Monday, July 31, 2017 3:45PM /ARM
Sustaining the trend from the first quarter of the year, Lafarge recorded another strong topline growth in Q2 17 (+34% YoY to N74 billion) with its PAT of N14.6 billion (vs. N28 billion loss in Q2 16) exciting equity investors (company share price: +48% YTD at N60.75) in the last few days.
Without doubt, Q2 17 EPS, which rose to its second highest level since consolidation after being flattered by a N6 billion tax credit from UNICEM, provides some explanation to the company’s recent share price rally.
That said, this report focuses on a comparison between Lafarge’s rebounding margins and pre-2016 levels to ascertain the true depth of current earnings resurgence.
Price Is Everything to Nigerian Top-Line for Now
Going by breakdowns provided, Lafarge raised cement prices (+81% YoY to N48,260/ton, +54% from Q2 15 levels) multiple times in the past few months to recover from gross margin contraction and align with the trend in Nigeria.
However, the cumulative price increase also drove down Nigerian sales volumes (down 23% and 38% from Q2 16 and Q2 15 levels to 1.1MT) in the review quarter.
In South Africa, operations also benefitted from price increases effected in the prior quarter as well as the appreciation of the rand over naira that left revenues 21% higher YoY at N21 billion despite reported contraction in cement demand in the clime.
Indeed, revenue gains from higher prices also proved timely considering slow progress on results from ongoing energy flexibility efforts despite management’s plan to dedicate 50% of planned CAPEX to the course.
Precisely, we think input cost declines (Q2 17: -17.3% QoQ to N50 billion) should have been wider considering heavy broad-based cutback in cement and other product volumes in the review quarter.
However, reflecting strong pass-through from raised prices, especially in Nigeria, gross margin expanded 18.7pps YoY to 32%. Notably, this represented sizable recovery from the trough of 2016 as well as a 62bps jump relative to the average over the last eight quarters (pre-2016).
Further down, the company’s operating margin also printed 3.4pps above pre-2016 levels at 18% to mask a more than double YoY surge in operating expense and underpin the depth of the price-led recovery thus far in 2017.
In other positives, the company reported foreign exchange gains of N1.4 billion in Q2 17 (vs. N27 billion in unrealized FX loss in the corresponding period of 2016) related to its hedge of $88.4 million in 2016 at N274.5/$ via one-year non-deliverable forwards which was followed by the hedging of a further $220million at NAFEX window.
Rise in borrowings detracts but fail to halt margin stroll
The company’s margin story however got complicated following a three-fold YoY rise in net finance charge which reflected a surge in net debt (+115% YoY to N219 billion) following the reclassification of $220 million of quasi equity into debt.
Thus, although Q2 17 PBT margin represented significant progress relative to 2016, it lagged pre-2016 levels by 4.6pps. Irrespective, PAT margin ended up bettering prior year average (+13.5pps to 20%) after the business reported another high write-back from past tax overprovisioning from the Mfamosing business.
It is official, … 2017: the year of prices
Going forward, we expect ex-factory gate prices to remain at currently elevated levels of N48,260/ton as Nigerian companies make up for lingering energy challenges despite reported investments in energy flexibility projects.
On the volume end, we expect pass-through from prices to continue to inform volume weakness. Thus, we see Nigerian output dropping 16% YoY to ~4.4MT. Irrespective, Nigerian revenues should print N192 billion (vs. N155 billion in 2016).
In South Africa, recessionary impacts and higher prices should continue to discourage customer patronage in cyclical sectors including cement. This guides our expectation for 28% YoY contraction in South African cement volumes to 1.6MT.
On balance, pass-through from strong price increases in both the domestic and SA market, despite as an assumption for relatively weaker second half of the year, should leave 2017 revenues in good shape (FY 17: +21% YoY to N265 billion; H1 17: +44% YoY to N155 billion) in our view.
As communicated in the review, we are cautious on Lafarge’s energy flexibility programme—and our outlook for the rest of the year reflects this (i.e. FY 17 cost to sales: 70%, vs. average of 69% prior to 2016).
For one, the business’ failure to trim overall cost in line with sizable down-leg in output provides backing to our thesis. On a positive note though, the business’ successful hedging of over $300 million in foreign currency exposure strengthens the case for less volatile earnings in 2017.
Furthermore, our forecast does not provide for substantial tax credit over H2 17. Thus, gains from tax credit should be sizably reduced by YE.
Overall impact of our adjustment, which includes a correction of weighted average Nigerian cement price to N43,000/ton and an approximately two-fold increase in net debt to N219 billion, as communicated by management, should leave 2017 PAT estimate at N29 billion (2017 undiluted EPS: N5.30, 2016 EPS: N3.10, 2015 EPS: N5.40).
Lafarge trades at 2017E EV/EBITDA of 7.7x (vs. 8.3x for Bloomberg EMEA peers). However, our FVE of N52.33, which already factors in dilution with the company due to go ahead with its N140 billion rights, implies a SELL recommendation by our rating system. Instructively, we note that without the dilution adjustment, our FVE should sit at N66.54.
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