Dangote Cement Plc (“DANGCEM” or “the Group”) reported Q4:2016 earnings result last week, outperforming analysts’ expectation across metrics. Q4 standalone revenue grew 37.0% Y-o-Y to N173.0bn, bringing FY: 2016 turnover to N615.1bn, up 25.1% Y-o-Y relative to our projection of 20.0%.
Similarly, Q4 standalone PBT grew at an astonishing rate of 170.4% Y-o-Y to N78.7bn as margins expanded due to higher mark-up on Nigerian sales and a more efficient kiln fuel mix.
The impressive Q4: 2016 operating result was however not enough to completely offset underwhelming performance in Quarter 2 and 3 as FY: 2016 PBT declined slightly by 3.9% Y-o-Y to N180.9bn.
Nonetheless, FY:2016 earnings per share rose 4.5% Y-o-Y to N11.34, ahead of consensus estimate of N10.71 and Afrinvest Research forecast of N9.31, on the back of deferred tax credits from Pan-African operations.
The Group also declared dividend of N8.50 per share, 4.0% higher than FY: 2015 dividend and our forecast of N8.00. We present a more detailed analysis of the FY: 2016 result below as well as our outlook and valuation.
Margin Pressure Reflects on Earnings despite Impressive Revenue Performance
The impressive FY: 2016 revenue numbers were primarily driven by sales ramp-up in Pan-African operation and pricing hike effected in Nigeria in September 2016. Group sales volume rose 25.0% Y-o-Y to 23.6MMT as Pan-African (ex-Nigeria) sales volume rose 50.6% Y-o-Y to 8.4MMT (35.8% of Group Sales from 29.7% in FY: 2015).
Nigeria’s volumes also expanded 13.8% to 15.1MMT, supported by a demand boost in the first 9 months of the year following cuts in cement prices and commencement of export to neighbouring countries (0.4MMT exported to Benin in 2016).
Margins were however pressured all through the year with cost of sales ratio up 11.6ppt Y-o-Y to 52.6%, while EBITDA and Net Margin fell 11.6 and 6.5 ppt Y-o-Y to 41.8% and 30.3% in FY: 2016 respectively.
The margin pressure reflects: 1) low revenue mark-up in Nigeria due to intense price competition till September 2016, 2) higher cost of sales due to inefficient fuel mix as gas supply clipped in Nigeria following attacks on oil & gas installations by militant groups and 3) subsistent weak margins from pan-African operation partly due to price competition in oversupplied markets like South Africa & Ghana and high energy cost in Tanzania.
236.0% Y-o-Y increase in Net FX gains to N41.2bn as well as deferred tax credits in Pan-African operation buffered the impact of the weak operation margins on net income which rose 2.9% Y-o-Y to N186.6bn.
Outlook and Valuation: Positive Outlook on Operating Margins but Expiring Tax Breaks Cast a Cloud on Forward Earnings and Valuation
DANGCEM remains poised to grow operating income in FY: 2017 on the back of the pricing action taken in its biggest market (Nigeria) in Q3:2016 and dividend from diversification of energy sources in Nigeria into coal to reduce vulnerability to supply shocks in the Niger Delta.
All production lines in Nigeria now have coal capacity with DANGCEM’s Parent Company (Dangote Industries Limited – DIL) investing in coal mines in Kogi State to supply the plants with coal feedstocks which are cheaper than imported coal and domestic gas supply.
However, a key source of concern to us is the expiring tax holidays on production plants in Nigeria. In computing its FY:2016 tax liability, management assumed Ibese production lines 1 – 4 and Obajana production lines 3&4 are on tax holiday, but auditors noted that:
“Ibese production lines 1&2 and Obajana production line 3 which enjoyed pioneer holiday for three years and expired on 31 December 2014 and 31 December 2015 respectively require extension, while Ibese production lines 3&4 and Obajana production line 4 are expansion projects requiring Pioneer Status Incentive (PSI) with production day of 1 February 2015 as applied”.
Applications for a 2-year extension of pioneer tax incentive on Ibese Lines 1 & 2 and a 3-year holiday on Obajana Line 4 and Ibese Line 3 & 4 expansion projects are awaiting regulatory approval.
Whilst the chances of the applications being rejected is very slim, based on existing regulation, the major concern for us is that 52.9% (or 11.25MMT/a) of existing capacity (21.25MMT/a) benefiting from pioneer tax status will run off the incentive by FY: 2017.
This would leave only 9.0MMMT/a enjoying the tax break by FY: 2016 – barely enough to meet 60.0% of estimated sales volume in the year.
Thus, we expect tax liability to increase substantially from FY: 2018 and this consideration – along with profitability of Pan-African operation – would be an important variable in valuation of the stock going forward.
We have retained most of our estimates for FY: 2017 – forecasting sales to grow 7.4% to N660.6bn and EPS to come in flattish at N11.29. We trimmed our 12-Month TP marginally to N193.25, 27.0% upside potential to current price: N152.15 (08/03/2018), hence we remain overweight on the stock with a “Buy” rating.