Dangote Sugar Refinery Plc - Bet the Ranch?


Wednesday, August 16, 2017 9:45AM / ARM Research

Across the consumer clime, Dangote Sugar Refinery (DSR) has been one of the more attractive stocks with key drivers pointing to sustained momentum.

Particularly, higher refined sugar prices, softer raw sugar prices, and improved dollar liquidity drove operating performance to record levels.

Reflecting the sturdy earnings—H1 17 EPS: N1.37 (+132% YoY)—and the consequent declaration of an interim dividend (N0.50) by the company—first on record, the company’s share price has rallied 109% YTD, outperforming the food index (+45%) and the broader NSEASI (+41%).

For sake of context, interim dividend as a percentage of FY 16 final dividend is 83%.

Irrespective, we maintain our bullish view on the stock as we believe valuation remains relatively cheap hinged on a promising earnings outlook.

Tempered import cost bolsters margins

Despite a 10% QoQ contraction in refined sugar prices, DSR reported its highest quarterly gross margin of 32.2% (QoQ: +19pps, YoY: +13pps) in Q2 17. The gross margin expansion reflected sizable moderation in previously elevated COGS in the wake of FX gains and downtrend in global raw sugar prices.

Hitherto, following CBN’s strategy of dollar demand management in the five months ending February 2017, DSR had relied on the parallel market for its FX needs with management quoting average FX rate of N400/$ for Q1 17.

However, given the U-turn in CBN’s FX policy which helped bolster dollar liquidity, the company’s FX rate hovered around the N365/$ obtainable at the IEW in Q2 17.

This, together with lower raw sugar prices (-22% QoQ), following weather-induced expansion in global production, drove average raw material cost (83% of COGS) 15.2% lower QoQ to N189,000/metric ton.

Also, irrespective of lower refined sugar prices, revenue fell more modestly (-0.6% QoQ to N59.1 billion) largely reflecting recovery in volumes (+6.7% QoQ to 186.1kmt).

Gains in demand were underpinned by higher sugar consumption during Ramadan season.

In management’s view, the company would have reported even stronger volume growth in the period if it had not contended with serious gridlock in Apapa which affected delivery of products to consumers.

On balance, the sizable temperance in COGS chiefly contributed to the 143% QoQ surge in gross profit to a record high of N19 billion in Q2 17.

Cost containment support earnings

Furthermore, the company intensified its cost-cutting measures by scaling down on management and royalty fees (-44% QoQ to N360 million), which applied downward pressure on OPEX (-14% QoQ to N1.2 billion).

The decline in operating cost moderated impact of a N216 million net finance expense in Q2 17 (vs. net finance income of N971 million), which stemmed from a 38% QoQ cutback in cash as well as commencement of interest payment on its newly obtained N2 billion CBN loan facility.

Consequently, PAT surged 147% QoQ to a record high of N11.7 billion while related margin climbed to record peak of 20% (+12pps QoQ).

Earnings to remain at lofty heights

Going forward, we expect a slight moderation (relative to H1) in revenue over H2 17 against the backdrop of lower prices with traditional support from Ramadan induced demand already gone by.

However, relative to the corresponding period of 2016, H2 17’s top-line growth should remain stout largely owing to higher prices (+12% YoY) and modest volume growth (+2% YoY).

On balance, we project a 35% YoY growth in FY 2017 revenue to N229 billion (H2 17: N110.7 billion).

On cost, amidst sustained stability in the FX market, bearish outlook on global raw sugar prices informs our expectation for sustained temperance in import cost.  

Furthermore, given the improved gas supply trailing the re-opening of the Forcados pipeline in May, which should lower reliance on expensive alternatives, we see scope for a much-tempered energy cost relative Q1 17. 

Overall, we project a modest rise in COGS (+15.8% YoY to N170 billion) leading our FY 17 gross profit (+159% to N59.5 billion) and gross margin (+12pps to 25.9%) expectation higher YoY.

Given the stable outlook (-2% CAGR) of raw sugar prices over our forecast horizon (2017- 2021) by the World Bank, which tempers scope for significant gross margin compression, we raise our gross margin expectation for the company over our forecast horizon to 21% from 17% previously.  

In addition, we think sustained operational efficiency would keep OPEX in check (+14.5% YoY to N7.9 billion) over FY 17 while we project a net finance income of N843 million (vs. net finance expense of N88 million) on the back of elevated finance income reported in Q1 171 (N1.6 billion). 

Overall, reflecting higher pricing and lower input cost, we expect FY 17 earnings to print at N35.9 billion, which translates to 150% YoY increase (EPS: N2.99). 

Using a dividend payout ratio of 50% (fiveyear average: 53%), we expect the company to pay a final dividend of N1.00 bringing the total dividend for the year to N1.50.  

Net impact of these assumptions results in an upwardly revised FVE of N17.75 (vs. N12.96 previously). DSR trades at a current P/E of 6.5x vs. 16.4x for Bloomberg Middle East & Africa peers.We have a STRONG BUY rating on the stock. 

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