TESLIM SHITTA-BEY |
With the onset of recession last year several companies got punched and bloodied none so fiercely as those in the construction sector. Between 2015 and 2017 Nigeria’s construction industry suffered stunted growth; rising costs, falling revenues and shrinking cash flows, left scores of firms cemented to their knees. A prickly case in point is Nigeria’s second largest cement manufacturer, Lafarge-Africa, which saw profit before tax take a dive as foreign exchange adjustments and debt management problems took a huge bite out of its first three quarterly revenues.
The company’s net revenue before major cost deductions dipped by -17.8 per cent from N 267.2m in 2015 to N 219.7m in 2016. The revenue fall was the consequence of sliding economic activity that chased down growth in gross domestic product (GDP) which slid by -1.5 per cent, heralding Nigeria’s first official recession in 25 years.
Apart from a slump of a fifth or 20 per cent of its annual revenue, the company’s gross profit also crashed by a disturbing-50.8 per cent slumping from N82.6m in 2015 to N40.7m in 2016. In other words red paint got splashed all over the company’s top line figures as rising operating costs pierced multiple dents in corporate performance. The company’s direct production cost rose from a modest 68per cent of total revenue in 2015 to a staggering 81 per cent of gross revenue in 2016. ‘You get a sense that the company is sinking in a vat of limestone as its business almost toppled over, especially in the first nine months. Indeed last year appears to have been a dead drop zone for Lafarge; the economy hit it right between the eyes.’ says Olusegun Atere, a onetime principal analyst at stock broking house Apel Asset and Trust Limited. But Atere acknowledges that, ‘the company’s half year result for 2017 certainly shows signs of a tidy reversal of fortunes’
Lafarge-Africa’s net profit margin for 2015 was rooted at an uncomfortable 7.69 per cent but rose marginally by over 2 per cent to 10.16 per cent by 2016, a better performance but still relatively weak judging by historical standards.
The company’s rising sales and general expenses (SG&A’s) put sweat beads on management’s rising distribution costs, which was made worse by heavy gas shortages and production stoppages which created a nightmare for the company in 2016 as SG&A as a proportion of its sales rose from 12 per cent in 2015 to 14 per cent. The upward flip in the SG&A margin was more a function of a fall in net sales than a rise in the absolute value of its administrative and distribution expenses which dropped marginally from N31.5b in 2015 to N30.7billion in 2016.But even though SG&A was not much of an immediate worry, the cement maker’s short term liquidity plus working capital have been under pressure and called for urgent attention. The company’s working capital stumbled from a negative of N20.47billion in 2015 to a larger pool of red by falling to a negative figure of N 77.64bilion in 2016. This explains the explosion in the company’s bank overdrafts which flared up from N3.33billion in 2015 to N22.99billion in 2016, representing a staggering 887 per cent rise in short term liabilities.
Like poorly made pancakes, Lafarge-Africa’s liquidity caved in last year leaving corporate analysts concerned about the company’s medium term financial health. Apart from the sudden spike in its short term borrowings ( which represented a tenfold rise in bank liabilities), the company’s short term assets barely covered half of its near term liabilities resulting in the company’s liquidity ratio falling from 0.78 in 2015 to 0.55 in 2016. Temple Assets and Trust Limited, a local asset management company’s Corporate Finance head, Chuks Nwajei, notes that Lafarge has had a nasty time coping with short term production schedules and the management of its short term liabilities. Says Nwajei, ‘the books clearly show trouble in stone towns, If you take a look at the company’s so-called ‘quick ratio’, a tighter measure of the company’s liquidity, its rising inventories or stack of unsold goods (equivalent to 35 per cent between 2015 and 2016) makes its ‘current’ ratio (a looser measure of liquidity) appear like a fairy tale. The quick ratio in 2015 was 0.31 as against 0.43 in 2016; meaning that the company’s financial safety net appears peppered with giant holes’.
Nwajei equally notes that the limestone manufacturer had other rocky problems to fix. ‘The company turned a decent profit last year because it was able to leverage a debt restructuring exercise which converted a chunk of its debt into equity by removing an unpleasant item from one layer of liabilities to another. The manoeuvre will not repeat itself in 2017.’ Lafarge would, therefore, have to see how it can improve both market share and cost reduction in the current year.
The company’s 2016 debt restructuring effort was bold and brilliant. The USD$581m debt restructuring helped the firms debt to equity ratio slide down a notch and reduced concerns over corporate solvency (meaning that the company was not, as previously thought, a dead man walking), borrowings of the company tumbled from N135.5billion in 2015 to N68.05billion in 2016, representing a -49.63 per cent reversal of its debt liabilities.
If anyone thought that the cost of construction material, particularly cement, would fall in 2017, they have buried the idea. Trouble in the building materials sector seems guaranteed to ensure that no such event happens any time soon. Indeed Lafarge-Africa has stated clearly in its fourth quarter summary of its 2016 financials that the company would need to raise product prices to cover the cost of foreign exchange adjustments and the rise in its sundry operating expenses. The report sees the cement market growing by a modest 2 per cent in the year with no appreciable growth coming from its South African operations. The company raised prices by 46 per cent in September 2016 to compensate for the 16% fall in the external value of the naira and the rise in distribution costs. The upward price jerk assisted the company in making a revenue recovery in the last quarter of the previous year with earnings before interest, tax, depreciation and amortization (EBITDA) rising from a loss of N300million in the third quarter to a profit of N18.8billion in the final quarter of the year.
It is unlikely that Lafarge will be able to raise prices further in the current year but the price hike of 2016 would seem to assure management of its ability to sustain profitable operations as the naira appreciates and local costs drop to improve operating margins.
Investor’s tricky earnings gamble
For investors looking at Lafarge Africa’s medium to long term prospects the past may have been bleak (especially the first three quarters of 2016) but the future looks bright. The company seems to have been able to successfully pass increased product prices onto customers and with the federal government set to spend trillions of naira in 2017 on improving roads, schools and housing infrastructure, prospective revenues should drag profits up to dilute the effects of lower cost pass-through rates last year. Improved prospective earnings for 2017 could prompt a reversal in the company’s persistent price decline (the company’s share price is currently around N60.31 per share down from N70 a year ago).
Year –to- date the company’s stock price has risen 46.54 per cent but on a year-on -year basis it has climbed 11.52 per cent. At a twelve trailing month (TTM) price earnings multiple (p/e) of 4.53 Lafarge is not too badly priced, especially if its recent earnings per share of N12.81 rises to N15.23 judging by Business Hallmark analysts preliminary forecast for 2017. The company’s recent indicative dividend yield of 1.80 per cent might not entice investors to pop out the Champaign bottles yet, but in the run up to the end of the year if the economy maintains an even keel, the building materials giant could reward investors with bright capital gains and a slight top up of its dividend yield.
With the federal government already believed to have spent over two trillion naira in fresh capital votes at the end of the second quarter of 2017, Lafarge Africa may find itself rising from its knees. Revenues should start to climb and, hopefully, with relatively stable foreign exchange rates, net profit should begin to grow again. For example H1 results of the company in 2017 were sterling as gross earnings grew from N107billlion in half year 2016 to N154.8 billion in H1 2017, representing a 44 per cent hike. Current operating income rose by a staggering 785 per cent rising from N2.9 billion in H1 2016 to N25.9 billion in H1 2017. Admittedly this came off from an upward review of the company’s product prices and the relative price inelasticity of demand for cement. A rise in cement prices typically lead to a proportionally lower fall in the demand for the product.
The company also seems to have overcome the massive loss in foreign exchange transactions that led to a N28billion bleeding of its income in H1 2016. Undoubtedly 2017 will be a delightful year for Lafarge investors rebounding from the company’s harrowing operational travails last year, larger investors in the company may decide to take a deserved trip to Honolulu in Hawaii or perhaps simply wait to see if the recovery sticks, after all this is Nigeria.