13 June 2018 ( Lagos) : Analysts expect Lafarge Africa Plc (Lafarge) to demonstrate improvement in fundamentals, mainly from higher volumes, energy savings and lower finance cost. Basically, with FX issues effectively addressed in the near term, analysts expect gains from higher volumes (a fallout of improving domestic cement consumption in Nigeria) and energy savings should have more telling impact on earnings in 2018. On volumes, analysts estimate a Nigeria cement consumption of ~4.7MT (+5% YoY). 

On energy, they look for a stable energy source over 2018 with gas and coal gaining more prominence in Nigeria and ongoing turnaround plan in South Africa. Consequently, analysts have adopted a conservative cost to sales ratio of 77% which translates to 6ppts expansion in gross profit margin to 23%. Overall, they project EPS and DPS of N0.65 and N1.15 respectively for 2018.

However, this is eclipsed by its excessive valuation, in their view. Analyst downgrade the stock to a SELL (previously: NEUTRAL) as they revise their FVE lower to N34.71 (prior: N48.45). Lafarge trades at 2018 EV/EBITDA and P/E of 9.7x and 53.3x compare to Bloomberg EMEA peers of 9.2x and 16x respectively.

Cost pressures drive a second-rate first quarter

Largely lagging the industry, Lafarge recorded a slight moderation in group revenue (0.82% YoY to N80.6 billion) in Q1 18, driven by decline in Nigeria’s sales as the elevated price was unable to support the decline in volumes. Going by breakdown, after recording a 15.8% YoY decline in volumes in FY 17, Lafarge continues to shed market share with volume contracting by 5.25 YoY to 1.3mt. As such, despite a 2.3% YoY increase in price to N44,328, revenue in Nigeria contracted 3.0% YoY to N57.8 billion in Q1 18. In South Africa, operations benefitted from higher prices and slight improvement in volumes (+2.6% YoY), with revenue rising 5.2% YoY to N23.0 billion.

Notwithstanding the group’s volume decline, input cost remained elevated (+3.7% YoY to N62.6 billion) with cost to sales expanding 338bps YoY to 78%. Going by provided breakdown, management’s claim of improved energy flexibility, with relative availability of gas and improved use of alternative energy across Ewekoro I and II as well as in Ashaka, yielded some results. 

However, a surprise jump in other variable costs (+49.2% YoY to N37 billion) and production costs (+26.8% YoY to N9.6 billion) continues to be a major drag on cost even as material and consumables continues to exact pressure on cost, with the impact reflecting on the contraction in gross profit margin to 22% (vs. 26% in Q1 17).

Elsewhere, operating profit was down 50.2% YoY to N6.2 billion in Q1 18, following a sharp jump in operating expenses (+41% YoY to N11.8 billion), with large chunk of the pressure emanating from higher administrative costs (+47.6% YoY to N10.3 million). Going by provided details of admin expense, the pressure was driven by a combination of wages & salaries, consultancy fee, office & general expenses and technical service fees. 

In a related development, the rise in debt levels (more than doubled YoY to N250 billion in Q1 17) cascaded to strong pressures at the net finance cost level (+84.7% YoY to N9.5 billion). With the concoction of the aforenoted pressures, the company reported a before tax loss of N3 billion (versus PAT of N9.4 billion in Q1 17) with the absence of a tax surprise leaving the company at a net loss of N2.0 billion.

Base effect from current one-offs to magnify 2018 earnings

Going forward, analysts expect ex-factory gate prices to remain at current elevated levels with a marginal upward adjustment over the year to average N44,328/ton as the company continue to access the impact of price increases on margin and in line with that of industry leader – ( DANGCEM ). On the volume end, analysts believe Lafarge would struggle to gain market share during the year, which is already reflective in the 5% decline in volume in Q1 18. 

However, given analyst’s outlook of increased consumption over 2018, they look for a 4.9% YoY growth in Nigeria output to ~4.7mt. Accordingly, analysts expect Nigerian revenue to print at N217 billion (vs. N205 billion in 2017). Elsewhere, they look to see a more substantial recovery in South Africa in 2018, with the attendant impact informing their cement volume and revenue forecast of 1.9MT (+8% YoY) and N101 billion (+6.9% YoY). At the group level therefore, analysts see scope for sales in excess of N318 billion in 2018E.

Elsewhere, analysts expect the improvement in energy flexibility to persist over 2018 with fuel and power cost contribution to cost of sales expected to decline (FY 18: -16.4% YoY vs 18.1% in FY 17) to N40.2 billion. However, the pressure point for cost of sales remains rising cost of raw material & consumables, production, maintenance and distribution activities. Also, with the ongoing turnaround plan in South Africa, analysts do not rule out the possibility of another impairment charge on redundant equipment. 

Accordingly, they have adopted a conservative cost to sales ratio of 77% (83% in FY 17) which translates to a slight moderation in cost of sales to N244 billion and a 7% YoY decline in cost per tonne to N36,000. Thus, they expect a 44% YoY increase in gross profit to N73 billion (gross margin: +6pps YoY to 23%). Furthermore, they review their FY 18 OPEX to N42 billion in tune with current realities to leave their implied FY 18E EBIT at N34.1 billion (vs. N7.9 billion in FY 17) barring any negative surprise in form one-off administrative charges from the ongoing turnaround in South Africa.

On borrowings and finance cost, management recently received shareholders’ approval for N100 billion capital raise with focus on refinancing existing FCY borrowings and general business spend. However, given management access to cheaper FCY borrowings (currently estimated at $442 million as at FY 17), analysts do not expect any significant decline in its FCY obligations especially with management focus on revamping the South African operation. As such, while 68% of total debt stock (N250 billion as at Q1 18) are due for maturity during the year, analysts believe management will rollover a large chunk of it with an extension of its maturity profile to fund its capex plan and working capital needs. 

For context, management guided to a capex plan of N19.2 billion for the Ashaka coal power plant, South West alternative fuel project, Mfamosing crusher and Ashaka debottlenecking. On balance, analysts expect the company’s net debt position to print at N241 billion by year end. On impact, they do not expect any sizeable loss on its FCY positions with the relative stability of the Naira and thus, hold out for 26%YoY decline in finance cost over 2018, which pushed analyst’s overall net finance cost for the year to N28 billion (vs. N42 billion in FY 17).

Thus, with FX issues effectively addressed in the near term, gains from higher prices and energy savings should have significant impact on earnings in 2018. Analysts therefore forecast PAT at N5.7 billion barring any positive surprise in form of tax writeback. This should translate to EPS and DPS of N0.65 and N1.15 respectively for 2018.

Lafarge trades at 2018 EV/EBITDA and P/E of 9.7x and 53.3x which compared to Bloomberg EMEA peers of 9.2x and 16x respectively. In view of analyst’s recent adjustments, they now have FVE of N34.71 (vs. N48.45 in previous communication), which implies a SELL recommendation by their rating scale.

Source: Oluwasegun Akinwale from ARM Securities Limited