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Dangote Cement - Weaker Growth, Higher Valuation, Turning Cautious!

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Thursday, March 29, 2018  9.39AM / By ARM Research 

DANGCEM posted another impressive performance to over-shadow the historic feat achieved in 2016. Much of the strong performance mirrored margin improvement in Nigerian operations, a reflection of price-induced revenue growth as well as cost-effective energy mix. Also, non-Nigerian operations recorded volume growth on the back of higher demand in Tanzania, Senegal, Cameroun, Ethiopia, and Zambia. Consequently, the company reported a cumulative FY 17 EPS (N11.99) that is 1.4x and 1.1x those of FY 16 (restated) and FY 15 respectively. However, over Q4 17, the company’s EPS was 79% lower YoY at N0.65 following a surprise provision for unapproved tax incentives at the Ibese 3&4 and Obajana 4 lines which pushed the quarter’s effective tax to 84%. 

Going into 2018, we remain broadly positive on DANGCEM and expect the company to sustain earnings growth, albeit at a much slower pace than 2017. Specifically, we see volume induced revenue growth and lower energy as key drivers of earnings in FY 18, relative to the price-induced growth story in prior year. On pricing, we believe with Nigeria gross margin now ahead of the pre-crisis level of ~61.8%, the argument for leaving prices at currently elevated levels to compensate for cost pressures will fall apart. 

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And on energy, we look for a stable energy source over 2018 with locally mined coal now gaining more prominence and the streamlining of energy source in the non-Nigerian operation, especially with the installation of a gas genset in Tanzania. Consequently, the impact of lower energy cost is expected to moderate the waning effect of price hikes on margin which we expect to print at 57% (2017: 56%). Overall, we project EPS of N14.52 (+21% YoY). That said, while we think earnings growth story is compelling, it looks expensive from a valuation standpoint. Accordingly, we maintain our NEUTRAL recommendation with a FVE of N256.85 (previously: N282). DANGCEM trades at 2018 EV/EBITDA of 10.4x which is at a discount to EMEA peers of 10.5x. 

Improved Margins but growth momentum cools off
Going by the breakdown, much of the margin expansion in 2017 stemmed from higher prices in the Nigerian business (+56% YoY to N45,595/tonne) which more than made up for weaker volumes (-15.9% YoY to 12.7MT)1. On the other hand, non-Nigerian volumes growth (+8.4% YoY to 9.3MT) was supported by Tanzania, Senegal, Cameroun, Ethiopia, and Zambia with revenue in the Non-Nigerian region rising 22.8% to N258 billion and accounting for 31% of the group’s revenue. Consequent on the price-inspired momentum in Nigeria, and volume-led growth in Non-Nigerian, the group’s revenue printed 31% higher YoY at N805 billion – missing our estimate by only 1.1%. 

Further down, input cost was subdued, rising 8% YoY to N351 billion. Much of the containment in input cost mirrored improved energy efficiency. According to management, Obajana and Ibese reported lower usage of LPFO in the period to 2% and 1% of total energy respectively (2016: 29% and 16%), with local coal and gas usage assuming greater prominence. The foregoing, alongside price-induced revenue growth drove gross margin in Nigerian operations to 71% - above pre-crisis level of 61.8%. However, non-Nigerian operations faced margin pressure in the period, reflective of energy challenges, particularly in Tanzania, where the company reported high usage of expensive diesel. Consequently, the group’s gross margin printed at 56%, below pre-crisis shock levels of 61% with gross profit tracking higher by 56% YoY to N454 billion. 

The foregoing translated to a strong growth of 60% YoY to N289 billion at the PBT level. However, PAT rose at a much slower pace of 43% YoY owing to an unexpected surge in tax provisions to N58 billion which pushed FY 17 tax provision to N85 billion, representing an effective tax rate of 29% versus 21% in FY 16. On the tax provision, management submitted that the earlier tax benefits of N28 billion and N44 billion taken in 2015 and 2016 respectively on the Ibese 3&4 and Obajana 4 lines assumed that it qualified for a pioneer status incentive. However, given the delay on the approval of the status by Nigerian Investment Promotion Commission (NIPC), management decided to make a total provision of N134 billion (with N71 billion treated through prior year reserves) for the year and at the same time reversed previous benefits booked in 2016. 

Price correction to stimulate Nigerian volumes in 2018
Going into 2018, with Nigerian gross margin having exceeded pre-crisis level of ~61.8% (71% in FY 17), the argument for leaving prices at currently elevated levels to compensate for cost pressures will fall apart. But, we expect the price correction to be gradual, as the sustainability of current gains are considered. In view of this, we now adopt per ton Nigerian cement price of N42,590 (-7% YoY) on average over 2018 which should stimulate volume growth (+9.4% YoY to 13.9MT) with related revenue expected to print at N590 billion (7% YoY). 

For the non-Nigerian operations, the company’s drive to ramp up sales in Tanzania, Congo, and South Africa guides to volume growth in the regions. Specifically, in South Africa, there are ongoing discussions to extend the tariffs on imported cement to other import destinations like China which bodes well for volumes if implemented. In Senegal, Ethiopia, Zambia, Cameroun, Ghana, and Sierra Leone, we expect the currently lower pricing in Q4 17 (compare to the average selling prices in Q3 17) to support volume growth. Overall, we project non-Nigerian volumes and mean price at 11.1MT and N28,790/ton respectively with related revenue of N298 billion. In all, we now look for FY 18 group revenue of N889 billion (+10.4% YoY). 

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Improved energy mix to sustain margin
On cost, expected currency and energy stability over 2018 guides to further moderation in cost of sales. In addition, for Tanzania, management guides to the delivery of gas gensets in Q2 18 which should reduce the plant’s usage of expensive diesel. Accordingly, we expect input cost to print at N386 billion (+10% YoY) which should sustain gross margin at 57% (+1pps YoY) – gross profit to rise 11% YoY to N502 billion. Further down, we expect the company to achieve efficiency in terms of its distribution to other countries, however our forecast of higher volumes speaks to increased distribution expense going into the year. Thus, we expect a slower increase in operating expense (+7% YoY in FY 18 vs. 30% YoY in FY 17), which should drive a 158bps YoY expansion in operating margin to 39% (vs. 38% in FY 17). Consequently, we expect an expansion in Nigeria and non-Nigeria EBITDA margin to 67% and 16%2 (vs. 65% and 14% in FY 17) respectively, with overall group EBITDA margin 58pps higher YoY to 49%.

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The pace of increase in DANGCEM’s borrowing slowed to +4% YoY (vs. 46% in FY 16) in FY 17 to N372 billion, with a total of N236 billion (N76 billion in 2018) expected for maturity between 2018 and 2019 – with the parent company related loans accounting for 84% of the maturing obligations. Accordingly, management has guided to refinance the maturing obligations with a naira denominated bond of N300 billion (expected to be issued in a tranche of N50 billion to take advantage of pricing). Also, to support its refinancing and fund its estimated capex of $350 million, the company is issuing a Eurobond of $500 million. 

On impact, given that most of the parent company’s loans were provided at MPR+1, with overall weighted average cost estimated at 13.9% in 2017, and management guiding to a possible 200bps decline in the yield environment (from current levels of ~14.27%) before opening the bond program, we expect the refinancing of the loans to be at a discount (100bps) – with estimated weighted average cost of 13.1%. Given our expectation of a cut in MPR over H2 18, with the related impact on the yield environment, we look at the company issuing the bond over H2 18 and thus we still hold out for slight increase in finance cost over H1 18, which pushed our overall cost for the year to N53 billion. 

On tax, while management has guided to a possible approval of the pending pioneer tax incentive on Ibese 3&4 and Obajana line 4 – which could drive a reversal of the sizeable provision in 2017 – we are very much cautious given the current political landscape and thus expect effective tax rate to play around 25% (vs. 29% in 2017). On balance, we now look for 2018E PAT of N247 billion (+21% YoY).

Coalescing these changes translates to a 10% decline in our FVE to N256.85. DANGCEM trades at 2018 EV/EBITDA of 10.4x which is at a discount to EMEA peers of 10.5x. Accordingly, we maintain our NEUTRAL recommendation on the stock.   

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About the Author
Oluwasegun Akinwale of the ARM Research Unit makes its debut coverage of Dangote Cement (DANGCEM). He can be reached vide Oluwasegun.akinwale@arm.com.ng  

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