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What is the most obvious textbook explanation of margin attrition at a time of double-digit topline growth? That the business is tryingto gain market share by becoming price completive. Not for Rafhan Maize (PSX: RMPL).

The lone wolf of Pakistan's corn-based industrial starches announced its nine-month CY19 accounts at the bourse this week, boasting a strong 20 percent jump in revenue over last year.Rafhan's topline performance is also impressive as it is growing at the fastest pace in eight years, backed by resurgence of demand from its primary B2B target market, textile industry.

Recall that demand for company’s industrial starches had staged a rebound last year, reflecting itself in 12 percent increase. Turnaround in volume had come after a lull of four years between CY13-CY17, when productioninched forward at a stunted average annual rate of 0.22 percent.

Despite the change in demand dynamics on the back of improved textile sentiments, channel checks indicate that the company is in fact facing volumetric pressure on the back of higher cost of raw material, which it is finding hard to pass on to its buyers in the industrial segment.

Historically, procurement cost of maize has constituted roughly 95 percent of total raw material consumed by the company during a given period (remainder five percent being chemicals and packaging material, in equal proportion); and over two-thirds of total cost of sales.

But increasing demand for maize from competing segments amid slower increase in crop productivity has made the crop scarce for wet millers, driving grain prices upward in the domestic market. Recall that of the total 6 million tons annual domestic maize production, over 4 million tons is consumed by the poultry sector. According to sources in maize seed industry, demand for maize is projected to increase at a minimum of ten percent annually in coming years, mostly led by upbeat outlook for poultry meat.

Currently, maize is estimated to constitute fifty percent of poultry feed meals; with the rest being contributed by soybean and other oilseeds. However, rupee depreciation during the last year coupled has driven cost of imported soybean meal upwards, with the challenge further compounding into crisis due to weak farmer interest in oilseed cultivation. This has led to an increase in maize constitution of poultry meals to up to 65 percent in some cases, reportedly.

Thus, despite improved demand for Rafhan’smajor products such as industrial starches, the company appears to have begun bleeding on the margin front, with gross and operating margin declining by 188bps and 202bps, respectively. Delta between gross and operating margin is explained by higher overhead costs, as the company’s cost on freight, distribution, and commission expense appears to have grown in tandem with prevailing inflation rate.

Rafhan Maize Products Company Limited
Rs (mn) 9MCY19 9MCY18 YoY % chg
 Sales     25,504     21,258 20%
 Cost of Sales    (18,957)    (15,401) 23%
 Gross profit      6,548      5,857 12%
 Administrative expenses        (437)        (347) 26%
 Distribution costs        (619)        (503) 23%
 Profit/(Loss) from core operations      5,491      5,007 10%
 Other income         279         146 91%
 Other expenses        (378)        (325) 16%
 Earnings before interest & taxes      5,392      4,827 12%
 Finance cost          (16)          (19) -18%
 Profit before tax      5,376      4,808 12%
 Taxation     (1,584)     (1,466) 8%
 Net profit for the period      3,792      3,343 13%
Earnings per share (Rs)     410.58     361.91 bps
GP margin 25.67% 27.55% ê 188
Operating margin 21.53% 23.55% ê 202
EBIT margin 21.14% 22.71% ê 157
PBT margin 21.08% 22.62% ê 154
PAT margin 14.87% 15.72% ê 86
 Source: PSX notice 

Nevertheless, lean financial management with nil bank borrowing means that the company was able to maintain EBIT and PBT margin in healthy territory of over 20 percent, despite a slide of over 150bps on both levels.

The real story, however, lies in future prospects of the segment. While the company may be able to bring overhead expense under control as inflationary pressures calm down, there is slim chance that the pressure on grain price will ease any time soon. As the renewed governmental push for cotton cultivation grows under the incumbents (reflected in cotton sowing target being achieved at over 95 percent), bonus acres gained by corn on cotton’s expense in previous years are set to be lost.

Moreover, dithering by MNFSR on regularization of bt.corn has dealt a quick death to previously burgeoning chances of maize productivity increasing dramatically in near term. And lest it be forgotten that Rafhan’s management has led from the front in stakeholder opposition to bt. corn, ostensibly to protect export to customers in Kenya, which although contribute 25 percent of company’s total exports but only 1 percent of total sales.

Rafhan only hope then is that hybrid corn cultivation may somehow mark gains in sowing area, possiblyat the expense of sugarcane. Except that acreage under latter has also bottomed-out in the ongoing season, with nowhere else to go but up.

The company may have been able to hold the fort on profitability until now, but nothing short of a miracle will be needed for margins to remain intactin coming periods(GPM to PBT margin all stayed over 20 percent during CY18). Whether that miracle will be changing sentiment of the company toward bt. corn or crashing of global soybean prices – both appear unlikely.