Thursday, August 2, 2018 /1:10PM/ ARM Research
Lafarge Africa Plc (Lafarge) recently released its Q2 2018 result wherein the company delivered another poor performance for the fourth consecutive quarter, to report a cumulative H1 18 loss after tax of N3.9 billion (vs. profit of N19.7 billion in H1 17).
The loss was driven by contraction in gross margin (-470bps YoY), increase in OPEX to sales (+200bps to 14%) and foreign exchange loss of N4.8 billion on its FCY loans which drove net finance cost double-fold YoY to N22.7 billion. Specifically, in Q2 18, Lafarge reported a before-tax loss of N1.9 billion (vs. N14.6 billion profit in Q2 17). Management announced a N90 billion rights issue – with the purpose similar to that of the N131 billion raised in 2017– and a bridge financing of N20 billion in form of commercial paper to refinance expensive overdrafts.
Over the rest of the year, we expect further margin contraction, surge in OPEX which would be further amplified by the turnaround maintenance in South Africa and persisting pressure from finance cost with associated FX losses. On finance cost, with total net borrowings of N256 billion as at H1 18, a successful rights issue of N90 billion is expected to reduce borrowings to N171.9 billion at year end.
That said, given that the rights issue is expected in Q4 18, we expect persisting pressure on finance cost and have thus raised our net finance cost for the year higher to N39 billion, which would further swamp operating profit (EBIT) to instigate a loss after tax of N8.3 billion for the year. As such, we have cut our FVE to N23.57 (unadjusted for additional shares via announced N90 billion rights issue), which implies a SELL recommendation by our rating scale.
Same story all-over again
Over the second quarter of 2018, Lafarge reported group revenue of N81.6 billion (+11% YoY) – 4.6% above our estimate – with growth stemming from its Nigeria and South African operations. For the former, it was a case of higher volumes (+18.7% YoY to 1.3MT) which more than swamped the decline in price (-5.3% YoY to N45,690) to boost sales of N59.3 billion (+12.4% YoY).
In South Africa, topline grew 7.7% YoY to N22.4 billion following upward adjustment to prices across segments1 to more than neuter the persisting decline in volumes (-7% YoY). In terms of product segments, the growth in the group’s revenue stemmed from higher cement sales (+16.4% to N56.9 billion) which offset the decline in aggregates (8.6% to N15.2 billion).
Despite higher revenue, Lafarge reported a faster rise in cost of sales (+21% YoY). The cost pressure was due to the combination of higher maintenance (+33% to N5.5 billion) and general (+936% YoY to N5 billion) expenses which outweighed the decline in variable costs (-14% to N39.2 billion)2. Consequently, the group’s gross margin contracted 640bps YoY to print at 25.7%. Against this backdrop as well as additional pressure from higher operating expenses (+7.2% to N10.9 billion), EBIT margin contracted 580bps YoY to 12.3% while EBITDA margin contracted 640bps to 19.4%. The business breakdown revealed that Nigeria’s EBITDA margin contracted 160bps to 32.2% while South Africa’s EBITDA was a loss of N3.3 billion vs. positive of N1.1 billion in Q2 17.
Furthermore, Lafarge recorded N4.2 billion in foreign exchange losses which combined with a finance expense of N9.9 billion (+64.1% YoY) pushed total net finance cost higher to N13.5 billion. With the confluence of the aforenoted pressures, the company reported after tax loss of N1.9 billion (versus N14.6 billion profit in Q2 17). Precisely, its South Africa operations reported a loss of N3.6 billion which swamped the profit of N1.7 billion in Nigeria.
Heavy up, light down
Going forward, having adjusted our FY 18 volumes higher to 5.1mt (previous: 4.7mt) and associated average price of N45,328/ton, we now expect Nigerian revenue to print at N240 billion (previous: N217 billion). Over in South Africa, while management guided to an optimal capacity utilisation over H2 18, we have lowered our volume estimate to 1.5mt (previous: 1.9mt), with the attendant impact informing our revenue forecast of N89 billion (previous: N101 billion).
Thus, at the group level, we see scope for volume and sales in excess of 6.8mt and N329 billion respectively in 2018E. On energy cost, we maintain our expectation of N40.2 billion (with FY 18 energy expense to costs of 16.4% vs 18.1% in FY 17) and further emphasize the subsisting pressure emanating from raw material & consumables, production, maintenance and distribution activities with ongoing turnaround in South Africa suggesting possibility of another impairment charge on redundant equipment.
Accordingly, we maintain a conservative cost to sales ratio of 77% (76% in H1 18 and 83% in FY 17) which translates to cost of sales to N254 billion and a 3% YoY decline in cost per tonne to N37,480. Thus, we expect a 49% YoY increase in gross profit to N76 billion (gross margin: +6pps YoY to 23%). With an upward adjustment to opex, we now expect FY 18 EBIT of N28 billion (vs. N7.9 billion in FY 17) barring any negative surprise in form one-off administrative charges from the ongoing turnaround in South Africa.
Remain Cautious on Near-Term Headwinds
On borrowings, recall that over Q2 18 management received shareholders’ approval for N100 billion capital raise. At the time, we had thought the focus would be on extending the maturity of existing obligations without necessarily sourcing fresh capital from shareholders. However, management recently guided to a N90 billion rights issue (after N131 billion rights issue in 2017) and N20 billion commercial paper (CP).
Clearly, as at H1 18, total net borrowings stood at N256 billion (N219 billion related to Nigerian business) with a total of N167 billion classified as current. Specifically, management stated the CP will be used as a bridge financing for maturing overdrafts estimated at N13 billion and the rights issue will be used refinance the N20 billion CP, other maturing short-term debt of N26 billion3, and N36 billion of intercompany4 payables, and the N8 billion balance to reduce the parent company’s obligation to N89 billion with the excess rolled over with an extended maturity of 7 years5. Overall, at the end of the rights issue exercise (expected to be concluded by Q4 18) total borrowings would have been reduced to N171.9 billion.
However, we do not think all is yet Uhuru for Lafarge as regards its current liquidity trap. To be clear, over Q1 2019, the first tranche (N26.4 billion priced at 14.69%) of the N60 billion bond issued in 2016 will mature. With the company’s current cash position, we believe a new issue of either bond or CP will be needed to refinance the maturing bond, coupled with the need to finance its remaining capex spend of N16 billion, we estimate an additional borrowing of N50 billion over Q1 19.
Assessing the impact of the aforementioned on finance cost, we have raised our net finance cost for the year higher to N39 billion, which would further swamp the impressive EBIT to instigate a loss after tax of N8.3 billion barring any positive surprise in form of tax writeback.
Lafarge trades at 2018 EV/EBITDA of 6.4x which compared to Bloomberg EMEA peers of 8.7x. In view of our recent adjustments, we now have FVE of N23.57 (vs. N34.71 in previous communication), which implies a SELL recommendation by our rating scale.
4. Lafarge Africa Plc Q2 18 Results - Unchanged Rhetoric As Earnings Remain Depressed