Tuesday, November 1, 2016 12:17 PM / Vetiva Research
· Cement volume down 17% q/q amidst price hike in Nigeria
· 9M’16 revenue up 21%, buoyed by strong Q3 Pan-African performance
· Currency weakness stretches margin despite improved Q3 fuel mix
· Cement prices to remain strong as DANGCEM prioritizes profitability over growth
· Sharp Valuation little changed due to post-FY’16 outlook
Cement volume down 17% q/q amidst weak volume from Nigeria
For the first time since Q4’2014, DANGCEM’s overall cement volume declined on quarterly basis, down to 5.4 million MT in Q3 from the historic high of 6.5 million reported in Q2. Nigeria operation was the main culprit as shipment declined 26% q/q to 3.1 million MT.
The drop was however expected as we had earlier guided in our Nigeria outlook report, Seeking a Winning Formula (20 September 2016) that the 46% price hike implemented at the beginning of September could hurt volumes.
Speaking with management at the analyst call held after the release of the result, we understand that the hike indeed weighed on volumes, with September volume declining 7% y/y to halt an 11-month y/y growth streak. We recall the nationwide long-week strike (organized by National Association of Block Moulders of Nigeria) to protest the price increase, and believe this could have further impacted volume.
Rest of Africa cement volume shipment also bucked the recent growth trend albeit marginally down 2% q/q amidst political disruptions in Ethiopia and intense rainfall in Tanzania. Notwithstanding the q/q decline, overall 9M’16 volumes remain impressive on the back of stronger earlier run-rate, up 41% y/y to 18.3 million MT, 8% ahead of our estimate.
Topline remains strong on Q3 Pan-African performance
Revenue from Nigeria declined 17% q/q to N91.2 billion as the volume drop outweighed the price increase (price increase only took effect from start of September); Q3 Nigeria average selling prices up only 13% q/q.
Rest of Africa operations however delivered strong topline over the 3-month period with revenue up 43% q/q to N60.6 billion amidst price increases across some of the regions – cement prices in Cameroun, Ethiopia and Zambia were raised to $114/tonne (Previous: $110), $95/tonne (Previous: $74) and $80/tonne (Previous: $72) respectively.
In fact, Rest of Africa contribution to Group revenue rose to a record 40% over the quarter, compared to the 26% as at H1’16. Cushioned by the strong ex-Nigeria performance, DANGCEM’s Q3 revenue was relatively flat q/q at N150 billion, whilst 9M revenue grew 21% y/y to N442 billion, 4% below our estimate.
Currency weakness pressures margins despite improved Q3 fuel mix
One of the brightest spots in the three-month period was the improvement in fuel-mix. Amidst relatively less attacks on oil and gas facilities, Q3 gas supply to Obajana and Ibese plant improved to 37% (Q2: 33%) and 38% (Q2: 18%) respectively of total fuel used.
More importantly, the use of LPFO (3x more expensive than gas) at the plants reduced to 32% (Q2:54%) and 19% (Q2: 29%) – for Obajana and Ibese respectively.
Notwithstanding the more favourable mix, DANGCEM’s cash cost of production rose further in Q3 as currency depreciation over the period (average interbank exchange rate up 46% q/q to NGN308/USD) weighed on the cost of dollar-exposed input materials - gas (priced in dollars paid in naira), imported coal, gypsum and some other imported materials.
In fact, we believe DANGCEM may have sourced FX at much higher rates as management said the company could not meet its entire FX need for the quarter via the interbank market due to liquidity challenges. Amidst the cost pressure, EBITDA margin in the Nigeria operations continued on the freefall to 44% (H1’16: 57%).
Rest of Africa however reported an improvement in EBITDA margin in Q3 to 24% (H1’16: 11%) amidst higher cement prices.
Further improvement in fuel mix expected in Q4
Although we expect currency weakness in Nigeria to continue to take its toll on dollar-based input materials in the coming quarters, we believe the pressure would be tapered by the traction DANGCEM has gained thus far in restructuring its energy mix.
According to management, coal mills are now operational on all lines of Ibese and Obajana plants, and Line 1 of Gboko plant – together 93% of capacity in Nigeria.
Furthermore, we understand that the use of LPFO has been discontinued since September, with coal (imported blended with local) used as substitute. We expect this to start yielding results from Q4. We also highlight the ongoing works on local mining project (in Kogi State) which management projects to be completed in January 2017.
Upon completion, we expect a sharp drop in DANGCEM’s cash cost of production as own-mined coal is zero-exposed to dollar, 0.7x cheaper than gas according to management.
Prices to remain strong as DANGCEM prioritizes profitability over volume growth
Even after alluding to the fact that the last price hike did hurt volume, management still played down possible plans of a downward price revision anytime soon. Management categorically explained that DANGCEM currently seeks to keep margins strong, rather than to pursue volume growth.
We also understand that DANGCEM is ready to immediately pass on any further increase in cost to consumers in a bid to protect margins. We expect cement prices to remain strong in the short to medium term on this ground.
On the Rest of Africa front, we highlight that the price increase effected in Ethiopia (accounting for c.20% of Pan-African volume) came amidst supply shocks due to political instability.
With the situation now under control according to the management, we believe prices could normalize soon in the region, and consequently taper average prices in Pan-Africa operation.
Valuation little changed due to post-FY’16 outlook
We expect to see further drop in Nigeria cement volume in Q4 as we believe the last price hike would continue to cap demand. As such, we revise FY’16 Nigeria volume to 14.8 million MT (Previous: 15.2 million MT). We have however maintained our Rest of Africa volume at 8.7 million MT given the current strong run-rate (9M’16: 6.5 million).
Consequently, our Group FY’16 volume forecast now stands at 22.6 million MT (Previous: 23.0 million MT), below management’s guidance of 24-25 million MT. Notwithstanding, our FY’16 revenue forecast is only little changed at N613.2 billion (Previous: N616.7 billion) as we expect the full-blown effect of the price increases to become apparent.
Despite the expected savings from the close-to-zero-use of LPFO in Q4 as earlier said, we expect currency weakness to keep production costs on the high for the rest of FY’16. Amidst this, coupled with inflationary pressure on OPEX and expected strain on topline, we revise our FY’16 EBITDA to N229.7 billion (Previous: N293.9 billion).
Our post-2016 earnings forecasts are however relatively unchanged; we expect a significant reduction in dollar exposure as the own-mined coal project attains significant threshold in FY’17, consequently boosting margins.
Our target price is revised to N191.09 (Previous: N191.72). DANGCEM trades at 18.3x FY’16 P/E, a premium to 5-year historic average of 17.2x and Middle East and Africa peer average of 10.2x. We have a HOLD rating on DANGCEM.
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