Dangote Sugar Refinery Plc :Tough operating environment dim outlook   

02 November 2018 : Dangote Sugar Refinery (DSR) released its 9M 18 result for the period ended September 2018. Revenue for the period was down 29.2% YoY to N116.7 billion owing to lower refined sugar prices (-19% YoY) and lower volumes (-13.5% YoY). On volumes, pressure stemmed from increased competition from smuggled sugar and unrelenting gridlock in Apapa owing to the bad road condition. As a result, EPS for the period declined 37% YoY to N1.41, below analyst's expectation of N1.55 for the period – 9M 18 EPS is about 61% of their FY 18 estimate.


For the rest of 2018, analysts cut their FY 18 revenue estimate by 8.1% to N154 billion to reflect the sustained decline in volumes. Analysts forecast EBIT margin of 19.6% (previous estimate: 21.7%) due to higher operating expense to sales ratio from weaker volumes. Overall, analysts forecast FY 18E EPS to decline 41.3% YoY to N1.95. Based on historical 50% payout ratio, analysts forecast DPS of N1.00 for FY 18E which translates to a dividend yield of 7.9% based on current pricing. In 2019, analysts do not see pressures from smuggling activities abating due to slow action from the authorities to curb the illegal activity. Regarding the Apapa road, repairs are underway, but its completion is taking longer than anticipated. Analysts therefore see gridlock from the bad road persisting into 2019. Consequently, analysts cut their FY 19E EPS by 13% to N1.75. Analysts also cut their FY 20- 22E EPS by 3% on average. Following adjustments to their forecasts, and having rolled forward their model to 2019, analysts cut their FVE to N14.44 (previous: N17.01) which translates to an OVERWEIGHT rating.


Bad roads, increased smuggling impact revenue: Over Q3 18, the company’s performance was dull, as EPS declined 57.6% YoY to N0.34 (Q3 17: N0.79). The disappointing earnings was due to lower revenue (-26.3% YoY) following loss of volume from the smuggling of cheap low-quality sugar into the country and constant gridlock in Apapa1. On smuggling, management noted that smuggled sugar has taken up to 40% of the market despite efforts being deployed by regulators to stem the tide. Analysts estimate that this took out 15% of DSR’s market share2 and thus explains the loss in volumes since Q3 17. Volumes in the review quarter was down 19.3% YoY to 118KMT. Also, as stated earlier, the unrelenting gridlock in Apapa impacted on revenue as the bad roads in the region constrained the number of trucks required to distribute finished goods from the plant to its consumers thus impacting on volumes in the period.


To add, due to the free fall in raw sugar price (-26.5% YoY) in international markets as well as effort to regain market share, DSR rolled back prices with its refined sugar price down 19% YoY to N256,680/MT. However, the cut to selling prices hasn’t supported volumes due to the fact that smuggled sugar remains cheaper than its refined sugar. In their last update on DSR, analysts noted that the price of the low-quality sugar is at a 10% discount to refined sugar price.


Lower sales volume pressure EBIT margin: Although EBIT margin in Q3 18 contracted by 13.7ppts to 14.9%, it remains higher than 5-year historical average of 13.6%. The sharp contraction in EBIT margin stemmed from (1) decline in gross margin (-12.1ppts YoY) owing to higher per unit fixed costs (direct overheads & depreciation) because of lower volumes and (2) higher OPEX to sales ratio (+156bps YoY), owing to weaker revenue.


Sales volume on track to touch its lowest level in five years


Analysts cut their FY 18 revenue estimate by 8.1% to N154 billion to capture the sustained decline in volumes worsened by the incessant bad roads in Apapa which limited distribution of products. Precisely, while analysts maintained their per ton price forecast of N256,000 (-14% YoY), analysts cut their FY 18 volume forecast by 8.5% and estimate volume to touch a 5-year low of 562KMT (FY 17: 667KMT). This combined with their per ton price forecast translates to a FY 18E revenue of N154 billion (-24.9% YoY).


Analysts forecast EBIT margin of 19.6% (previous estimate: 21.7%) to capture the increase in per unit fixed cost as well as higher operating expense to sales ratio due to weaker volumes. Overall, with the reduction in their revenue estimate and lower EBIT margin forecast, analysts forecast EPS to decline 41.3% YoY to N1.95. Based on historical 50% payout ratio, analysts forecast DPS of N1.00 for FY 18E which translates to a dividend yield of 7.9% based on current pricing.


In 2019, analysts do not see pressures from smuggling activities abating due to slow action from the authorities to curb the illegal activity. Management explained in its H1 18 conference call that the company is in partnership with regulatory authorities and others in the sugar industry to stem the influx of poor-quality unlicensed sugar into country, but analysts are pessimistic due to the elections which will distract the authorities for much of H1 19.


Regarding the Apapa road, repairs are underway, but its completion is taking longer than anticipated. Analysts therefore see gridlock from the bad road condition persisting into 2019. Hence, analysts forecast a muted volume growth of 0.5% YoY to 565KMT over FY 19. With their price forecast of N225,000/MT (-12% YoY), analysts forecast FY 19E revenue of N138 billion.


EBIT margin should remain flat at 19.4% (FY 18E: 19.6%; 5-year historical EBIT margin average: 13.6%). Analyst's EBIT margin forecast is based on further moderation in raw sugar prices which should offset pressures from expected higher operating expenses (+10.2% YoY). Management plans to establish new markets to improve sales. This entails investment in its route-to-market thus, prompting analyst's expectation of higher operating expenses over the period.


Net impact of the above translates to a FY 19E EPS of N1.75 (FY 18E: N1.95; FY 17: N3.32), with a dividend expectation of N1.00. Analysts also cut their FY 20-22E earnings by 3% on average.


Following adjustments to analyst's forecasts, and having rolled forward their model to 2019, analysts cut their FVE to N14.44 (previous: N17.01) which translates to an OVERWEIGHT rating. A sooner than expected successful curtailment of smuggled sugar and repairs of the Apapa road will be an upside potential to earnings and FVE. On their numbers, Dangote Sugar trades at a 2019 forward P/E of 6.5x, a discount to 5-year historical average of 7.6x.


Reporting for EasyKobo on Friday , 02 November 2018 in Lagos, Nigeria


Source: Feyisike Ilemore from ARM Securities Limited


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