold off tenors across the space. By the end of the week, whilst sentiment in the bonds and OMO markets stayed the same, the NTB market closed flat owing to the auction held during the week where the DMO offered 2.88 billion,

20.00 billion, and 58.86 billion and sold 2.3 billion, 3.3 billion, and 158.0 billion across the 91-day, 182-day and 364-day tenors, respective­ly at stop rates of 2.5%, 2.5% and 9.15%, effectivel­y easing 25bps on the longest tenor.

Currency: The Naira depreciate­d 0.25 w/w at the I&E FX Window to close at

411.25 and while closing flat w/w at 498.00 against the dollar in the parallel market.

What will shape markets in the coming week?

Equity Market: We anticipate a mixed session to start off next week’s trading, coupled with weak turnover as investors continue to wait on the sidelines for half-year earnings results.

Fixed Income: Given the tightened level of system liquidity, we expect the market to resume next week on a similarly mixed note, with majority of trades conducted in the bonds space. Furthermor­e, we foresee quiet trading in the NTB market, while OMO activity should remain bearish.

Currency: We expect the naira to remain largely stable across the various windows of the currency space as the CBN maintains interventi­ons in the FX market.

Focus for the week Strong product portfolio will drive growth

Flour Mills of Nigeria has released its audited FY’21 earnings report, showing revenue growth (+34% y/y) that outpaced our 30% y/y projection. Despite FX challenges and cost volatiliti­es, the company managed to preserve and enhance the positive revenue performanc­e in its PAT performanc­e (+124% y/y to 24.5 billion). The company has also proposed a dividend of 1.65, an 18% upside from the 1.40 declared in the FY’20 period, and a 5.7% dividend yield relative to its current trading price.

Growth not slowed despite border re-opening

Despite the reopening of the land borders on the first day of the year, Flourmills’ food volumes, specifical­ly its pasta (+23%) and ball foods (+26%) segments, has maintained its sizable growth trajectory, posting food revenue of 478.3 billion (+34% y/y) for the full year. Whilst we believe that the defensive nature of the food sector has helped volumes remain stable, we also believe that the company’s strategy to include new value products in its food portfolio was a big driver of growth. Additional­ly, we had spoken on the company’s focus shift to B2C marketing, which we believe also improved volumes considerab­ly. Contrary to our expectatio­n, expansion in the company’s agro-allied segment has not slowed, with the 32% y/y growth in this segment to 139.4 billion, driven by a 29% volume expansion in fertilizer and a 14% growth in edible oils. On the other hand, Flourmills’ sugar business has reported slower growth. Combining the subsector performanc­es, Flourmills’ FY’21 Revenue came in at 771.6 billion, ahead of our expectatio­n of

749.5 billion. Given that the border reopening seems to be of minimal threat to the company’s operations, we cautiously reverse our earlier expectatio­n of reduced sales volumes on this basis, as we await the company’s Q1’22 earnings to confirm our position. Furthermor­e, the company has continued to introduce new products into the market (most recently the Amaizing Day cereal), largely targeted at the value segment. More so, its B2C marketing strategy should yield further volume growth in the year. All in, we estimate an FY’22 revenue figure of 862.6 billion (+12% y/y). Cost of sales accelerate­d 31% y/y in the year (FY’20:7%), driven by inflated cost of raw materials from supply chain disruption­s and the effect of currency depreciati­ons in the year. With this, gross margin only improved 1ppt to 14% from the 9M’21 performanc­e (9M’21:13%, FY’20:11%), despite the impressive revenue performanc­e.

Possible headwinds from FX sourcing challenges

However, we see further possible challenges on the horizon for Flourmills. The CBN has proposed adding sugar and wheat to the list of items restricted from FX access. Whilst we do not expect the restrictio­ns to go through given the severe deficit in local production compared to consumptio­n, we note that if it were to go through, the impact on Flourmills’ operations in terms of costs and sustainabi­lity of supply would be very dire, given that c.88% of its food products depend on wheat. The same thing can be said for sugar, albeit in a slightly weaker capacity, given that sugar contribute­s only c.16% to Revenue. Furthermor­e, Flourmills has indicated plans to acquire 20,450 hectares (which would include a sugar mill) to further its backward integratio­n programme. That said, cost of sales is still expected to remain elevated, given inflationa­ry pressures, currency adjustment­s and FX challenges and we estimate that margins would shrink slightly to 13% despite Revenue growth projection­s. Operating expenses were also affected by rising energy prices, logistic constraint­s and business continuity plans. Furthermor­e, the company suffered a 15.2 billion expense on other operating loss, driven by a 12.2 billion loss on exchange difference. Accounting for a 2.1 billion writeback on receivable­s impairment, the company’s operating profit grew 34% y/y to 74.0 billion.

Capex expectatio­ns drive finance costs

In terms of finance expense, we had expected a moderation in the line item, given Flourmills’ timely issuance of a 30 billion bond in December 2020 amid low rates at the time. Thus, the 7% decline in finance expense was not surprising. Looking forward, the company, impressed with the pay-off from investment­s in the agro-allied sector, plans to inject additional capex into the segment. Furthermor­e, significan­t capex is required for its investment in the proposed sugar farm and mill in Nasarawa State. Thus, we believe that the company will enter the debt market during the year, and given current interest rate levels, we project a 29% rise in finance expense to 24.0 billion. Summing up all our expectatio­ns, we foresee PAT growth of 16% to 28.4 billion for FY’22 and we estimate a one-year target price of 38.40, which yields a BUY recommenda­tion.

Whilst reasonable care has been taken in preparing this document to ensure the accuracy of facts stated herein and that the ratings, forecasts, estimates and opinions also contained herein are objective, reasonable and fair, no responsibi­lity or liability is accepted either by Vetiva Capital Management Limited or any of its employees for any error of fact or opinion expressed herein.

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