Tuesday, August 08 2017 1:00 PM/ARM Research
Dangote Cement Plc. (DANGCEM) released its H1 17 results, which revealed a 39% YoY expansion in EPS to N8.45 (H1 17 estimate: N8.11). As with Lafarge and CCNN, price hikes was a strong pillar of support to DANGCEM’s Q2 17 earnings (+45% YoY) and look set to remain so for the rest of the year.
Unsurprisingly, current earnings growth momentum has also seen positive investor reactions in the equity market with the company’s share price rallying for extended periods in 2017 (+37.94% YTD) even as Dangote Industry’s recent sale of 2.3% stake to foreign investors provided markets with greater free float in tilting towards NSE specifications.
Going forward, we expect the company to record another strong growth in earnings in H2 17 but note that Q4 17 top-line could be weaker (compared to prior three quarters) as high base effect from Q4 16’s price surge trims support from pricing.
Top-line positive, but are non-Nigerian “roses” gradually drying up?
In the review period, revenue came in 34% higher YoY at N205 billion (estimate: N203 billion) on the back of higher weighted nominal prices (+72% YoY at N38,873/ton) which more than offset volume weakness (-16% YoY to 5.5MT) across the group.
Going by provided breakdown, Nigerian operation, which accounted for 68% of group revenue, reported a 27% YoY rise in revenue to N139 billion that was buoyed by a 75% YoY nudge in ex-factory cement prices to N45,070/ton.
The foregoing subsequently clouded impact of another volume softness in the review quarter (-27% YoY and -18% QoQ to 3.1MT). Given this slow pace of output contraction relative to the industry (-28% YoY), we believe the company largely retained its market share in Nigeria.
In other climes, revenue was sturdy at N66 billion (+149% YoY) largely owing to foreign currency translation gains consequent upon the conversion of sales from Pan-African currencies to the naira.
However, output decomposition suggests that the company struggled to match strong non-Nigerian volume growth recorded in prior quarters with output coming in only 3% higher YoY at 2.4MT in Q2 17 despite maiden contribution from Sierra Leone (34KT).
The subdued Pan-African output growth mainly reflected sales weakness in recession-hit South Africa (H1 17: -4.9% YoY) and pass-through from declines in construction and building activities in Zambia following prolonged rainfall and monetary policy-induced pressures on disposable income.
Gains from energy flexibility drown in sea of exogenous worries
Pass-through from significantly higher Nigerian prices and foreign currency translation gains from Pan African operations led to a 54% YoY surge in group gross profit to N115 billion with gross margin also printing at 56.1% (+6.9bps YoY).
To be clear, Q2 17 margin gain was achieved in spite of sustained cost pressures (Q2 17 COGS: +16.6% YoY, +2.2% QoQ to N89.7 billion) which mainly mirrored currency-related concerns in Nigeria and expensive energy mix in Tanzania and Zambia.
In Nigeria, the business was faced with higher gas and imported coal prices following sizable naira depreciation (-45% YoY to N308/$) while pressures in Tanzania and Zambia reflected sustained use of expensive diesel which drove the former to another EBITDA level loss in the period.
For context, we note that whilst Q2 17’s group gross margin gain represents significant improvement from past year readings, it is still 5.1pps shy of trend levels—suggesting that higher prices and energy flexibility investments are yet to normalize the company’s margin.
Further down, pressures in operating expenses expectedly rescinded (-7.2% YoY at N35 billion) after one-off investments in maiden market penetration in Pan-African operations in the prior year.
Consequently, DANGCEM’s group operating profits came in in tandem with our forecast at N80 billion with related margins at 39.2% (vs. 27.6% in Q2 16 and 44.5% average in the eight quarters leading to 2016).
In other highlights, the business reported an over 62% rise in interest charges after it increased borrowings (net debt: +30% YTD to N314 billion) and endured negative translation impact from the conversion of Pan-African interest expense. The foregoing pared growth in PBT to 11% in the review quarter.
That said, with ongoing tax concessions in Nigeria and other Pan-African operations extending into the quarter (effective tax rate: 6.1%), PAT rose a firmer 45% YoY to N73 billion with related margin also expanding 2.5pps YoY to 35.9%. (vs. average of 40.1% in the eight quarters leading to 2016).
Price and tax concessions to crown doozy FY 17 results
Going forward, we expect Nigerian cement price level to remain a strong influence on earnings in Q3 17 with its impact expected to sizably wane in Q4 17 given high base effect from Q4 16’s price surge (+57% YoY to N36,805/ton).
At the other end, we retain a cautious volume expectation for Nigerian operation over H2 17 with higher prices likely to keep private demand (~70% of market) largely at bay.
That said, having factored in expected rise in FGN CAPEX spend over H2 17, we now project a 16% YoY decline in Nigerian cement volume to 12.7MT (H1 17: -22% YoY to 6.9MT).
Superimposing this with a weighted average prices of N43,200/ton, we now forecast Nigerian revenues at N548 billion (29% YoY).
Elsewhere, we expect stronger volume growth in Pan-African markets in the coming months owing to gradual output ramp up in the business’ two new plants (Sierra Leone and Congo).
In view of this, we now forecast FY 17 non-Nigerian volumes 18% higher YoY at 10.2MT (vs. 4.7MT as at H1 17) with our estimate for mean Pan African prices at ~N27,000/ton.
The foregoing, combined with our expectations for the domestic market, should drive 2017 group top-line 29.5% higher YoY to N797 billion (vs. +41% YoY to N412 billion in H1 17).
On the cost front, we expect gains from energy flexibility to become more evident in Nigeria over H2 17 as the high base implied by the currency down-leg in June 2016 (-61% YoY to N351.82/$) moderates pass-through from NGN weakness.
However, away from Nigeria, concerns in Tanzania and Zambia are likely to subsist as usage of expensive diesel continues in the near term. This, in addition to our relatively tamer revenue expectation for the second half of the year, should leave the company’s gross margin at current run-rate level of 57% over FY 17 (vs. 47% in 2016 and 61.1% in the five years leading to 2016) despite expected H2 17 energy gains in Nigeria.
On the OPEX leg, pressures are expected to re-surface over H2 17 as the business expends more money to get the Sierra Leonean and Congolese plants up and running (FY 17 OPEX: +30% YoY to N155 billion).
Irrespective, largely reflecting our high weighted average price for 2017 (+49% YoY), we now look for 65% YoY surge in operating profits to N301 billion in the current year (2017E: EBIT margins: +8pps YoY to 38%).
For context, we note that whilst expected operating margin would represent substantial improvement from the 2016 reading, it is however 10pps lower than the 5-year average prior to 2016 largely reflecting the margin dilutive impact of non-Nigerian operations.
With tax concessions expected to subsist across Ibese (lines 3&4) and Obajana line 4 until 2019, Nigerian effective tax for 2017 is also expected to remain around currently benign levels of 7%.
This positive should be bolstered by similar concessions in climes such as Zambia, Ethiopia, and Cameroon. On balance, we expect 2017 PAT to come in 42% higher YoY at N266 billion (vs. N144 billion as at H1 17) with related EPS of N15.61 (vs. N11.34 in YE 16 numbers).
Furthermore, aided by the company’s average dividend payout ratio of 74% in the last two years, we forecast 2017E DPS of N11.55.
Overall, net adjustments to our model, which includes the adoption of average prices over the last three years for 2018 and beyond and an increase in net debt to N321 billion (vs. N271 billion as at YE 16), result in a 5% increase in our FVE to N215.11.
Relative to last market price, our FVE is however at a 10% discount following positive sentiments trailing the impressive earnings as well as expectation of a solid FY 2017—our view.
Thus, further aided by an expensive relative valuation outcome, which indicated 2017E EV/EBITDA of 11.8x for the company (vs. 9.0x for Bloomberg EMEA peers), we downgrade our rating on the stock to a SELL (vs. NEUTRAL in prior communications).