Monday, July 08, 2019 / 06:27PM / By
Set-off deal is likely to open material upside potential
In our June 10 2019 update on Lafarge Africa Plc (Lafarge) titled “On the verge of leapfrogging the South African challenge”, we highlighted the substantial premium paid by Lafarge Holcim for LSAH, as well as delineated other key rationales for the transaction. In this report, we drill down to likely valuation implications of the eminent set-off deal with a view to ascertaining the attractiveness of the stock at current price. The highlight of this report is our attempt to re-examine Lafarge’s competitive potential within Nigeria’s dynamic cement market, now that the South African distraction is set to be off the table.
Potential moderation in leverage ratios is positive for valuation. On the balance sheet front, we adjust property plant and equipment lower to N377.70 billion (vs group PPE of N419.6 billion in Q1’19) in FY’19E, largely reflecting the potential transfer of LSAH to Lafarge Holcim, the capitalization of c.N20.0 billion on transition to IFRS 16, and depreciation of N22.6 billion. In addition, we factor in management’s plan to spend N29.0 billion in capital expenditure (CAPEX) that would be wholly financed with internally generated cash in FY’19E. As at Q1’19, only 6.6% of targeted CAPEX had been achieved, but a robust Nigerian cash balance of c.N45.1 billion (as at Q1’19) suggests that the targeted CAPEX is likely to be implemented in the current year.
Furthermore, adjusting for the set-off transaction (N113.8 billion), LSAH debt (N43.2 billion), transition to IFRS 16 (N20.0 billion), and interest payment, we project FY’19E gross debt at N124.6 billion (vs. N253.2 billion as at Q1’19). Thus, assuming a post-CAPEX cash position of c.N40.4 billion by year end, we forecast FY’19E net debt at N84.2 billion. This translates to FY’19E net debt to EBITDA of 1.4x (compared to 6.1x in FY’18 and 2.5x for EMEA peers).
The improved ratio signals that Lafarge’s ability to meet debt obligation and fund projects using internal cash is likely to materially improve after the current transaction. On the latter, our projections suggest that the company could be in a net cash position by FY’22E. The outstanding debt on the book of Lafarge is likely to comprise mainly of the second tranche of its corporate bond (N33.8 billion), CBN’s Power Intervention Fund through the Bank of Industry (N19.9 billion), and the corresponding liability entry for the capital lease by end of FY’19E.
Lafarge is likely to experience low volume growth in FY’19E. Lafarge’s Nigerian operation faced slight moderation in market share between FY’15 and FY’18 (i.e. -5.7 pps to 23.4%), largely reflecting additions to industry capacity. The weak 2.0% YoY growth in Lafarge’s cement volume in Q1’19 (relative to c.6.0% YoY increase for the sector) also suggest that the trend extended into the first quarter of 2019. However, management’s new initiatives are likely to halt market share erosion going forward.
Specifically, Lafarge is currently investing to improve strategies around route to market, commercial, and logistics & supply chain. In addition to this, the business is developing and launching new products. To this point, Lafarge recently launched its Mortar cement and is likely to roll out additional products before the end of the year. Irrespective of current efforts, we expect volumes to increase by c.5.0% YoY to 5.1MT in FY’19E (vs. FY’18A: 8.6% YoY; management’s FY’19E: over 5.0% YoY growth) to account for the impact of the early commencement of rainfall and the introduction of more rainy season adaptive competing products such as the Bloc Master.
Farther out, using internally generated cash, management is planning a $50.0 million (c.N18 billion using N360/$) debottlenecking of Ashaka that is aimed at increasing effective kiln capacity to 1.2MTPA (from 0.7MTPA currently) by end of next year. Thus, Ashaka, which is fully utilising its effective kiln capacity of c.0.7MTPA now, is likely going to be key to Lafarge’s strategy to grow market share in FY’21 and beyond.
Transfer of LSAH is likely to drive significant revenue decline in FY’19E. In April 2019, Nigerian cement price was increased by N150 per 50kg bag to N2,278.35 (or ₦3,000 per tonne) before discounts. We believe the impact of price increase, as well as the projected volume growth, will result in FY’19E revenue of N280.3 billion (with LSAH’s contribution likely to stop by July 2019). However, this is still likely to result in a 9.1% YoY contraction in revenue in FY’19E given the impending switch to Nigeria-centric operation. Over our 5-year forecast horizon, we expect revenue to grow at CAGR of 4.3%, aided by capacity investments in Ashaka.
We forecast FY’19E EBITDA margin at 21.5% compared to 15.4% in FY’18. Beyond the significant moderation in debt level, we believe the most impactful fallout from the sale of LSAH is likely to come in form of a sharp contraction in overall operating cost. To this point, we note that while LSAH was contributing c.29.3% to group revenue, it accounted for 38.1% of operating cost (ex-depreciation) as at Q1’19 and as such, the sale is likely to support margins. In addition, management has also mothballed the relatively inefficient Sagamu plant in previous periods. Beyond FY’19E, management’s strategy to improve cost efficiency is likely to benefit from an ongoing $20 million investment in a coal-utilising captive power plant in Ashaka, which currently has a relatively high cost per tonne. In addition, the company is aiming to reduce variable cost associated with trip turnaround time via extensive engagements with stakeholders across its transport value chain. These initiatives are likely to drive Lafarge’s EBITDA margin to 27.4% by FY’23E.
Free Cash Flow to Equity (FCFE) is likely to improve to N62.6 billion in FY’19E (vs. negative N21.5 billion in FY’18). In our view, the key driver of FY’19E FCFE would likely stem from significant improvement in core operating cash flow on better working capital management and reduced cash cost. In addition, with management suggesting only a $70 million (N25.2 billion) Ashaka capital expenditure in the coming three years as at now, we believe that a substantial moderation in CAPEX intensity could be in the offing beyond the current year. Specifically, we forecast an average CAPEX intensity of 5.0% between FY’20E and FY’23E (vs. 9.0% in FY’19E). Lower capex intensity is expected to significantly support FCFE going forward.
Adjustments to our model result in a 12-month target price of N24.10 for Lafarge. This implies a total return of 77.7% on current price of N13.70. Our valuation reflects the impact of the proposed sale of LSAH, switch to IFRS 16, and changes in CAPEX expectations. We have assumed a WACC of 16.6% as well as forward EV/EBITDA and P/E ratios of 8.1x and 11.8x (respectively) for peers. We also assigned a 30% weight each to P/E and EV/EBITDAderived target prices and a 40% weight to DCF-derived target price. Key risks to our outlook include unexpected price cuts, delay in completion of Ashaka debottlenecking and captive power plant projects, gas shortages, and lower government stimulation.