Nigeria | Lafarge Africa Plc FY2015Earnings: Weak Numbers with Mixed Outlook

LAGOS, Nigeria, Capital Markets in Africa — Lafarge Africa Plc (“Lafarge” or “The Group”) released its FY:2015 result last Thursday, 17th March 2016. The result, which is a consolidated account incorporating its new subsidiary – The United Cement Company of Nigeria Ltd (UNICEM) – showed a 2.5% growth in top-line and PBT (from continuing operations) fell 27.5% Y-o-Y to N267.2bn and N29.3bn respectively. Turnover, excluding UNICEM, was up 3.5% Y-o-Y relative to our forecast of 4.5% Y-o-Y. EPS however declined sharply by 18.1% Y-o-Y to N6.29. Our review of the result, revised earnings and valuation estimates are presented below.

FY: 2015 Top-line Growth Supported by Nigeria  Operations
The positive performance in turnover of The Group in FY: 2015 was largely supported by 3.3% growth in consolidated Nigerian operations which offset a 2.0% contraction in South Africa sales. The South African market has continued to experience volume and price pressures in a declining economic & industry growth environment and stiffer competition brought about by new entrant (Sephaku  Cement – majority owned by DANGCEM) and importations. On the contrary, Nigerian operation was resilient due to strong prices of products in H1:2015, ramp-up of capacity utilization in South West operation near optimal level (to 86.4% in FY:2015 from 80.9% in FY:2014). Ashaka sales was down 17.7% Y-o-Y impacted by production disruption in H1:2015; while UNICEM sales declined 1.2% on what management attributed to volume shut-in in Q4:2015 due to flooding. In summary, the three cement operations in Nigeria (Ashaka, UNICEM and South West) saw a combined 0.8% increase in capacity utilization to 80.1% while Ready Mix Concrete (RMC) sales volume was up 26.4% Y-o-Y.
We however note the slowdown in both sales and sales/tonne in  Nigeria in Q4:2015, which was in line with our expectation of industry price-cuts impacts on market share and turnover. Nigeria cement operation and RMC sales/tonne were down 20.5% and 5.0% Q-o-Q in Q4:2015 respectively and we base our 2016 sales estimate on newly established prices.

Operating Margins Weakened on Cost Pressure
Operating margins were materially weaker in FY:2015 despite  the consolidation of UNICEM which bolstered reported Group EBITDA. This was mainly due to: 1) 100bps increase in cost of sales ratio as we observed 4.6% jump in variable cost (mainly fuel) as well as one-offs – N1.0bn for Kiln  Repair in South Africa and N2.5bn Ashaka security impact; 2) 281.5% increase in expenses related to Lafarge Africa integration and restructuring cost of merging Lafarge Africa with Holcim; 3) 271.7% increase in advertising expenses to N1.0bn as competition in the two key markets has led to responses to improve branding. EBITDA and EBIT margins contracted 2.9% and 3.0%  Y-o-Y to 23.1% and 17.1% respectively in FY: 2015 relative to 53.5% and 42.3% recorded by DANGCEM in the    period. EBITDA margin contracted across the 4 of the 5 operating structures of the Group with UNICEM the outlier as its recorded 5.0% margin expansion to 19.2%. South West operations remained The Group’s cash cow with the highest EBITDA margin (32.9%) contributing 55.5% to Group EBITDA.

Higher Leverage Impacted Net Margin Despite Lower Effective Tax Rate
The consolidation of UNICEM while boosting Group EBITDA, has raised its leverage position with mounting interest expense. Also, 46.0% of total loans are denominated in USD adding to the pressure on bottom-line from exchange losses arising from exchange rate volatility. Net finance cost rose 13.8% Y-o-Y to N9.0bn and N7.3bn was recorded in losses on assets. A combination of these factors led to a 2.9% decline in net margin to 10.1% despite an 11.0% contraction in effective tax rate.

Outlook: Nigeria Volumes to Increase but Price Competition Remains Headwind on Turnover and Margins
We expect another flattish year in South Africa as macro headwinds persist; whilst projecting cement sales volume across the three operational structures in Nigeria to grow 6.2% Y-o-Y as well as the RMC segment should also gain traction. These would be driven by the Government’s CAPEX (30.0% allocation in 2016 Budget) which is anticipated to offset decline in households and consumer spending growth, as well as additional 3.0Mmt/a capacity (2.5Mmt/a from UNICEM and 0.5Mmt/a from Ashaka) coming on stream by H2:2016. Yet, the upside from forecasted volumes growth will be limited as we expect the full impact of price actions in Nigeria to weigh on sales figures in FY:2016, hence we project turnover to trim 0.6% to N265.6bn. However, with consolidation phase now over, we expect some level of operational synergies with the strategic acquisitions in Nigeria to lower operating costs profile while restructuring charges and one-offs that pressured margins in FY:2016 would also be eliminated. Thus, we have raised our FY:2016 EBITDA estimate to N66.3bn (from N48.8bn) broadly due to the aforementioned factors and consolidation impact of UNICEM not incorporated in previous forecast. We also revised FY:2016 our PAT forecast to N32.1bn (previous forecast – N31.0bn). In the medium term, we expect Investments in power projects to support EBITDA margin expansion.

Valuation: TP Raised to N88.2/share; Reiterate “HOLD”
Following more certainty on the Group’s EBITDA position post-consolidation, we adopted a relative weighted valuation methodology incorporating Target P/E (69.0%) and EV/EBITDA (31.0%). Our estimated EPS and EBITDA forecast were priced at 12.0x and 8.6x, 21.0% and 30.0% discount to our justified multiple for DANGCEM due to the Group’s higher leverage, smaller size and weaker margins. Consequently, we revised our 12-Month TP upwards to N88.2/share (from N81.8/share) implying a 12-month upside of 6.8% relative to current price (N82.6/share). Hence, we reiterate our “HOLD” Rating on the stock.

Key Risks
Risks to the upside include: 1) upward revision in cement prices in Nigeria 2) better than expected capacity utilization and cost optimization. To the downside: 1) lesser than expected operational synergy 2) Slower volumes growth in Nigeria.