25 July 2018 ( Lagos ) : Dangote Cement (DANGCEM) released Q2 18 result showing a steep decline of 23.8% YoY in EPS to N2.41 (missing analyst's estimate of N4.27). Largely, the variance between expected and actual stemmed from net foreign exchange loss of N15 billion and higher than expected tax provision for the year of N36 billion - which resulted in effective tax rate of 46.8% in the review period (vs. 33.5% in Q1 18 and 31.2% in Q2 17).

Going forward, analysts reiterate their positive outlook on DANGCEM and expect the company to sustain earnings growth over 2018, at a faster pace than their earlier estimate as analysts are now more positive on the writeback of the tax provisions booked thus far. On tax, management further expressed confidence on the possibility of a reversal of the cumulative excess tax provision made since Q4 17 on Ibese 3&4 and Obajana line 4. 

More clearly, management stated that over Q2 18, every related documentation had been filed and inspection done by NIPC, however, a final confirmation which was needed to make the move didn’t come in time. Accordingly, analysts have lowered their effective tax for the year to 24% to reflect a possible reversal of the cumulative tax booked, which informed their PAT estimate of N254.9 billion and translates to 8.4% increase in their FVE to N278.54. 

However, on a highly conservative note, adopting a worst-case scenario which assumed no reversal of the previous provisions with an effective tax rate estimate of 42% in 2018, resulted in a slight moderation to analyst's 2018E PAT of N195 billion which translates to a 2.8% cut to their FVE to N249.71.

Impressive volume growth swamped by tax worries

Going by the breakdown of Q2 performance, Nigerian business recorded buoyant volume growth of 24.5% YoY to 3.8MT, the impact of which more than neutered the lower price (- 1.7% YoY to N44,311/tonne) to drive growth in Nigerian revenue by 22.4% YoY to N170.2 billion. For the non-Nigerian business, despite the persisting volume contraction (3% YoY to 2.3MT), the relatively higher prices (10% YoY to N30,149/tonne) pushed sales from the region higher by 6.7% YoY to N70.1 billion. 

The volume decline in non-Nigerian business resulted from still weaker sales in Tanzania, cutback in exports to Ghana and the impact of the civil unrest in Ethiopia. Consequent on the improvement in volumes in Nigeria, as well as pass-through from still high per tonne price (group average: +4.5% YoY to N38,970/tonne), group revenue remained solid, rising 17.5% YoY (after a solid outing in Q1 18 of 16.3% YoY) to N240 billion – 3.5% higher than analyst's estimate of N232 billion.

Still on the positives, over the review quarter, the company’s cost per tonne moderated 68bps YoY to N16,255/tonne following decline in material consumed per tonne (2.9% YoY N5,357) which more than subdued the 3.4% YoY growth in energy consumed per tonne to N5,672. Overall, cost of sales rose at a much slower pace than revenue (+11.7% YoY to N100.2 billion, 1.2% variation from analyst's estimate). As a result, gross profit was 22% higher YoY with related margin expanding 220bps YoY 58.3% (forecast: 56.3%).

Elsewhere, still reflecting the impact of the currency movements across Africa, the company booked N11.5 billion net FX loss. For context, while the Nigeria business booked a net FX gain of N9.5 billion, the Pan African business recorded a loss of N24 billion due to weakness of the weaknesses of currency across the region, especially the CFA franc which took a hit from the depreciation of the Euro (€). Consequently, group net foreign exchange loss printed at N15.4 billion in Q2 18, which drove net finance cost of N19.6 billion (8x YoY), despite moderation in finance charges (-37% YoY to N8.1 billion).

On tax, recap management guided to the possibility of finalising the necessary requirements for the approval of the extension of the pioneer tax incentive on the Ibese 3&4 and Obajana line 4 over Q2 18, which had informed analyst's expected 20.7% effective tax rate over the period. However, due to delays in finalising the process with the approval still pending with Nigeria

Investment Promotion Council (NIPC), the company made full provision with the effective tax rate far exceeding analyst's expectation at 46.8% with related tax expense rising 47.8% YoY to N36 billion which significantly pressured PAT to N41.0 billion (lower 23% YoY).

Volume shaping the story in 2018

Going forward, analysts are more sanguine on volumes over 2018 and have raised their volume expectation for the year by 5.7% to 14.7 MT. Looking through the Q2 18 numbers, despite the seasonality impact in the quarter, volumes declined by 3.2% relative to 18.2% in Q2 17, suggesting a strong pick up. On pricing, analysts expect price level in Nigerian to remain flat over Q3 18, with a slight moderation over Q4 18. 

Analysts now adopt per ton Nigerian cement price of N44,210 (3.8% higher than previous estimate) on average over 2018 with related revenue expected to print at N649 billion (prior: N590 billion). For the non-Nigerian operations, reflecting the lull in sales in Ethiopia, Ghana, South Africa, Tanzania and Senegal over H2 18, analysts have lowered their volume projection to 9.7MT (previous: 11.1MT) and adopted average price of N29,040/ton (87bps higher than previous estimate) to reflect the higher currency translation of ?338/$1 (previous ?331/$1) which informed analyst's non-Nigerian revenue of ?267.9 billion (12.4% lower than previous). In all, analysts now look for FY 18 group revenue of N917 billion (N889 billion previous).

On cost, with management guiding to a complete installation of gas generating set in Tanzania in August, analysts expect a much meaningful improvement in cost over H2 18, with their cost of sales estimated now revised lower to N379 billion (previous N386 billion) which should sustain gross margin at 58.6% (+220bps YoY) – gross profit to rise 18% YoY (previous: 11% YoY) to N538 billion.

Further down, analysts raised their opex for the rest of 2018, driven largely by the sizeable jump in sales and distribution cost over H1 18 (+19.8% YoY) a fallout of the higher per tonne haulage cost (12.45 YoY to N3,378) – a component that accounts for 68% of total S&D. This should lead to higher opex of N183 billion (previous: N162 billion), which should drive a 157bps YoY expansion in operating margin to 39% (vs. 38% in FY 17). Overall, analysts maintained their Nigeria and non-Nigeria EBITDA margin of 67% and 16%1 respectively, with overall group EBITDA margin now expected to expand slower by 27bps YoY (previous: 58pps) to 48.5%.

On tax, management further expressed confidence on the possibility of a reversal of the cumulative excess tax provision made since Q4 17 on Ibese 3&4 and Obajana line 4. More clearly, management stated that over Q2 18 every related documentation had been filed and inspection done by NIPC, however, a final confirmation which was needed to make the move didn’t come in time. 

Accordingly, analysts have lowered their effective tax for the year to reflect a possible reversal of the cumulative tax booked, which informed their PAT estimate of N254.9 billion and translates to 8.4% increase in their FVE to N278.54. However, on a highly conservative note, adopting a worst-case scenario which assumed no reversal of the previous provisions with an effective tax rate estimate of 42% in 2018 resulted in a slight moderation to their 2018E PAT of N195 billion which translates to a 2.8% cut to their FVE to N249.71.

DANGCEM trades at 2018 EV/EBITDA of 10.5x which is at a premium to EMEA peers of 9.4x. Accordingly, analysts maintain their NEUTRAL recommendation on the stock.

Reporting for EasyKobo on Wednesday, 25 July 2018 in Lagos, Nigeria

Source: ARM Securities Limited

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