Dangote Flour Mills 1Q18 results showed reported revenue and earnings tracking behind annualised SBGS estimates by 27% and 42% respectively. 1Q revenue of N26.2bn declined by 9% y/y, despite a mid-single digit price increase taken in 4Q17, according to our channel checks.
Net earnings also declined by 39% year on year, mainly as a result of cost pressures and subsequent margin compression.
Possible reversal of market share gains might undercut sales in FY18E: On a sequential basis, flour sales saw some recovery in the quarter (+10% q/q versus a 30% decline in 4Q17), though down sales declined by 9% on a y/y basis.
Pasta sales declined for the third consecutive quarter (-16% q/q) which likely speaks to heightened competitive pressure in that segment, particularly from Honeywell and Dufil Prima, whose products retail at lower price points.
Given the intense competition we see in the flour milling industry, we once again highlight the risk of sustained volume pressure in FY18E, and flag the possibility of a reversal in market share gains made by Dangote Flour in FY16 and FY17 when competitors struggled to access FX to import wheat.
1Q18 gross margin of 18% lowest since 4Q15: We believe that Dangote Flour’s earnings are vulnerable to cost pressures given its relatively low pricing power in an industry that has excess capacity. This has materialized in 1Q18 with gross margin contracting to 18% from 25% in 4Q17 (1Q17: 24%), as production costs rose by 14% q/q.
This is the lowest reported gross margin since 4Q15 when a significant industry-wide price increase was effected. We maintain the view that Dangote Flour will continue to report margin pressure over our forecast period as costs accelerate at a faster pace than revenue.
Upside risks: We forecast dividend yield of 7% in FY18E for Dangote Flour on a 46% pay-out ratio. We view this as an upside risk to our numbers and a possible catalyst for TP re-rating. We also see faster than modelled volume growth for flour, and higher than forecast selling prices as key catalysts for our earnings estimates.
Valuation: We maintain our SELL recommendation for Dangote Flour Mills and target price of N7 per share. On our numbers, Dangote Flour is trading on a FY18E P/E multiple of 6.7x compared to Nigerian agro-allied peer average of 8.5x.