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Naira devaluation exposes FMCG firms to exchange rate risk

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The devaluation of Nigeria’s currency, the naira, as a result of the decline in oil price, has left companies in the Fast Moving Consumable Goods sector (FMCG) vulnerable to exchange risk as they rely mainly on imported raw materials to meet production.

Almost all the major manufacturing firms in the country which source their raw materials abroad and go to the foreign exchange market for funds are being hard hit, as the local money they put out for dollar equivalent is hardly enough to purchase the required quantity of raw materials .

The naira has come under pressure since June 2014, and has lost about 4.5 percent of its value against the dollar this year, because of declining crude prices, which fell more than 50 percent of its value in 2014.

Nigeria relies on crude exports for 95 percent of its foreign exchange and 70 percent of government income. The currency was 0.21 percent weaker at N201.85 per dollar by 5:00 p.m. yesterday in Lagos.

There is palpable fear that the emerging situation would force down the production capacities of firms which depend solely on imported raw materials.

“We imagine that most of these firms will struggle to survive daunting pressure on costs, occasioned by the naira volatility and the pass-through impact of naira depreciation,” confirmed Saheed Bashir an analyst at Meristem Securities Ltd, in a response to questions.

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“Brewers and flour millers in Africa’s largest economy import more than 50 percent of their raw materials and other inputs. Even other household and personal product firms such as Nestle, PZ, Unilever and Cadbury which had diversified and gone into sourcing local raw materials, are not exempted from the impact of the falling naira,” Bashir said.

The rise in the cost of raw material occasioned by the fall in value of naira has also impacted on the sales and profits of the affected firms. The early earnings update of these FMCG firms (Guinness Nigeria Plc (GN), Flour Mills Nigeria Plc , Northern Nigeria Flour Mills (NNFM) Plc, Dangote Flour Mills Plc (DFM), PZ Cussons Nigeria Plc, International Breweries Nigeria Plc (IBN) and Seven Up Bottling Nigeria Plc) show sluggish growth in sales and profits.

Cumulative nine months to December 2014 results of these seven firms showed single digit growth of 5.19 percent in sales.

Despite the slight growth in revenue, the bottom line was pressured by huge costs as cumulative profit after tax shrank by 30.15 percent, to N11.41 billion in the review period from N16.50 billion the preceding year.

Exchange rate volatility is indeed debilitating the performance of manufacturers, as further analyses show that the cost of sales ratio, which measures the relationship between sales and production costs was as high as 74.37 percent, leaving them with low average profit margin of 2.67 percent.

Analysts also said that the dollar denominated debt of some firms placed them in a downside and exposed them to financial and currency risks.

“Earnings from firms like Nestle and Flour Mills with dollar loan exposures will be negatively impacted in the near term, due to foreign exchange losses on the loans,” said Kayode Omosebi, equity analysts at UBA Capital, in an email note to BusinessDay.

According to Omosebi, Flour Mills had over $20 million denominated borrowings, though the company began to hedge on this since the naira fall began.”

Investigation by BusinessDay shows that Flour Mills’s total borrowings, as at nine months to December 2014 increased by 26.23 percent to N191.27 billion from N151.76 billion the preceding year.

Additionally, the largest miller by market share, had a debt to equity ratio of 239.37 percent, exposing the company to financial risk.

The unfortunate insecurity challenges in northern Nigeria and poor infrastructure are also taking a toll, they are increasing distribution costs of companies and also slowing growth.

Other factors inhibiting growth of FMCGs are difficulty in sourcing products for small local manufacturing and pressure on consumer wallets, caused by hike in price of petroleum products.

“Our outlook for the sector is rather modest in the near term, given the tighter economic environment ,resulting from heightened insecurity in the northern part of the country, monetary policies and instability in the global space,” Bashir summed.