South African consumer goods group Tiger Brands has “underestimated” the challenge of operating in Nigeria, where it now plans to mothball flour mills to turn around the performance of Dangote Flour Mills (DFM).

The group last week reported that it would write off about half of its investment in DFM – some R849-million – less than two years after buying a majority stake in the business, as a result of underperformance and excess milling capacity that continued to dog its operations in the Nigerian flour market.

“We underestimated the challenge of operating in Nigeria,” CEO Peter Matlare said at Tiger Brands’ results presentation on Wednesday, adding that the group paid a “strategic premium” for obtaining scale in the market that had recently seen sweeping capacity changes.

“We're not excusing this, it’s about learning what we did wrong and fixing what we did wrong.”

The impairment, coupled with “significant” cost inflation in the domestic business, which was not fully recovered through pricing, have curbed Tiger Brands’ margins and distributable earnings for the six months ended March 31.

The group’s overall gross margin declined by 0.9% to 30.9%, negatively influenced by the inflationary effects of the weak rand on input costs, which were not passed onto the South African consumer in the first quarter of the year.

Matlare reported that pricing had since been adjusted to restore margins and improve profitability.

“However, the group continues to partially absorb cost increases in a number of categories, mitigating the impact, where possible, through cost reduction initiatives and improved efficiencies,” he commented.

The impairment had a significant impact on Tiger Brands earnings a share from continuing operations , which declined by a 53% to 376c. Excluding the impairment, earnings a share increased by 9% to 877c, while headline earnings a share from continuing operations increased by 7% to 856c.

Despite the impairment hit, Tiger Brands remains committed to its Nigerian business, stating it would now focus on enhancing the long-term prospects of its investment in DFM.

“We continue to believe that Nigeria is central to the group’s long-term expansionary ambitions. Short- to medium-term action plans are being implemented to turn around the performance of the business.

“These include reducing DFM’s fixed cost base, mothballing mills where appropriate, and rebuilding the brand equity of its product basket, which has suffered from quality issues and internal inefficiencies,” the company held. 

In addition, Tiger Brands, together with DFM, was evaluating a number of “key strategic initiatives” aimed at rapidly expanding the business into more sustainable, value-added categories.

“At this stage, there is still a significant amount of work that needs to be completed to properly evaluate these new category opportunities which, if proved viable, should enhance margins and improve the capacity utilisation of the existing DFM assets,” said Matlare.

He added that the carrying value of the company’s investment in DFM would be re-evaluated at the end of the financial year to assess the impact of the planned interventions that would have been implemented.

VOLUMES UP, MARGINS DOWN

Looking more closely at the group’s finances, turnover from continuing operations for the six months, which amounted to R14.9-billion, was 11% higher than the prior year.

Operating income for the period of R1.7-billion was 9% higher than in the corresponding period a year earlier.  

Net financing costs increased as a result of higher average debt levels, while the overall effective tax rate benefitted from special incentive allowances granted in respect of qualifying capital projects. 

Income from associate companies grew by 4% to R266-million, with good performances recorded by fishery company Oceana, Nigeria-based food company UAC Foods and Zimbabwe-based holding company National Foods Holdings.

Revenue from the domestic businesses of R11.2-billion showed an improvement of 8%, whereas the export and international businesses, including DFM, grew turnover by 20% to R3.7-billion, benefitting to an extent from the weaker rand.  

Sales volumes achieved by the export and international businesses, excluding Nigeria, were strong, the group noted, but this was offset by pressure on volumes at DFM, primarily owing to intense competitor activity.  

The export and international businesses outside Nigeria continued to show strong growth, benefitting to some extent from the rand’s relative weakness.

Trading conditions in the Nigerian market remained challenging and DFM continued to sustain operating losses in the period, primarily the result of ongoing top-line pressures.

Domestic sales volumes increased by 4%, with selling price increases generally in line with, or below, inflationary levels, while domestic performance was weighed down by a weaker result in the maize, groceries and home, personal care and babycare businesses.

Realisations in the groceries business were maintained in the first quarter in order to stimulate volume recovery, which drove strong volume growth and improved market shares recorded in the quarter; however rising input costs resulted in significant margin erosion.

“This should ease over the balance of the year, as pricing is adjusted to partially absorb the higher costs,” the company noted.

Meanwhile, the homecare and personal care businesses continued to face stiff competition in the market as competitors increased their promotional activity. As a result, Tiger Brands advised that plans were under way to drive innovation more aggressively in these categories and to refocus on core brands. 

“The strategic cost saving projects that started last year remain on track, with the relocation of the tomato paste plant to Musina, in Limpopo, as well as the consolidation of the beverage facilities at Roodekop, in Ekurhuleni, having been successfully completed,” Matlare said.

“Initial supply constraints were experienced in the beverage business, [following its relocation], but these have now been largely resolved.”

The company declared an interim dividend of 329c a share for the first half of the year, representing an increase of 6% compared with the 2013 interim dividend of 310c a share.

PROSPECTS

Looking ahead, Tiger Brands expected trading conditions in the domestic market to continue to be challenging, with ongoing volume pressures emanating from continued constraints on consumer spending and rising inflation.

This would likely be exacerbated by a highly competitive landscape with limited volume growth in many fast-moving consumer goods categories.

Margin pressures should ease over the balance of the year, as pricing was adjusted to partly offset the higher input costs, but the group cautioned that
this could negatively affect volumes. 

“Exports and the remainder of the international businesses are expected to continue to deliver strong growth, albeit at a slower pace given the recent strengthening of the rand exchange rate.

“We also continue to look at new opportunities, and we’ll leverage the lessons learnt in Nigeria. Our mergers and acquisitions team is on the road,” Matlare concluded.