Cement Sector Research Update - Vetiva

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Thursday, March 17, 2011
 
Following the recent persistent rise in the price of fuel (diesel and Low Pour Fuel Oil), we examine in this report the vulnerability of Nigerian Cement producers to this development and providean update of our views on the industry. Please find attached and see highlights below;
 
LPFO and Diesel Prices on the Rise… Over the last 3 months, Low Pour Fuel Oil (LPFO) and Diesel prices have been on an increase due initially to scarcity and subsequently to rising crude oil prices since the products are deregulated. LPFO and diesel prices (landing costs) have gone up by 8% and 10% over the last 3 months; and also by 17% and 28% over the last one year respectively. While all the cement producers would somewhat be affected since they still use diesel for power plants, the extent of vulnerability would further depend on the type of kiln fuel used by the producers, as plants running solely on LPFO as kiln fuel would be the most exposed to rising fuel price. In our coverage universe, CCNN would be the most affected by this development. We expect very minimal impact on Ashaka since it is increasingly using more of coal rather than LPFO. WhileDangote Cement’s Gboko plant which uses LPFO makes the company susceptible, the Obajana Plant (which runs on gas) would cushion the impact since gas price and supply have been stable. Apart from higher diesel costs which Lafarge WAPCO would also incur, it appears to be the least vulnerable as the kilns of its two plants (Ewekoro and Sagamu) operate on gas.
 
…Notwithstanding, FY’10 Earnings Should Meet Expectations: Though the rise in fuel prices began around December 2010, it would impact FY’10 earnings very minimally, if at all; hence we largely maintain our forecasts and expectations for FY’10 numbers. We note however, that demand rose quite strongly around mid Q4’10, as against the general wane in demand observed across the industry in Q3’10.
 
But Pressure Points Anticipated in Q1’11 Margins: With the persistence of high fuel price for most part of this year, we would likely see some pressure on Q1’11 profit margins. On the back of this, Q1’11 numbers for the more vulnerable producers may deviate measurably from managements’ forecasts.
 
Overall, Sector Fundamentals  Remain Strong: From a long term perspective, the fundamentals of the cement sector remain strong and the current high fuel price are at best short term challenges. Moreover, the new plants (Ibese, Obajana and Lakatabu) expected to come on board later this year are being built with the flexibility to operate on multiple fuels – gas and coal particularly. While noting the possible impact of the inherent political risk on gas supply, we maintain our overall expectation of continuing stability in the long term. Hence the impact of volatility in LPFO and diesel prices would henceforth be  insignificant. At least, a total of 11 million tonnes (annual capacities) from on-going expansion in the industry would be added to existing capacities later this year. With the existing infrastructural and housing deficit in Nigeria, we remain optimistic that demand for cement would remain buoyant in the medium to long term.
 
Valuation:Our favourite pick in the sector remains Lafarge WAPCO, as it has the highest upside potential of 34% relative to the midpoint (N51.62) of our target price range. Thus, we reiterate our “Buyrating on Lafarge WAPCO. Following recent losses in the share price of Dangote Cement, the stock now trades at an upside of 11.5% to our target price range mid-point of N139.25. Hence, we have an “Accumulate” rating on the Dangote Cement. Despite our optimistic earnings outlook on Ashaka, we maintain a “Reduce” rating, as the stock, at its current price of N27.60, has been fully stretched beyond its fair potential. With the recent increase in fuel price, we are worried about the earnings potential of CCNN. Hence, we maintain a “Sell” rating as the stock is trading at a downside potential of 29% to our target price estimate. On a relative valuation basis, the cement producers are trading at a FY’10 and forward (FY’11) P/E estimates of 19.5x and 13.2x relative to market estimates of 16.7x and 10.9x respectively.
 
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