Dangote Cement being loaded in a truck at Okene factory. Photo credit: Yalwa

…as crashing revenue takes a toll on capital expenditure

By JULIUS ALAGBE

One of the main drivers of the economy in the country is set to take a major hit this year as the effects of both the prolonged lockdown of the economy over the COVID-19 pandemic and the crash in global oil price begin to manifest. The construction sector, which is the heart of capital projects and expenditure, is expected to suffer in this year’s reviewed budget, which has dropped by almost 50 per cent in size.

Cement is a major component of the construction and reports show that this may not be the best of years for the producers of the products, which constitutes a massive share volume on the Nigeria Stock Exchange, NSE. Any poor performance by the sector on the exchange is likely to drag down the overall outlook of the market.

Analysts have predicted a quite downward slope in demand for cement across the industry in 2020. Cardinalstone projects that it will take two or more year for the cement industry to recover from the current shock. In a research report, Cardinalstone explained that the Nigerian cement sector may be set for a difficult year on account of COVID-19.

This expectation of slow demand was connected to a shift in capital expenditure budget in Nigeria, just as it is happening in other African countries. Key cement producers will be put under demand pressure, as analysts adjust estimates downward through cement operators are yet to reveal new guidance for 2020.

DangoteCem, Lafarge and BUA Cement are expected to increase rivalry as the market peters out, though the industry has enjoyed an increase in the average price of cement but going forward, price raise could affect operators’ performance. Analysts explained that COVID-19 has set the stage for increase rivalry among the Cement warlords, which may reduce the price of products and further affect margins.

“BUA Cement is bringing extra capacity, Dangote is expanding base and improving logistics; Ashaka cement is raising internal capability and Lafarge is struggling to transform”, Cardinalstone remarked.

Investment analysts think that the Dangote might have been hammered, but the company’s stock is still enjoying its BUY rating. Based on fundamentals, analysts expect to see DANGCEM vertical move becoming steep due to strong cash flow position. The investment firm analysts expect the sector’s full recovery to take at least two years, in line with the macro guidance of African finance ministers.

“These expectations result in a 12-month Target Price of ₦191.56 as against ₦200.00 previously for the industry giant, Dangote Cement Plc”, analysts estimated.

Cardinalstone stated that the new TP still implies a 63.7% capital appreciation on last market close due to aggressive sell-offs of equities and other risk assets globally.

The company’s relatively strong cash flow position and ROAE also support an unchanged BUY rating on the stock as COVID-19 may also mean lower cement volumes for producers, analysts remarked. The spread of COVID-19 has altered the global economic outlook for 2020. Cardinalstone held that the pandemic has led to border closures as well as restrictions on construction and other nonessential business activities largely at the behest of authorities.

Thus, CW Group expects African cement demand to moderate by about 5.0% in 2020.

“In our view, the Nigerian cement market estimated to drop by 16.0% to 18.2Mt in FY’20 is likely to underperform the rest of Africa. Given that imposed restrictions in its country of domicile have been concentrated in key construction hubs (Lagos and Abuja), which cumulatively account for about 48.0% of the country’s GDP”.

Analysts believe the shutdown of activities in these zones is likely to last till the end of Q3’20 in one form or the other, in line with global expectations.

However, Cardinalstone said it expects DANGCEM to report 15.0% and 10% year on year contractions in cement volumes in Nigeria and across its pan African operations in FY’20, apiece.

“If prices remain largely stable, Nigerian and Pan African sales are also likely to approximate ₦506.7 billion which represents a 17.0% contraction and ₦253.6 billion (-10.3% YoY) respectively in FY’20.

“On Pan African markets, we note that the pandemic has cast a dark cloud on growth outlook in oil-producing countries like Cameroon and Ghana”, it said.

Analysts expect a drawback in other commodity-reliant economies such as Ethiopia and Zambia due to the drastic fall in prices of coffee & oilseeds and copper respectively. Cardinalstone said that higher effective tax rate is more likely to compound earnings woes.

“Earnings will likely be pressured by greater income tax deductions going forward, following the expiration of pioneer tax grants on Ibese Lines 3 & 4 and Obajana Line 4 in February 2020.

“In our view, an effective tax rate of about 30.0% in FY’20 as against 19.9% in FY’19 will likely offset the high base effect from elevated operating expenses last year”, the firm held.

Notably, the company recorded a surge in distribution cost in FY’19 as a result of an increase in its number of truck fleet and the proportion of sales distributed by trucks to customers. Analysts explained that promotional and marketing initiatives are likely to be high in FY’20 as manufacturers strive to minimize inventory accretion.

They linked this to movement restriction enforced in Nigeria, saying EBITDA margin could remain flat at 43.2% on the impact of the high base effect. However, margin pressures are likely to resume after the operating line drags performance, coming in the form of higher interest expense of ₦63.8 billion as against ₦50.1 billion in FY’19 and effective tax.

“Our view on the former is premised on the assumption of greater debt buildup to part-finance the proposed share buyback of about ₦199.4 billion while the latter is linked to the expiration of pioneer tax status already highlighted.

“We forecast net profit margin at 15.7% for FY’20 compared to 22.5% in FY’19”, Cardinalstone stated

Lafarge: Analysts Cut Target Price

After coronavirus, it might take nothing less than two years for the global economy to heal. It could take twice of that for African countries as the regional economy goes down the tube, analysts explained. The construction segment is the last to experience a bullish trend in activities. This explains why equity analysts are becoming bearish to cement producers’ stocks.

Valuations have been affected, and stock prices have dropped significantly. What this means for investors is to find an equilibrium point between greed and fear. Analysts have projected that the cement industry will shrink due to weak economic performance. This time, Cement producers spread across African countries provide marginal advantage due to pandemic.

Stock market performance

At the close of the trading session on Friday, investors valued Lafarge Africa Plc stock at ₦186.850 billion on 16,107,795,496 shares outstanding. The share traded at ₦11.60 though it peaked at ₦12.85 in the last 7-trading session on NSE amid COVID-19 scare.

At the target price of ₦19.06 placed on the stock by Cardinalstone, the stock gives upside potential for investors. Today, lower investment sentiment in Lafarge has knocked off more than 26% from the 2019 opening value of the stock. Lafarge has a start price of ₦15.30, though it peaked at ₦17.60 in the year, data available from Cashcraft portal showed.

Financial scorecard

The Group made ₦15.517 billion profit in 2019 which was 91% above ₦8.097 billion declared in 2018. The profit recorded was not due to increased sales volume or declining cost of sales but for improving finance strategy. Sales dropped by 2% from ₦217.813 billion to ₦212.999 billion in 2019. However, cost of sales expanded 4% to ₦157.046 billion from ₦150.701 billion.

Meanwhile, the cement company reduced finance cost by more down half. Analysts said this is because Lafarge paid off some foreign debts. It however made more money from interest yielding investment outside its business as finance income jerked up. The audited report shows that interest paid dropped more than 51% from ₦41.562 billion in 2018 to ₦20.176 billion in 2019.

Finance income grew by twice the amount made in 2018 from ₦1.524 billion to ₦3.158 billion in 2019 as well. But unlike tax credit advantage the Group enjoyed in 2018 it is tax obligation became positive in 2019.

Lafarge shed more than 8% in total assets to the tune of ₦497.152 billion compared to the balance sheet position of ₦540.736 billion in 2018. This decline was driven by more than ₦4 billion reductions in other assets line from ₦10.594 billion to ₦6.302 billion. The composition of the other assets line includes prepayment for gas, advance payment to transporters, suppliers and other related contracts.

Covid-19 hurt transformation drive

Lafarge is projected to suffer weak performance up until the financial year 2021 (FY’21). Analysts are now afraid to ramp up Lafarge shares into their stock pick for now. There are weak fundamentals to push the stock to go vertical in the short term, they said, especially now when the sentiment in the market has been cornered by banking stocks – largely.

Based on Cardinalstone analysts’ projection, the investment firm cuts its target price for the WAPCO-Lafarge stock by 18.89%. The investment firm thinks that Lafarge cement would underperform in terms of sales in 2020 due to lower demand and rivalry. Unfortunately, demand is facing pressure due to the low capacity to spend in the market. This, coupled with the fact that capital expenditure of government would be suspended.

Cardinalstone partners believe that the transformational story of Lafarge Africa Plc (WAPCO) was largely about its handling of endogenous challenges. Specifically, as analysts pointed out, the firm is seeking resolutions to the margin-dilutive South African operation and a huge FX debt in FY’19. This means a further devaluation of Naira would pressure the Lafarge balance sheet.

“With the spread of coronavirus in Nigeria, the business faces a test of its resistance to exogenous shocks in the current year”, analysts noted.

Cardinalstone explained that the shocks are likely to rein in demand for cement and harm cash flows in 2020.

“Thus, even if we retain a bullish medium-to-long-term view on the company, we reduce our Target Price to ₦19.06 as against ₦23.50 previously to reflect potential difficulties in FY’20 and FY’21.

“Along with the sector, the business is likely to fully recover from the current impasse in, at least, two years. All roads may lead to a plunge in volume in FY’20, analysts stated”.

Cardinalstone explained that it has noted in an earlier report, it is base case expectation is that the Nigerian cement sector would decline by 16.0% to 18.2MT in FY’20.

“We expect Lafarge to slightly underperform the sector with a 17.6% contraction in cement output to c.4.1MT”, analysts remarked.

“This projection was made owing to the intensifying competition from BUA Cement across Lafarge’s support hubs in the Northern and Southern zones of the country. More concerning for us, however, is whether competitors would respond with price actions to prevent a free fall of output in the current year”, analysts noted.

The consensus among industry analysts is that price would reduce the industry’s profitability. But now, with developments in the economy, it is more likely operators would slash cement prices.

Cardinalstone review pointed at the fact that a possible Lafarge reaction to such price actions, amidst growing competition, is likely to adversely affect revenue in FY’20. On the expectation that local cement prices remain flat, Lafarge’s FY’20 revenue is likely to decline by 17.6% to ₦175.5 billion. The cement company is also estimated to drop further 4.3% to ₦168.0 billion in FY’21 estimates.

“We expect a resurgence afterwards in line with the cyclicality of the company, with revenue likely to grow by an average of 8.8% between FY’22 and FY’24”, analysts held.

The investment firm stated that a cost savings strategy couldn’t have come at a better time. Following the implementation of cost-cutting measures across power; energy and general administrative expenses, the company reported a 21.9% plunge in operating expenses in FY’19. In FY’20, analysts believe these cost-saving measures could slightly taper the potentially huge impact of lower cement volumes on margins.

Analysts note that the ongoing crisis is likely to delay the commissioning of Ashaka’s captive power plant project, which was expected to reduce cost in the North East. Meanwhile, Cardinalstone explained that topline weakness may offset the benefits of strategic deleveraging in FY’20.

“In our view, Lafarge’s improved balance sheet creates scope for limited exposure to exchange rate volatility. Also, it reduced finance expense and acquisition of additional debt for new CAPEX, if needed”.

Analysts recalled that the firm settled its erstwhile foreign-denominated loan of $338.3 million in 2019. This comprises $315 million principal repayments and $23.3 million accrued interest at the time; in addition to reducing interest expense by 41.3% to ₦11.8 billion in FY’20 as expected. The decision on the forex obligation may have yielded as it protects the firm from the FX losses that would have arisen from the recent naira devaluation.

Analysts explained that the knock-on effect of weaker top-line is likely to drive earnings lower by 11.8% to ₦13.7 billion. This comes despite a low effective tax rate expectation of 13.3%. Lafarge Africa cash flow will be negatively impacted by the projected contraction in operating performance and forecast weakness in working capital, analysts said.

Analysts said the firm’s working capital weakness is likely to be driven by inventory buildup due to crisis-induced demand slowdown. However, given the expected pressures, analysts forecast a 56.4% decline in cash flow to ₦35 billion for FY’20.

“Ultimately, closing cash balance is likely to contract by ₦10.8 billion in FY’20, despite expectations of lower CAPEX spending during the year”, analysts reckoned.

Valuation

Analysts at Cardinalstone stated that notwithstanding the current shock, the firm believes Lafarge remains a compelling proposition in the medium-to-long term.

This is due to its recent restructurings. Notably, the company’s cash flow position is likely to recover strongly in FY’22 alongside an expected pick up in domestic macro.