Leveraging sustainable backward integration for profitability

For many Nigerian manufacturers, foreign exchange exposures remain a major risk for operations and profitability. At a time when access to FX is increasingly difficult, designing a formidable hedge has become necessary. For operators in the fast-moving consumer goods segment, a backward integration plan appears to be a viable currency hedge, alongside other sustainable measures. FEMI ADEKOYA writes.

As a result of macroeconomic challenges in the country, fiscal and monetary authorities often emphasise backward integration, even though they ignore the financial outlay required to start it. For many firms that are bold enough to take the dive, the gratification lies in the fact that they can manage and sometimes control their supply chain and avoid disruptions that emanate from value-chain operations, especially imports.

For many Nigerian businesses, the impact of the volatile FX market is better imagined than experienced, considering the myriad of other challenges that they will have to contend with. In the last one year alone, energy costs and depreciating value of the local currency have put producers on the edge.

Operating in an economy where purchasing power has been grossly eroded by rising inflation, producers are caught in the web of cost effectiveness and right pricing, alongside competition from imported products.

FX risk has become an inevitable byproduct of the Nigeria market, but one that can be mitigated by effective hedge strategies prior to operations. It is important to emphasise that hedging practices are not meant to generate profits but, rather, to protect the company and avoid substantial losses. It is a way to ensure that no money will be lost because of exchange fluctuations. Many firms in the retail sector have left Nigeria as a result of this challenge.

The need for sustainability strategies that can facilitate a paradigm shift away from unsustainable and dominant globalisation to pragmatic ways of developing local content and capacities for security and self-sufficiency within nations gave rise to the quest for backward integration and content localisation in Nigeria.

Hedging operations act as a price protection in which the participant protects, fully or in part, a given future exposure to foreign exchange against adverse variations in rates and prices. This strategy eliminates all uncertainty within an exchange rate, regardless of variations that may occur in the market.

Indeed, the Group established a Backward Integration Programme (BIP) to create value in the supply chain and reduce dependence on imported raw materials, especially sugar and wheat.

A clear demonstration of its commitment to the development of the sugar value chain in Nigeria is through Sunti Golden Sugar Estates in Niger State, which is widely regarded as the country’s premier greenfield investment in the sugar industry since its inception in 2012.

With a total landmass of over 21,000 hectares, including a sugar refinery, the company has continued to expand operations at Sunti Golden Sugar Estate including an additional $300 million in Nasarawa state and a commitment to investing another N70 billion over the next three years to develop the upland area of the Sunti Sugar Estate.

More so, in pursuit of increased local production of raw materials, the Group has established seed multiplication sites in Nasarawa and Kaduna for trials and testing for locally engineered seeds. At Kaboji Farms, FMN partners with smallholder farmers, creating an enabling environment for farming by providing land, security, and infrastructure while they produce the crops essential to operations. This model has also been implemented through FMN’s Project Yalwa – designed to strengthen farmers’ capacity to boost maize and soya beans production across the country.

Additionally, FMN is building high-yield, high-resistant cassava seedlings at SAH Lab, a partnership with the cassava supply chain stakeholders in Ososa, the Group also acquired more land in Edo State for processing premium oil palm in partnership with Okomu Oil Palm Company Plc at AgriPalm.

By leveraging exchange-related pricing and favourable mix of its businesses, Flour Mills of Nigeria (FMN) Plc, said it recorded double-digit revenue growth of 38 per cent up to N720.5 billion from N522.8 billion recorded in the corresponding period of 2021.

According to the company’s unaudited half-year financial results for September 2022, the half-year growth was underpinned by the company’s improvements in the food and agro-allied segment and factored by a favourable mix and some exchange-related pricing.

With a solid performance recorded, the food segment contributed N445.6 billion signifying 61.8 percent of the total revenue. Similarly, the agro-allied segment of the business contributed N153. 9 billion representing 21.35 percent of the total revenue.

According to the company, the performance was occasioned by a propelled drive for better market penetration and increased customer participation despite the challenging macroeconomic environment and pressure from inflation in purchasing power.

The financial report revealed that the company’s cost of sales increased by 39 per cent to N651.8 billion compared to N468.4 billion during the same period in 2021. The increase in the cost of sales affected the company’s Profit after tax which declined by 46 per cent to N5.7 billion from N10.5 billion recorded in 2021.

Commenting on the result, Group Managing Director, FMN Plc, Boye Olusanya said, the group is integrating the Honeywell business to realise the synergies anticipated with a focus on restructuring the balance sheet to reduce FX exposure and ensure manufacturing stability while adding that this is expected to lead to strong results in the long term.

He said, “FMN continues to meet the needs of the consumers with our sustainable route-to-market structure and new product initiatives across our touchpoints.

“As we can see in the H1 22/23 report, the Sugar segment recorded a significant rebound compared to H1’21/22, a clear demonstration of the Group’s continuous and significant investment in the sugar value chain and across all our key value chains and sectors. As the Group continues to make headway in our backward integration activities through various strategic efforts, we remain committed to feeding the nation, every day.

“Also, our investment in product innovation and supply chain optimisation was sustained in furtherance of the execution of our long-term strategy. As part of the Group’s strategic roadmap, FMN continues to put in place a business continuity plan to safeguard its supply chain and food production processes to ensure that Nigerians can continue to have access to their daily nourishment.”

As localisation is gradually becoming globally adopted for the purpose of regaining sustainability, more nations are likely to experience healthy, flourishing, and globally diverse communities. Localisation would also involve (particularly for high-income countries) more constrained production and consumption, entailing minimisation of the redistribution of resources.

Thus, to ensure that Nigeria partakes in this globally viable process of local content development, corporate organisations, the government, and key opinion leaders within and outside the country need to leverage the FMN model of localising sustainability within this supply chain.

As commodity risk becomes more relevant to companies looking to reduce cash flow disruptions, backward integration and automated solutions can optimise overall corporate profit and loss.