Nigeria | Lafarge Africa Plc Q1:2016 Earnings Update

LAGOS, Nigeria, Capital Markets in Africa — Lafarge Africa Plc (“Wapco” or “the Group”) released its Q1:2016 result last Thursday, 28th of April, reporting substantially weaker than expected numbers. Turnover fell 29.3% Y-o-Y to N52.4bn amid weaker macroeconomic fundamentals and intense competition in cement markets in Nigeria and South Africa which impacted volumes and product prices. The Group’s high operational and financial leverage further squeezed margins, resulting in a pre-tax loss of N2.2bn in the Quarter from a pre-tax profit of N6.1bn in Q1:2016. Highlights of the result, our outlook and valuation of the Group are presented below.

Intense Competition Weakens Revenue Numbers across Business Segments
The 29.3% Y-o-Y decline in turnover exceeded our 10.4% forecast contraction as downside risks scenarios we earlier painted materialised; this includes 1) lower prices of products in Nigeria and South Africa 2) Decline in sales volume in Nigeria and implied lose of market share, and 3) high base impact of FX gains recorded Q1:2015 (N4.4bn) not repeated in Q1:2016. The Group’s revenue profile deteriorated across segments; with Nigeria operations down 30.2% Y-o-Y to N38.9bn, reeling from the impact of price-actions initiated in Q3:2015 which resulted in over 25.0% Y-o-Y decline in cement price/tonne. Sales volume also came under pressure (down 5.0% Y-o-Y to 1.7m MT) despite a positive market growth in the Quarter, which suggests that industry leader, DANGCEM, captured the industry’s volume growth in the Quarter and gained market share from Wapco. Meanwhile, South Africa revenue also declined 3.6% Y-o-Y as sustained pricing pressure limited upside from stronger cement volumes.

High Operating and Financial Leverage Contract Margins
High level of operational and financial leverage magnified the impacts of the decline in the turnover on margins and profitability. The cost to Sales and OPEX ratio increased 18.8 percentage points (ppt) and 2.0ppt to 85.1% and 12.3% respectively which  led to an 18.8ppt and 19.6ppt contraction in Gross and EBITDA margins  to 14.9% and 10.8% respectively; compared to 55.7% and 51.5% recorded by DANGCEM in the same  period. Operating income (EBIT) trimmed 96.0% Y-o-Y to N0.3bn while EBIT margin weakened by 11.1ppt to 0.7%. Impacts of higher financial leverage further weighed on profitability, leading to a loss before tax of N2.2bn. Notably, Nigeria operations accounted for all Group operating income with Lafarge South Africa posting a loss at EBITDA level.

Outlook: Demand Outlook is Positive but High Leverage will Keep Profitability Down
The high degree of operating and financial leverage of the Group requires aggressive volume growth and/or an upward reversal in cement prices as well as more prudent cost management initiatives to stay profitable. On volumes, we are positive that the Group’s Nigeria operation will benefit from public spending on cement-intensive construction activities in Q2:2016 to Q4:2016; although it might struggle to gain market share. Management guided that prices in Nigeria have been increased by about 8.0% in March which is in line with the price increase by the market leader. This is also positive for revenue and margins but we believe that margins in Nigeria’s cement industry remain above average and market oversupply could yet force prices downwards in the medium term if macro fundamentals do not improve to support demand growth. South Africa volumes were surprisingly strong in the Quarter but the impact was muted as prices trimmed further and we expect a flattish performance by full year. We observed a noticeable decline in direct and indirect costs in Q1:2016 but the extent to which these could be pruned further is limited in the short term. Management has guided that the UNICEM debt portfolio will be refinanced via N60.0bn bond issuance programme which we assume will be at a cheaper rate with a positive impact on earnings. We acknowledge the Group’s move to diversify revenue sources by selling energy (40MW according to management) to Nigeria’s  power grid and we expect this to have a circa N2.0bn impact on revenue if supply commences in July. Margins are much healthier in power generation but it is hard to ignore the structural developments in its core business. Thus, we have slashed our EBITDA growth projection from +7.4% to -28.8%; whilst also revising FY:2016 EPS  from N6.40/share to N2.59/share.

Valuation: Group Well Positioned for Market Growth but Structural Margin Pressure hard to ignore… TP Revised to N72.90; “Reduce”
We think the Group still faces bottom-of-the-cycle earnings in the short term but we generally like the pan-Nigerian exposure of Wapco via acquisitions, capacity expansion activities and cost saving measures being initiated. Also, the anticipated completion of UNICEM plant capacity expansion in South East Nigeria by 2.5m MT/A would boost cash flow to pay down on the debt accumulated to finance the expansion and possibly increase market share. Thus, we believe the Group is well positioned for market growth and efforts to prune operating and finance costs in the medium term would unlock value for shareholders in the next 2 to 3 years. We have adopted a pure EV/EBITDA relative valuation methodology with an implied pricing of 8.6x, a 30.0% discount to our implied pricing of DANGCEM. This gives our 12-Month TP of N72.90, a downward revision from N88.22 and 0.1% downside relative to current price (N73.00). Hence our “Reduce” Rating on the stock.

Source: Afrinvest (West Africa) Limited Research Team