Thursday, November 17, 2016 5.56PM / Cordros Capital Research
In announcing its 9M-16 result, the management of LAFARGE informed investors/analysts that the company, as at July, 1st 2016, converted shareholders' loan for an amount of USD493 million (out of USD510 million) to an equity instrument, on which the repayment (including interest at an average 6% p.a.) is discretionary.
The summary of this renegotiation (permissible under IAS 32) is that it removes volatility on the income statement by
(1) significantly reducing losses from currency depreciation to only those emanating from outstanding third party USD borrowings and
(2) charging interest expenses accruing from the loan to retained earnings.
Going forward, while acknowledging the impact of the debt conversion as par the summary above (recall that forex losses from sizeable USD loans -- accounting for about 60% of gross loans -- contributed significantly to the post tax loss the company reported over 9M-16), we choose to focus more on the
(1) impact of higher cement price on margins, beginning from this quarter;
(2) somewhat stable, but still expensive energy supply; and
(3) on-boarding of 2.5MTs UNICEM’s Line II at Mfamosing.
We believe these have more direct link with the company’s operations and in determining earnings over next year.
We expect LAFARGE to return to profitable operation in 2017 and forecast PAT of N11.2 billion.
The assumptions driving this forecast are
(1) 5% volume growth;
(2) higher average cement prices in Nigeria;
(3) significantly lower forex losses; and
(4) reduction in finance charges.
Notwithstanding the expected return to profitable operation next year, we think fundamentally, WAPCO’s earnings recovery (to pre consolidation levels) has some miles to cover. Key risk is that the current high price of cement (N41,000/tonne price) -- which is imperative to a quick and strong earnings recovery -- is not sustainable.
Even in terms of volume, growth expectation (from the newly commissioned plant) is doused by the weak national consumption outlook (short term) and especially, the expected fierce competition from DANGCEM.
Our hunch is that DANGCEM -- the market leader -- might cut prices next year (in the second half), considering
(1) the company’s potentially lower production costs from conversion to cheaper fuel and
(2) the need to protect its market share, particularly in the East which is exposed to threat from the on-boarding of UNICEM’s Line II.
Noting that LAFARGE lacks the capacity to counter aggressive competition, lower prices should slow down the pace of earnings recovery, more so that the elevated industry production costs (forex and energy especially) experienced over 2016 is unlikely to moderate materially in 2017. Notably, LAFARGE’s energy diversification investments in key markets in Nigeria began way behind competition, and the results on earnings, in our view, are not expected (given pressure on cash flow, amid weak forex outlook) up until 2018/2019.
The performance of the South African subsidiary has been unimpressive. Down 64% as at 9M-16, the group’s EBITDA from the subsidiary in Africa’s second largest economy has fallen consistently in each of the three years since consolidation. Outlook remains weak, in light of intense competition and weak infrastructure investments faced in that market. We think the price increase implemented in July will be reversed in 2017.
Besides pricing and volume challenges, LAFARGE still has sizeable debt profile. Despite the above noted debt conversion (totaling N150 billion) to equity, the balance of gross borrowings as at 9M-16 was N133 billion (vs. N148 billion in 2015FY).
In our view, while the huge loan book suggests that interest expenses will remain high over the next two years, combined with imminent forex losses on the outstanding USD85 million external borrowings (should they not be restructured), potentially constitute risks to earnings.
Following the revision to our forecasts, we have increased 2017 TP to N60.10 (from N50.38) and upgrade recommendation to BUY (from HOLD) due to the 31% correction in the company’s share price since we last updated.
At current price, the stock is trading on a forward PE and EV/EBITDA of 14.8x and 6.7x, at 33% and 13% premium respectively to Bloomberg's SSA comparables. While acknowledging the risks to earnings recovery in the short term, we think LAFARGE’s shares have faced intense pressure and expect the market price to rise to our 2017 TP on relatively (compared to 2016) better performance.
1. Explanatory Statement to Shareholders of ASHAKACEM Plc on Its Proposed Voluntary De-Listing from NSE