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CCNN Q2 2017 - Moving Beyond Recovery to Growth

Proshare

Tuesday, August 08 2017 9:46 AM/ARM Research

Cement Company of Northern Nigeria Plc (CCNN) is expected to benefit from a ramp-up in plant size by FY 2018 based on the ongoing capacity expansion from 500kT to 1.5MT per annum.

Furthermore, the company’s plan to diversify its energy mix to include coal suggests substantial moderation in cost pressures in the coming years.

Consequently, the stock outperformed its peers (CCNN: +96.8% YTD, Cement Sector: +39.6% YTD) as sector-wide price increases (Lafarge: +81% YoY, DANGCEM: +75% YoY) was supported by expectations of capacity expansion over H1.

Largely reflecting pass-through from the former, the company reported an over 43% and 23% YoY surge in revenue and PAT to N4.2 billion and N515 million.

Although the benefits from pricing failed to cascade to margin recovery in Q2 17, optimism continued to run high as market looked beyond current earnings to capacity-led growth in coming years.

We roll-over our model one year forward and posit that currently elevated prices should support top-line gains despite declines in volumes. Notwithstanding Q2 17 cost pressures, pass-through from raised prices and gradual improvements in Kaduna refinery should keep gross margin 8pps higher YoY at 36%.

Thus, leaving other cost assumptions largely unchanged, we project 2017E EPS at N1.45 (+45% YoY). Furthermore, having factored in expected capacity and energy improvements in the coming years, we expect EPS CAGR of 36% over our forecast horizon. Accordingly, we revise our FVE higher (77%) to N8.19 (previously: N4.64) but retain our SELL recommendation on the company.

Energy concerns subsisted in Q2 17

On the revenue front, CCNN reported a 43% YoY increase in revenue, outperforming its peers by 9pps1 and supporting our often-stated view that the North-West market is relatively less price sensitive.2 By our estimates, CCNN’s volume dropped 21% YoY to ~86KT in Q2 17 (Lafarge: -26% YoY, DANGCEM: -27% YoY).

However, the company was unable to achieve energy efficiency in the period with its input cost rising 51% YoY to N2.8 billion (+1.6% QoQ) despite lower output. Pointedly, management noted increased volatility of LPFO prices in the period in its notes to the financial statements.

This was also consistent with results from our attribution analysis, which showed that energy cost accounted for 77% of total input cost in Q2 17 (vs. 62% in Q2 16 and 86% in Q1 17) as cost of LPFO tracked higher crude prices as well as reflected pass-through from reported fire outbreak at the Kaduna refinery in mid-first quarter.

Consequently, related margin came in 3.5pps lower YoY even after an over 29% jump in gross profits to N1.4 billion.

Capacity expansion to bloat post 2017 earnings

Overall, CCNN recorded strong growth in earnings but had to endure margin pressures owing to set-backs from higher input and operating cost.

Going forward, we see scope for further top-line gains from currently elevated prices but note that high base effect from Q4 16’s price adjustment could limit price influence in the fourth quarter of the current year.

For 2017, we adopt weighted average cement price of N45,000/ton (+55% YoY) for the company which should lead to an extension of current negative consumer reaction over the rest of the year (2017E volumes: -25% YoY to 365KT) and drive our 2017E revenue 17% higher YoY to N16.4 billion (vs. +31% YoY to N8.5 billion as at H1 17).

Farther out, we make provision for the company’s ongoing three-fold capacity expansion to 1.5MTPA but adopt a cautious average capacity utilization of 50.5% alongside cement price of N32,950/ton over 2018-2021 horizon. This implies revenue CAGR of 17.56% over the period.

Elsewhere, we see scope for near term pressures on the cost front with activities in the Kaduna refinery (H1 17 capacity utilization: 30%) only gradually recovering. This informs our projection for a 4% YoY increase in cost to N10.6 billion by YE 2017 despite expected volume contraction.

That said, pass-through from raised prices should leave cost to sales ratio at 64% with gross profit forecast at N5.8 billion (+49% YoY; Gross margin: +8pps YoY to 36%).

Farther out however, the company’s plan to expand capacity and diversify its energy mix to include coal suggest substantial moderation in cost pressures in the coming years (cost to sales over forecast horizon: 62.5%).

Leaving other cost assumptions largely unchanged therefore, we project 2017E PAT at N1.8 billion (vs. N1 billion as at half year) with EPS expected to sit at N1.45 (compared to N1 in 2016 and 82 kobo over H1 17).

Going by the improvement in earnings, which takes EPS nearer to 2014 highs, we believe the company would be looking to pay out 20% of its current earnings (DPS: 29 kobo) in the current year.

Having adjusted for plant size, expected energy improvements and cement prices for the coming years, we expect an EPS CAGR of 36% over our forecast horizon.

Overall, net impact of the aforementioned adjustments drove our FVE 77% higher to N8.19 with 2017E P/E at 6.2x (vs. 12.7x for Bloomberg EMEA peers)—a discount we believe is still justified by the company’s small size in a universe of relatively bigger cement companies.

Due to the recent strong rally in the company’s share price, our FVE is at a 24% discount to current market price of N10.84, which implies a SELL recommendation by our rating system.

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