In this report, we provide an update on Dangote Sugar Refinery Plc following the release of its impressive H1’17 results. Following adjustments to our projections, we have revised our target price (TP) to N14.45 (previous: N9.78) and retain our HOLD rating on the counter. Our price target implies a potential upside of 11.2% to current market price. Kindly see highlights below;
Further moderation in production costs anticipated as FX supply improves
Dangote Sugar Refinery, in its Q2’17 results, reported an impressive earnings growth of 159.4% QoQ despite a 0.6% QoQ decline in turnover. This was mainly the result of relatively lower production costs as the company obtained more FX for its imports (majorly raw sugar) at the official rate during the quarter.
We highlight that the exchange rate at the official market is at a 16% discount to the parallel market. Owing to this, the company’s gross margin expanded by 1903bps QoQ to 32% in Q2’17 and largely led to the 291bps YoY expansion in gross margin as well as the 131.7% YoY growth in H1’17 after-tax earnings.
With no major threat to the FX outlook in the near term, as well as the gradual accretion in FX reserves, we believe the apex bank can sustain FX supply in the official market in H2’17 which would largely drive gross margin expansion and earnings growth in FY’17.
We also expect the improvement in FX supply to offset the negative impact of sustained energy challenges arising from upsurge in the price of Low Pour Fuel Oil (LPFO). We note that energy contributes about 7% to the group’s cost of sales.
Backward integration project moving at a slow pace
We continue to reiterate that significant value in the stock will be unlocked when the company begins to produce refined sugar efficiently from locally harvested cane sugar, eliminating its exposure to the volatility in FX and international raw sugar prices.
However, the company’s backward integration project (BIP) has been moving at a slow pace. In H1’17, Savannah sugar factory produced and sold 15,805MT and 9,561MT of refined sugar from cane sugar which contributed 4.3% and 2.7% to aggregate sales and production volumes respectively in H1’17. The company continues to guide to the completion of its BIP in the next six years beginning from 2017, with current focus on two sites – Savannah (located in Adamawa) and Taraba.
For Savannah, Dangote Sugar plans to rehabilitate the refinery and expand its annual installed capacity to 100,000 MT from its current capacity of 50,000 MT while land development is ongoing in Taraba. The intention is to complete capacity expansion in Savannah in the next fifteen months and management is confident that production can ramp up having expanded its acreage area and harvested sufficient cane sugar for production.
We however expect Dangote Sugar to continue to rely on imported raw sugar in the next one to two years given that the expected volume of refined sugar from Savannah, even after capacity expansion, is only about 12% of the group’s average annual production volume.
We raise our target price to N14.45 and retain our HOLD recommendation
Given the significant outperformance of Dangote Sugar’s H1’17 earnings to our previous expectation (+81.8% deviation), we have revised our forecasts for FY’17. We raise our FY’17 turnover projection by 1.7% to N231.2 billion which implies a 36.2% YoY growth from FY’16. Our FY turnover projection is mainly driven by higher pricing (+41.0% YoY) as we expect a 4.7% YoY contraction in sales volume.
However, relative to H1’17, we expect a mild recovery in sales volume (+5.8%) in H2’17 as we envisage further cuts to refined sugar prices given the moderation in productions costs. Following improved macroeconomic conditions and FX supply, management noted an uptick in production for some of its industrial consumers which also is positive for volume in H2’17.
Given the cost of sales surprise (-16% deviation from our H1’17 estimate), we cut our FY’17 cost of sales projection by 4.7% to N177.4 billion and project FY’17 margin at 23.3% (FY’16: 13.5%). Our lower cost of sales projection is driven by the company’s ability to source more of its FX requirement from the interbank than the parallel market which was previously its main source. Given the above, we project a 134.1% growth in FY’17 earnings to N33.7 billion (FY’16: N14.4 billion) and raise our target price on Dangote Sugar to N14.45 (previous: N9.78). Our target price implies an 11.2% potential upside from current market price thus, we retain our HOLD rating on the counter.